China’s semiconductor industry: Seeking for self-sufficiency amid tensions with Taiwan and the US chip export ban

Semiconductors are the brains of all electronic devices, from microwaves to mobile phones and from drones to automobiles. They are essential components that allow the development of technologies crucial for economic growth, national safety, and global competitiveness. Therefore, countries are competing to win the semiconductor industry race and gain a competitive edge. However, with the US recently implementing a chip export ban on China and the growing tension with Taiwan, China’s semiconductor industry stability and growth are under threat.

Breaking down the global semiconductor industry

To understand the power and position of China and other countries in the semiconductor industry, we have to know how semiconductors are made and then split the industry into smaller pieces. Essentially, semiconductors are created through three steps: design, manufacturing, and assembly. We can also divide the semiconductor industry into four major segments based on their role in the value chain:

  1. Design: companies that design integrated circuits (ICs) for a specific purpose.
  2. Manufacturing: companies that fabricate the ICs.
  3. Assembly/Packaging/Test (APT): companies that assemble the ICs into a chip which is then integrated into electronic devices (smartphones, computers, automobiles, etc.) by product manufacturers.
  4. Semiconductor manufacturing equipment: companies that manufacture the capital goods used by the companies in other segments to carry out and automate their functions.

While some companies adopt an Integrated Device Manufacturers (IDM) business model –combining design, fabrication, and packaging functions– there has been a noticeable trend towards specialization over the past few decades. Thus, most semiconductor companies today focus only on one of the four supply chain segments:

  • Pure-play design (Fabless) companies–purely focus on creating software and intellectual property without actually manufacturing anything.
  • Pure-play manufacturing companies (Foundry) –manufacturing chips for Fabless companies.
  • OSAT (Outsourced Semiconductor Assembly and Test) companies –specialized in the APT segment.
  • Equipment manufacturing companies
semiconductor industry structure
Source: Forbes, designed by Daxue Consulting, semiconductor industry structure

Fabless companies require high skill levels and high R&D costs, spending 25% of their income on R&D. Semiconductor foundries are capital-intensive due to the expensive facility and equipment costs, while assembly companies are labor-intensive. The pure-play Fabless Business Model dominates on other business models. In fact, pure-play design companies produce 56% more value than foundries, 4 times more value than IDMs, and 11 times more value than IC Packaging companies for every US dollar of sales of the products.

The landscape of China’s semiconductor industry

Globally, 1.15 trillion units of semiconductors were distributed in 2021, around 146 units for every person on Earth. Taking the number one spot, China manufactured 35% of the world’s semiconductors in 2019. Despite that, China is a net semiconductor importer. In 2020, China imported chips with a total value of US$350 billion, a 14.6% increase from the previous year. In the same year, China’s semiconductor industry consumed nearly a quarter, 24%, of the global semiconductor-enabled electronic devices.
In 2021, the Chinese semiconductor industry experienced a rapid rise in revenue for fabless, foundry, IDM, and OSAT, corresponding to yearly growth rates of 36%, 32%, 23%, and 23%, respectively.

top 10 Chinese semiconductor firms by revenue in 2020
Data source: Semiconductor Industry Association (SIA) Analysis, designed by Daxue Consulting, top 10 Chinese semiconductor firms by revenue in 2020

China’s efforts to cut dependence on the US

Although China has already started the journey to self-sufficiency in 2014 after China’s State Council released the “National Guidelines for Development and Promotion of the Integrated Circuit (IC) Industry” and a year later when the Chinese government initiated “Made in China 2025”, a 10-year comprehensive strategic plan to reduce the country’s dependence on foreign technology imports, they are picking up the pace recently. The US-China trade war that began in 2018 and the famous Huawei blacklisting could be the reasons behind the increase in development speed.

  • The National Integrated Circuits Industry Development Investment Fund (Big Fund) which was established in 2014 to finance China’s semiconductor industry had a second round of state financing in 2019. Until July 2021, Big Fund has allocated US$39 billion to China’s semiconductor industry.
  • The Chinese semiconductor industry’s sales jumped to 9% in 2020, exceeding Taiwan’s for two successive years.
  • China the largest market for semiconductor equipment for the second time in 2021 reached US$29.6 billion, a 58% increase.
  • Semiconductor Manufacturing International Corporation (SMIC) accomplished a major breakthrough by advancing to a quasi-7nm process in two years, faster than Taiwan Semiconductor Manufacturing Company (TSMC) and Samsung.

Comparing China’s and the global chip industry

When it comes to sales, the US semiconductor industry is at the front with a 47% market share. On the other hand, China’s semiconductor industry is lagging far behind with a 5% market share, after South Korea (20%), Japan (10%), Europe (10%), and Taiwan (7%).

2020 global market share of semiconductors
Data source: Semiconductor Industry Association (SIA) Analysis, designed by Daxue Consulting, 2020 global market share

In general, The US semiconductor industry leads the market in areas that demand intensive R&D such as EDA (Electronic Design Automation) and core IP (Intellectual Property), chip design, and manufacturing equipment. On the other hand, Asia dominates in areas that require intensive Capital expenditure and labor such as raw materials, water fabrication, and APT.

Taking a closer look at who are the frontrunners of each segment, we have the US semiconductor industry in the fabless segment, Taiwan in the foundry segment, and Japan, The Netherlands, and the US are sharing the lead in the manufacturing equipment segment. Meanwhile, the Chinese semiconductor industry holds a modest but vulnerable position in the low-value packaging segment as it is not powerful enough to exert considerable economic impact.

All four segments are important and interrelated, a disturbance in one will impact the whole chain. However, chokepoints –when a certain company has power over crucial supply chain links in certain segments that can create bottlenecks – do exist.

value added in the semiconductor industry by various countries
Image source: Semiconductor Industry Association (SIA) Analysis, value added in the semiconductor industry by country

The chip export ban and tension with Taiwan on China’s semiconductor industry

After the conflict between Russia and Ukraine broke out, the US government banned advanced technology export to Russia to impede its economic and military development. The country then extended the export ban to China using “to keep advanced technologies out of the wrong hands” as the motivation.

On August 2022, the Biden administration banned the export of artificial intelligence (AI) computing chips to China specifically Nvidia Corp’s and Advanced Micro Devices Inc.’s (AMD) chips. Taking a further step, the US authority is also now devising plans to extend the ban to semiconductors used in AI and chipmaking tools with KLA, Lam Research, and Applied Materials as the three targeted companies.

China’s AI industry currently depends on Nvidia and AMD. Thus, China’s semiconductor industry, especially its AI industry, is undoubtedly affected. We can consider the ban –on Nvidia and AMD– as the first chokepoint for China.

China’s second chokepoint is TSMC, the largest foundry in the world. Over 90% of highly developed nodes and 50% of global semiconductors are produced by TSMC. The Chinese semiconductor industry relies heavily on TSMC. In the first half of 2022 alone, China imported ICs from Taiwan with a total value of US$79.4 billion, 15% more than in 2021 and accounting for almost 38% of the country’s total such imports during the period. Thus, unlike other sectors, China does not impose sanctions on chip imports from Taiwan even amidst the growing tension with the country, specifically after the visit of the Speaker of the United States House of Representatives, Nancy Pelosi, in August 2022.

China’s chip industry’s potential responses

Fabless segment

First is the fabless segment. The semiconductor industry is generally divided into logic –the building blocks of chips–, memory –storing data and code information–, and DAO (discrete, analogue, and others). This segment is largely dominated by the US, especially for logic chips. Thus, China would have to increase their R&D expenditure to develop logic chips. On the other hand, since South Korea and Japan, respectively, are the leaders in memory and DAO chips, China can rely on those countries at least in the short run while developing their own for the long run.

Foundry segment

In the foundry segment, SMIC has been making plans to build more plants and receiving fund support from various local governments. The company received US$2.25 billion in government funding from the Big Fund. In 2021, SMIC’s new US$8.87 billion chip factory in Shanghai was partially financed by China’s state-affiliated chip fund. In the same year, the Chinese foundry firm was also building a US$2.35 billion plant in Shenzhen, of which 23% is owned by the local government. Then on August 2022, SMIC announced that it will be constructing a $7.5 billion wafer production line in Tianjin.

Undoubtedly, China is slowly making moves to decrease dependency and compete with TSMC in the future. With the rising tension with Taiwan, we would probably see similar occurrences: private-public collaborations, where a private entity drives more efficient private capital toward achieving national objectives. Yet, the foundry segment still has a long road ahead.

Semiconductor manufacturing equipment

The US government is attempting to prevent the sales of semiconductor manufacturing equipment to China. Manufacturing equipment is currently dominated by the US, the Netherlands, and Japan. The US officials managed to stop ASML, a Dutch company and one of the world leaders in semiconductor manufacturing equipment, from exporting its extreme ultraviolet (EUV) lithography to China in early 2020. Recently, the US once again pressured the company to cease exporting its other technology –deep ultraviolet (DUV) lithography. Japan is the other viable option; however, the Biden administration is extending the pressure to Japan vis-a-vis Nikon’s DUV machines.

The future of China’s chip industry

According to an IT columnist, Chinese chip makers need an ecosystem that could support their expansion rather than the technology required to create high-end chipsets.  Despite having already received a large amount of investment from the government, funds were not efficiently and strategically allocated. The Chinese semiconductor industry relies on state-owned enterprises (SOEs). As a result of SOEs’ poor management, inefficient production, and wasteful expenditure due to the backing received from the government, the semiconductor industrial plans were hampered as they only produced chips that fail to gain commercial success. However, there has been a crackdown on Big Fund recently which will bring the semiconductor industry in China a step forward in the right direction.

What to know about China’s semiconductor industry:

  • China is a net importer of semiconductors. The country is one of the largest purchasers of semiconductors in the world and is also a dominant player in the manufacturing of less sophisticated chips.
  • China’s semiconductor industry occupies a modest but vulnerable position in the low-value packaging segment as it lacks the strength to wield a significant economic influence.
  • The chip export ban, dependence on TSMC, and the difficulty to obtain semiconductor manufacturing equipment are the three major chokepoints for the semiconductor industry in China.
  • We would most likely observe numerous strategies and efforts from both the Chinese government and semiconductor companies to achieve self-sufficiency. The private-public partnership is one of them.
  • China’s central government would almost certainly take stronger control to create an ecosystem that can cultivate the semiconductor industry in China, no longer heavily dependent on SOEs.

Author: Regina Sukwanto

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