(Note: In an earlier post, I talked about development’s in China’s semiconductor industry, including shifts on the policy front. In this post, adapted from a recent article I wrote with my colleague Chris Thomas, I talk about the implications for multinational chip makers.)
China is by far the largest consumer of semiconductors; it accounts for about 45 percent of the worldwide demand for chips, used both in China and for exports. But more than 90 percent of its consumption relies on imported integrated circuits. Integrated-circuit companies in China entered the semiconductor market late—some two decades after the rest of the world—and have been playing catch-up ever since in an industry in which success depends on scale and learning efficiencies. The Chinese government made several attempts to build a local semiconductor industry, but none really took hold. Now, however, things are changing on both the business and policy fronts.
Low-cost smartphones designed in China are flooding the market. For instance, Android phones designed in China now represent more than 50 percent of the global market, compared with their negligible presence five years ago. Lenovo’s significant deals early in 2014—first acquiring IBM’s low-end x86-based server business for $2.3 billion and then buying Motorola from Google for almost $3 billion—further suggest that the customer base for hardware is moving to China.
Multinational corporations in every industry—from automotive to industrial controls to enterprise equipment—increasingly are establishing design centers on the mainland to be closer to customers and benefit from local Chinese talent. McKinsey’s proprietary research indicates that more than 50 percent of PCs, and between 30 and 40 percent of embedded systems (commonly found in automotive, commercial, consumer, industrial, and medical applications), contain content designed in China, either directly by mainland companies or emerging from the Chinese labs of global players. As the migration of design continues, China could soon influence up to 50 percent of hardware designs globally (including phones, wireless devices, and other consumer electronics).
Fabless semiconductor companies are also emerging in China to serve local customers. For instance, Shanghai-based Spreadtrum Communications, which designs chips for mobile phones, and Shenzhen-based HiSilicon Technologies, a captive supplier to Huawei and one of the largest domestic designers of semiconductors in China, are among the local designers that have shown rapid growth over the past few years.
There has been slower but steady progress among local foundries. As global players such as Samsung, Taiwan Semiconductor Manufacturing Company, and Texas Instruments set up shop in China, leading local foundries such as Shanghai Huali Microelectronics Corporation, SMIC, and XMC are poised to benefit from the development of a true technology cluster.
A market-based policy effort
The government, realizing that earlier bureaucrat-led investment initiatives failed to bring the desired results, is now aiming to take a market-based investment approach. In this case, decisions about allocating for-profit investment funds will be managed by professionals but will remain aligned with the government’s policy objectives. Chinese officials have convened a unique task force charged with setting an aggressive growth strategy. This group helped develop a policy framework that is targeting a compound annual growth rate for the industry of 20 percent between now and 2020, with potential financial support from the government of up to 1 trillion renminbi ($170 billion) over the next five to ten years.
To avoid the fragmentation issues of the past, the government will focus on creating national champions—a small set of leaders in each critical segment of the semiconductor market (including design, manufacturing, tools, and assembly and test) and a few provinces in which there is the potential to develop industry clusters.
For instance, Tsinghua Unigroup, a state-owned enterprise, recently bought two of the top four Chinese fabless companies—in 2013, it acquired Spreadtrum for $1.7 billion and RDA Microelectronics for $0.9 billion—and aims to combine them into a single entity. The new policy framework specifically encourages consolidation within China’s assembly-and-test market segment.
Implications for semiconductor players
China released the high-level framework for its new national semiconductor policy in June 2014; the details and the long-term effects of its new approach to developing the industry remain to be seen. Will it lead to a world-class semiconductor industry, or will Chinese semiconductor companies continue to lag behind global players? Three medium-term effects seem likely.
1. Pressure for localization will increase
China’s strong desire for national champions may further tilt the system in favor of local players. According to industry estimates, Chinese original-equipment manufacturers will design more than half of the world’s phones in 2015. Under the national-champions model, they may be encouraged to take advantage of domestic suppliers’ low-cost strategies and strong local technical support.
2. More partnership opportunities will arise for second-tier players
Many of the Chinese government’s previous policies have not offered opportunities for global players to benefit. However, government leaders in China’s semiconductor sector are now beginning to realize that the country needs to partner with global technology companies to improve the local talent base and supply chain. As a result, they are more open than ever to “win–win” engagements between global players and national champions.
3. Chinese companies will become more aggressive in pursuing international mergers and acquisitions
Indeed, it would be quite difficult for Chinese players to build a complete and competitive semiconductor value chain without capitalizing on foreign assets; collaborations between Chinese and global players probably will not be enough to meet the country’s objectives. We should expect China to continue to actively seek opportunities to acquire global intellectual property and expertise, usually with the intent of transferring them back home.
How should multinational players respond?
Most global semiconductor players have invested heavily in their Chinese operations over the years, but many are still operating below their potential, especially in functions beyond sales and marketing. Considering the emerging policy and business trends we’ve just discussed, we believe it’s a good idea for leaders to inventory their company’s current position in China.
This process should start with the most timely and immediate concern—the potential effects of changing Chinese policy. Questions for reflection might include: How will you align your operations with the Chinese government’s new plans? Are your relationships in China strong and deep enough to provide you some warning of potential risk as a result of domestic-policy changes?
Market-level questions might include the following: Given the different buying factors and supplier-management philosophies of Chinese customers, do you still have a winning product road map? Can you respond to the emerging needs of Chinese-based customers as fast as a local company can? Have you followed your global customers as they set up design centers on the mainland?
Capabilities-level questions might include the following: How are you leveraging Chinese manufacturing and design talent to win in China—or to win globally? Are your leaders in China as strong and empowered as they are in your home region? Do your global leaders have enough connections in, experiences with, and insights about the Chinese market? How robust is your talent pipeline in China?
There is no one right answer to any of these questions; depending on its role and standing in the market, every company faces its own unique challenges in China.