China's Chip Industry Will Weather Economic Downturn

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China's contract chip makers, battered by a sharp downturn in demand for semiconductors, will survive the recession and become increasingly competitive over time, according to an Accenture executive.

"There is still some reduction in total orders and cleaning out of capacity commitments but, at least from what I've heard from my clients, overall they do see that stabilization beginning and I think you will see that China is still a play," said Scott Grant, global semiconductor lead at Accenture and author of a recent study on how chip makers should adapt their operations to survive the recession.

Contract chip makers, known as foundries, produce chips under contract for companies that design and sell chips but don't own the multi-billion-dollar plants needed to make them.

In recent years, Chinese foundries like Semiconductor Manufacturing International Corp. (SMIC) carved out a niche for themselves providing access to second- and third-generation chip technologies instead of the cutting-edge technologies offered by larger rivals, such as Taiwan Semiconductor Manufacturing Co. (TSMC).

Generous government support helped Chinese chip makers survive and expand their manufacturing capacity in recent years, despite posting heavy financial losses.

The financial downturn has made the financial pressures worse. SMIC, China's largest chip maker, saw its first-quarter revenue fall by 50 percent. Its gross margin during the period was -88.3 percent, which means every US$1 of products that it sold cost $1.88 to produce, excluding other costs such as sales, general administration and R&D expenses. This was the eighth consecutive quarter that SMIC posted a loss.

"On the foundries, margins have always been challenging. It's compounded now as the demand signal is unclear, so there's not a good read as to what they can do with their total capacity," Grant said, adding that the current margin and cost pressure these companies face are a concern.

As demand stabilizes and Chinese chip makers gain more visibility into future demand patterns, they will be able to manage their costs and capacity allocation better, he said. But it remains to be seen whether or not China's chip industry will see the level of investment in new plants that has been seen in recent years.

"Will there be as much investment in new capacity in China? I'm not certain, but I think you'll see the continued maturing of their foundry and assembly-test facilities and they'll become considerably competitive," Grant said.

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