An Outlook on the Semiconductor Industry
Updated: Dec 6, 2019
By: Kim Tae Hwan
Past and Present of the Industry
A semiconductor chip is a complex and small-sized device which comprises of billions of components that store, transmit and process data. The chip-making industry began initially from the invention of the transistor, a simple device capable of regulating the flow of electricity, and thereafter, in 1958, the advent of integrated circuit (IC) allowed the integration of thousands of resistors, capacitors, inductors, and transistors on a piece of semiconductor substance working as a single device. The semiconductor has been developed at a rapid speed. Gordon Moore, a co-founder of Intel, came up with an observation called Moore’s Law which states that the number of transistors in IC will be doubled approximately about 18 months and this can be translated as the cost reduction in production of the chips but with its enhanced performance. Thanks to the continuous improvement, computer became an affordable appliance and came into wide use between the 1980s and 2000s. As the demand of semiconductor increased significantly, and by the time the PC craze had cooled down, mobile devices like smartphones and tablets is driving the demand for semiconductor chips ¹.
In the Future
With the continuous development of IT, enabled by the rapid improvement of semiconductor, we are now at the doorstep of the fourth industrial revolution. This change will bring an integration of IT and other technologies to achieve effective control and significant increase in efficiency. Internet of things, artificial intelligence, and the self-driving car would be the core technologies that allow us to integrate and make a huge shift to the paradigm of the value chain.
Fig 1. Market growth by application type (Source: PWC, 2019)
Based on reports, the following are the sectors that would be disrupted with advancement in the production of semiconductors:
Communication: Communication sector is mostly driven by the smartphone industry which is highly saturated. However, the introduction of 5G and the increase in demand for the smartphone in emerging markets will boost the demand up to CAGR of 2.2% ².
Consumer electronics: This sector is comparably stagnant, but as to improve its connectivity throughout consumer appliances to achieve better accessibility and controllability of them: the use of semiconductor would be expected to increase and maintain with CAGR of 2.3% ².
Data processing: The emergence of cloud computing services like Amazon Web Services (AWS) or Azure from Microsoft is expanding at a fast rate and so the demand for data storage devices increased with a CAGR of 12.3% ².
Automotive: Considering the fact that traditional car in the course of production averages US$300 in value of semiconductor, while standard electrical vehicle uses more than US$1000 value of chips, automotive is expected to be the highest growth potential market. Moreover, on 7th of November 2017 Waymo, subsidiary of Alphabet, announced its plan to test their level 4 self-driving technology, which refers to a car that is able to drive itself automatically almost without human input except unmapped and severe weather conditions. By Oct 2018, the test reached 10 million miles of driving on public roads and over 7 billion simulation miles. As the feasibility of technology has been proven and if we consider the use of semiconductor, it is estimated about five times more than a partially automated vehicle ³.
Industrial: The automation rate throughout the industry steadily increase, by the year of 2030, it is estimated to be 45% in the manufacturing sector, and so it is expected to achieve a CAGR of 10.8% through 2022. On the other hand, demand for semiconductor for security is one of the fastest-growing sector at a CAGR of 17.8% ².
How are they made?
Fig 2. Production process of a semiconductor (Source: Kim, 2019)
As the industry requires highly specialized technology and heavy investment, two production models have emerged. One is an integrated device manufacturer (IDM) model which refers to a company dealing with both design and manufacturing like Samsung and Intel. On the other hand, there is the fabless-foundry model, which refers to achieving specialization by segregation of production process. The First stage of production starts from designing the chip by Fabless company and afterwards foundry firm fabricates the chips accordingly to the design which Fabless companies ask for and lastly all the production stage is finalized by Outsourced Semiconductor Assembly and Test (OSAT) firms. The OSAT firm deals with packaging and testing process which involves enclosing and testing of fabricated integrated circuit before the chips are assembled into electronic gadgets. As the difficulty of each production process intensifies, it is more competitive to specialize in one sector for a firm. As a result, many different firms interrelated in this sophisticated global supply chain, and exceptionally, U.S. companies, are involving every sector of the value chain ⁴
The Characteristics of industry
Fig 3. 2018 Semiconductor Market Share in different sector (Source: SemiconTaiwan, Trend Force)
Fig 4. Number of leading-edge chip manufacturing firms (Source: Economist)
Figure 3 shows that each sector of the industry is generally dominated by one or two companies with a market share of 60 to 80 percent. The reason being, highly consolidated market consists of one existing dominant player building a wall of patents in a specific field. Meanwhile, competitors who join the market later would bear significant disadvantages by paying fees for using the intellectual property, else risk starting from ground zero. Knowing that developing a new chip takes large amount of funds and time, it might be wiser for new entrants to choose the former. Additionally, the uncertainty of newly developed chip’s performance being poorer than the existing ones may result in most companies opting not to invest in such risky business. Moreover, in terms of fabrication, if a company holds a better technology than others, it results in better performance of chips as well as the better cost efficiency of production, as evident in Figure 4, showing the remaining 5 leading-edge chip manufacturing firms that have survived ⁵.
U.S. VS China
In May 2015, Made in China 2025 was issued by Li Keqiang and his cabinet showing its ambition to become a leading manufacturing nation. The main strategy of this plan is to gradually increase localization of core materials which are substantial for maintaining the value chain that would be created in the course of the 4th industrial revolution. [From 2020(40%) to 2025(70%)] ⁶
Fig 5. Global Regional Semiconductor Consumption market by Region (Source: PWC)
Figure 5 shows that China is consuming more than half of the world’s semiconductor production. However, Figure 6 shows there is a significant gap between export and import of semiconductor. In 2018, China imported nearly worth of US$300 billion dollars. Home-made chips can only supply less than 20% of domestic consumption ⁷. The significant dependence on foreign supply might be a great threat to China’s economic development.
Fig 6. Comparison of China’s Import and Export of semiconductor
So, the Chinese leadership came up with an ambitious plan to maintain a safe pipeline of supplying demanding semiconductor, and this has initiated with massive investment on Local (Chinese) companies like Fujian Jinhua IC, SMIC, Tsinghua Memory Technologies, and Yangtze Memory Technologies by a total worth of US$ 118 billion ⁸. The initial plan of Chinese leadership was meeting the demand for memory chips like Drams and Nan-flash memories, which are relatively simple to develop, so it would take less time to reach the stage of mass production than non-memory chips. Moreover, the memory sector is also the most number used semiconductor in the local market recently. However, in Oct 2018, with the allegation of stealing intellectual property from U.S. Micron Technology, U.S. banned exporting of core manufacturing software and equipment which are made from companies like Applied Materials, Lam Research, and KLA-Tencor. As a result, Fujian Jinhua IC has fully stopped the ambitious attempt of developing Dram ⁹.
On 16 April 2018, as a part of the sanction, ZTE, the second-largest telecommunication equipment maker in China, was banned buying the core components from U.S. tech companies which the company was greatly relied on by U.S. government. As an impact of sanction, the stock price of ZTE went down from 31.31 CNY (April 16) to 13.04 CNY (June 6) ¹⁰. Moreover, the largest smartphone maker in China, Huawei was also banned to trade with U.S. tech firms, so the core components including software like Android as well as chips from Qualcomm. Addition to all those sanctions, banning the use of ARM architecture which is the very fundamental design of most of the smartphone AP including Kirin series which is developed by HiSilicon, one of the subsidiaries of Huawei, brought the deadliest impact to Huawei 11.
Fig 7. Cross-border semiconductor M&As by Chinese companies (Source: Nikkei Asian Review)
As an extension to the sanction, U.S. government restricted Chinese funds to flow in M&A market of U.S. tech firms, so as you can see from the Figure 7 the M&A deal value has been shrunk from US$4.1 billion (2016) to US$0.8 billion (2017) ⁶.
Without a doubt, semiconductor industry would be the fundamental of future value chain during the 4th industrial revolution but both its minimal domestic production and rapid growth rate of domestic consumption built a huge gap between the amount of production and consumption. To deal with this problem, raising its self-sufficient ratio was the main priority of Made in China 2025. As described in the previous section, the semiconductor industry is different from other industries. In the past, China used to nurture their domestic firms by investing in massive capital with less interest and by giving them subsidies to win the price competition against foreign companies. The strategy worked effectively in industries like secondary battery, display, and shipbuilding. However, in terms of semiconductor industry, Current standard which involves ultrafine manufacturing process that requires a great degree of precision and complexity intensifies the difficulty to reach at the competitive level of mass production Moreover, the myriad of patents of companies that have already taken control of the market across the industry heighten the entry barrier to the Chinese firms. In order to minimize the impact of U.S. sanction, China calls for cooperation to those countries like Taiwan and Korea that are significantly dependent on trade with them. However, this effort would never be an ultimate solution to resolve the fundamental problem because even Taiwanese and Korean companies significantly dependent on patents and equipment from U.S. companies. In conclusion, accomplishing the plan to raise domestic production capacity to 70% by 2025 seems almost impossible without the cooperation of U.S, so to achieve the quantitative and qualitative levels of growth desired by the Chinese leadership, cooperation with the U.S. is an indispensable option.
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