Behind TSMC’s Decision to Build a Chip Factory in Arizona

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Yan Yu

Senior Research Fellow of the Chinese Academy of Social Sciences

Two events in two days last week are set to have repercussions for years or even decades to come. Last Thursday, the world’s largest semiconductor manufacturer TSMC (a.k.a Taiwan Semiconductor Manufacturing Corporation) announced its decision to invest US$12 billion in a 5-nanometer chip factory in Arizona, with a timetable for starting construction in 2021 and production in 2024, sending its stock price roaring. However, TMSC’s stock tumbled the following day when the Trump Administration unveiled new rules to cut Huawei off from its chip supplies, an escalation in its year-long targeted hostility towards one of China’s innovation champions.

Caught in the Middle

The Trump administration has been trying to contain China by waging a trade war and playing the South China Sea card, the Taiwan Strait card and the Hong Kong card. The ongoing technology war is just another gadget in its arsenal.

Last Friday, the Bureau of Industry and Security of the U.S. Department of Commerce announced plans to bar Huawei from using U.S. technology and software to design and produce semiconductors under the grounds of protecting “U.S. national security”.

The new rules require any producer that uses U.S. technology or software to apply for export permission from the U.S. government when supplying chips to Huawei. It means any company, not just a U.S. one, with a supply relationship with Huawei is subject to the U.S. oversight.

TMSC, a chip supplier to Huawei, Apple and Qualcomm, was instantly hurtled into the eye of the storm. Chipmakers in China’s mainland are unable to produce chips smaller than 12 nanometers, leading to Huawei’s dependence on overseas manufacturers.

Too Good to Go Unnoticed

TSMC, founded in 1987 and headquartered in Hsinchu, Taiwan, is one of only three producers in the world that produce 10-nanometer chips or smaller, with the other two being U.S.-based Intel and South Korea-based Samsung Electronics. It is a dominant player in 5G chips, with a 90% market share. While North America remained its largest market, which brought in about 60% of its total revenue, mainland China accounted for only 20% of TSMC’s sales as of late 2019.

Against the backdrop of the intertwined global supply chain, geopolitics inevitably plays a role in TSMC’s business operations. In recent years, U.S. President Donald Trump has been urging TSMC to build a chip plant in the United States that applies the most advanced chip technologies. Caught in the middle of the U.S.-China rivalry, the semiconductor producer was reluctant to choose a side.

Behind its reluctance, there were structural conflicts of the proximity to the supply chain (in favour of mainland China) and to the clients (in favour of the United States) as well as the avoidance of political risks (in favour of the United States) and slashed costs (in favour of mainland China).

TSMC Chairman Mark Liu had previously said that a factory may be built in America only when the conditions of “economic benefits, cost advantages as well as labor and supply chain” were met. He also indicated that manufacturing technologies for 5-nanometer and 3-nanometer chips would stay in Taiwan. In a big reversal from his equivocation, TSMC stated on May 14 its intention to build a fabrication foundry in Arizona.

TSMC’s decision was met with praises from senior U.S. officials. “This manufacturing facility will be one of only two of its kind globally capable of producing the world’s most advanced semiconductors. TSMC’s planned investment will create an estimated 1,600 high-tech jobs, in addition to thousands of additional jobs in the broader semiconductor ecosystem,” U.S. Secretary of Commerce Wilbur Ross said, adding that the plan was another indication that his government’s policy has led to a renaissance in American manufacturing. While his comments focused on the economic impact of the decision, U.S. Secretary of State Mike Pompeo highlighted its geopolitical significance.

Pompeo hailed the deal as a move to “bolster U.S. national security at a time when China is trying to dominate cutting-edge tech and control critical industries.”

Vigilant Against Overdependence

TSMC has retained its Taiwan identity despite its global footprint. At the end of 2019, the chip manufacturer had a total of 51,000 employees, with plants and offices in Taiwan, Asia, North America and Europe employing 89.2%, 7.5%, 3.1% and 0.1% of its total workforce, respectively. When it comes to business structure, the “Taiwan First” policy has been upheld by deploying the most advanced technology and capacity on the island. In September 2017, TSMC announced it would invest in a 3-nanometer foundry in southern Taiwan, with production scheduled in 2022 at the earliest.

Despite its Taiwan roots, TSMC has become increasingly cozy to the United States in recent years. TSMC’s management has many ties with the United States. For example, Liu holds a dual citizenship, including the U.S. citizenship. TSMC has research cooperation with prestigious American universities, such as Stanford, MIT and the UC Berkeley. It also has an 8-nanometer semiconductor plant in Washington state and research centers in Texas and California.

Moreover, a majority of TSMC’s shares are held by overseas shareholders, mainly U.S. investors. The company was listed on a Taiwan exchange in 1994 and the New York Stock Exchange in 1997. As of December 25, 2019, over half of its shares were held by institutional investors, with Citigroup as biggest ADR holder (20.54%) and a state-owned Taiwan-based fund as the second biggest holder (6.38%).

The traditional wisdom of not putting all the eggs in one basket is a principle that resonates to each and every company. Its heavy dependence on the United States is apparently worrying. The concentration of the equities in the hands of American funds has alarmed Morris Chang, the founder of the company.

Why Arizona?

Arizona, the Grand Canyon State, has been home to a galaxy of leading companies in the semiconductor industry, including Intel, Motorola, NXP Semiconductors, STMcroelectronics, Honeywell, Philips and Western Digital. With the onboarding of TSMC, Arizona will boast a large and advanced industry cluster.

From the perspective of U.S. domestic politics, Arizona, traditionally a red state, is at increasing risk of becoming a blue one. The motive behind Trump’s push for TSMC’s entry into the state is to consolidate his grip in the upcoming 2020 presidential elections. The site selection is still ongoing, with the involvement of the Arizona state government and Apple.

In November 2019, TSMC founder Morris Chang said that the company “has become the hotly contested spot for geopolitical strategists”. Now the company is ensnared in the “tech war”, waged by the United States against China. According to news reports in Taiwan, the U.S. government had pressured TSMC to make chips for the military. Intel CEO Bob Swan wrote directly to two senior Pentagon officials, expressing his intention to partner with the government and offering to build the next U.S-based commercial foundry. The Taiwan-based media outlets speculated that the Arizona plant may sell chips to the U.S. military with a hefty unit price, significantly boosting U.S.-Taiwan security and business cooperation.

Chan once said “TSMC is a fab foundry for everyone.” His vague expression is wise as the word “everyone” is open to different interpretations. In recent years, the demand from the mainland has increased exponentially. Among the company’s clients, the largest client Apple contributed 23% of its total revenue and the second largest client Huawei 14%. The evaporation of revenue from Huawei would deliver a heavy blow to the company.

In terms of costs to build a foundry, the mainland reports the lowest, Taiwan comes second lowest and the United States the most expensive. A foundry in the mainland would be close to both clients and plants, and cut intermediary links and maximize economic benefits.

Clearly, the decision to build a plant in Arizona does not mean its disentangling from the mainland but betting on both sides.

Many Uncertainties Ahead

There are still many tests and hurdles to overcome before reaching the production stage in 2024.

The first test is geopolitical uncertainties. Mounting U.S.-China trade tensions, unpredictable U.S. presidential elections and murky prospects for the coronavirus pandemic have cast a shadow over the construction of a fab plant.

The second issue is the lack of human resources. TSMC’s existing engineering team consists of talents with a master’s degree but it would not be easy to find enough skilled professionals in Arizona. Moreover, it is hard to replicate the around-the-clock model of work shifts in the United States.

The third hurdle is an incomplete industry chain. TSMC needs mid-stream and down-stream plants for semiconductor testing and packaging. If such plants are not in place in the short term, TSMC will be forced to transport their wafers to East Asia or southeastern Asia for testing and packaging, pushing up costs.

Due to similar reasons, the construction of Foxconn’s plant in Wisconsin has yet to begin although the plant was scheduled to start production by late 2020. Even U.S.-based Intel is seeking to build overseas foundries to cut costs. It is argued by some that the United States is has an edge over China in design and R&D, but not in manufacturing.

Given the long cycle of building a plant and the need for massive investments as well as uncertain returns, TSMC might be half-hearted in building the plant.

Taiwan, Always Ballast for TSMC

TSMC, nicknamed a “guardian” of Taiwan, contributed 6% of Taiwan’s overall GDP and drove 13% of private investments in Taiwan. Politicians in Taiwan must have mixed feelings about its decision to invest in Arizona. They must be happy about increased relations between Taiwan and the United States but worried about the investments in Arizona will channel investments away from the island.

However, the chip manufacturing giant set 2024 as the year to start production in Arizona, implying that another presidential term is over and 5-nanometer chip technology is no longer the most advanced by then. TSMC may be producing 2-nanometer chips in Taiwan in that year. It demonstrates that TSMC is unwilling to deploy its best technology in the United States.

TSMC has always retained its most advanced technologies and manufacturing capacity in Taiwan. It never forgets its Taiwan roots. Before the site for the Arizona factory is selected, it has acquired 30-hectare land in southern Taiwan and plans to produce 3-namometer chips by 2023, one year before the rollout of its first chip in Arizona.

TSMC, which aimed to remain “technologically neutral”, has been embroiled in geopolitical turmoil. How to navigate unchartered territories amid the U.S.-China rivalry is a question to be pondered by the management. However, they believe that Taiwan is their home and fortress against various risks regardless of ups and downs in global geopolitics.