Issues to consider when putting China in your business plans
02/01/2003
By Lisa Tafoya, Fabless Semiconductor Association, Dallas, Texas
overview As the semiconductor industry climbs out of its current down market, China plays a significant role in how it will unfold in the future. Yet China remains an enigma. Part of future successes will stem from how fabless semiconductor companies align with emerging fab capability in China.
Interest in China as a contender in the global semiconductor market is exploding. The industry has come to recognize in the past two years that China could be a stabilizing force that adds innovation and talent and influences growth for the overall semiconductor industry and global economy. Initially, however, this dedication to developing the semiconductor market in China, while beneficial to that country in many ways, presents steep challenges. In particular, fabless companies and their suppliers must learn a different set of business practices and prevail over the risks of setting up shop and operating in China.
The foundry conundrum
The Fabless Semiconductor Association (FSA) forecasts that by 2010, 50% of all IC revenue will come from outsourced operations, up from 12% in 2000. This forecast envisions a substantial increase from current outsourcing levels. To accommodate this increase, the industry will require many more pure-play foundries than those in operation and on the drawing board for launch. This provides an excellent opportunity for China to capitalize on future growth by putting its stamp on the foundry map.
China is relying heavily on the foundry model. Two Chinese start-up foundries, Semiconductor Manufacturing International Corp. (SMIC) and Grace Semiconductor, are making aggressive strides in ramping up technology and capacity. There is more that can be accomplished, however.
To be successful, China must overcome limitations inherent in its approach before it can attain equilibrium with its biggest competitor, Taiwan. From this perspective, China must address technology impediments that leave its fabs one to two generations behind those in Taiwan (Fig. 1).
Working to overcome this challenge, several companies have entered agreements with tier-one foundry players, TSMC and UMC, gaining quick access to aggressive technology. Additional partnerships of this nature will provide China with an added leg in the semiconductor supplier segment.
 Figure 1. Worldwide foundry technology acceleration. (Source: FSA) |
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The FSA predicts that early adopters of China's foundry offerings will be companies that service end markets on the mainland. They will benefit from the greatest cost advantage, estimated to be as high as 17% related to tariffs on products destined for the mainland China market. However, those requiring leading-edge technology, such as 300mm wafer manufacturers, will be more reluctant to use Chinese foundries in the initial years of production.
At this time, the cost advantage offered by Chinese foundries does not balance the risks that an IC designer takes to do business in this start-up environment. For example, if a fabless company already has access to 300mm technology in Taiwan, then a design transition to a smaller geometry provides greater cost savings than switching to a China foundry operating at 200mm.
Unlike China's emerging foundries, Taiwan's foundries, TSMC and UMC, and Singapore's Chartered, have strong roots in the fabless world. Therefore, they are able to quickly ramp up designs and turn around chips.
Thus, the ability of China's foundries to attract business from Taiwan's market share leaders will be based on its power to provide competitive technology, at fair market value pricing. Without technology advances and cost advantages, Chinese foundries will face an uphill climb against Taiwan.
Fabless companies have access to several second-tier foundries in the Asia Pacific region, such as Malaysia's 1st Silicon and Silterra Malaysia and Korea's Dongbu Electronics, which have technology expertise and three years or more of operational development over their Chinese counterparts. These companies have recognized that price and reputation are issues for them, so they have differentiated themselves on other factors, such as customer service or location.
China accounts for 2% of total industry capacity and in the coming years will add more capacity than any other region, with the exception of Taiwan and the US. To be successful, these Chinese foundries will also need to differentiate themselves on other features. Price and reputation alone will not win them market share.
Market potential
In terms of market potential, analyst predictions indicate there is and will continue to be a strong demand for analog, discrete, and power products in China. This trend creates a variety of domestic market opportunities for Chinese IC firms.
In addition, it is forecast that the IC market in China will grow approximately 25%/year during the next five years, with wireless communications acting as the main driver. According to In-Stat/MDR, 2002 worldwide wireless local area network (WLAN) chipset sales are forecast to top 14 million units, an increase of 75% over last year, but much of that demand is expected to come from Taiwan. The Market Intelligence Center estimates that Taiwan shipped more than 60% of the world's WLAN networking cards, access points, and other gear in 2002 and is forecast to expand its market share to 70% in 2003. China will be watching this market closely for future entry opportunities.
For China's chip designers to emerge as top-tier competitors, they must be able to meet design requirements and sell to markets beyond the domestic realm. In addition, a number of preconceptions exist regarding China's design firms, including lower-quality performance issues, lower reliability, and concerns over product availability. The firms must immediately enact procedures to eliminate any evidence that these preconceived notions hold substance.
 Figure 2. Fabless semiconductor manufacturers worldwide by region. (Source: FSA) |
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Current IC design structure
Most IC designs coming out of China today include ASICs, MCUs, DSPs, and power supply management ICs, primarily for application in communications and consumer designs. Few of China's design engineers are working on advanced system-on-chip designs, one of the trademarks of the US fabless design segment. In fact, much of the design in China centers on printed circuit board and low-level system design.
This is likely due to the fact that China's design industry is relatively small, capping out anywhere from $100 million to $250 million. Despite its size, however, it is growing quickly, with an estimated 250 design firms located in greater China (Fig. 2 on p. S17). Unfortunately, just a handful of these companies control more than half of the market.
US companies, such as ESS Technology, Silicon Storage Technology, and Trident, are likely to provide a competitive boost to the Chinese sector by setting up design houses with operations in Shanghai.
Is your IP safe in China?
Beyond issues of market potential and supplier worries lies an even more critical obstacle — intellectual property (IP) protection. The entire fabless industry is waiting for China foundries to outline their protection plans for IP, a top priority for fabless companies in developing foundry partnerships.
Being able to efficiently and safely transfer designs and proprietary technology will be critical for design firms. In spite of great advances in China, with more foundries establishing themselves, and related vendors setting up operations there, IP protection issues are far from resolved. Foundries have much more to do to instill confidence that proprietary design schemes will be protected under China's historically lax policies.
Recruiting the best and brightest
Another issue China must face is the ability to attract and hire battle-proven semiconductor-engineering and management professionals. In addition to its low-cost labor pools, China needs to find top management talent to help guide the industry from infancy to an established competitive presence. Thus, China will look to lure top management with experience in the chip industry as well as engineers and factory workers, notably from Taiwan and the US.
Enhancing the attractive employment deals offered by Chinese IC firms is the growing debate in the US over stock option expensing. As it looks more and more like the US will adopt punitive accounting rules for expensing options, the US fabless semiconductor industry will be less competitive with the growing Chinese industry, where stock grants are a regular part of the compensation package to virtually all employees. If the practice continues, the US semiconductor industry could be at a serious competitive disadvantage, with China winning over the world's IC brain trust.
A light at the end of the tunnel
China's semiconductor industry faces a variety of challenges, from head-on competition with Taiwan to IP protection to recruitment. China's advantages, however, make it a strong economic investment opportunity. From inexpensive labor to a vast market of consumer product needs, China's design firms and foundries are poised to become worldwide contenders in the semiconductor arena. The FSA predicts that all fabless companies and their suppliers must add China to their long-term business plans or be left without potential for future growth.
Lisa Tafoya is director of research and projects at the Fabless Semiconductor Association, 5430 LBJ Freeway, Suite 280, Dallas, TX 75240; ph 972/866-7579, fax 972/239-2292, e-mail [email protected].