Why US sanctions on ZTE might turn out to be the best thing for China’s microchip ambitions

Case study from 18 years ago may provide lessons for Chinese telecoms company that has been denied access to US technology

PUBLISHED : Friday, 20 April, 2018, 8:02am
UPDATED : Friday, 20 April, 2018, 10:14am

Eighteen years ago a small fire in a microchip factory in the US city of Albuquerque set off a chain of events that led to the demise of one mobile phone giant and market share gains for another.

The damage from water and smoke to millions of Philips-made radio frequency microchips disrupted the supply chain for Ericsson and Nokia – both major mobile phone makers at the time.

Ericsson bungled its response to the crisis and posted huge losses, eventually exiting the mobile phone business. Nokia responded adeptly, immediately seeking alternative sources, leading to increased profits and sales until missteps years later saw its phone business sold off to Microsoft.

The incident has since been widely used as a case study in crisis management.

China’s chip makers rise in mainland trading on government support hope amid ZTE ban

How Chinese telecoms maker ZTE responds to its supply chain disruption – losing access to products from US chip makers for seven years – could largely determine if it remains a strong player or falls by the wayside. More importantly, it could be the catalyst for China to move towards its long term goal of becoming less reliant on foreign technology.

ZTE chairman Yin Yimin said in an internal memo to employees that the company has set up a crisis management team to analyse the situation and come up with solutions. The company delayed its earnings results scheduled for Thursday, saying it needs time to assess the impact of the US ban.

The ZTE crisis – self-inflicted because it flouted an embargo on US components sold to Iran and then tried to cover up the wrongdoing – comes at a time of increased trade tensions between the US and China. It is not difficult to connect the timing of the US commerce department ban on ZTE to the ongoing pressure by the Trump administration for China to open markets and stop forced technology transfers of US IP. 

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While it is likely that a compromise will be reached between the two governments, with China offering further trade concessions in return for a lifting of the ban on ZTE, the US move no doubt has Chinese officials wringing their hands over the country’s reliance on American technology.

The shock of possibly seeing one of its star state owned tech companies struggle for survival will push Beijing even harder in its efforts to reduce reliance on some US$200 billion of annual semiconductor imports, which it fears undermines national security and holds back its own technology sector. 

China’s National Integrated Circuits Industry Investment Fund, a central government subsidy programme aimed at reducing the country’s reliance on foreign microchips, wants to raise as much as 200 billion yuan (US$32 billion) in its latest round of funding. The first round of about 140 billion yuan was allocated to more than 20 companies, including ZTE.

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Much of China’s investment in the semiconductor manufacturing industry to date has been in factories (wafer fabs) to produce memory chips, and in silicon wafer foundries that manufacture chips designed by fabless companies, so named because they don’t own their own wafer fab. Each one of these factories cost several billions of US dollars, yet the devices they make are mostly seen as commodities these days. Only vertically integrated giants like Samsung Electronics have the scale to manufacture such devices profitably.

Analysts say China should be focusing its chip efforts on devices to enable artificial intelligence (AI) applications, such as neural network processors and graphics processors, as well as special-purpose reprogrammable chips of the kind made by US chip maker Lattice Semiconductor. After all, Beijing has set 2030 as the target for the country to become a global power in AI.

China has the capital and the consumer market to support its own chip industry, but the road to get there won’t be easy

There are Chinese chip makers focusing on these AI-specific products, but analysts say they are at least 10 years behind the west. These companies are also fabless operations that rely on outside wafer fabs to manufacture their chips, meaning they are vulnerable to supply chain shocks like the ones experienced by Nokia and now ZTE.

Over the past two decades China has tried everything to catch up to the US in microchips, from outright theft to forced IP transfer via joint ventures, and more recently acquisitions. However, the Trump administration has rejected two Chinese takeover bids for US chip-related companies, including one for Lattice Semiconductor, citing national security concerns.

US export ban affecting ZTE threatens China’s 5G plans

China has the capital and the consumer market to support its own chip industry, but the road to get there won’t be easy. More often than not, a crisis is the best way to achieve a breakthrough – perhaps in a new technology that could make current manufacturing methods obsolete and vault the inventor to No 1 position. 

Intel, the world’s No 2 chip maker, was so tested in the mid-1980s when a price war in memory chips saw it post huge losses, forcing staff lay-offs and factory closures. A decision made by then Intel president Andy Grove to walk away from the memory chip business and bet on a risky new product – microprocessors – paid off big time.

Keep calm and carry on, ZTE chief says in leaked memo amid US ban

Whether or not ZTE survives its current crisis, 18 years from now the company may be cited in the case studies on how China caught up with the west in microchips – or did not.

Craig Addison, a tech news editor at the South China Morning Post, has been covering Asia technology since 1992