China is carving out a bigger role for itself in the semiconductor industry and has lined up a huge war chest to fund acquisitions in the sector. Based on its rising chip consumption profile and an aggressive political strategy, observers believe China will eventually become a major force in the sector despite Western opposition over the possible transfer of dual-use (military-civilian) technology to the country.
Chinese officials recently disclosed the creation of a $30 billion – government/private enterprise – fund to finance acquisitions and other investments primarily in the semiconductor market but also in other key areas of the high-tech industry. The fund is further evidence of the government’s determination to empower Chinese firms to not only acquire foreign firms but also to accelerate the development of indigenous technologies through higher R&D investments.
The government’s goals are clear. First, China wants to continue the diversification of its economy by moving up the high-tech food chain. Second, it aims to shield government infrastructure, military and technology systems from foreign snooping by putting firewalls around components used in critical areas of the economy. The latter goal became even more pressing following news that the U.S. had allegedly conducted a massive spying program on various governments worldwide, sometime using IT products produced by Western companies.
The U.S. was alleged to have encouraged the creation of backdoor channels for intelligence gathering in components and electronics hardware manufactured by foreign firms. (See: Edward Snowden: Leaks that exposed US spy programme).
China has other reasons for pushing for a bigger electronics supply chain role. The country is placing greater emphasis on higher-value manufacturing and more profitable activities, including design engineering. After years of operating as the lower-cost manufacturing Mecca for the world’s biggest companies, China is transforming its economy to be a major consumer center. It has become a major consumer of electronics equipment, making it one of the biggest buyers of components globally.
"They've already got the mandate in place and Chinese companies have been told to start sourcing electronic components locally," said Dale Ford, VP and chief analyst at IHS Corp., in a recent interview. "China doesn’t think short-term. Four to 5 years in China is a very short time in terms of how they strategize. Their strategy is likely to be, ‘how do we in the long-term position ourselves to become a strong [and] independent-almost player in the electronics world?’ "
Latest industry statistics show why China wants to push up the high-tech food chain. From a very low beginning less than two decades ago, China, in 2014, accounted for roughly 50 percent of global semiconductor consumption but this number is heading higher, according to the International Trade Administration (ITA), a unit within the U.S. Department of Commerce.
However, despite being the single-largest consumer of semiconductor components globally, China in 2014 generated only 4 percent of the industry’s global $336 billion sales. Its total consumption meanwhile was $168 billion, according to the 2015 ITA Semiconductors and Semiconductor Manufacturing Equipment Top Markets Report. The researchers project Chinese IC consumption will continue to rise about 10 percent per year to $203 billion in 2016, outpacing the rest of the world.
“China accounts for over 50 percent of the world’s electronics production, which is the main driver of semiconductor demand. However, not all of the buying decisions for semiconductors are made in China,” the ITA report noted. “Such decisions are often made by the foreign companies that contract out electronic goods production to China. To counter the dearth of domestic semiconductor design and production the Chinese government has unveiled an ambitious plan – China’s National Integrated Circuits Industry Development Plan – with the goal of establishing a world-leading semiconductor industry in all areas of the integrated circuit supply chain by 2030.”
Regional Power Shift
The numbers from independent industry research organizations are only slightly more alarming for other regional consumption centers in the global semiconductor market. China’s share of the market is surging at a pace no other region can match, according to researcher PricewaterhouseCoopers LLC. The company believes China consumes 57 percent of global semiconductor production, but observed that the major suppliers to the country were all foreign chipmakers.
“Seven companies have been among the top ten suppliers to China every year from 2003 through 2014: Intel, Samsung, TI, Toshiba, SK Hynix, ST and Freescale. AMD joined the list in 2004 and has been among the top ten suppliers to China for the last ten years,” PwC said. In a report titled “China’s impact on the semiconductor industry – 2015 update,” the consulting firm added:
Qualcomm, which joined the list in 2012 at number 10, moved up to number 6 in 2013 and to number 4 in 2014. During 2014 China’s consumption of semiconductor products from these ten largest suppliers increased by 11%, somewhat less than the growth of the overall semiconductor market in China. The Chinese semiconductor consumption market continued a trend of becoming less concentrated than the worldwide market as the top 10 suppliers’ share of China’s consumption declined to 42.4% in 2014, down from 43% in 2012 and 45% in 2011.
It’s understandable that China no longer wants to just be the electronics world’s low-cost manufacturer but the country isn’t aiming for a small piece of the semiconductor market, either. China wants to dominate the sector, rolling back the massive market share current Western-based leaders enjoy. Although the electronics manufacturing supply chain has shifted to Asia, with China as the leading beneficiary of that change, the real profit center for the industry remains firmly entrenched in the West, including South Korea and Japan. Companies like Broadcom, Intel, Samsung, STMicroelectronics, Texas Instruments, Analog Devices and Qualcomm are the global leader in their various semiconductor market segments.
The leading semiconductor suppliers have become entrenched and difficult to surpass due to exclusive rights to cutting-edge technology, efficient manufacturing and huge cash hoards; few rivals have gained a viable foothold in decades. The only other Asian players that have successfully penetrated and joined the inner circle of the world’s richest semiconductor companies were Japanese and Korean firms. In more recent years, Taiwan-based players like TSMC have become global players too, becoming contract semiconductor wafer suppliers to even the largest chip manufacturers.
It’s a very rich club, with huge profit margins, large cash flows and enviable market valuation. Intel’s gross profit margins, for example, hovers between 58 percent on the low level to as high as 65 percent annually. Vendors like Analog Devices, are in the same category. In the fiscal year ended October, 31, 2015, Analog Devices reported gross profit margins of 66 percent, up from 64 percent in the prior year. Even Qualcomm, which is facing pressure as China squeezes its operations in the country, is still posting gross profit margins in the region of 60 percent.
Hefty margins like these in the high-end semiconductor market dominated by Western enterprises contrast sharply with the much lower gains reported by Chinese and other manufacturing companies involved in low-cost, labor-intensive assembly and production. Contract manufacturers operating in China can report gross profit margins as low as 3 percent to 7 percent, putting them squarely in the bottom-half of the industry food chain.
Companies like Intel and Qualcomm have parlayed their high profit margins into huge cash piles. In the fourth quarter of 2015, Intel reported total cash, short-term investments and long term investments of approximately $37 billion while Qualcomm posted $30.6 billion in similar liquid assets. No other segments of the electronics components market are able to produce such numbers. Certainly not players in the backplanes, enclosure and commodity components markets currently dominated by Chinese companies, hence the push and desire for a bigger role in the industry.
Supply Chain Control
Then there is the issue of control over the supply chain. The Chinese have indeed become the leading players in the electronics industry but as the ITA observed, China’s clout and control over the supply chain do not match its current role. The center of power in the electronics industry remains in the West where design engineers and purchasing executives at OEMs and contract manufacturers determine who gets what and when. Western OEMs manufacture products in China but decisions about the supply chain are taken in North America and Europe, the ITA report referenced earlier noted.
Chinese OEMs now rank amongsts the world’s top buyers and consumers of production semiconductors, according to the ITA. These top-tier OEMs include Datang Telecomm, Haier, Huawei, Xiaomi and ZTE, the U.S. agency noted. The fact that its leading OEMs rank in the top-tier of global semiconductor users even as it continues to import more than 90 percent of the components consumed globally is a sore and irritating point for the Chinese government, observers said.
"China certainly wants to move beyond being the location of production to being the location of originating the designs, originating the technology and controlling the standards so that they can capture the higher value of the supply chain," said the IHS' Ford. "That’s where they’ll bring the pressure."
Aside from the supply chain power play, the Chinese government is even more worried about the security implications of having foreign enterprises as the main suppliers of components used in critical sectors of its economy. While the rise of local electronics and information technology OEMs has been widely celebrated by the Chinese government, their dependence on foreign parts remain a nagging concern, according to observers.
“Chinese leadership views their country’s reliance on foreign ICs as a major strategic threat,” said the ITA. “On June 24, 2014 the Ministry of Industry and Information Technology (MIIT), the Ministry of Finance (MOF), the National Development and Reform Commission (NDRC), and the Ministry of Science and Technology (MOST) published the “Guidelines to Promote National IC Industry Development”, a central government document outlining measures to support an aggressive growth strategy for China’s semiconductor industry. MIIT is the lead ministry responsible for drafting and implementing this policy.”
In the second part of this report, we will explore specific actions being taken by the Chinese government and avenues by which China expects to become the world’s leading semiconductor vendor in 10 years.