Huawei should not be forced to make its own semiconductors

Huawei Technologies began building backup systems to prepare for potential U.S. sanctions decades ago. One thing it did not do was build its own fab, otherwise known as a semiconductor fabrication plant or foundry.

This has turned out to be a devastating mistake. After tightening U.S. restrictions cut Huawei off from third-party fabs last May, the Chinese telecommunication giant’s smartphone shipments could drop more than 60% this year, while its industry-leading chip design unit HiSilicon has quickly fallen behind its rivals. HiSilicon shipments fell 88% during the first quarter of 2021.

There are many reasons why Huawei did not build its own fab

Firstly, the company grossly underestimated the rigor of U.S. actions blocking Huawei’s access to advanced tech. For example, changing the de minimis thresholds — which specify which goods are subject to U.S. duties — from equipment containing more than 25% U.S.-made technology to equipment containing any U.S. technology.

The actions also vastly broadened the range of products inaccessible to Huawei, leading Huawei to lose the ability to contract third-party manufacturers such as Taiwan Semiconductor Manufacturing Co. (TSMC) to produce the advanced chips it needed.

Moreover, in the heyday of its successful growth, it made little economic sense for Huawei to build its own fabrication plant. In 2010, Huawei made $3.6 billion net profit on revenues of $28 billion.

That year, TSMC’s regular R&D budget was nearly $1 billion and its capital expenditures were nearly $6 billion. Huawei’s scale was not enough to support the massive capital expenditure and research costs associated with advanced chip manufacturing. When Samsung Electronics entered the fab business in the 1970s, costs were far less prohibitive.

The most fundamental reason that Huawei never entered the chipmaking business was that Huawei was simply acting logically as a commercial entity in accordance with industry trends. The period between 1991, when Huawei started developing semiconductors for its telecommunication products, to the late 2010s, when trends reversed, saw a major industry transition.

Huawei was simply acting logically as a commercial entity in accordance with industry trends.

During these two decades, the idea of having separate fabs tasked to make chips for chip design companies became mainstream after initially being rejected. When HiSilicon was established in 2004 as a fabless entity, Huawei could not have foreseen how it would one day become the biggest victim to what was then an industry norm.

In fact, this can be extended to other Chinese tech arenas. Why did not China build its own computer operating system? Why did not China make its own advanced machine tools or lithography machines?

While there were external factors such as a Western tech blockade, the basic reality is that China’s tech development was essentially a factor of China being integrated into the global supply chain. The mainstream thinking in China was that after initially serving as an assembly center and manufacturer of low-end products, the country would slowly move up the value chain.

In semiconductors, for instance, China first established itself as a center for testing and packaging, the most labor-intensive but least value-added segment in the semiconductor supply chain. After the turn of the century, Beijing initiated policies to promote chip design and chip manufacturing in a bid to climb up to higher value-added segments.

The policies were designed on the premise of globalized supply chains. Beijing gave more support for fabless companies, which were categorized as software companies and enjoyed more comprehensive policy incentives such as preferential interest rates and funding for training.

In addition, the policy offered import tax incentives for imported chips manufactured by foreign fabs but designed by domestic companies when such chips could not be made by domestic Chinese companies.

In other words, Chinese policies reinforced the globalized supply chain by further bundling Chinese chip designers with foreign chip manufacturers. The indirect outcome was that it created an almost impossible market environment for Chinese fabs to advance technologically because their most likely clients — Chinese chip designers — were incentivized to contract out to foreign fabs.

In parallel, the adoption of the globalized supply chains led to the dominant position of Chinese makers of things like televisions, air conditioners, refrigerators, computers and telephones, but also led to deeply bundled companies that are reliant on imported parts.

In hindsight, Chinese tech companies did not focus on self-development as much as they should have during more benign times when they could have built domestic substitutes. Despite Chinese corporations’ R&D expenditures growing by 119 times from 1995 to 2019, China is still today heavily reliant on foreign tech, from semiconductors to medical equipment.

As the wisdom of the globalized supply chains is being questioned around the world, China’s tech sector, particularly Huawei, has learned its lesson the hard way.

But nations should try to limit the damage to our global supply chains all in the name of national security. If China tech’s rise rested on global supply chains, their breakdown would hurt everyone. Huawei did not build its own fab, and it should not be required to do so. Other companies should be spared Huawei’s predicament.

Author: Nina Xiang, Nikkei Asia