2024-06-25 - tech

A key role in Japan's chip recovery

How to Save Japan's Chip Industry from the Lost 20 Years?

Xie Yongfen, a former materials scientist turned entrepreneur, established her company's second laboratory in Kumamoto Prefecture in southwestern Japan late last year. She is currently considering whether to set up a third one.

As the founder and CEO of Hongkang Technology (widely known as MA-tek), Xie Yongfen is expanding her business in Japan in line with the steps of the company's main clients, such as TSMC and Sony. MA-tek's primary business is to test cutting-edge semiconductor materials and certify new products.

"We believe that the revival of Japan's chip industry may be faster than expected," she said. "Japan has a solid foundation in chip manufacturing, with top-notch materials, equipment, and a supply chain network that has been carefully built over the years and is essentially complete." MA-tek derived 8% of its revenue from Japan last year. Xie Yongfen said the company's goal is to increase this proportion to 20% by the end of the year.

The arrival of companies like MA-tek has changed the fate of Japan's domestic chip industry. Once the world's leading semiconductor industry, Japanese chip manufacturers continuously lost ground to competitors from South Korea, Taiwan, and the United States in the 1990s and early 2000s. After multiple failed attempts to restructure the industry, Tokyo has almost lost confidence in this sector.

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"The word 'semiconductor' is closely associated with 'failure' in the eyes of politicians," said Hamashima, the president of the Semiconductor Equipment and Materials International (SEMI) Japan and a former executive of Tokyo Electron, a global chip equipment manufacturer. In 1989, Japan accounted for six out of the top ten global chip manufacturers. By 2023, there were no Japanese companies among the top ten revenue-generating chip manufacturers.

However, Japan's political leadership is now determined to turn the tide and attract foreign companies that have surpassed domestic manufacturers. In the past few years, generous government subsidies have attracted industry leaders like TSMC, Micron, and Samsung to invest in Japan. For some projects, such as Samsung's, government subsidies account for about 50% of the total investment.

The supply of advanced semiconductors, crucial in the modern economy, has raised concerns for the Japanese government, analysts say. This has prompted the government to promote the redevelopment of the semiconductor field. Under the guidance of Prime Minister Fumio Kishida, the government has allocated nearly 2 trillion yen (13 billion US dollars) for the semiconductor industry in this fiscal year as a supplementary budget, an increase from last year's 1.3 trillion yen, setting a record for the highest semiconductor budget by the Japanese government.Charles Shi, a chip analyst at American investment bank Needham & Co, said: "Japan's semiconductor industry is undergoing a significant transformation, re-emerging on the global stage. If China was the emerging region for global semiconductor industry growth over the past decade, then Japan is poised to be the next rising region."

Tokyo's commitment to support not only domestic but also foreign companies demonstrates the government's determination to revitalize Japan's position as a semiconductor powerhouse. "Companies like TSMC can manufacture what Japanese companies cannot," such as advanced chips for artificial intelligence and autonomous driving technologies, said Jun Okamoto, a partner at KPMG Consulting in Japan. Attracting these companies is a "strategic advantage" for Japan's economic security.

New foreign investors include American memory chip maker Micron, which announced in 2023 that it will invest up to $3.7 billion in the coming years in a DRAM chip factory in Hiroshima, located in the western prefecture of Japan's main island. South Korea's Samsung announced at the end of last year the establishment of a research and development facility in Yokohama, a coastal city near Tokyo, with an expected investment of 35 billion won ($280 million) over the next five years.

However, Japan's real coup is TSMC's plan to invest billions of dollars. TSMC, the world's leading chipmaker, opened its first Japanese factory in Kumamoto, in the southern part of Kyushu Island, on February 24. The initial investment for the factory is expected to reach $8.6 billion, and TSMC recently announced plans to build a second factory in the same area, bringing the company's total investment in Kumamoto to at least $20 billion by 2027.

Okamoto from KPMG believes that TSMC's investment—something few industry insiders foresaw a few years ago—symbolizes a new era for Japan's semiconductor industry. He told the media: "Before the recent investments, it was unheard of for foreign semiconductor companies to invest in building factories in Japan."

"Silicon Island"

Previously, industry leaders and politicians alike celebrated the start of production at TSMC's factory in Kumamoto. The factory is located on a 21-hectare site in Japan's "Silicon Island," surrounded by cabbage fields. "Silicon Island," or Kyushu Island, got its name in the 1960s when manufacturing giants such as Mitsubishi, Sony, and Toshiba chose to establish their main factories there.

This new factory will produce Japan's most advanced chips by the end of 2024.Mr. Morris Chang, the founder of TSMC, attended the ceremony along with other business leaders, including Mr. Akio Toyoda, Chairman of Toyota Motor Corporation from Japan, Mr. Kenichiro Yoshida, CEO and Chairman of Sony Group, and Mr. Yasutoshi Nishimura, the Minister of Economy, Trade and Industry of Japan, among other senior political figures.

"This (new factory) will enhance the supply resilience of chips for Japan and the world," Mr. Chang stated at the opening event. "I believe and I hope this will also herald a revival of the semiconductor industry."

Japanese Prime Minister Fumio Kishida "endorsed" the event through a video message, anticipating the start of large-scale chip production later this year, and stated that the Japanese government will continue to "act swiftly" to support the industry through financial backing and easing of restrictions.

The impetus for the Kumamoto factory is not only Japan's evolving industrial policies and generous incentives for foreign chip manufacturers. In addition to internal pull factors, there is also a push factor: the new efforts of chip manufacturers to build and invest abroad to reduce supply chain risks. TSMC is seeking to diversify its production. The company is undertaking its most ambitious overseas expansion ever, following a large $40 billion factory in Arizona, USA, with the establishment of a factory in Kumamoto, Japan. The Arizona facility is expected to begin its first phase of large-scale production in 2025.

These factories also form a key part of the chip supply security architecture advocated by the United States, triggered by factors such as the global chip shortage and pandemic disruptions. The United States has formed a "value-sharing" chip alliance. Analysts say this move highlights the importance of establishing a resilient supply chain and emphasizes the key role of advanced chips.

TSMC's investment momentum in Japan is strong, even surpassing the company's ongoing projects in the United States. The Kumamoto factory was announced at the end of 2021 and began construction in 2022. The factory will produce specialty chips for automotive and industrial applications, with large-scale production expected to start later this year.

Earlier in February, TSMC announced plans to build a second factory on Kyushu Island, which will use 7-nanometer and 6-nanometer production processes, making it the most advanced chip manufacturing plant in Japan. This level of technology is suitable for manufacturing processors for automotive and electronic devices.

According to four informed sources, TSMC is even considering building a third factory, possibly for the production of more advanced 3-nanometer chips, similar in technological level to the factory established in the United States.

TSMC has found that its expansion in Japan is more likely to achieve a break-even point more quickly compared to investments in the United States and Europe. A chip industry executive familiar with the matter told the media, "When choosing overseas investment locations, several factors need to be considered: which region performs better in terms of finance, supply chain, and operational efficiency? Where can customer satisfaction be the highest? And where can TSMC have access to sufficient local talent resources? After comparison, Japan might just be the answer."

TSMC's early success and relatively smooth development process in Japan have helped to persuade other chip manufacturers and suppliers to follow suit.Semiconductors are a major driver of greenfield investments (a type of foreign direct investment that includes building new factories or establishing local subsidiaries) into Japan. According to a report by the Japan External Trade Organization (JETRO), from January 2021 to August 2023, Japan has been announcing greenfield investments averaging over 15 billion US dollars annually. Of this, nearly 10 billion US dollars in the chip sector accounts for about two-thirds of the total. This is a significant departure from the past, when "foreign direct investment related to chips was primarily driven by foreign companies acquiring Japanese chip businesses," says Okamoto from KPMG.

The Japanese government's substantial subsidies and tax credits have played a crucial role in the country's chip revival. However, even with these incentives, questions remain about Japan's (relatively high labor costs) competitiveness in chip manufacturing. In an interview, Tsai Shikai, Chairman of Powertech Technology, a chip packaging service provider, stated that operating costs in Japan are about twice as high as in Taiwan. Nevertheless, he believes that expansion is still worth considering if there are suitable partners to co-invest, such as Sony's investment in TSMC's Kumamoto factory.

Tokyo's big-ticket investments have also raised eyebrows among neighboring countries, potentially sparking fierce competition to attract investments and talent.

Rise and Fall

A significant advantage for Japan compared to its competitors is the attempt to "rebuild" rather than "establish" the chip industry.

In the 1980s and early 1990s, Japan dominated the chip world. In 1988, Japanese companies accounted for 50% of global chip sales, occupying six out of the top ten chip manufacturers in the world. This included companies like NEC, Toshiba, and Hitachi. However, by 2019, according to a report from the Ministry of Economy, Trade and Industry of Japan, Japan was only producing 10% of the world's semiconductors.

One reason for the decline of Japan's semiconductor industry was trade friction with the United States, which dealt a particularly heavy blow to Japanese chip manufacturers. At the end of the 1980s, under strong pressure from Washington, Japan agreed to restrict the export of semiconductors, mainly DRAM chips, to the United States. Subsequently, American chip companies turned to TSMC to produce the chips they designed.Tokyo Sakura Meirin University Special Appointed Professor of Business, Shūhei Yamada, stated that another reason for the decline of Japan's chip industry is the decline in market share of Japanese consumer electronics companies such as Toshiba and Hitachi, which were once leaders in chip competition. As price wars with China led to a contraction in sales of Japanese consumer technology products, the demand for Japanese chips also decreased.

Yamada said: "Japan's consumer electronics and semiconductor industries have dragged each other down, and both industries have experienced a decline."

Another significant reason for Japan's loss of leadership is the instability of the memory chip market. The chip industry goes through a so-called chip cycle every three to four years, with the market rising and falling continuously. As chip technology rapidly develops, manufacturers have to go to great lengths to raise funds to keep up with the investment demands of new devices.

Large chip manufacturers continue to invest even during difficult times in the industry because waiting for the economy to improve would cause them to lose valuable time to enhance their products.

Japanese electronics manufacturers could not continue to hold their ground in the semiconductor investment game during economic downturns, as semiconductor investment seemed more like a "gamble" compared to consumer electronics business, said Hamajima of the Japan Semiconductor Industry Association.

In the 1990s, in order to survive, Japanese chip companies attempted to consolidate, but they did not achieve much success. Due to their "lack of strong leadership," the mergers did not go smoothly, and the merged companies still behaved as if they were two separate entities, leading to slow decision-making, Hamajima said.

A typical example of this failed restructuring is Elpida Memory, which was a joint venture of NEC and Hitachi's DRAM business. Despite receiving financial support from the Japanese government, Elpida Memory went bankrupt in 2012 and was later acquired by the American Micron Technology in 2013.

These failures alienated the government and lawmakers, who felt that intervening in the chip industry "neither worked nor helped gain more votes," Hamajima said. Industry insiders refer to this period—from the 1990s to the 2010s—as the "lost 20 years" of Japan's chip industry.

Despite losing some market share, Japan still controls some key parts of the chip supply chain, which could pave the way for its resurgence.

Japanese suppliers such as Tokyo Electron and Shin-Etsu Chemical hold significant shares in several key chip-related markets, including silicon wafers, photoresists (basic chemicals used in advanced chip production), and chip manufacturing tools.Despite losing its leading position in the global competition for chip manufacturing, Japan's domestic suppliers of chemicals, materials, and equipment have demonstrated remarkable resilience, said Liu Wenlong, a senior figure in the chemical industry and CEO of LCY Chemical, a key supplier to TSMC, Intel, and Micron, in an interview.

"Japanese companies have not lost their craftsmanship and manufacturing consciousness," he added.

This foundation, coupled with a shift in the Japanese government's attitude, seems to have yielded results in attracting foreign investment. Semiconductor companies in Japan have followed TSMC's lead in investing in the country, which is precisely what Tokyo hoped for in its efforts to court manufacturers from Taiwan.

"There are many significant projects underway that are supported by government funding," said Masato Goto, President of SCREEN Semiconductor Solutions, a chip tool supplier. "After experiencing the 'lost two decades,' expectations for domestic investment in Japan are very high."

The Kyoto-based company opened a facility in Kumamoto last year to train engineers to maintain and inspect manufacturing equipment. "We need to be prepared for further market expansion," Goto said, adding that the company plans to increase its equipment maintenance and inspection staff by about 50% by 2030.

Among Japanese suppliers, Ebara Corporation is also heavily investing, producing equipment used for wafer polishing. The Tokyo-headquartered company is currently building a third factory to produce these devices near TSMC's factory.

Companies like chemical supplier Tokyo Ohka Kogyo and wafer supplier Sumco have also announced investments in Kyushu, the southern island located in Kumamoto Prefecture.

This broad range of investments is crucial for creating a comprehensive chip ecosystem from raw materials to the final process, said Okamoto. "TSMC will strengthen the cultivation of new Japanese chip engineers and consolidate related industries," he added, noting that this will benefit Japan's future economy."The second step"

The issue is whether these foreign factories can truly bring about the revival of Japan's domestic industries, or whether the trillions of yen in subsidies will merely make Japan an ideal location for foreign companies to set up factories.

The biggest challenge in revitalizing Japan's chip industry is the lack of experienced engineers within the country. According to a Morgan Stanley Mitsubishi Securities analyst, Tetsuya Wada, a chip factory requires hundreds of engineers, but due to a long period of lack of training, "the winter of Japan's semiconductor industry has been so long that available talent is becoming increasingly scarce." Many Japanese engineers have turned to other industries, and those who return to the industry are "already over 50 years old."

Attracting new talent is a priority for the industry, but cultivating enough new graduates is a slow process. However, Tai Shigeaki, the head of the chip equipment department at Ebara Corporation, said that he has noticed that more and more students are interested in joining his company or the semiconductor industry due to recent large-scale projects. He said, "The semiconductor industry has returned to its former status for the first time in 30 years."

An official from the Ministry of Economy, Trade and Industry of Japan explained why the government is funding TSMC's factory: He stated that strengthening domestic chip capabilities has become "imminent," and the possibility of Japanese companies starting up and quickly achieving large-scale production of advanced chips to compete with TSMC in a short period of time is quite small.

However, the official also added, "In the second phase, ensuring that businesses and their (commercial and talent) bases remain within Japan is extremely important." He said that foreign companies would not be excluded, but also acknowledged the necessity of "Japanese participants."

The final link in Tokyo's plan to regain its position as a chip powerhouse is Rapidus, a Tokyo startup established in 2022. It was founded with an investment of 7.3 billion yen from 8 Japanese companies, including Toyota. Rapidus plans to mass-produce the next-generation 2-nanometer chips on the northern island of Hokkaido by 2027. The cost of this project is estimated to be as high as 5 trillion yen, and Tokyo has pledged to provide 330 billion yen.

Producing 2-nanometer chips is by no means an easy task—no Japanese chip manufacturer has achieved such advanced chip technology, and Rapidus will compete with global giants like TSMC and Samsung in the race to compress more transistors on a single chip. TSMC, Samsung, and the United States' Intel plan to produce 2-nanometer chips by 2025.

The Rapidus project is seen by some analysts as having a "very slim chance of success," but it is precisely Japan's attempt to cultivate domestic enterprises to challenge global chip giants.

Rapidus's chairman, Tetsuro Higashi, said at a recent press conference that his project has the support of international companies because some companies are concerned about the "quite monopolistic market structure" in the advanced logic chip field. Higashi did not mention TSMC, but implied that his company could become an alternative supplier in certain areas.Regarding confidence in this project, Toshitaro said: "We have received broad support from Japan, foreign organizations, and tool manufacturers. I have not a single second of doubt that this project will be successful."

Rapidus has indicated that by collaborating with American IBM and global institutions such as the Belgian R&D team Imec, it can take the lead in developing cutting-edge chips over its competitors.

Toshitaro is not the only one brimming with confidence in Japan's chip industry. Peter Wennink, the CEO of ASML, the largest chip equipment manufacturer in Europe, stated that Japan has a long history in the semiconductor industry, and the Japanese government clearly values the restoration of this status.

Wennink said: "The challenge lies in having to rebuild some parts of the supply chain that have slowed down over the past few decades, which means you need to invest in human resources, invest in the ecosystem."