Opinion: China Should Slash Reliance on Foreign Chips

* China should accelerate development of its own chip-production supply chain

* Case could interfere with country's goal of developing 5G mobile network

The seven-year ban on purchasing American-made components imposed by the U.S. on Chinese telecom equipment-maker ZTE Corp. is sounding an alarm over China’s dependence on third-party chips.

China should accelerate the speed at which it is developing its own chip-production supply chain instead of just talking the talk because this sector is of great importance to the national interest and people’s livelihoods.

The country does an excellent job in certain areas of semiconductor production but is limited to lower-end solutions. As China races to develop 5G communication technology, the progress will be hampered by the ZTE case.

The crisis emerged after the U.S. on Monday slapped a seven-year ban on ZTE’s buying of parts and components from American companies, alleging the Chinese company made false statements to U.S. officials and violated a previous settlement over making illegal shipments to Iran and North Korea.

The U.S. Department of Commerce said ZTE made false statements in 2016 and 2017 during settlement negotiations and the probationary period “related to senior employee disciplinary actions the company said it was taking or had already taken.”

“ZTE misled the Department of Commerce,” Commerce Secretary Wilbur Ross said. “Instead of reprimanding ZTE staff and senior management, ZTE rewarded them. This egregious behavior cannot be ignored.”

The injunction will deal a great blow to ZTE, which according to figures from China International Capital Corp. Ltd. currently has around 10% of the global telecom equipment market, and it enjoys an even higher share of 30% in China.

China lagged behind in the 2G and 3G races, but has managed to play catch-up in 4G. Now it wants to lead in 5G by building the world’s largest network by the end of 2020.

Early this month, ZTE announced it had successfully made China’s first 5G phone call. It has worked closely with U.S. chipmakers on 5G, especially Qualcomm Inc.

The ban is set to seriously hit ZTE’s component sources. Information from the China Semiconductor Industry Association shows that the company purchases as much as 40% of its chips and other components from U.S. partners.

According to Bloomberg statistics, 4 out of the top 10 ZTE suppliers are U.S. companies. Chipmakers Intel Corp. and Micron Technology Inc., for instance, are the largest and third-largest suppliers respectively. In addition, ZTE buys from Oclaro Inc. and Acacia Communications Inc., and is in fact the biggest customer of these two optical-component-makers.

For its own-brand handsets, ZTE purchases a huge amount of chips from Qualcomm, panel screens from Corning Inc., and audio solutions from Dolby Laboratories Inc.

The greatest challenge now is that there aren’t any major alternatives from which ZTE can purchase parts in the short term. It’s understood that its current inventories will last for only around two months.

That means the injunction will lead to a suspension of ZTE’s production of products, including routers, base stations, equipment for private telecommunication networks and microwave transmitters.

ZTE’s 2017 earnings report shows it saw revenue growth in all divisions. Carrier networks accounted for almost 59% of total revenue at 63.8 billion yuan ($10.16 billion); the consumer business took up slightly over 32% at 35.2 billion yuan; while its government-enterprise section contributed 9% to 9.8 billion yuan.

If such a ban were to happen to Huawei Technologies Co. Ltd., the impact would be much less severe. This is because Huawei is less dependent on third parties such as Qualcomm and Samsung Electronics. It’s commendable that its higher-end smartphones use chips from own unit Hisilicon Technologies Co. Ltd.

ZTE said it has started evaluating the impact of the sanctions and coming up with contingency plans. But market watchers said that without mediation between Beijing and Washington, ZTE is going to suffer.

Nonetheless, the case highlights the importance of China’s efforts to hasten the development of own semiconductor supply chain.

The author is a Caixin reporter.