The U.S. wanted to starve Huawei of chips. It’s working

August 10, 2020, 2:32 PM UTC

Last Friday, the CEO of Huawei Technologies’ consumer business group, Richard Yu, said the Chinese smartphone manufacturer will stop developing the chips that power its flagship smartphones, jeopardizing the company’s position as the world’s largest smartphone manufacturer.

“Huawei’s mobile phones have no chip supply, which makes our shipment volume this year a little less than 240 million units (shipped last year),” Yu said at the industry event in Huawei’s hometown of Shenzhen last week, stating the decline “is a huge loss for us.”

Kirin chips, which Huawei designs in-house, power the company’s most advanced smartphones, but the manufacturing of Kirin chips is outsourced to Taiwan Semiconductor Manufacturing Company (TSMC). In May, the White House prohibited TSMC from taking more product orders from Huawei, a move that leveraged TSMC’s reliance on U.S. tech to run its factories.

Yu said production of Huawei’s high-end Kirin chips will cease on Sept. 15—the end of the 120-day window the U.S. gave TSMC to finish outstanding Huawei orders. Without TSMC, Huawei has no way to produce its own chips, and so, Yu said, “this year may be the last generation of Huawei Kirin high-end chips.”  

Huawei declined Fortune‘s request for further comment.

There are few alternatives to TSMC. The $380 billion company is the world’s most advanced manufacturer of semiconductors, occupying over 50% of the global market for contract chip manufacturing. The capabilities of China’s own rival contract manufacturer, Semiconductor Manufacturing International Corporation (SMIC), is generations behind TSMC—meaning it wouldn’t be able to produce the chip designs Huawei creates.

Huawei could use generic chips provided by companies like Qualcomm to power its smartphones, but the cost of such an alternative would be higher and the performance would be lower than Huawei’s custom-made chips. Plus, there’s the risk that the White House will prevent California-based Qualcomm from selling to Huawei, too.

The U.S. has long viewed Huawei as a security threat. Last year, the Department of Commerce prohibited U.S. chipmakers from selling components to Huawei, without special permission, but the agency has so far not enforced the rule. According to the Wall Street Journal, Qualcomm—as well as other U.S. chip companies—is lobbying the Trump Administration to keep Huawei as a customer, warning that the ban could cost U.S. chipmakers a $8 billion market.

Another possibility is for Huawei to get its chips from Taiwan’s MediaTek—the world’s fourth largest chip designer. MediaTek outsources manufacturing of its chip designs to TSMC, so it would be able to provide Huawei with a chipset that’s nearly as sophisticated as Huawei is used to.

“MediaTek said in their last earning call that they will have 40% of the Chinese market for 5G chips by the end of the year, so we already suspect it will be shipping many more processors to Huawei,” says Brady Wang, associate director at Counterpoint Research.

The Taiwanese firm is an attractive business partner for Huawei, Wang says, because it is less susceptible to U.S. intervention. But Huawei’s engineers will need time to figure out how to get the best performance from MediaTek’s processors, meaning Huawei’s future releases likely “won’t be as good as before—at least in the beginning.”

The problem Huawei is now facing with its smartphone chips also may apply to the chips TSMC manufactures for Huawei’s 5G base stations. Currently, Huawei produces the world’s most advanced 5G infrastructure systems and has won more contracts for developing 5G networks than any of its competitors. But, as with smartphones, market dominance requires producing your own designs.

“If things cannot change and Huawei cannot get TSMC to produce chips, Huawei will lose the 5G market very fast,” Wang warns. Huawei has been stockpiling chips in anticipation of U.S. sanctions cutting off its supply lines, but it’s unclear how long that inventory will last. If Huawei can’t promise clients it can provide future maintenance, customers may go elsewhere.