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China is poised to dominate the market for legacy chips, and the U.S. may only have itself to blame

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China is poised to dominate the market for legacy chips, and the U.S. may only have itself to blame​

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Fortune· NurPhoto/Getty Images

Sat, Jul 6, 2024, 5:00 AM GMT+86 min read

In April, U.S. Commerce Secretary Gina Raimondo took the stage in the Belgian city of Leuven with a warning: “About 60% of all new ‘legacy chips’ coming into the market in the next handful of years will be produced by China,” she told reporters.

The U.S. and its allies are controlling China’s access to advanced chips used to power cutting-edge applications like AI. But much of the industry makes so-called mature chips, less sophisticated products that power household appliances, electric vehicles, and other everyday products.

And China—despite an increasing array of U.S. policies meant to constrain the country’s chip industry—could be set to dominate that market. Chinese chip production jumped 40% in the first quarter, according to government data. Mainland Chinese firms could be major players in the legacy chip market, behind Taiwan-based firms, and account for 33% of the market by 2027, predicts TrendForce, a market research firm.

Western officials in recent months have delivered a steady drumbeat of concerns over Chinese “overcapacity,” alleging that China uses state subsidies to help industries like electric vehicles and solar panels undercut their foreign competition.

But unlike EVs or renewable energy—industries that Beijing and private companies recognized as strategic opportunities early on—analysts suggest that China’s dominance of mature chips is instead a by-product of other policies. And they note U.S. pressure likely (and ironically) played a major role in fostering China’s potential success in legacy chips.

China’s goal is to eventually produce the advanced chips that can power AI or 5G mobile technology. Yet Washington’s export restrictions are stopping Chinese chip manufacturers from getting the tools they need. That means Chinese chip manufacturers are turning to the less advanced chips they can still produce.

“They have to start somewhere,” says Chim Lee, a senior Asia analyst at the Economist Intelligence Unit. “You have to start with the mature nodes … then scale up the market gradually.”

Why is China investing in legacy chips?

Legacy chips, also referred to as mature chips or mature nodes, are less advanced semiconductors used in a wide array of electronic devices, ranging from household appliances to electric vehicles. U.S. export controls define legacy chips as those larger than the “16- to 14-nanometer” generation. Chips of that size are slightly more than a decade old. By comparison, TSMC, the world’s leading contract chip manufacturer, is set to mass produce two-nanometer chips meant for high-end electronics like Apple’s smartphones or Nvidia’s processors next year.

Linghao Bao, a senior analyst at consulting firm Trivium China, suggests China’s increasing legacy chip production is a by-product of Beijing’s support for “sectors that are strategic for China.”

“They’re trying to secure their industrial supply chain,” he says.

China invested heavily in industries like clean energy and electric vehicles in a bid to become a world leader in those sectors. These industries require semiconductors, but not the most advanced ones used in high-end consumer electronics and AI.

Chinese chip manufacturers are starting operations at 18 projects this year, according to U.S. trade group SEMI.

These incoming projects will almost certainly focus on mature chip production. Export controls from the U.S. and its allies bar companies like ASML from selling their most advanced chipmaking tools to China.

Yet sanctions (for now) don’t prevent Chinese companies from buying some older equipment. In fact, Chinese chip companies hoovered up chipmaking machinery last year, owing to fears that the U.S. can tighten the screws even further, explains Marco Mezger, chief operating officer of Neumonda, a European memory component firm.

Those worries may not be unfounded. Bloomberg in January, quoting unnamed sources, reported that ASML canceled some shipments bound for China late last year amid political pressure.

“The primary goal is to replace American equipment” in the chip supply chain, Bao says.

What is China’s semiconductor policy?

Still, Beijing has strong opinions on where Chinese companies should get their chips from.

In May, China unveiled a $47.5 billion fund to further bolster the local semiconductor industry. The “Big Fund III” (as it’s colloquially called) is almost as large as Beijing’s previous two chip funds combined.

The Big Fund hopes to wean China’s chip industry off foreign technology, and Beijing has had mixed success. While these programs led to some chip champions like Semiconductor Manufacturing International Corp. (SMIC), it also led to some high-profile corporate failures and corruption scandals.

Beijing is also reportedly telling Chinese companies to stop using foreign-made chips in their products, which could close off access to foreign chipmakers. Beijing could leverage its vast EV market as well to promote local chips to the “detriment of European and Japanese suppliers,” according to a nonpublic European Commission report uncovered by Bloomberg.

What happens next?

Non-Chinese companies may struggle to compete with Chinese legacy chip manufacturers. Chinese companies still lag the best legacy chip manufacturers when it comes to technological prowess, but “in terms of price, local competitors are already there,” Lee from the EIU notes.

The threat of “oversupply” has led some companies to worry about price wars, as foundries become desperate for customers. And some in the U.S. want controls to go even further to limit the use of Chinese chips.

But new sanctions on mature chips could be a step too far for U.S. allies, who still sell to China’s chip industry.

Netherlands-based ASML, in spite of U.S. controls, still shipped one chipmaking machine a day to China last year, according to Mezger. ASML’s sales to China surged last year, and the Chinese market was the second-biggest for the Dutch firm, making up a quarter of its 2023 sales.

Japan, another U.S. ally that’s joined on to its chip controls, also exports chipmaking tools to China. Both Tokyo Electron and Canon, which both make less advanced chipmaking tools, expect China to contribute 40% of their sales this year.

In the meantime, governments like that of the U.S. are also enticing chip manufacturers to invest in local manufacturing. Earlier this year, the Biden administration allotted $1.5 billion in CHIPS Act money to GlobalFoundries, in part to expand its production of mature chips.

Mezger isn’t convinced these programs will be enough to make onshore legacy chip manufacturing sustainable. Margins are already low in the mature chip space—and Chinese competition will reduce those margins even further. Without subsidies, other regions won’t be as economically competitive as China, he says.

“This will end in tears,” he notes. “No company can just run on subsidies.”

 
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