Chronicle of China’s Electronics Industry: A Retrospective of Recent Developments — Part 1
Originally written in Chinese by: Chen Er at Wechat
The year 2009 marked a significant turning point for China’s electronics industry, driven by three notable events. Firstly, the immense popularity of the iPhone 3 paved the way for the burgeoning smartphone market in China. Secondly, the global electronics giants, seeking to replace their high-cost suppliers mainly from Japan and Korea, accelerated the process of finding low-cost suppliers following the 2008 financial crisis. Finally, China’s State Council issued the Chinese Electronics Industry Revitalization Plan, which played a pivotal role in promoting the growth and development of China’s electronics industry.
These three things were not related by nature, but like a chemical reaction, they resulted in the rapid growth of China’s electronics manufacturing over the following 10 years. The results are shockingly impressive: China became the world’s manufacturing center of consumer electronics; more than 70% of smartphones are now made in China; a number of small Chinese electronics companies grew into large global leaders; and a couple of Chinese mobile phone companies were born, grew, and took over the market from the well-known companies worldwide.
The rise of the industry is also reflected in its strong stock prices. The electronics industry index rose by 450% in the past decade, which is 6 times the broad market increase. Sunny Optical rose 300 times; AAC Technologies rose 65 times. Goertek and Luxshare ICT, which rose 9 times, are not even able to get on the watch list.
However, just when people believed China had become a challenger of the United States in the industry, this was turned around in 2018. Two Chinese electronics giants, ZTE and Huawei, were sanctioned by the US. People started to find that China actually doesn’t own the core technologies in the electronics industry. Those are still owned and controlled by the US, Japan, and several European countries. China is vulnerable to the competition. The stock price of China’s electronics industry dropped hard in less than a year. This inevitably makes people wonder: how far has China’s electronics industry come in the past decade?
To answer this question, we might need to understand the electronics industry’s structure. To do that, let’s take a look at two businesses: Foxconn and Samsung.
Foxconn has about a million employees. They collect sky-high revenues but make ground-low profit margins. The company’s annual revenue is about $150 billion, equivalent to 60% of Apple’s revenue. However, the company’s $40 billion market value is only 4% of Apple’s. For many years, Foxconn’s net profit has been maintained at only about 3%.
Samsung Electronics’ revenue in 2018 was more than $200 billion. It seems to fall into the same level as Foxconn, but their profit is crushing. Samsung’s gross profit margin is as high as 40%. Their net profit is $34 billion, which is more than 8 times that of Foxconn.
Why then? It’s because Foxconn sells labor primarily, which is at the bottom of the industrial value chain, while Samsung sells technologies, which have a much higher profit margin. Samsung is also less affected by the Japan-South Korea trade war.
If you want to know how far Foxconn, the iconic Chinese electronics manufacturing company, is from Samsung Electronics, let’s take a closer look at the major parts of a mobile phone. It may tell you where Chinese electronics manufacturing is now.
1. Camera
Why is it that China produces 70% of the world’s mobile phone cameras, but does not have a well-known manufacturer?
If you ask what the most important feature of mobile phones is, there is no doubt that it is the camera function. The core component of this function is the increasingly expensive camera module. In the new model of iPhone, the camera module price is as high as $73 — the camera module has become a more costly part than the chip.
The mobile phone camera business has a $30 billion market. 90% of the value of the camera falls into three components: image sensor (CMOS), lens, and module assembly.
1. The upstream of the camera industry is the image sensor (CMOS). The market is worth more than $15 billion and has a high profit rate of 50%.
2. The lens market, in the middle, has certain technical barriers with a gross profit of up to 70%. It sometimes makes more money than the image sensor business. But its market size is $4–5 billion, which is much smaller than the image sensor’s.
3. The downstream of the industry is the assembly of the lens module. It is a laborious task of hiring a large number of people to assemble the lens, chips and other parts. Although the market size is similar to the lens’, the profit margin is only 1/5 that of the lens.
Module Assembly
There is no doubt that China dominates in the module assembly business. Among the 5 billion camera modules, more than 70% are produced in mainland China. However, this is both a capital- and labor-intensive industry. Regardless of the level of the efforts, the barrier to entry is not high. The money and labor can put you a decent position as long as they are sufficient.
China’s OFILM started their business in the camera module industry in 2013, but after raising sufficient funds from the capital market, they have defeated the industry veterans, the Taiwanese companies, with their use of scale effects. In 2016, only three years after entering the industry, OFILM achieved the №1 position in the world in terms of the number of modules.
In 2017, Sony decided to leave the low-profit module assembly business to focus on the high-profit image sensor business that they have been leading in. They sought to sell their Chinese module assembly company, and OFILM took it over by paying more than $200 million.
However, the successful expansion and acquisition did not allow OFILM to gain a firm foothold. Only one year later, the mainland connector giant, Luxshare ICT，acquired Taiwan-based Lite-On’s camera module business and broke into this market. It successfully joined Huawei’s business line. It ushered in the new round of the battle in the camera module assembly market, which was already less profitable.
This fierce competition is determined by the low technical barrier of the module assembly. It is foreseeable that with the increase in the Chinese labor costs, OFILM and Luxshare ICT will most likely face challenges from companies in Southeast Asia and India in the near future. In the module business, the competition is cruel. Companies come and go. But moving up to the lens business, the number of players is decreased significantly.
Lens
The lens business is a more profitable business. Largan Precision, a Taiwanese company, received an annual revenue of only $1.54 billion, a quarter of OFILM’s, but its profit was $750 million, more than 2 times OFILM’s past five years’ net profits combined.
The Chinese optical giant, Sunny Optical, has been more aggressive in this field. Before 2009, it was only able to produce low-end lenses, and the volume was not high. However, it increased its technical capabilities significantly after acquiring Korea’s Power Optics and Japan’s Konica Minolta Optical Instruments. Sunny Optical increased its investment in R&D and has become more competitive than before. In the past 5 years, Sunny Optical has grown rapidly at an average annual rate of more than 50% in the field of lenses. Its current market share has approached 25%. Although its market share is growing rapidly, its gross profit margin is still 30% lower than Largan Precision’s. Largan Precision still has advantages in the high-end lens field. The war continues.
Mainland China is still quite competitive in the lens market, but in the next-level field, the image sensor field, it’s not looking good.
Image Sensor
The image sensor is the core of the camera and defines its technological capabilities. Sony, which sold its downstream module business, is the absolute overlord in the image sensor field. It has a market share of more than 40%, with an annual net profit of more than $1 billion.
Sony holds the most patents for image sensors. For quite a long time, it has been waiting for competition in image sensors for high-end mobile phones. Apple has never used any image sensors other than Sony’s in iPhone since the iPhone 4s. Huawei’s P30 mobile phone, whose camera function is surprisingly amazing, is equipped with the IMX600 series sensor jointly developed by Huawei and Sony. Huawei’s flagship Mate series also uses image sensors customized by Sony.
When you try hard to compare the camera functions of Huawei and Apple, you might not know that they are both based on Sony’s CMOS.
Next to Sony, South Korea’s Samsung accounts for 20% of the market. They have been making many amazing sensors too. The recently-released Xiaomi CC9 Pro carries a 108-megapixel camera, one of the highest resolution cameras. This was achieved by Samsung’s ISOCELL Bright HMX photosensitive chip. Chinese companies don’t have much talking power in this area. The representative companies, GalaxyCore and SuperPix, are not even close to the world-class level. Fullhan, a hot public company listed on the Chinese stock market, is still in the R&D stage.
Both GalaxyCore and SuperPix make CMOS sensors targeted at the low-end market. In terms of quantity, the delivery volume of these two, GalaxyCore in particular, is very large and has surpassed Sony’s. However, because the unit price is too low, it is classified just under the “Others” on the world’s market sales chart. In the field of image sensors, advanced technologies, which result in a high unit price, have an overwhelming advantage.
In this area surrounded by high technical barriers, China has only obtained one competitive business after the acquisition of OmniVision Technologies.
OmniVision Technologies is a leading image sensor manufacturer of CMOS and BSI Sensors. It’s the American company that invented CMOS. Facing heavy competition from Japanese and South Korean companies, it has gradually retreated to №3 in the industry. The Chinese consortium seized this opportunity and bought OmniVision for $1.9 billion in 2016, selling it to China’s WillSemi this year.
Now let’s try to answer why China produces 70% of the world’s mobile phone cameras, but does not have a well-known manufacturer? It’s because people only care about the big brands that own the core assets — intellectual property. Every iPhone user knows their phones are made by Apple. Few people care about who is the assembler of the iPhone, even if Foxconn is the largest electronics manufacturing company.
Chinese companies like OFILM produce most of the cameras in the world, but the majority of their work is low-tech assembly work. Their net profit is not higher than Foxconn’s. Companies like Sony and Leica, which own the technologies and the IP, have brand awareness working for them. On one side the Chinese companies sought to acquire the technology firms from Japan and the US; on the other side they defeated the old leading manufacturers from Taiwan. It seems China has been leading the camera manufacturing market, but the only company that can come close to Foxconn is Sunny Optical.
To be continued…
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