China watch: Opportunity works both ways - Comment

Electronic News, Feb 25, 2002 by Lin Sun

WHILE THE WORLD semiconductor industry is in deep recession, companies turn their attention to offsetting high production costs. They also seek out markets with huge demand for a wide range of IC products, from cell phones to PCs and consumer electronics. In short, they turn their attention to China.

Since 2000, the international IC industry has made a strategic shift to relocate production and even R&D to China. Heavyweights like Taiwan Semiconductor Manufacturing Co. Ltd., Intel, Philips, Toshiba and others led the way.

Much of the semiconductor industry's interest is in Shanghai's Zhangjiang High-Tech Park, which is emerging as a virtual center for the industry in China. The park is located in the center of Pudong New Zone, and has recruited more than 60 IC-related companies, including Semiconductor Manufacturing International Corp. (SMIC), a Taiwan-based wholly-owned chipmaker and the only company in China capable of producing 0.25-micron or lower chips. Recently SMIC secured a loan for $480 million from Chinese banks to expand its 8-inch wafer production.

As more foreign companies go to China to open production or sales, potential risks will arise, as they will inevitably be competing with companies like SMIC and Chinese government-owned chipmakers.

Historically, foreign investment in China presents a mixed picture: a large number of companies invested heavily in a market they were unfamiliar with, many driven by the flocking mentality that "if everybody does it I must be there, too." They did not take the time for careful analysis of market conditions, regulations and the partnerships that might be only relevant to them. As a result, many failed miserably and could not retrieve their investment due to lack of legal protection and government interference.

In many respects, China does present an attractive opportunity, especially for innocent company executives after a few trips. Cities like Shanghai can easily make one's heart pound and one's mind jump to conclusions. However, attraction of a country's appearance does not mean a company can succeed in that market, with its complicated and tricky rules in business conduct, like how to set up a wholly owned, joint venture, or a technology transfer. Companies must be prepared for headaches in deciphering government regulations and overcoming differences in operations and management styles before making a commitment to long-term investment.

The other consideration is demand. Think twice about setting up a production facility in China to increase sales in that market. While it is true that currently the market is growing rapidly and demand for IC products seems to be great, the reality can change quickly as many Chinese chipmakers are also trying hard to get their fair share. Recently the Chinese government launched several key projects, and ultra large-scale IC development is among the top. Try too to avoid linear extrapolation, where demand is calculated based on either population or what happened in the past. If an investment decision is based on either of them, it could go awry, because it usually takes two or three years to straighten out operations in China. By then, the market conditions may already have slipped away.

Unfortunately there is no quick solution to this problem, because each company has different objectives, investment scales and product lines. The best way to maximize a venture in China while reducing potential risk is to find a really good partner and develop a strategic relationship with the company. The term strategic entails that both parties must be very clear in the very beginning about potential risks, and include a mechanism to protect each company's interest in case of failure or withdrawal. This requires establishing binding responsibilities and constant "check-and-fix." Empty promises won't cut it.

Lin Sun is president of ChinaNex.com, a professional web service for China's IT industry.