In the past year, for leaders and investors in the semiconductor industry, the Chinese business has been their top priority. In traditional chip consumption, China has always held an important position, but now understanding the opportunities in the Chinese market and actively updating Chinese strategies have become increasingly important for enterprises. There are three reasons: firstly, the Chinese government is actively seeking to reshape the domestic semiconductor market in China and support local enterprises to develop into national leading enterprises. Secondly, Chinese consumers and companies are increasingly important for the growth of the global semiconductor market. Thirdly, the Chinese government and private sector funds are actively seeking merger, acquisition, investment, and cooperation opportunities globally.

These changes pose some important questions to local Chinese enterprises and multinational corporations - how can practitioners continue to achieve growth in the Chinese market? Do market and policy changes require them to develop new capabilities and methods? How can local and multinational enterprises form mutually beneficial cooperative relationships?

The reasons why China has become increasingly important

China plays an increasingly important role in the global semiconductor industry, and the political, economic, and financial market factors behind it will continue to affect the market landscape in the coming years, which deserves careful study.

Strong support from the government

In June 2014, the State Council issued the long-awaited "National Integrated Circuit Industry Development Promotion Outline" to promote the development of the domestic semiconductor industry (see the sidebar "National Integrated Circuit Industry Development Promotion Outline"). This new outline presents ambitious goals in industry revenue, output, technological progress, and other aspects. This is not the first time that the Chinese government has introduced policies to support the development of the local semiconductor industry. There are three important differences between this outline and previous policies:

The Chinese government's investment has increased by 40 times compared to its previous target and has set a five-year investment target of approximately $19 billion. The government hopes that the total investment received by the semiconductor industry can reach 100 to 150 billion US dollars, with funding sources including state-owned enterprises and other investors. This outline focuses more on creating regional market winners or national leading enterprises through mergers and acquisitions and other integration measures. The government adopts a more market-oriented investment approach - assigning the responsibility of distributing public funds to local private equity companies. This bold experiment is aimed at increasing the chances of success.

The Chinese government's investment has increased by 40 times compared to its previous target and has set a five-year investment target of approximately $19 billion. The government hopes that the total investment received by the semiconductor industry can reach 100 to 150 billion US dollars, with funding sources including state-owned enterprises and other investors. This outline focuses more on creating regional market winners or national leading enterprises through mergers and acquisitions and other integration measures. The government adopts a more market-oriented investment approach - assigning the responsibility of distributing public funds to local private equity companies. This bold experiment is aimed at increasing the chances of success.（Figure 1）

Demand Surge

The consumption growth rate of Chinese semiconductors continues to exceed the global market growth rate, with a 9% increase in consumption in 2014, reaching approximately 160 billion US dollars, accounting for half of the total global consumption. Both Chinese fabless companies and the Chinese branches of multinational fabless companies experienced faster growth in 2014, with sales increasing by 20%, thanks to the rapid growth of Chinese consumers, especially those in the mobile industry. For example, between the fourth quarter of 2013 and the second quarter of 2015, China's leading smartphone brands (such as Huawei, Lenovo, Meizu, and Xiaomi) increased their global market share from 15% to 27%. Since 2010, the mobile phone market in China has grown fivefold. However, like the overall economy of China, the growth of this market has also significantly slowed down, and the consumption of smartphones in 2015 remained the same as the same period last year.

This slowdown in growth reflects that the global smartphone market is cooling down, and some weaker original equipment manufacturers (OEMs) will be eliminated. This slowdown is intensifying price competition and adding uncertainty to the long-term growth prospects of semiconductors needed in mobile devices and devices.

Increase in capital activities

During the 18 months from the promulgation of the National Outline for Promoting the Development of the Integrated Circuit Industry to the writing of this article, the Chinese government announced six investment funds - the China Integrated Circuit Industry Investment Fund, as well as investment funds released by the governments of Beijing, Hefei, Shanghai, Wuhan, and Xiamen, with a managed capital of approximately 32 billion US dollars. These funds may also receive more funds, such as Xiamen Investment Fund, which received $47 million in the first phase of fundraising, with a goal of $157 million. These six funds have invested in several Chinese companies, including Zhongwei, Changdian Technology, Sanan, SMIC, and Spreadtrum Communications.

Chinese domestic companies and financial investors are focusing on foreign markets, recently announcing a $15 billion investment in controlling or investing in a small amount in 10 global semiconductor companies on the value chain. Although this is significantly higher than last year's investment amount, it only accounts for 15% of the announced mergers and acquisitions in the global semiconductor industry. Since the Chinese government introduced new policies in 2014, the global semiconductor M&A transaction amount has reached 100 billion US dollars. During the same period, the global semiconductor industry has invested approximately $80 billion in capital expenditure and research and development, which is 20 times the investment of domestic Chinese semiconductor companies.

Global enterprises also increased their attention to the Chinese market last year, including making more efforts to cooperate with local enterprises. Here are some of their new initiatives:

Qualcomm announces cooperation with SMIC to develop 28 nanometer products and 14 nanometer processes

Lianhua Electronics, Xiamen Government, and Fujian Electronic Information (Group) Co., Ltd. jointly invested 6.2 billion US dollars to build a wafer factory

Intel has invested $1.5 billion in a subsidiary of Unigroup. Ziguang Group previously acquired Ruidike and Spreadtrum Communications, both of which are among the fabless design companies in China.

Building a leading enterprise in China

Semiconductors are a globalized industry, and there are very few products customized for specific regions. There is no packaging from Taiwan, chips from South Korea, or industrial semiconductors from Japan in the market - these products have global customers. Therefore, the notion of building a leading enterprise in China is a misconception. More precisely, domestic companies should establish themselves in China and strive to become global leaders.

Having scale and experience is essential for efficiency, therefore, global leadership is crucial for Chinese companies. In fact, McKinsey's research shows that one or two leading companies in the semiconductor industry achieve 100% economic benefits, while their competitors suffer losses. In addition, profitable leading companies will never limit their market to a single region, on the contrary, their businesses are all global. Based on this pattern, in the long run, it is particularly important for enterprises to strive for the top two positions globally.

To achieve this goal, Chinese enterprises need to achieve three fundamental transformations. Firstly, significant improvement in technical skills and global management capabilities; Secondly, cultivate the thinking patterns of technology leaders; Thirdly, encourage patient capital investors to make long-term investments throughout the entire business cycle.

lifting capacity

To become an internationally leading enterprise, Chinese companies need to strengthen their necessary capabilities in order to manage more complex businesses. Learning from leading semiconductor multinational companies in the industry, Chinese companies must also develop their relationship networks and strength overseas over the years. Many emerging semiconductor leading companies in China have made great strides in this direction, but there is still great room for improvement. For example, domestic companies need to establish international sales and customer service teams to win overseas business. At the same time, Chinese companies may also need to manage multiple research and development centers, as well as operational hubs spread around the world.

The company conducting the transaction must master the art of mergers and acquisitions. Merely acquiring the target company is not enough, but also needs to unleash the synergies and improvement potential that the acquisition target can bring. As Chinese companies seek growth in new fields such as the Internet of Things, they need to expand their capabilities beyond semiconductors and invest in software development, ecosystem management, sales solutions, and reference designs.

Several areas of capacity building require special attention, among which talent management is of utmost importance. Recruiting, training, and retaining the world's best (often rarest) talents is difficult, especially in the fields of hardware architecture, firmware, and applications. This situation is even more severe in China, as the most proficient talents in semiconductors are usually not in China. Effective management after a business merger is crucial for talent introduced through acquiring companies. For example, it is necessary to systematically integrate new teams with existing Chinese teams, new engineering tools and processes with existing ones.

Chinese companies also need to strengthen the development, management, and protection of intellectual property. Firstly, it is necessary to establish a systematic approach to identifying, selecting, and executing intellectual property strategies. This requires every company to have a thorough intellectual property roadmap that distinguishes it from the company's product line. This roadmap needs to clarify which intellectual property rights must be owned and developed internally by the company, and which can be obtained from partners or intellectual property suppliers. Secondly, Chinese semiconductor companies should support the country in continuously consolidating its intellectual property system, on the one hand to protect their innovative achievements, and on the other hand to improve the overall environment and strengthen the willingness of multinational enterprises to establish intellectual property and research and development partnerships with Chinese enterprises.

Finally, whether domestically or globally, Chinese companies need to do a comprehensive job in integrating after the merger (not limited to the talent aspects mentioned above).

Looking back, there has been a significant gap in the results of mergers and acquisitions in the high-tech sector. The merger of enterprises that can leverage the advantages of both parties to do a good job in management has created great value, while unsuccessful acquisitions may lead to catastrophic consequences. Retaining employees is the key to success, therefore, Chinese leaders must establish a spirit of teamwork. The control of product and project splitting is also crucial. McKinsey's research shows that conducting semiconductor research and development in multiple locations reduces efficiency by an average of over 10%.

If a company organizes employees from different cultures and regions into strong and cohesive teams, and allows these teams to focus on suitable projects, the company will become a winner. In the semiconductor industry, transactions led by China are much higher than those in other fields, as most transactions imply the transfer of global cluster technology to China. Generally speaking, achieving synergies through research and development and the transfer of intellectual property rights is more difficult than entering the market and manufacturing operations.

Adopting the mindset of a technology leader

For enterprises with outdated and advanced processes in the semiconductor industry, technological innovation and technological leaders are of great significance. Due to choice and necessity, Chinese companies generally focus their energy on mature technology and adopt the innovative achievements of other companies to reduce costs (although there are exceptions, such as Huawei HiSilicon, which produces baseband chips, following technology specifications that are comparable to market share leaders). Although mature products can be profitable with low risk and low investment, they are not enough to drive a company to become one of the top companies in its field.

McKinsey has investigated the key purchasing factors for Chinese companies purchasing semiconductor products. Similar to similar international companies, when discussing the primary factors to consider when purchasing, they all unanimously mention the performance and leading technology of their products. Therefore, the ***** suppliers of these companies are manufacturers who can represent and deliver leading technologies in multiple fields. These areas include circuit design, product integration, production processes, and features that go beyond chips, such as firmware, reference design, and software.

Chinese companies cannot rely solely on technology transfer and mergers and acquisitions to enhance their local technological leadership. The export controls and other restrictions on purchasing "Fist" technology make it difficult for many to achieve their desire for excellent teams, intellectual property, or corporate mergers and acquisitions. In addition, many cutting-edge knowledge is implicit and cannot be transferred through a single contract or other means. The most important possibility is that technological progress is never-ending. Even if Chinese companies acquire technology through purchase and transfer, competitors from other countries will always improve and drive innovation, and Chinese companies must keep up with the pace. For the above reasons, Chinese companies must promote scientific and engineering breakthroughs internally and achieve commercialization and scaling of these breakthroughs in order to become suppliers with a larger market share in industry segments.

Running a technology leading company is different from running a follower company. This transformation requires Chinese companies to change their business and investment models, as well as their thinking patterns in engineering. This transformation should be well controlled in terms of structure and pace, allowing Chinese companies to pursue technological leadership and make innovative investments while solidifying their strong business foundation.

Due to the numerous risks involved, Chinese companies must adopt a carefully considered approach when building the necessary new capabilities, key performance indicators, and processes. They must form a systematic improvement roadmap, linking all business opportunities, technological trends, capacity needs, and skill building initiatives into a unified plan. It is crucial to reach consensus with different stakeholders, including government, investors, and potential global partners, to ensure that all parties jointly support the implementation of the plan. They should set goals according to international benchmarks, reflecting the current and future competitive battlefield.

Due to the shortage of talents and abilities and the high demands of global leaders, Chinese enterprises have a long way to go in order to achieve one of the top international leading positions in this field. To support these enterprises, the government can formulate clear and relevant policies to help them achieve their goals. In China, the more fields and technologies one wants to seize a leading position, the more dispersed the energy of the industry and government will be; The more companies want to achieve a leading position in a certain niche field, the more outstanding talents will be dispersed into more teams; The more investment tools used to achieve international and domestic acquisition goals, the higher the price will be. However, a top-down approach can limit competition and may also hinder innovation, trapping talent in unsuitable positions. Therefore, governments, investors, and business leaders need to work hard to find a balance point.

Investors willing to provide patient capital

Although improving abilities is the most important factor in determining victory or defeat, having endurance capital is also essential. Due to the previous failure of official led investment management to achieve ideal results, the Chinese government has allowed local private equity companies to manage their investments in the semiconductor industry after the introduction of new policies. When making investment decisions, these enterprises will not only follow the government's direction and goals, but also strive to achieve market investment returns. Whether investors can continue to provide funds during economic or industry downturns is crucial for businesses. However, the special capital requirements of the semiconductor industry may make things more complex. Firstly, the semiconductor industry has a long development cycle and strong commercial cyclicality. Secondly, the industry's return rate is lower than the average level. The threshold return rate or minimum expected investment return rate for the vast majority of private equity companies is 8%. Overall, the returns of semiconductor companies over the past 40 years have been lower than those of other equity investments. In fact, many sub sectors are in a downturn, with negative returns for several consecutive years. Finally, the semiconductor industry, especially in the processing and manufacturing sectors, generally takes longer than the average time to generate profits. A payback period of 5, 10, or even 15 years is the most common. For financial investors with multiple investment options, adhering to long-term, stable, and wise investments throughout the entire cycle is a challenge.

Investors face greater challenges during acquisitions. Semiconductor companies and assets that perform well already have a healthy market, therefore private equity capital will have to compete with corporate investors, who have lower capital costs and the ability to leverage the synergies of acquisitions. So, investors in the same asset company can afford higher prices.

Multinational enterprises in China: thoughtful and step-by-step approach

Foreign multinational corporations have different goals and restrictions in their operations in China. Due to the fact that the vast majority of these enterprises already possess global capabilities, they are mostly focused on expanding their market share in China and formulating strategies to compete with emerging Chinese enterprises. Many multinational corporations, including those with years of experience in China, still have a fragmented grasp of the competitive landscape. For the leadership, CEO, business unit, and international functional supervisors who manage business in China, they have different personal experiences and priority factors based on their observations of China, and have different views on the business or functions in China. These different perspectives will lead to disagreements when formulating detailed strategies for China, hindering the process of strategic formulation. To solve this problem, multinational corporations should invest in establishing a shared and unified fact base to accelerate the decision-making process. During this process, business leaders should attempt to reach consensus on various issues (including those listed in Figure 2).

In fact, companies have eliminated various speculations about winning in China by answering these questions. For example, a multinational corporation once believed that Chinese customers wanted to purchase products from domestic companies, so they needed to establish a large joint venture research and development center in China. However, after conducting interviews with customers, it was found that customers from different social classes have different preferences. Small customers have relatively simple technical requirements and tend to choose local suppliers, while large customers who want international level products require global, non Chinese suppliers equipped with local customer service teams. Another company once firmly believed that a Chinese competitor's low product price was due to their satisfaction with meager profits. However, product disassembly analysis has shown that the gross profit of this Chinese company is higher than that of a multinational corporation, as the Chinese company has made product design simpler and more simple in order to compete with other Chinese OEMs in the low-priced field.

A consistent fact base also simplifies the debate on changing alternative methods to improve China's performance, as it can help leaders find truly effective solutions to problems. For example, the company may be seeking strategic development in China, such as faster technical support and localized reference designs. In such a situation, the solution may only require more investment and better implementation. But if the situation is more complex, such as government regulations that only local enterprises can receive significant research and development subsidies or participate in specific bidding projects, multinational corporations may need more comprehensive solutions, including establishing partnerships with Chinese companies. If it is necessary to establish partnerships, multinational and local companies must build an exclusive and ideal "win-win" partnership structure.

Building effective partnerships

Multinational companies outside the semiconductor industry have already extended their reach to China. They often trade technology for market access and financial support - this model is the most cutting-edge and primary strategy for international semiconductor companies today.

Multinational corporations may encounter many challenges when establishing cooperative relationships. For example, when formulating transaction terms, multinational corporations need to find sustained and long-lasting commercial value for themselves and their partners. When merging and integrating Chinese and foreign teams, complex issues may arise. However, multinational corporations can reduce many potential problems through a systematic partnership mechanism rather than making last-minute decisions. This approach may be a bit difficult in the current situation, as many multinational companies receive olive branches from multiple Chinese investors, government agencies, or organizations with ideas at the same time. In this situation, multinational corporations should take the initiative to "attack" and adopt a comprehensive cooperation strategy, rather than just responding. Some effective measures have emerged in this regard.

Set clear goals

Multinational corporations can seek various types of cooperative relationships. If the position in China is high, one can prioritize defensive measures; If China's position lags behind its global position, cooperative relationships are opportunities to seek additional value. Similarly, some multinational companies hope to seek partners who can support their entire business operations, but some companies only want support in a particular business or product. Multinational corporations should take multiple measures and estimate China's funding and support in order to achieve their goals outside of China. Figure 3 shows several potential partnerships based on the current market position and key product areas of a certain enterprise.

Evaluate Chinese partners based on specific goals

The business situation in China is quite complex, and there are also a variety of potential partners - from private companies specializing in semiconductor production to state-owned enterprise giants. In addition, multiple government units may also be involved in the finalization of the cooperation process. Each unit brings different chips, networks, and goals to the negotiation table. The goals of cooperation are different, and the corresponding partners are also different. For example, if forming a partnership is to enter the market and increase local market share, priority should be given to selecting distributor partners; If we want to produce products, we will focus on our experienced partners who have practical production experience. Multinational corporations should establish objective partner selection criteria based on specific goals in order to evaluate and prioritize them.

Rank the benefits brought by various potential partnerships

Different cooperative relationships can have significant differences in multiple aspects - business scope, geographic coverage, intellectual property and research and development cooperation, as well as division of labor, responsibilities, and ownership. Based on the above aspects, various types of partner relationships can be summarized. For example, contractual relationships between distributors and suppliers, or comprehensive joint ventures and dual control partnerships in research and development and production. Regardless of the type of cooperation, multinational corporations should objectively identify their respective interests for themselves and partners, and identify which areas are worth investing in and profitable for both parties.

For example, multinational corporations only hope to seek sales partners because their main purpose is to open up the Chinese market; On the other hand, its Chinese partners only hope to establish global business. By evaluating short-term and long-term benefits, as well as the bottom line of both parties' acceptance of multi regional sales costs, multinational corporations can determine whether they can achieve fair and beneficial transaction cooperation.

Conduct stress testing on the plan using military exercise mode

When multinational corporations examine their path forward, they cannot assume that the environment is static, as all industry participants - competitors, customers, and other Chinese companies - will take their own actions, whether they are proactive or responsive to the actions of other multinational corporations. The cooperative relationship cannot be easily relaxed, but needs to remain stable under a series of responses from competitors. Therefore, if the benefits of cooperation may fail due to the strategic behavior of competitors, multinational corporations should think twice before taking action. Meanwhile, multinational corporations should avoid situations where a partner or competitor seeks more benefits. Exercising competitor behavior helps clarify the need for partnerships and also helps clarify the series of actions that need to be taken when communicating and negotiating with partners.

Referring to the ******* approach of establishing cooperative relationships in China

Regardless of the niche market or product line that the company belongs to, multinational corporations should observe the general rules for forming partnerships in the Chinese market.

It should be noted that China's national conditions are very complex - no partner, company, or investor can control or drive China's strategy; No company or investor can bet 100% of their chips on China - only in their influential areas

It should be noted that there is no "China expert" who knows China's national conditions very well. Therefore, multinational corporations should cleverly utilize information from multiple channels when designing their initiatives

The constraints of the transaction, including product strategy, business scope, ownership, and intellectual property transfer, should be clear from the beginning and throughout the negotiation period. These are the most likely areas of disagreement that could lead to difficult conversations and negotiations. Honestly dealing with these issues can build trust

Plan a partnership, but leave a way out. Sometimes, the significant difference in goals between multinational corporations and their partners makes cooperation no longer feasible. Therefore, multinational corporations should clearly establish contractual mechanisms that can fairly and friendly end partnerships.

The tentative reform of the Chinese semiconductor market requires high attention and change from all enterprises in the industry, and will also have a huge impact on domestic and multinational semiconductor companies in China****** The change may be the mode of cooperation between all parties. In this industry dominated by strong players, strict government management, huge capital requirements, and rapidly changing technological development paths make it difficult to establish and implement far-reaching cooperative relationships. Adding cultural differences and a mixed history of cooperation between Chinese and foreign companies in other industries, it is evident that this requires all participants to carefully consider and take a long-term approach.