(FB)Semiconductors and the U.S.-China Innovation Race

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April 11, 2021

Geopolitics of the supply chain and the central role of Taiwan

A SPECIAL REPORT BY FP ANALYTICS  |  PUBLISHED: FEBRUARY 16, 2021

Semiconductors, otherwise known as “chips,” are an ­­essential component at the heart of economic growth, security, and technological innovation. Smaller than the size of a postage stamp, thinner than a human hair, and made of nearly 40 billion components, the impact that semiconductors are having on world development exceeds that of the Industrial Revolution. From smartphones, PCs, pacemakers to the internet, electronic vehicles, aircrafts, and hypersonic weaponry, semiconductors are ubiquitous in electrical devices and the digitization of goods and services such as global e-commerce. And demand is skyrocketing, with the industry facing numerous challenges and opportunities as emerging technologies such as artificial intelligence (AI), quantum computing, Internet of Things (IoT), and advanced wireless communications, notably 5G, all requiring cutting-edge semiconductor-enabled devices. But the COVID-19 pandemic and international trade disputes are straining the industry’s supply and value chains while the battle between the United States and China over tech supremacy risks splintering the supply chain further, contributing to technological fragmentation and significant disruption in international commerce.

For decades, the U.S. has been a leader in the semiconductor industry, controlling 48 percent (or $193 billion) of the market share in terms of revenue as of 2020. According to IC Insights, eight of the 15 largest semiconductor firms in the world are in the U.S., with Intel ranking first in terms of sales. China is a net importer of semiconductors, heavily relying on foreign manufacturers—notably those in the U.S.—to enable most of its technology. China imported $350 billion worth of chips in 2020, an increase of 14.6 percent from 2019. Through its Made in China 2025 initiative and Guidelines to Promote National Integrated Circuit Industry Development, over the past six years, China has been ramping up its efforts using financial incentives, intellectual property (IP) and antitrust standards to accelerate the development of its domestic semiconductor industry, diminish its reliance on the U.S., and establish itself as a global tech leader. As U.S.-China competition has intensified, notably under the former Trump administration, the U.S. has been tightening semiconductor export controls with stricter licensing policies, particularly toward Chinese entities. Concerns continue regarding China’s acquisition of American technology through civilian supply chains and integration with Chinese military and surveillance capabilities.

Caught between these global superpowers is the Taiwan Semiconductor Manufacturing Corporation (TSMC), a leading manufacturer in the industry, owning 51.5 percent of the foundry market and producing the most advanced chips in the world (10 nanometers or smaller). TSMC supports both American and Chinese firms such as Apple, Qualcomm, Broadcom, and Xilinx. Until recently, the firm also supplied Huawei but severed ties with the Chinese giant in May 2020 because of U.S. Department of Commerce restrictions on Huawei suppliers over security concerns.

Taiwan has also become a geopolitical focal point because the Trump administration’s moves to strengthen American-Taiwanese relations heightened tensions in the Taiwan Strait and increased China’s military activity in the region, testing the Biden administration’s resolve. Together, these factors present significant risks to a critical manufacturing node for the global semiconductor industry. Taiwan represents one part of the industry’s complex ecosystem and shows more broadly the increasing difficulty for companies and countries to remain insulated from geopolitics—particularly amid pressures contributing to U.S. and China decoupling. As geopolitical, trade, and technology disputes mount and the COVID-19 pandemic continues to harm the supply and value chains, semiconductor firms are trying to secure their manufacturing processes by stockpiling supplies or relocating production facilities—disrupting the industry at large.

With semiconductors at the heart of U.S.-China strategic and technological competition, the industry continues to experience a range of protective tariff and non-tariff measures that threaten production and competitiveness of the industry. This FP Insider Report analyzes the evolving strategic economic relationship among China, Taiwan, and the United States as it pertains to semiconductors, examines the growing economic and security challenges that key private and public sector actors within the industry face, and pinpoints opportunities for the Biden administration as it seeks to bolster U.S. competitiveness while containing China’s technological ambitions. In particular, this report finds:

  1. Semiconductors represent the linchpin for U.S. and China’s mutually dependent technological ambitions. Semiconductors are a critical technological vulnerability for both China and the United States, which rely on each other as well as Taiwan for cutting-edge semiconductor devices.
  2. Despite massive investment, China is highly unlikely to achieve independent semiconductor manufacturing capabilities in the next five to 10 years. Chinese companies are unable to compete against top-tier firms because of limited access to semiconductor manufacturing equipment (SME) and software, and their overall lack of industry knowledge hinders the development of a self-sufficient supply chain.
  3. Taiwan is set to become the center of U.S.-China tensions. Given the country’s central role in semiconductor manufacturing and technology supply chains, China will likely leverage its economic influence through trade restrictions, talent recruitment, and cyber to attack key companies in order to obtain core semiconductor intellectual property (IP) needed to bolster its domestic industry.
  4. Unilateral restrictions fostering distrust among companies and country governments risk economic decoupling. Unilateral economic measures imposed by the United States on segments of the supply chain, notably manufacturers such as TSMC, have fostered concern among private and public actors on the impact of action by U.S. leaders on global supply chains and corporate competitiveness. Recognizing critical bottlenecks and vulnerabilities, some companies are evaluating new production models, diversifying investments and suppliers to circumvent American economic policies, which could undermine U.S. primacy in the industry.
  5. Collaboration between the Biden administration and American corporations will be key to balancing national security and commercial interests. Given that multilateral frameworks on semiconductor regulation do not include Taiwan or China, the Biden administration could bolster existing forums for enhanced American-Taiwanese economic relations through the Economic Prosperity Partnership Dialogue (EPP) and Sino-American relations through the Strategic Economic Dialogue. Evaluation of current tax codes and permitting processes under the Federal Clean Air Act, which now disincentivizes companies from investing in U.S.-based fabrication plants, will also be important to attracting investment and strengthening U.S. competitiveness in the sector.

The Global Semiconductor Ecosystem is Highly Interconnected

Broadly speaking, semiconductors, also known as integrated circuits (ICs), computer chips, microchips, or chips are the building blocks of technology. A semiconductor is a crystal material that possesses features of both insulators (materials that do not conduct electricity) and conductors (materials that do). Semiconductor devices such as transistors, which perform an essential function of controlling electrical current flow, are often connected or “printed” onto circuit boards, a hardware component of an electrical product that provides structural support to hold all other components in place and provides necessary wiring to connect signals and power to these components. Each device performs specific functions across various microprocessor chips such as central processing units (CPUs), memory chips, sensor chips, graphics processing units (GPUs), and power management. Semiconductor devices can also allow communication among devices like mobile phones, gaming systems, aircraft, industrial machinery, and military equipment and weaponry.

While demand for semiconductors has been surging, the cyclical nature of the industry contributes to market volatility and unpredictable returns. Profits depend on types of chips produced, consumer preferences, and shortening product lifecycles and demand for newer, faster applications that make tech quickly obsolete. As each new generation of semiconductors becomes smaller and more densely packed with transistors, the complexity and cost of production increases, giving each segment of the supply chain a chance to enhance product competitiveness and quality. Because of this, only a few companies can design and manufacture advanced chips while also being flexible enough to make continual technological improvements. From equipment production to chip manufacturing, companies with products and services that are marginally better than their competitors are able to capture an outsized portion of industry revenue (on average half).

The three main segments of the production process include: design, manufacturing, and assembly, testing & packaging (ATP)—with various design and fabrication facilities, or “fabs” contributing to the supply chain. The largest semiconductor manufacturers are in the U.S., South Korea, Europe, and Japan, but only a handful are vertically integrated; these Integrated Device Manufacturers (IDMs) include companies such as Intel, Samsung, SK Hynix, and Micron Technologies. Much of the industry, however, employs a “fabless-foundry model,” which delineates tasks to specialized companies, and relies on outsourcing parts of the value chain— notably to firms in Taiwan, China, and Singapore —to mitigate production costs and leverage local expertise to improve product performance. The “fabless” firms have no manufacturing capabilities and specifically design chips, while foundries focus on manufacturing, and outsourced semiconductor assembly and testing companies (OSATs) support testing and assembling semiconductor components into workable devices. Ninety percent of the value of a chip is split evenly between the design and fabrication stages, and 10 percent is added during the ATP stage. The graphic below details the general production process for semiconductors starting with raw material sourcing, which is critical to enhancing the industry’s rate of technological innovation, through distribution for use in electronic goods.

THE SEMICONDUCTOR MANUFACTURING PROCESS

The semiconductor manufacturing process is completed in six primary steps: raw material sourcing, research & development (R&D), designing, manufacturing, assembly, testing, and packaging (ATP), and distribution. Various levels of specialization and functional delineation across the supply chain have resulted in two production models in the industry: Integrated Device Manufacturers (IDM) and fabless-found

1

Raw Material Sourcing

Semiconductors are usually composed of silicon or gallium arsenide. Each material has advantages depending on the functionality of the semiconductor, differing on cost-to-performance ratios, high-speed operations, high-temperature tolerances, or desired response to a signal.

2

Research and Development (R&D)

Notable semiconductor R&D companies include:

  • CEA-Leti, France
  • Interuniversity Microelectronics Centre (IMEC), Belgium
  • Itron Inc., United States
  • SEMATECH, United States
  • Semiconductor Research Corporation, United States
3

Production

After sourcing the necessary raw materials and research comes design, manufacturing, and assembly, testing and packaging (ATP). The raw material sourcing, R&D, and distribution segments are not strictly part of the production process but are included in this analysis because of the essential role they play in the value chain.

Fabless-Foundry Model

At each stage of the production life cycle, specialized companies split production across designing, manufacturing, and ATP. Companies that concentrate on design are known as “fabless” firms because they have no fabrication capabilities, foundry companies offer contract manufacturing services for these fabless firms, and Outsourced Assembly and Test (OSAT) companies perform ATP services. The fabless-foundry model benefits from task specialization and allows companies to concentrate and invest on a singular part of the manufacturing process.

3a. Designing

Also known as “fabless” because they have no fabrication capabilities themselves, design firms lack their own manufacturing capabilities and outsource the manufacturing and ATP segments of the production process to third parties. Top ranking fabless firms in 2020 by revenue include:

  • Qualcomm, United States
  • Broadcom Inc., United States
  • NVIDIA, United States
  • MediaTek Inc., Taiwan
  • Advanced Micro Devices (AMD), United States
3b. Manufacturing

Foundries manufacture semiconductors based on designs by fabless firms. This segment of the supply chain often has high fixed costs and manufacturers must constantly improve facilities to keep up with rapid tech innovation. Top ranking foundries in 2020 by revenue include:

  • Taiwanese Semiconductor Manufacturing Company (TSMC), Taiwan
  • Samsung, South Korea
  • GlobalFoundries, United States
  • United Microelectronics Corporation (UMC), Taiwan
  • Semiconductor Manufacturing International Corporation (SMIC), China
  • Tower Semiconductor, Israel and United States
3c. Assembly, testing, and packaging (ATP)

Top ranking Outsourced Semiconductor Assembly and Testing (OSAT) firms in 2019 by revenue include:

  • ASE Technology Holding Co., Taiwan
  • Amkor Technology, United States
  • JCET Group Co., China
  • Silicon Precision Industries Co., Ltd., Taiwan
  • Powertech Technology Inc., Taiwan

Integrated Device Manufacturers

3a-3c. Designing, manufacturing, and ATP

Integrated Device Manufacturers (IDMs) vertically integrate the entire production processes. Depending on the type of chip, one company will execute the production segments—designing, manufacturing, and ATP—on their own. For instance, Samsung, and SK Hynix are IDM businesses that produce their own advanced memory chips, namely DRAMs and NAND flash chips. However, they lack such capabilities in non-memory chips and may outsource the production of non-memory chips to other companies. Notable IDMs in the semiconductor industry include:

  • Intel, United States
  • Samsung, South Korea
  • SK Hynix Inc., South Korea
  • Micron Technology Inc., United States
  • Texas Instruments, United States
4

Distribution

Semiconductors are shipped to distributors and equipment manufacturers for use in electronic goods. Electronics manufacturing services (EMS) distribute electronic test components and printed circuit boards (PCB) assemblies and provide return/repair services for these electronic components and assemblies for original equipment manufacturers (OEMs). Semiconductors can also be distributed directly to the OEMs.

Notable EMS and ODM market leaders in 2019 include:

  • Foxconn Technology Co., Ltd, Taiwan
  • New Kinpo Group, Taiwan
  • Universal Scientific Industrial Co., Ltd., China
  • Shenzhen Kaifa Technology Co., Ltd., China
  • Venture Corporation Ltd., Singapore

WORLD GALLIUM PRODUCTION AND RESERVES 2020

In kilograms

NOTE: NO DOMESTIC PRIMARY (LOW-GRADE, UNREFINED) GALLIUM HAS BEEN RECOVERED SINCE 1987 IN THE UNITED STATES. THE FOLLOWING VALUES ARE ROUNDED BY THE USGS.

Semiconductor Trade Between China, Taiwan, and the U.S. - Exports

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