Feeding China's Insatiable Hunger for Chips

Its manufacturers are thriving amidst a soft global market

Chip factories in the U.S., Europe, and much of Asia are struggling to recover from their worst year ever. Yet in the Chinese coastal city of Wuxi, the production lines at Central Semiconductor Manufacturing Corp.'s factory are working overtime. The chips coming off the lines at the state-backed plant may not be cutting edge, but they're in high demand by Chinese makers of calculators, clocks, and other low-tech gadgets. And the plant's Taiwanese managers are confident they'll be just as successful when they start making more complex chips for fancier consumer electronics.

CSMC is part of fast-growing swath of semiconductor plants, stretching from Beijing in the north to Shenzhen in the south. The expansion has been fueled by China's insatiable domestic demand and by the central government's push for new fabrication plants, or fabs--complete with tax breaks and cheap land. "China is the place to go," raves CSMC President Robert N. Lee.

In Shanghai alone, companies have announced plans for about a dozen plants that, by 2005, will be capable of processing a half-million wafers a month. They're attracting new partners like Toshiba (TOSBF ) and Singapore's Chartered Semiconductor Manufacturing, while other investors such as Advanced Micro Devices (AMD ) and IBM (IBM ) are expanding their chip-assembly operations. Other big plants are in the works in Beijing, Shenzhen, and also in western Sichuan Province.

Why binge on plants when the global industry is drowning in chips? Because in China, demand for chip-hungry gadgets--from computers to air conditioners to DVD players--continues to surge. On top of that, China is a rising exporter of wireless phones, computer peripherals, and other gear. And its exports will swell now that it belongs to the World Trade Organization. Merrill Lynch & Co. predicts China's chip market will grow upwards of 25% annually for the next four years, double the worldwide rate, to $43 billion.

For China, all of this activity is a big boon. Currently, the country buys 90% of its semiconductors offshore. If it can reduce imports to 70%, its chip output will surge to $13 billion in 2005, from $1.2 billion in 2000. "This place will be one of the biggest integrated-circuit manufacturing centers in the world," predicts Nava Tsai, president of Grace Semiconductor Manufacturing Corp., a Shanghai venture that's building a $1.6 billion plant.

Rapid growth comes with risks. China could repeat the mistakes of Taiwan and South Korea, which overinvested in wafer fabs in the 1990s. Still, long-term economics should favor Beijing's gambit. For one thing, foreign electronics giants such as Motorola (MOT ), Nokia (NOK ), and Samsung (SSNLF ) are rapidly shifting manufacturing to China, and will need semiconductors for all their phones and other gizmos. "If you are building your phones over there, why not buy your chips there?" asks Peter Tsao, a Deutsche Bank investment banker in Hong Kong. True, some of these foreign giants may wish to source chips outside--and that will get easier to do after 2005, when China is obliged to lift import tariffs on most info-tech products. By the same token, though, it will become easier for China-based chipmakers to import advanced production gear and materials they will need to compete.

U.S. export laws are another possible roadblock. A relic of the Cold War, these codes could prevent Chinese entities from buying certain leading-edge American semiconductor technology. For now, though, they don't need to. Because the biggest demand for chips in China is in lagging-edge technologies, its chip companies can make money using yesterday's production facilities. Local plants can readily make chips used in low-end consumer electronics, says Richard R. Chang, CEO of Semiconductor Manufacturing International Corp. Over time, as circumstances change, they can migrate to the cutting edge.

Western partners could play a big role in that migration. Motorola is building a fab in the northern city of Tianjin. Phoenix-based On Semiconductor is investing in one in Sichuan province. And Philips (PHG ) and Nortel (NT ) have stakes in Shanghai's Advanced Semiconductor Manufacturing Corp. (ASX ) These companies want to get in on the ground floor--and who can blame them? China has already transformed global industries from apparel to consumer electronics. By all indications, semiconductors will be next.

By Bruce Einhorn in Wuxi, with Amy Borrus in Washington

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