China chip fever laid bare

CNN's Kristie Lu Stout

HONG KONG, China (CNN) -- With promises of lower costs and a massive market, China is widely heralded as an emerging chip making giant.

The sector is abuzz with two new start-up foundries in Shanghai planning to kickstart mass chip production in the Mainland -- Semiconductor Manufacturing International Corp. (SMIC) and Grace Semiconductor Manufacturing Corp. (GSMC).

But does China have what it takes to tackle South Korea, Singapore or Taiwan?

"It's too early to tell," said William Dong, a Taiwan-based chip analyst at UBS Warburg. "But I don't quite see China displacing other countries."

"Obviously the newcomers have a shorter period of time, they learn from the mistakes of others and so on," said Craig Addison, a columnist for Semiconductor Magazine.

"But I still think China has a lot of problems that will hinder the growth and development of the chip production industry."

Chip-hungry market

Microchips store computer memory or provide circuitry for microprocessors, and are cut to size from silicon wafers.

Both SMIC and GSMC believe their chip making strength lies in tapping China's low cost production base and being close to a huge home market for chip-hungry gadgets.

China is the world's largest market for cell phones and, according to research firm IDC, is expected to become the world's largest PC market by 2003.

The Chinese government is also offering tax incentives to support the chip industry.

Perhaps the most notable sign of the government's endorsement of the sector is that Jiang Mianheng, son of Chinese president Jiang Zemin, is a key backer of GSMC.

But official support and market might may not be enough to turn China into a chip-making powerhouse.

"A wafer fab (fabrication plant) is something very complex and a difficult business to run and operate," said Addison.

"And once it's established somewhere it's really difficult to move that somewhere else. So I think in China... the hype has been a little bit ahead of the reality at the moment. Iit will be a strong producer but it's not going to take over the world."

Semiconductor food chain

Lower labor costs do not make much difference in the costly wafer fabrication business.

"Perhaps only 7 to 10 percent at most of the cost of producing a wafer is labor," said Addison. "So there is a whole host of other factors that make a wafer fab competitive and the cost of labor is not really one of them."

In addition, China lacks the infrastructure to support a mature semiconductor sector.

"The opportunities are there, but the challenge is that they have to establish a semiconductor food chain -- packaging, test, fabless design customers," said Dong.

"You also need raw wafer supply for a more robust environment for a better semiconductor industry in China."

U.S. export laws also prevent China from buying certain leading-edge U.S. chip technologies.

In the mean time, analysts say it would make sense for China to focus on final packaging and chip testing -- a more labor-intensive operation that makes money by using yesterday's technology.

Industry watchers like Addison believe it will take ten years, along with strong government support, for China's fledgling chip sector to live up to the hype.

"But the point to remember is that it's not going to displace the industries that already exist in Taiwan, Singapore and Korea," he said.

"The wafer fab industry is fairly rooted where they are developed and they have a lot of support infrastructure. You can't easily take that away."