China's in the Chips

Semiconductor design finding its way into China, but the transition won't wipe out US jobs... yet

December 11, 2003

4 Min Read
China's in the Chips

PALO ALTO, Calif. -- China is already established as a chips manufacturer, and it's eyeing design and R&D as well. How soon before the country becomes a giant in the semiconductor industry?

It's happening, albeit slowly, said panelists examining the China question here at the MicroVentures 2003 conference yesterday. It might take a decade or more for U.S. and European jobs to see a significant drain, but China, with its lower cost of living and growing talent pool, is becoming a key outsourcing destination as well as a home for its own semiconductor startups.

"I'm actually encouraging public companies to start moving infrastructure over to China," says Drew Peck, a Crimson Ventures partner who spent years watching the chip industry as a financial analyst.

Panelists say the flight to China won't happen overnight. Despite its growth, China represents a sliver of the semiconductor industry; the country will build $1.2 billion worth of chips this year but will import $20 billion worth, estimates William McClean, president of research firm IC Insights. And manufacturing is China's primary entrée into chips; McLean believes it may be 10 or 15 years before U.S. companies are willing to outsource most of their engineering to China.

"The handwriting is on the wall" for U.S. chip engineering, Peck says. "There is not a lot of technology that is clearly defensible in the U.S."

Others agree, especially when it comes to the offshoring of U.S. jobs. The current Light Reading poll, Offshoring, shows 88 percent of respondents so far expect that trend to continue even as the economy recovers. Seventy percent of respondents believe it's going to benefit companies in the short run, but roughly half think the trend won't help the high-tech industry or the U.S. economy in the long run.

Engineering work is being outsourced to India as well, but China has an extra wrinkle: Most companies want to sell products there. And the Chinese market demands prices so low that the chips just about have to be designed overseas.

"If you have a U.S. cost and China pricing, you're in trouble," says Lip-Bu Tan, chairman of Walden International Investment Group. He noted that he's talked to a company that needed less than $1 million to crank out two or three chips; most North American startups take at least ten times that to produce just one.

Then there's the tax question. Devices "built" in China get a value-added tax of 6 percent or less, compared with 17 percent for imports, says Brent Carlson, senior consultant with Deloitte & Touche LLP. That's encouraging chip companies to put test and assembly plants in China, which is enough to dodge the higher tax.

Meanwhile, China's own semiconductor industry is moving into gear as Chinese engineers move back home after living the startup life in the United States.

"There's a massive repatriation of engineers over there who understand the market," McClean notes. Peck adds that he's hearing every week from teams who have worked in the U.S. and would like to start companies back home in China.

None of this means the U.S. chip industry is doomed. For one thing, China isn't good at everything yet. Radio frequency (RF) and analog engineering remain more North American specialties, Peck says, although China will eventually catch up in those areas.

And it's not naive to think that new pockets of innovation could keep North American engineers working. After all, the chip industry has lost its thunder before. Japan in the 1980s drove most U.S. firms out of the dynamic random-access memory (DRAM) business, and Korea similarly usurped Japan in the 1990s.

Moreover, outsourcing to China is kept in check by skittishness over intellectual property protection. China drafted new laws to meet World Trade Organization requirements, but it remains difficult to pursue a patent infringement case in that country, panelists agreed. "You've got a real fight on your hands compared to taking them to court in Europe or the U.S.," McClean said.

Language remains a barrier as well. "You do have to know the ways. I saw a survey of electronics manufacturers and 30 percent said the toughest issue facing them were linguistic and cultural differences," said Deloitte & Touche's Carlson.

Some 40 percent of the Light Reading poll respondents say intellectual property concerns will kill the outsourcing trend, and 20 percent feel the same about language differences.

— Craig Matsumoto, Senior Editor, Light Reading

The Light Reading poll on offshoring will be open until the end of December. To vote, click here.

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