Semiconductor Manufacturing International Corporation
(SMIC) is China's flagship semiconductor foundry.
It’s a leading player in challenging TSMC, Samsung and Intel in the semiconductor technology race.
Founded by the intensely driven Richard Chang, SMIC ruthlessly hired from its Taiwanese rivals,
outcompeted its Chinese ones, and quickly established itself as the top dog
in China's burgeoning semiconductor industry.
In this video, let's look at SMIC - China's fiercest semiconductor foundry player.
SMIC was founded in January 2000 by Richard Chang. Chang is an interesting fellow. Born in Nanjing,
his family fled to Taiwan along with a million other ethnic Chinese migrants.
The waishengren, as they are called, grew up in Taiwan but held
deep roots to the Chinese mainland. I did a video about them earlier.
Many of the waishengren, disoriented and feeling unwelcome in Taiwan,
emigrated to other locales like the United States. Chang was one such person. After graduating from
the prestigious National Taiwan University, he got a master's degree from the State University of
New York in Buffalo. Then he and his wife went to work for Texas
Instruments in Dallas. TSMC founder Morris Chang (no relation) also worked at TI for over 25 years.
At TI, Richard Chang oversaw foundry work in East Asia for twenty years. He did well there and took
early retirement in 1997. Returning to Taiwan, he started a foundry of his own - Worldwide
Semiconductor Manufacturing Corporation and eventually sold it to TSMC in 2000.
Richard soon then itched for another opportunity and China came calling with cheap land,
water and electricity. He crossed the Strait and started SMIC with
$1.6 billion of investment from Goldman Sachs and a few other private equity firms.
Chang and SMIC soon found themselves in fierce competition with Grace Semiconductor.
Grace was founded around the same time as SMIC by two political heavyweights.
The first was Winston Wang, son of powerful Taiwanese industrialist Wang Yung-ching.
Wang Yung-ching founded one of Taiwan's biggest chemical empires, Formosa Plastics Corp.
The second heavyweight was Jiang Mianheng, son of Chinese paramount leader Jiang Zemin.
Naturally having such connections would put Grace at the very forefront
of the Chinese semiconductor foundry industry. SMIC knew that it would have to compete
extremely hard in order to distinguish itself from the competition. They did.
As it turns out, being a rich guy's son does not help much in competitively running
a semiconductor foundry. For Richard Chang and his team, this was their second startup
and they knew how to get things done. In contrast,
Winston Wang had little experience in building and running leading edge independent foundries.
Grace could not keep up. In the same time Grace took to get its first foundry to mass production,
SMIC had two in Shanghai, a bunch more in the hopper, and was already prepping for their NYSE
IPO. Grace settled into a number two position and the Chinese government soon
shifted their favor to SMIC in terms of subsidies, cheap loans, and more.
By 2004, less than 5 years after its founding, SMIC had ascended to become the fourth biggest
player in the independent foundry industry. Only TSMC, UMC, and Singapore national
champion Chartered Semi were ahead of it. And it was rapidly eating up market share.
Two big things you need when running a startup foundry is a fab to make the chips
and a lot of talented people to run it. Otherwise,
I'm not sure you might have a feasible business. You might have a Hongxin.
SMIC's business model at the time is not all that different from an NFL or NBA sports team.
A foundry needs an expensive multi-billion dollar fab to do their work. Likewise,
a sports team "needs" an expensive multi-billion dollar arena. Neither of those organizations
can raise or risk the billions of dollars to self-finance one. So, get someone else to do it.
Unable to tap bank financing, SMIC thus went to Chinese municipalities around the country
and got those local governments to finance a fab's construction.
SMIC would then move into the fab on a contract basis to operate it. The local government would
get a fee against the future revenues and the opportunity to build a "semiconductor cluster".
Kind of like how NFL teams like to say that on game day,
local businesses benefit from all the increased traffic around their billion dollar stadium.
You should Google those claims to see how it turned out for those local cities.
As SMIC ascended up the chain and the leading edge process got more and more expensive,
these capital expenditures became onerous even for the richest local governments.
SMIC began performing a type of regulatory arbitrage,
shopping their services to cities around the nation looking for the best deal.
For example, in 2005 SMIC was running two factories in Shanghai.
Then the next year they engaged with the cities of Chengdu and Wuhan
to start foundries there too. Two more joint ventures at a cost of some $1.5-3 billion each.
It allowed SMIC to grow extremely fast while keeping their actual invested capital low.
In a previous video, I likened advanced semiconductor foundry work to baking.
And like baking, accumulated, unwritten experience is critical. For the life of me,
I can't make a decent cake even if the steps in the recipe are right in front of me.
This is a broad generalization, but foundry work is in many aspects an
art that cannot be easily boiled down into steps.
Not everything is or can be written down - so it is critical to have with you the best chefs.
Both Grace and SMIC aggressively recruited overseas talent to fill their ranks,
including Taiwanese from TSMC and UMC. Being a startup, these companies lured such employees
with the promise of stock option riches. At the time, salaries on the Chinese Mainland
were far below that which can be found in the US or Taiwan. A senior manager in China for
instance would get paid a quarter or a third of what that same person could get in the US.
Grace handed out stock options but SMIC gave out them out like candy.
For certain key TSMC employees, SMIC offered 80,000 shares and stock option equivalents.
Such amount of shares at the $17.50 US IPO price in 2004 would be worth $1.4 million.
Not to say that those people actually got their hands on all of that $1.4 million.
I have worked at startups myself and it is very common for that 80,000 to quickly get diluted
as the company goes through funding rounds and the like.
Beyond the potential riches, people gravitated to SMIC for two other reasons.
First, many of these engineers were ethnic Han Chinese living and educated overseas
and wanted to give back to their country. Of SMIC's founding 1,000
engineers, nearly 40% of them were Chinese citizens returning to the motherland.
Second, many of them felt that they had hit the glass ceiling in an American or Taiwanese company.
Big companies have often established ranks of who gets promoted,
and there is often more qualified people than open spots. We should also mention the possibility
of racism against Asians and Chinese in the United States - the bamboo ceiling.
To join SMIC would be to step into a Silicon Valley-like environment and
get in on the ground floor on something exciting.
To build something for the future and glory of China. Hard to say no to that.
By 2003, TSMC realized that Grace and especially SMIC were growing faster than it should have.
For example, SMIC had managed to ramp up on 0.18 micrometer process
in just 12 months. This is without a prior track record of success in doing such things before.
This was implausible and implied the loss of private, extremely valuable trade secrets.
Thus in that same year as SMIC prepared to go IPO on the NYSE,
TSMC launched a pioneering intellectual property theft lawsuit against its mainland rival.
This lawsuit was filed in California and interestingly enough TSMC asked for a jury trial.
It would not be resolved for many years, but when it did,
the jury found that SMIC had indeed infringed on TSMC intellectual property.
The lawsuit went back and forth. But when the dust finally settled six years later
TSMC won. They received a 10% stake in SMIC. Richard Chang resigned in 2009
after attempting a counter-suit against TSMC that failed.
At the same time, TSMC took to battling SMIC directly on its home turf. In 2004,
TSMC won a public debate in Taiwan for permission to enter the Mainland market.
In 2007, TSMC's first fully owned foundry began operations in Shanghai.
This appears to be a page out of their playbook. In my video about Singapore's
Chartered Semiconductors, I mentioned TSMC founding a semiconductor foundry
joint venture with the goal of battling Chartered on their home market.
It helped to weaken the overall market enough to decelerate SMIC's once-torrid growth.
Throughout this entire saga, SMIC lost money. The company had been running on subsidies, loans
and the money it received from investors but the company could
not consistently turn a profit on its own. There are a few reasons for this.
First, there were the upstarts. SMIC was the largest Chinese foundry but it was
not alone. Other Chinese cities saw what was happening in Wuhan,
Beijing and Chengdu and wanted in on the action. They began creating small SMIC's of their own,
saturating the market and bringing down profits for everyone else.
One upstart takes place in the city of Ningbo, the place of TSMC founder Morris Chang's birth.
Ningbo Zhongwei was founded in 2002 by a team of mid-level TSMC managers.
They bought used equipment from TSMC and invested $150 million of taxpayer money
to build a leading fab capable of outputting 40,000 wafers a month.
The fab reached the 10,000 wafers a month benchmark behind schedule.
The company could not reach the necessary scale as TSMC's equipment was very old
and required expensive servicing ($100-150 per hour maintenance).
Eventually the company folded and it sold their factory to electric car maker BYD.
Another reason has to do with the product being sold. In order to make sure some of
its early fabs got online as fast as possible, SMIC devoted them to creating commodity DRAM.
The fabs indeed got up and running really quickly, but making a commodity product
meant low margins and intense competition. It is the same issue that Chartered dealt with. You need
to ascend the value chain and get to the leading edge. That means a lot of investment into R&D.
Too many startups. Too much supply sloshing around. Not enough differentiated product. And of
course some of the most economically challenging years with the global financial crisis.
Where can you get the money to invest in the R&D
for better product if you are not making money from your products?
Is the Chinese government just going to have to constantly pump billions into your company?
I guess they can, but how long can you put money into a company that doesn't turn a profit?
Singapore owned Chartered for 22 years and for the majority of those years Chartered
churned out losses despite becoming the third largest independent foundry in the industry.
Just because you have a lot of money doesn't mean you like rolling it up in a cigar and smoking it.
That was what's happening with SMIC so long as it did not own and create the
technology behind the processes themselves. They were trapped.
Over time, local city governments like Wuhan and Chengdu began to feel uncomfortable about
these seemingly unending operating losses. After Richard's resignation,
Chengdu and Wuhan terminated the partnerships. Chengdu sold its
fab to Texas Instruments and Wuhan decided to go it alone with Xinxin Semiconductor.
SMIC hired a new CEO in 2010 and sought to dial down on growth in order to achieve profitability.
If Richard Chang was Uber's Travis Kalanick - the vicious, driven founder determined
to take over the world - then his successor David Wang was more like Dara Khosrowshahi -
trying to turn the company around and make a profit.
David Wang did not last long. He resigned after being losing a vote of confidence a year later.
Tzu-Yin Chiu led the company as CEO until 2017,
whereupon he helped stabilize the ship and turn out a very small profit.
He retired in 2017 and was succeeded by co-CEOs Zhao Haijun and Liang Mong Song.
Liang is infamous in Taiwan for jumping ship from TSMC to Samsung and helping them
reach the leading edge process node. It seemed that he had been doing the same with SMIC too,
leading a team of 2,000 R&D engineers to ready the 7nm process node.
He realized just how important it is to research, create and thus own the
process technology itself. Not to take shortcuts like Chartered did in partnering with others.
Per recent reports, it seems like they are getting close
to high volume production with it. This is great news for the Chinese semiconductor industry
and represents a return to form for SMIC after many long stumbles.
SMIC remains the premier foundry on the China mainland. Their recent billion dollar IPO on the
Hong Kong and Shanghai markets after a 2019 NYSE delisting makes it clear. The Chinese
national government is starting to invest real resources in actually developing an indigenous
semiconductor space from the ground up. SMIC will likely be its centerpiece for making it happen.