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Page 1: Made in China: Taiwan Investment in China · PDF fileMade in China: Taiwan Investment in China Increases ... 2 Made in China: Taiwan Investment in China Increases ... A preliminary

Publication Date:5 March 2003

Market Analysis

Made in China: Taiwan Investment in China IncreasesAbstract: Taiwanese electronic manufacturers increase investment in China, creating a morecomplete supply chain for the Greater China region.

By Dorothy Lai and Jamie Wang

Strategic Market Statement

In the long term, by combining the great distribution channels that Chinese electronicsmanufacturers provide and the technology that Taiwanese manufacturers offer, theGreater China territory has the potential to be the world's largest electronic design,manufacturing and consumption region.

Recommendations

Taiwan's electronics industry should leave the less-sophisticated, more-labor-intensivemanufacturing to mainland China; the logical step for Taiwanese manufacturers is toconcentrate on the value-added industries, such as integrated circuit (IC) designs, R&D,product marketing, brand building and advanced manufacturing.

Taiwanese electronics manufacturers should be cautious when investing in China; whileit is necessary for Taiwanese manufacturers to develop new distribution channels inChina, the outsourcing model, so far, has worked very well for Taiwanesemanufacturers.

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2003 Gartner, Inc. and/or its Affiliates. All Rights Reserved.5 March 2003

IntroductionThis year's Chinese New Year marked a significant event for Taiwan andChina. The two political rivals took the first step toward restoring directair links that were cut more than 50 years ago, with the first chartedcommercial flight between Shanghai and Taipei in 2003. The businessrelationship between the two markets has grown stronger over the pastfew years. About 1 million Taiwanese citizens now live and work inChina, mainly lured by China's fast-growing economy and a commonlanguage.

For the past decade, Taiwanese companies have invested in China. Theoutflow of funds and technology presents a challenge to the Taiwanesegovernment, which believed that if the investment ban that was set in 1949was lifted, China would gain control of the island's economy. Therefore,Taiwan has been restrictive in allowing assets to shift away from theisland toward the mainland. However, many Taiwanese companies,ignoring the government's regulations, made large investments in Chinathrough convoluted third-party arrangements via Hong Kong, CaymanIslands or the British Virgin Islands. The government of Taiwan stillstruggles with how to manage the outflow of funds to China.

Because of the tremendous pressures put on by many local Taiwanesebusiness executives, the Taiwanese government has slightly softened itspositions on manufacturing and investment across the strait. In 2001, inaccordance with World Trade Organization (WTO) rules, Taiwan droppedrestrictions on more than 122 high-tech products that previously wereprohibited from being produced in the mainland. It also removed theUS$50 million limit for a single China-bound investment imposed underthe "no haste, be patient" policy. In 2002, it allowed semiconductormanufacturers to invest in China. Nevertheless, Taiwan's government stillhas concerns as it continues to impose strict rules and standards tocompanies that make investments in China. For example, it allowed onlythree 8-inch-wafer fabs with less-advanced processes to be transferred toChina within the next two years. Furthermore, since 1 January, a personholding a 5 percent or more stake in a company will be regarded as amajor shareholder of that company and will need to apply for governmentapproval if involved in Chinese investment projects. These actions wereset to limit Taiwan's fund and technology migration to China.

According to Taiwan's government, about 64 percent of Taiwanese IThardware production value came from China in 2002, compared with56 percent in 2001. About US$70 billion to US$100 billion worth ofinvestment in China came from Taiwan since 1991. Ties between Taiwanand China have become stronger economically and will continue to do soin the coming decade.

Electronic Equipment ManufacturingTaiwan produces about 60 percent of worldwide motherboards, notebookcomputers and optical storage devices. Taiwan also plays an important

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role in the manufacturing of cellular phones, digital still cameras, gameconsoles and wireless communications devices through originalequipment manufacturer (OEM) and original design manufacturer (ODM)activities. Meanwhile, more than 40 percent of Taiwanese production linesare in China. Gartner Dataquest estimates that Taiwan's electronicequipment produced in China will grow about 30 percent in 2003.

A preliminary estimate of Taiwan-made notebook computer shipments tothe world accounted for 64 percent, while liquid crystal display (LCD)monitor shipment accounted for 45 percent in 2002. Before late 2001, thegovernment of Taiwan prohibited Taiwanese notebook manufacturersfrom producing in China. After it removed the ban, almost all of theTaiwanese notebook manufacturers are producing in China. Although theglobal PC market grows slowly in the depressed economic downturn andprobably will remain flat in 2003, many of the leading Taiwanese notebookPC manufacturers have exerted great efforts to set up their productionsites in China. Stimulated by OEMs' requests for production setup inChina, a more cost-effective environment and an alluring mass market,notebook vendors are quite encouraged to move their bases to China.

Also, manufacturers of motherboards, cathode ray tube (CRT)/LCDmonitors and optical storage devices have already set out to China, andthis, indeed, has helped sustain many vendors' competitiveness andboosted their revenue and profits. While setting up a new line may notvary too much in China vs. in Taiwan, less-expensive labor costs and rawmaterials help manufacturers lower their costs by at least 15 percent to 20percent in China. Struggling with negligible profit margin caused bysevere competition and feeling a need to expand their business frontiers,Taiwanese electronic equipment manufacturers' move to China isinevitable. Under the deteriorating investment environment in Taiwan, itis imperative that Taiwanese industrial players diversify their productsand provide omnibus services to their clients. Global logistics andinnovation on products also should be encouraged.

Gartner Dataquest believes that new production lines from Taiwan toChina will increase in 2003, and electronic equipment manufacturing fromTaiwan investment will accelerate. Nevertheless, we also think that pricecompetition between Taiwanese vendors may arise because of possibleoverproduction. Further, some Taiwanese vendors may collide withmainland China's domestic vendors for market occupation on theconsumer front, including handheld devices, cell phones, digital camerasand game controllers. However, because most Taiwanese products aresold through their OEM clients, these products may be shielded fromdirect collisions against the Chinese brands or other foreign brands in theend-consumer markets. We believe Taiwanese ODM/OEM investments inChina should be established cautiously according to the customers'interest. Lower cost and better customer support are some reasons whyChina will be a preferable destination for new investment. However, fornon-ODM Taiwanese electronics manufacturers, a better branding strategymay still be needed to succeed in China and in foreign markets.

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2003 Gartner, Inc. and/or its Affiliates. All Rights Reserved.5 March 2003

What we suggest to Taiwan's electronic equipment vendors is to diversifyand improve their product lines, which many have done. This will helpalleviate direct competition against the mainland vendors. For example,Taiwanese vendors may continue their favorable position on notebookcomputer, display equipment and optical disk drive production. However,they can develop the higher-end segment by using their R&D resources.With that effort, Taiwan's electronic product R&D industry can bedeveloped and cultivated. Furthermore, Taiwan's electronics industry candevelop better branding strategies to distinguish itself from the Chinese-made products. Hence, Taiwan-made products can become more popularworldwide as well as in China. Taiwanese vendors may also get a chanceto promote their own brands to the mainland market and not just focusonly on the OEM/ODM businesses.

Gartner Dataquest expects that the westward movement of Taiwaneseelectronic equipment manufacturers will be positive, but the two markets'relationship will remain complex because of their governmentalregulations and sophisticated tax environment.

Semiconductor ManufacturingAnother important and complex business relationship between Taiwanand China involves semiconductor manufacturing. As China'ssemiconductor manufacturing industry becomes more important,Taiwanese manufacturers — front and back end — worry about losingtheir edge to their Chinese competitors. They are also concerned about thecost benefit their Chinese competitors enjoy. As stated earlier, theTaiwanese government lifted its restriction on semiconductor investmentsin China in April 2002. Only three companies with 300-mm waferproduction lines on the island are eligible to build their 8-inch-wafer fabsin China. Taiwan Semiconductor Manufacturing Co. (TSMC), UnitedMicroelectronics Corp. (UMC) and ProMOS are considering the westwardmove. By setting up their manufacturing plants in China, semiconductormanufacturers can bring down their costs, and, more importantly, theycan also expand their market share by servicing their China-based clientsmore efficiently.

The removal of the ban opens a new market for many Taiwanesesemiconductor manufacturers, both upstream and downstream. (Forinvestment guidelines and analysis, refer to "Taiwan's Foundries Head forChina," SEMC-WW-DA-0027.) Although three Taiwanese foundries areeligible to apply to invest in China, TSMC is the only one that hassubmitted its application. It is also the first Taiwanese fab that hasobtained the government's preliminary stamp of approval to invest inChina. Five months after the world's largest foundry signed a letter ofintent with Shanghai's Songjiang district government on a series of fabinvestments, Taiwan's Ministry of Economic Affairs (MOEA) finallygranted first-stage approval on 26 February. TSMC has become Taiwan'sfirst fab that attained a green light from the government to build asemiconductor manufacturing plant across the strait. Although TSMC stillneeds permission for the next phase of its investment plan, the

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announcement signifies a positive sign for TSMC as well as otherTaiwanese semiconductor manufacturers that want to invest in China.

To comply with the government's rule, TSMC and others will need to keepup with high-end technologies and make sure the new technologies stayon the island. Only the more-mature technologies will be allowed to betransferred to China. Even so, these mature technologies will be welcomedin China, as the country is still at the starting point of its semiconductormanufacturing learning curve. With more wafer fabs settling in China, weexpect more back-end assembly and test facilities will be movingwestward as well. A more complete and efficient electronic supply chainwill be seen in China in the near future. With this latest announcementfrom TSMC, China, effectively, is one step closer to becoming a moreintegrated semiconductor manufacturing base, while Taiwan will becomea more high-end value-added design and marketing center.

Gartner Dataquest PerspectiveFacing serious global deflationary pressure, Taiwan needs China morethan ever. China can provide a low-wage platform and a vast potentialdomestic market for Taiwanese electronics and semiconductormanufacturers. China also can provide a relatively low business entrybarrier for Taiwanese manufacturers. Furthermore, Taiwanesemanufacturers can take advantage of China's preferential policies in theelectronics and semiconductor industries.

The government of Taiwan has advocated Taiwanese businesses toconsider investing in Southeast Asia — the "go South" policy. It points outthat Southeast Asia also enjoys the advantage of inexpensive labor, withsome countries having less-expensive labor than mainland China. Thegovernment also points out the vast market size in the region. However,we believe Southeast Asia may have difficulties attracting a significantamount of capital from Taiwan, as the region's safety is a major concernfor many businesses. Furthermore, some countries in the Southeast Asianregion are still trying to recover after the Asian financial crisis. Languagebarriers and political stability are also issues that Taiwanese companies donot have to face when they invest in China.

While the "China fever" is still hot, Taiwan's electronics andsemiconductor industries need to reconsider their roles. By leaving theless-sophisticated, more-labor-intensive manufacturing to mainlandChina, Taiwanese manufacturers can concentrate on the value-addedindustries, such as IC designs, R&D, product marketing, brand buildingand advanced manufacturing. Furthermore, the rise in using outsourcingpartners will benefit Taiwan and China in the ODM and foundry sectors.For example, efficient ODM providers and foundry players in China must

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This document has been published to the following Marketplace codes:

SEMC-WW-DP-0250

For More Information...In North America and Latin America: +1-203-316-1111In Europe, the Middle East and Africa: +44-1784-268819In Asia/Pacific: +61-7-3405-2582In Japan: +81-3-3481-3670Worldwide via gartner.com: www.gartner.comEntire contents © 2003 Gartner, Inc. and/or its Affiliates. All rights reserved. Reproduction of this publication in any formwithout prior written permission is forbidden. The information contained herein has been obtained from sources believedto be reliable. Gartner disclaims all warranties as to the accuracy, completeness or adequacy of such information. Gartnershall have no liability for errors, omissions or inadequacies in the information contained herein or for interpretationsthereof. The reader assumes sole responsibility for the selection of these materials to achieve its intended results. Theopinions expressed herein are subject to change without notice. 113444

improve their logistic services as well as diversify their product lines pertheir clients' requests. By working together, both markets, in essence, willbenefit technically as well as financially. To achieve a win-win situation,Taiwan's manufacturers should work with China's domestic partners. Bycombining the great distribution channels that China's vendors provideand the technology that Taiwan's manufacturers offer, great businessopportunities can be discovered.

We believe the Greater China region can develop an efficient and completesupply chain. This region is able to attract customers in upstream anddownstream electronics industries. We also believe that the Greater Chinaregion has great potential to be the world's largest electronic design,manufacturing and consumption territory.

Key Issue

How will the continued value-chain migration alter the manufacturing industry?