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CHIP INDUSTRY MOVING TO ASIADespite the recent strong rally in semiconductor stocks, some pundits continue to predict the

demise of the technology industry as it has been known for the past half-decade. The good news is that many managers in the technology sector generally, and the semiconductor industry in particular, sees demand for chips picking up in the first half of 2003. Such demand is driven mostly by consumer products rather than sales of personal computers (PCs), and thus tracks a recovering economy. The bad news is that the manufacturing capacity needed to make the latest types of microprocessors, including memory chips and processors for PCs and other products, is rapidly moving to Asia. The leading provider of tools and materials for chip makers, Applied Materials Inc. (AMAT), now gets more than half of its business from Asia, including Taiwan (27 percent), Japan (14 percent). South Asia and China (12 percent) and Korea (9 percent). This compares to 26 percent for North America and 12 percent for Europe. The geographic distribution of AMAT's business shows that the continuing drop in the number of working "fabs" (fabricating plants) in the United States and Europe is forcing the entire semiconductor industry, including the producers of the chemicals and other inputs required for chip manufacture, to focus investment on China and other Asian venues. Whereas only one-third of all chip wafers are started in Asian labs today, that figure is expected to increase to more than 50 percent by 2005. Some analysts worry that the meat of the global semiconductor industry's whole production capacity gradually is moving to Asia, particularly mainland China. Others are more concerned that, as in the market for memory chips, too much new capacity is being built by growth-hungry Asian nations, suggesting that chips are set for another round of price wars, hurting the profitability of the entire industry. Both sets of concerns may be well-founded. Korea, for example, now holds half the global market for memory chips and steadily has increased output even as prices have fallen well below cost. The U.S. company Micron Technology recently won a U.S.-government trade investigation of Korean-government support for bankrupt chip maker Hynix. Dell Computer Corp. has announced that it soon will begin to market a generic "white-box" PC to be sold under labels of retailers worldwide. Working in partnership with Taiwan- and China-based suppliers, the U.S. PC maker is setting the pace in the PC market in terms of price competition. But one wonders if the same partners that today help Dell make the world's cheapest PCs will turn on Dell tomorrow and offer their own cut-price PCs. When somebody says that China is going to dominate the semiconductor industry of the future, they usually refer to Taiwan's giant contract chip manufacturers, or "foundries," rather than locally owned companies on China's mainland. Taiwanese chip manufacturers such as Taiwan Semiconductor Manufacturing Corp. (TSMC) and United Semiconductor Manufacturing already control half of the world's contract chip manufacturing. Contract manufacturers are expected to account for 50 percent of all chip production by 2010, according to the Far Eastern Economic Review; but all of these manufacturers depend on U.S. technology and some are hurting badly in the current slump. There clearly is a lot of new investment activity in China's semiconductor sector, but these investments vary as to the level of sophistication in fabrication. The type of chips made and

the size of the silicon wafers used to make the computer chips are what differentiate a leading producer of state-of-the-art chips from plants that make commodity chips for telecommunications or other applications. Yet the fact of China's large and growing market for all kinds of semiconductors is an important factor in the semiconductor marketplace. Low-cost labor, nonexistent environmental laws, lavish tax breaks, proximity to the largest and fastest-growing markets in the world and other incentives offer compelling reasons to locate chip-production capacity in China or nearby, especially for the less-expensive commodity devices. States such as California, Connecticut, Texas and New Hampshire that traditionally competed to attract new technology companies now face competition from purpose-built Chinese "cities" designed to house foreign firms and their workers. As a result, existing chip-making plants in the United States and Europe are being purchased, moved and reassembled in China, resulting in a net shift of production capacity out of the U.S. and Europe to Asia. It is no exaggeration to say that all of the major global players in the semiconductor industry are moving relatively modern (albeit not state-of-the-art) fabs, tool-production and materials facilities to China, both to address that growing market and to lower production costs. True, the most modern chip-making plants and tool-development facilities remain in the United States, Taiwan and Europe (in that order of technological sophistication) but, over the long term, the biggest part of the semiconductor industry's productive capacity in Asia will end up in China. As one industry veteran notes: "Chinese chip plants are half the cost of anywhere else in the world." Pay Shin King, a native of China and cofounder of a semiconductor software firm, says that the mainland Chinese are going to buy primarily used, but still capable, equipment rather than trying to acquire the leading technology. He sees Chinese firms concentrating on 1-micron or 0.5-micron devices, while foreign-owned firms pursue smaller, more costly, manufacturing processes. "China's companies really cannot afford to play directly in the high-end semiconductor industry," says King. "The big Taiwanese foundries will dominate new technology, but they will locate many new facilities in the mainland and produce large volumes of relatively lowtech chips. The leading producers will put some facilities in China, but they will always diversify the geographic location of production capacity around the region because of earthquakes and other risks." "A real 300 mm fab costs you $2 billion to complete," says James McKibben, head of sales for Tegal Corp., a manufacturer of plasma-etch systems used for making chips. "Only the top 10 players in the world can afford such investments." He recalls that the transition from 6inch to 8-inch (200 mm) silicon wafers was very difficult as well, with a lot of cost upfront to perfect the production process and chemistry. McKibben says that the huge cost reductions available in Asia, starting with Singapore and Malaysia, and now in China, are what is driving foreign chip manufacturers to move new and existing facilities to Asia. McKibben notes that China offers aggressive terms to foreign technology companies that locate there, including no mandatory local "joint-venture" partner, free electricity and water, long tax holidays and virtually free labor. He reckons that foreign companies may be able to repatriate upward of 80 percent of local profits after paying the requisite local taxes and "fees" McKibben also cautions that the Chinese officials now courting foreign equipment firms clearly want part of the local output exported, illustrating China's long-held goal of

building wealth by encouraging the production of manufactured goods and a new export market for China. "They will start with the simple chips, any products where they can add value and earn a return and build a foothold in the domestic market," says McKibben, who confirms that China provides numerous subsidies for local chip startups and encourages exports through free-trade zones. The most advanced plant in China today is a 0.35-micron fab built by NEC of Japan near the city of Shanghai, says McKibben. By comparison, Taiwanese manufacturers are struggling to keep up with the likes of IBM and Intel by moving to 0.11micron technologies for 300-mm production lines. He reports a steady flow of Chinese government officials visiting Tegal and other U.S. semiequipment companies to cajole them into building new facilities in China. Even with China's price advantage, though, there is an interesting trend favoring U.S. chip manufacturers. IBM, for example, has created the most advanced chip fab in the world less than 100 miles from Manhattan. No longer content to sell its advanced chip-making technology to the Asian foundries, IBM and other U.S. technology giants seem to be keeping their best technology away from the Asian foundries. Indeed, IBM now plans to expand its own foundry model to compete with the likes of TSMC, in part by withholding technology from its Asian competitors. Using 300-mm wafers and revolutionary copper technology, IBM's cost per chip at its East Fishkill, N.Y., fab reportedly will be 20 percent to 30 percent below that of the Asian competition. The reasons for the cost reduction? There are virtually no people inside the facility compared with dozens of operators for existing 200-mm labs around the world. Despite massive lobbying by the Chinese government, Intel Corp. confirmed earlier this year that it will not build advanced chip-making lines in China. A May meeting between Chinese Vice President Hu Jintao and Intel chief executive Craig Barrett appears to have done little to convince the U.S. chip maker to change its position on building fabrication plants in mainland China, according to the South China Morning Post. Intel hosts a continuous procession of delegations from China, often at Ming's restaurant in Palo Alto, Calif., but the U.S. technology leader has not budged on its refusal to build labs on the mainland. The long-term trend in the semiconductor-equipment industry implies a large-scale shift in production capacity to Asian venues such as Taiwan, China and Singapore. Today, with only one out of five chips sold in China made locally, the priority for China is to meet domestic needs. But longer term, there seems no doubt that China means to become a high-volume exporter of computer chips of all types, even if technology leadership remains in the United States and Taiwan. Makers such as IBM, Samsung and STMicro in Europe will lead the way in terms of chip design and manufacturing technology, but the volume capacity needed to make the generic semiconductors required for consumer products and other, even military, applications, increasingly resides in Asia. In the short run, the changes are relatively subtle and hard to notice, but the long-term outlook is for a permanent shift in production capacity to Asia and for lower prices for all chips as new capacity comes on line. The global leaders in the semiconductor industry will benefit from the growing demand for chips in Asia, but within a decade most new chipmaking capacity in the world will be commodity manufacturers of indeterminate brand located somewhere in Asia. A growing part of that expansion will be located in China. Factors fuelling semiconductor manufacturing growth

The Indian government offers several Incentives to global semiconductor companies to set up chip manufacturing plants in the country. Factors Fuelling Growth Chip manufacturing is receiving a fillip as various electronics manufacturing services (EMS) providers and mobile phone equipment manufacturers, such as Samsung, Motorola and Nokia, are setting up their plants in India. For example, according to a Gartner report, by 2011, 10 per cent to 20 per cent of mobile phone production in India is likely to be for the export market. There is potential for chip manufacturing companies to partner with EMS players and leverage this opportunity. The government has announced various tax Incentives for companies that are starting chip manufacturing operations in the country. The government has set up Fab City at Hyderabad in Andhra Pradesh; the city is expected to attract investments worth US$ 15.77 billion. Chip production moving to China: low costs and an expanding market increasingly are attracting the U.S. and European microchip makers to China, causing a shift in production capacity to the East

Semiconductor manufacturing in India The Increasing spend on electronics products in India offers a large opportunity to global semiconductor companies to set up manufacturing plants in the country. The Indian government has set up Fab City in Hyderabad, which houses 10 manufacturing plants and is expected to create 1.4 million jobs by 2016 in over 200 ancillary industries. It is estimated that approximately seven to eight solar photovoltaic (SPV) units will be set up in India at an investment of US$ 5 billion to US$ 6 billion. The number of solar chip fabrication units in India is expected to surpass the number of semiconductor chip fabrication units in the next few years. Currently, there are no operational wafer fabrication units in the country and semiconductor manufacturing is limited to three government companies (Bharat Electronics Ltd, Society for Integrated Circuit Technology and Applied Research, and Semi-Conductor Laboratory).
Returning Indians The Indian community has carved a nich for itself with the appointment of Indians as CEOs of global companies in the semiconductor market. Moreover, a large number of Indians, who had moved abroad, have gained exposure to the global electronics and semiconductor market. With growing

opportunities in India, they are now returning, which is leading to the countrys industry being led by the best-known people in their field

Semiconductor sector: Advantage IndiaOutsourcing Integrated device manufacturers (IDMs) have either set up captive centres or opted for outsourcing to third-party design houses in India over the last seven years. This trend, started by Texas Instruments, has led to most manufacturers setting up base in India or outsourcing to third parties such as Wipro, HCL and MindTree. Software strength The Increasing complexity and intelligence levels of electronic design systems have led to an Incremental complexity in the software that is used for such systems. Software plays a crucial role in complex computing, communication devices, consumer appliances and control systems. Indias strength in application software has extended into embedded software, which makes it a better investment option.

Intellectual property India is considered a safe environment for the development of IP, which plays a critical role in the protection of an innovation for the electronic design industry. The procedure for addressing the market begins with an idea followed by design and IP protection. IP protection is crucial for MNCs to source their designs from their captive centres or through third-party design houses. The fact that there have been no major breaches of IP over the last decade is a direct consequence of the Indian legal system and the countrys IP policy. Increasing market size The growing middle-class population, reduced trade barriers and global exposure of Indians with a high GDP growth have resulted in an Increased market for electronics consumption. Therefore, Increasing affordability, along with options catering to the lower segment, has aided the growth of this market. Industry-academia collaboration India produces over 500,000 engineers every year and about 50 per cent of them are in the field of electronics or software. Keeping this in view, several public-private initiatives have been launched to enhance the level of research and talent in academic institutions. The launch of the Special Manpower Development Programme (SMDP) by the Indian government, along with the establishment of research labs and Centres of Excellence (CoE) by various MNCs in collaboration with institutions, are positive steps in this regard.

COMPARATIVE ADVANTAGEIn economics, the law of comparative advantage says that two countries (or other kinds of parties, such as individuals or firms there as) will both gain from trade if, in the absence of trade, they have different relative costs for producing the same goods. Even if one country is more efficient in the production of all goods (absolute advantage) than the other, both countries will still gain by trading with each other, as long as they have different relative efficiencies. For example, if, using machinery, a worker in one country can produce both shoes and shirts at 6 per hour, and a worker in a country with less machinery can produce either 2 shoes or 4 shirts in an hour, each country can gain from trade because their internal trade-offs between shoes and shirts are different. The less-efficient country has acomparative advantage in shirts, so it finds it more efficient to produce shirts and trade them to the more-efficient country for shoes. Without trade, its opportunity cost per shoe was 2 shirts; by trading, its cost per shoe can reduce to as low as 1 shirt depending on how much trade occurs (since the more-efficient country has a 1:1 trade-off). The more-efficient country has a comparative advantage in shoes, so it can gain in efficiency by moving some workers from shirt-production to shoeproduction and trading some shoes for shirts. Without trade, its cost to make a shirt was 1 shoe; by trading, its cost per shirt can go as low as 1/2 shoe depending on how much trade occurs. The net benefits to each country are called the gains from trade.

David Ricardo and Comparative Advantage The Theory of Comparative Advantage David Ricardo, working in the early part of the 19th century, realised that absolute advantage was a limited case of a more general theory. Consider Table 1. It can be seen that Portugal can produce both wheat and wine more cheaply than England (ie it has an absolute advantage in both commodities). What David Ricardo saw was that it could still be mutually beneficial for both countries to specialise and trade. Table 1 Country Wheat Cost Per Unit In Man Hours England Portugal 15 10 Wine Cost Per Unit In Man Hours 30 15

In Table 1, a unit of wine in England costs the same amount to produce as 2 units of wheat. Production of an extra unit of wine means foregoing production of 2 units of wheat (ie the opportunity cost of a unit of wine is 2 units of wheat). In Portugal, a unit of wine costs 1.5 units of wheat to produce (ie the opportunity cost of a unit of wine is 1.5 units of wheat in Portugal). Because relative or comparative costs differ, it will still be mutually advantageous for both countries to trade even though Portugal has an absolute advantage in both commodities.

Portugal is relatively better at producing wine than wheat: so Portugal is said to have a COMPARATIVE ADVANTAGE in the production of wine. England is relatively better at producing wheat than wine: so England is said to have a comparative advantage in the production of wheat. Table 2 shows how trade might be advantageous. Costs of production are as set out in Table 1. England is assumed to have 270 man hours available for production. Before trade takes place it produces and consumes 8 units of wheat and 5 units of wine. Portugal has fewer labour resources with 180 man hours of labour available for production. Before trade takes place it produces and consumes 9 units of wheat and 6 units of wine. Total production between the two economies is 17 units of wheat and 11 units of wine. Table 2 Production Country Before Trade Wheat England P or tu gal Total 8 9 17 Wine 5 6 11 After Trade Wheat 18 0 18 Wine 0 12 12

If both countries now specialise, Portugal producing only wine and England producing only wheat, total production is 18 units of wheat and 12 units of wine. Specialisation has enabled the world economy to increase production by 1 unit of wheat and 1 unit of wine. The simple theory of comparative advantage outlined above makes a number of important assumptions: y There are no transport costs. y Costs are constant and there are no economies of scale. y There are only two economies producing two goods. y The theory assumes that traded goods are homogeneous (ie identical). y Factors of production are assumed to be perfectly mobile. y There are no tariffs or other trade barriers. y There is perfect knowledge, so that all buyers and sellers know where the cheapest goods can be found internationally.

INDIVIDUAL CONTRIBUTION ON CASE STUDY (CHIP INDUSTRY)

SUBMITTED TOPROF. (Dr.) PREM VASHISHTA Head R and D department SHARDA UNIVERSITY

SUBMITTED BYAMBUJ SHANKHDHAR MBA- International Business Roll no. - 100251008 Group one