Mainland China's Semiconductor and Equipment Markets: A Complete Analysis Of Technical, Economic, and Political Issues

From 2000 through 2005, the Chinese IC market registered a compound annual growth rate (CAGR) of 33% to $40.8 billion in 2005. As China becomes a global production base for electronic terminals, consumer demand for emerging multi-functional, highly integrated electronic products is increasing. Memory, MCUs and DSPs make up 33% in total IC products in China. In 2005, the market demand for these three groups of ICs was worth U.S. $14.6 billion.

Most of the first 200mm production lines established in the mainland have Taiwanese background, with proponents including SMIC, Grace and Hejian Technology. Maintaining low-cost manufacturing capability and providing foundry service for their existing customers are important considerations for Taiwanese enterprises. Price is the top consideration in setting up mainland foundries in addition to being lured by fast-growing markets in the mainland. Nearly 80% of notebooks supplied by Taiwanese ODMs such as Quanta and Compal are manufactured on the mainland.

Domestic companies have made impressive inroads into the development and commercialization of a few specific IC products such as second generation ID cards, audio decode chips, third generation cell phone base band chips and MP3 chips.

China has a total 650 semiconductor companies, with 200,000 employees. In a breakdown, the number of IC design companies in the country approached some 500 at the end of 2005, with an annual growth of sales revenue hitting 61.3% and an employed population reaching 18,000. China' s fab capacity grew 45% from 145,000 equivalent wafers per monthto 210,000, and we expect the same strong growth in 2007.

As Taiwan has shifted electronic manufacturing to the mainland, the mainland' s IC design capability has improved dramatically. For instance, communications ICs are already yielding System-on-a-Chip (SoC)-level products based on 0.13-0.18μm process, while consumer electronics products focus on 0.18-0.5μm process.

There are three major driving forces behind such phenomenal growth. First is the continuing growth of the domestic market that has provided new demand for outputs from the industry. China has become the largest manufacturing base for most consumer electronics products such as televisions, DVDs, personal computers and mobile phones. These consumer electronics products are fueling the growth of the China' s domestic IC market. In 2005, the market reached $40.8 billion, making China the largest IC market in the world with a global share of 22%.

The second driving force has resulted from the reform of the financial system, which has substantially improved the investment environment--especially for foreign investment. Foreign investment now accounts for 80% of total investment in the IC industry, even when domestic bank loans are taken into account.

The third driving force is the global recession of the IC industry after 2000. The recession exerted tremendous economic pressure for multinational corporations to relocate their manufacturing and R&D activities to China to take advantage of China' s cost advantage.

While the growth of China' s IC industry has been impressive, there are noticeable weaknesses of the industry. The industry is dominated by low value-added IC packaging and assembly, which accounts for half of the industry' s revenue. High value-added IC design work only generated 15% of the total revenue in 2005. Most of the 476 IC design companies are very small.

The government is well aware of these shortfalls and policies have been put in place to support the next-phase growth of the industry. Factor inputs need to be boosted. In terms of capital, it is estimated that a total of $30 billion investment will be needed in the coming five years to fuel the growth of the industry. Yet, the government will cede its role as a director investor in any IC programs while promoting investments from other sources, being it bank loans, domestic private investment, foreign direct investment or venture capital investment. Human resource is another prime area for improvement since there is a serious shortage of experienced IC engineers. The government has put in plans to "cultivate 40,000 IC designers and 10,000 IC processing technologists" over the coming 6-8 years. More importantly, however, indigenous competence needs to be built. "Independent innovation" has been identified as a priority for public policy in China' s 11th five-year development plan, whose goal is not to copy others' chips but instead to have its own.

Looking into the future, as China' s IC industry and market continue to grow, China is being integrated into the global innovation system. In the coming five years, there will be plenty of opportunities for Chinese companies and universities to collaborate with innovators from abroad, whether it is to shape next-generation technologies and technical standards, for multinational corporations to set up research and development centers in China, or for universities to collaborate on cutting-edge research.

• 1) After more than 20 years of development, China' s electronics industry has become established as a relatively complete system. The scale of economy is improving continuously, brand images are being formed, and product quality is improving. There is now a solid foundation for the future growth of the industry.
• 2) In China, there is a huge domestic market and a fast-developing economy; overall production costs are falling; the investment environment has become more tightly monitored and controlled; sales and distribution networks are improving; and process manufacturing capabilities have become stronger. Such changes and improvements make China an extremely attractive option to any company considering relocating its manufacturing overseas.
• 3) A new wave of industrialization driven by information technology will open up new business opportunities for the electronics industry to expand its markets. Fast growth in the sales of computers, software and networking products is anticipated.
• 4) The new policies for promoting the growth of software products and the IC industries announced by the State Council are being implemented, and tax reductions for IC products will be introduced. These factors will certainly accelerate the development of China' s software and IC industries. The size of the software industry is expected to increase by more than 30%, while the IC industry is expected to increase by 40%.
• 5) Exports of electronics products are expected to increase steadily this year. In the electronics industry, there will be an increase in foreign investment in factories, joint ventures and cooperative enterprises.
• 6) Growth this year is expected to come mainly from CDMA mobile phones, HDTVs, computers, networking products, software, etc. These factors should provide new market opportunities for the electronics industry.
• 7) The restructuring of the telecommunications business is almost complete. Following these adjustments, the large telecom operators will act to improve their competitiveness on the market. They will also increase their investment in the basic infrastructure, providing new opportunities for communications products and the manufacturing industry.
• 8) After its accession into the WTO, China will regulate the market in line with WTO requirements. The market economy system will be regulated, which will further improve the environment for the development of the electronics industry.

As this report describes, China is rapidly closing the gap on technologies needed for electronics manufacturing. It can be expected that WTO membership combined with more aggressive incentives for foreign direct investment will lead to changes over the next five years that will be significantly greater than those of the past five years. The priorities described in this report will continue and will result in a more competitive business environment. We can summarize the present as follows.

As this report will show, China has access to most of the technologies needed to manufacture today' s products. Companies are already using leading edge manufacturing technologies for assembly that include chip-on-board, chip-on-glass, and chip-scale-packages. While the semiconductor industry lacks the capacity to meet domestic needs, China' s IC design capabilities are competitive in the global marketplace. The design of ASICs for advanced products, like MP3 players and set-top boxes, has been well established. Such ASICs can be manufactured by any number of firms in Taiwan, Singapore, or Japan.

Mainland China represents a huge opportunity for semiconductor manufacturers and equipment and materials suppliers. The emerging semiconductor market will exhibit growth far in excess of any other country in the 2003-2008 time frame. This 260-page report analyzes Mainland China' s semiconductor and equipment industries, examining the technical, economic, and political issues that are shaping this nascent industry.