In January 2024, the United States Department of Commerce initiated a new survey on the U.S. semiconductor supply chain and the national security risks posed by China.

The focus, however, was not advanced technologies, but rather older generations of semiconductors made using the mature 28-nanometer process or larger that command about 70 percent of the global market and are widely embedded in cars and consumer electronics.

At about the same time, the European Union revealed that it was planning to pursue a similar information-gathering process to see if blocking China’s advantages in these mature processes was warranted.

What was it that prompted the U.S. and Europe to initiate these surveys?

“Many long-time trade experts fear that Chinese overcapacity will eventually become a problem, similar to what has transpired in steel and solar,” warned a report by U.S. think tank CSIS in early April that urged policymakers to get “better access to better data” to inform appropriate measures.

Could China’s capacity gluts that have distorted markets for other commodities really be replicated in the legacy chip market? 

CommonWealth Magazine obtained information from market research specialist TrendForce’s research team in Shenzhen on the status of China’s semiconductor factories and used that to calculate projected capacity for China’s contract chipmakers.

We found that based on China’s existing and planned factories in the sector, it intends to double its current capacity within the next few years, resulting in potential output five-times that of Taiwan-based foundry United Microelectronics Corporation, which offers a broad line of mature semiconductor technologies.   

Though such projections have yet to materialize, they are already causing the U.S. and Europe to break out in a cold sweat. 

There have been several dimensions to China’s strategy. 

Dimension No. 1: SMIC Looking to Double Capacity

According to TrendForce data, China has 26 existing contract chipmaking foundries and 23 others that are being built.

Most of these fabs are concentrated among three big players: SMIC (Semiconductor Manufacturing International Corp., 中芯國際), Huahong Semiconductor Ltd. (華虹集團), and Nexchip (合肥晶合). The three combined account for nearly 70 percent of China’s semiconductor capacity.

But the trends shown by SMIC are particularly interesting.

In September 2023, Chinese electronics giant Huawei announced that its flagship phone had an advanced 7-nanometer Kirin chip, which outsiders believed was an upgrade forged from SMIC’s 14-nanometer technology.  

That led people to speculate that SMIC was shouldering the mission of developing China’s advanced semiconductor technologies. 

Yet that has not stopped SMIC from building up its arsenal of semiconductors made with mature technologies, known in the trade as “legacy chips.”

“The new factory projects announced by SMIC during the pandemic were all concentrated on mature processes,” observed TrendForce industry analyst Eden Chung (鐘映庭).

An industry insider added: “80 percent of (SMIC’s) capacity is still tied up in mature node processes.” 

If SMIC’s factory expansion goes to plan, it will eventually be able to produce 1.097 million 12-inch wafers a month, tripling its capacity in 2023, according to TrendForce data. One Taiwanese industry expert described that as “over the top.”

In the past three years, SMIC has opened at least four new 12-inch wafer fabs, almost all of which were backed by local governments, which contributed nearly half of the capital. (Source: AFP)

The projections have raised eyebrows within the industry. The capacity numbers declared by SMIC would require building two US$10 billion large-scale wafer factories in a year, yet the company’s capital expenditure in 2023 was only US$7.5 billion.

A closer look at the company’s public statements shows that over the past three years SMIC has opened four 12-inch wafer factories around China. Among them, SMIC Dongfang in the Shanghai area was of national importance, helping turn the Lingang development zone into China’s wafer base. 

Local governments, however, have foot the bill for roughly half the cost of these new factories, explaining SMIC’s relatively low capital expenditure.

Regardless of whether this round of large-scale expansion of mature process capacity materializes, China’s existing manufacturers have already unleashed a low-price offensive that is affecting second-tier Taiwanese contract chipmakers such as Vanguard International Semiconductor Corp. and Powerchip.

Dimension No. 2: Low Prices Hurting Taiwanese Vendors

On Oct. 7, 2022, the White House announced that it was prohibiting equipment used to make advanced chips from being exported to China on national security grounds.

In the month following the White House ban, Beijing announced it would provide US$1.8 billion in grants to 190 publicly listed semiconductor companies, in effect treating wafers as strategic commodities for which China had to be self-sufficient.

The Chinese government took the lead in priming the pumps in supporting this massive capacity expansion, and it has yet to stop.

At the end of 2023, there was speculation that the third phase of the China Integrated Circuit Industry Investment Fund, also known as the “Big Fund,” would begin this year, after two five-year phases that ran from 2014 to 2019 and 2019 to 2024.

An executive in the Chinese investment sector estimated that about 300 billion Chinese yuan (US$41.5 billion) will be invested in the third phase, far higher than the more than 100 billion yuan injected in the first phase and over 200 billion yuan invested in the second phase.

The added capacity bought by this substantial windfall has led to steep price cuts by Chinese vendors over the past year to fill their capacity, giving some Taiwanese companies headaches.

Taiwan's second-tier foundries have felt the price wars of China's mature process manufacturers, and capacity utilization has been greatly impacted. (Source: Getty Images)

According to the 2023 financial statements of China’s big three – SMIC, Hua Hong, and Nexchip – SMIC had a capacity utilization rate of 75 percent, while it was more than 90 percent for the other two.

In Taiwan, on the other hand, the utilization rate for vendors of mature processes, such as Vanguard International and Powerchip, were about 60 percent in the third and fourth quarters of 2023.

“China started cutting prices last year to snatch orders,” a manager with a Taiwanese vendor said of his Chinese competitors.

Dimension No. 3: ‘State-owned Asset Losses’? 

Yet even with the jump in capacity, China’s big three semiconductor foundries experienced declines in gross margin and profit in 2023.

At the company’s Q4 investor conference in February 2024, SMIC co-CEO Zhao Haijun (趙海軍) worried about increased volume and falling prices, saying: “For the full year [2023], foundry shipments rose an estimated 20 percent, but prices fell 10 percent.” 

Poor operating performances represent bad news for Chinese companies that rely on government funding.

A veteran of the semiconductor sector said that given the recent weakness of China’s finances, these wafer foundries that rely on government grants could be negatively condemned for “state-owned asset losses” if they need to cut prices to fill their capacity.

In addition, though the third-phase funds came through, the major source of the funds were local governments rather than the central government. 

The implosion of China’s property sector has cost local governments revenue from land sales, leaving them with nearly empty pockets. 

“How long will local governments be able to hold on?” wondered a Chinese financial media worker.

This could affect whether China’s semiconductor vendors will be able to achieve their capacity ambitions. 

In fact, a comparison of the capacity projections with the market analysis of another TrendForce team offers a glimpse into the gap between “planning” and “reality.” 

Dimension No. 4: ‘Planning’ vs. ‘Reality’ 

TrendForce’s Taipei office has estimated that China will account for 39 percent of the world’s legacy chip capacity by 2027, up 8 percentage points from the present, far below what one might expect given the announced planned expansions of China’s semiconductor foundries.

“Market circumstances and the ability to acquire equipment will affect each vendor’s assessment [of whether or not to expand],” TrendForce’s Chung said.

That is about as clear a picture as one can get of China’s current mature process manufacturing, which is murky at best. 

What is clearer is China’s ambition to be self-reliant in semiconductors.

At the beginning of 2024, the Chinese Communist Party Central Committee’s Politburo held a collective study session focused on technology themes such as “promote self-reliance in high-level science and technology” and “ensure that industries are autonomous and controllable.” 

Those appeals reflect China’s reliance on imported semiconductors. Current estimates indicate that less than 30 percent of its semiconductor demand is produced at home.

Foreign media have reported that China’s Ministry of Industry and Information Technology, seeking to reverse that trend, has required BYD, Geely, and other electric car manufacturers to increase their procurement of chips made in China to at least 20 percent of the total by 2025.

No sooner had the government announced the domestic procurement goal than China’s semiconductor market shifted directions.

A Chinese investment sector insider said China’s obsession with expanding its capacity of legacy chips has been especially concentrated on display driver ICs, CIS/ISP (CMOS image sensors and image signal processors), and power components. Among them, display driver ICs have emerged as the top priority, and Nexchip has led the charge.

Nexchip was founded in 2015 through a joint venture between Taiwan’s Powerchip and the Hefei city government, becoming China’s third 12-inch wafer foundry with Taiwanese involvement.

Powerchip has since withdrawn from Nexchip’s management, leaving Hefei with a majority stake. Following a strategy consistent with the government’s push for self-reliance, the company has embraced the pursuit of complete control of the value chain, aggressively expanding capacity last year and snatching orders.

Taiwan’s Two Options to Combat China’s Strategy

In its April 2024 Greater China semiconductor report, Morgan Stanley pointed directly to Nexchip’s cutthroat pricing strategy to snatch orders and the harm it has done to Taiwanese vendors.

An executive with a Taiwanese IC design house warned of the consequences of such a trend. 

“Customers will not only demand that upstream IC vendors have to place orders with Chinese foundries, they will gradually require that IC design orders also go to Chinese companies,” the executive predicted.  

“In the future, the only Taiwanese companies that will retain a stable foothold in China will be the top two companies. From company no. 3 on down, they will all probably be domestic Chinese suppliers,” he warned.

This new ecosystem described by the executive represents the Chinese vision of “one world, two systems,” and Taiwanese companies that have done business with China are now reconsidering their deployment of resources.

One option is to go all in on the “de-Chinaization” of supply chains and markets. Vanguard International, for example, which has faced intense pressure from China’s mature process vendors, said at a recent investor conference that it would not engage in price competition with Chinese foundries. Instead, it said, it will focus more on targeting markets outside of China, in line with the “de-Chinaization” trend.

The other option is to confront the challenge head-on and pursue higher-end markets. Novatek Electronics Corp., a leading manufacturer of display driver ICs, is said to have received orders for iPhone components early this year to become the first Taiwanese IC design vendor to break into the Apple supply chain.

Ultimately, the explosion in Chinese foundry capacity for mature semiconductor processes is tied to Beijing’s pursuit of total self-reliance in semiconductors. Even if it falls short of that goal, Taiwanese companies have taken note and are contemplating how to respond.

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Translated by Luke Sabatier
Uploaded by Ian Huang