The U.S. in August introduced new rules that forbid foreign chipmakers that rely on U.S. technology from selling any chips to Chinese telecom manufacturer Huawei Technologies without obtaining a special license.
The sanctions will further starve Huawei of critical semiconductors. Just this week, Samsung Electronics and South Korean memory chipmaker SK hynix reportedly acknowledged that they will be ceasing their supply of semiconductors to Huawei on Sept. 15, the same day the new U.S. rule takes effect.
The new U.S. mandate means Huawei’s supply chain has gone from being “restricted” to “almost totally shut off,” particularly in regards to advanced semiconductor technology, said Paul Triolo, geo-technology practice head at the political risk consultancy Eurasia Group, focusing on global technology policy, cybersecurity, Internet governance, and emerging areas such as A.I. and fintech. He is also a China Digital Economy Fellow at the Washington, D.C., think tank New America.
Beijing has taken steps to strengthen its domestic semiconductor industry, but the restrictions against Huawei mean China faces an “uphill battle” to “wean [itself] off of U.S. technology” in manufacturing chips, Triolo said.
“This is a global industry that’s taken 20 or 30 years to develop,” he said. “It’s just really hard for China and Chinese companies to re-create these global value chains that took so long to develop.”
In a Eastworld Spotlight conversation with Fortune‘s Clay Chandler on Tuesday, Triolo talked about Huawei’s ability to keep up manufacturing with dwindling stockpiles of semiconductors, the company’s chances of survival, and the supply chain battle between the U.S. and China. The conversation below has been edited for length and clarity.
Fortune: The U.S. has set a Sept. 15 deadline on shipping semiconductors made with American technology to Huawei. How long can Huawei last before exhausting its stockpile of high-speed chips?
Paul Triolo: The ability of Huawei to last with those stockpiles depends on the product line. With smartphones, for example, Huawei was at one point producing over 250 million smartphones per year. They were using a lot of semiconductors that are key to smartphones’ advanced features. I think one estimate is that they’ll only be able to produce 50 million phones next year, so there’s a huge drop. They’ll run out of those advanced semiconductors probably sometime early next year because the volume is so high. For 5G base stations, they might be able to last a little bit longer because the volume there isn’t as high.
But at some point, the big issue is that they can’t compete internationally. When the initial entity list action happened, Google was not allowed to provide Google mobility services [to Huawei]. So right away nobody wanted to buy a [Huawei] handset outside of China, particularly in places like Europe, because they couldn’t get Gmail and YouTube and all the other things they were used to. So Huawei’s handset sales were already under stress from the software side; now, of course, you have the hardware part of it.
Is there a risk that this is so disruptive it could threaten Huawei’s existence as a company?
Yes, I think definitely that’s the case. The company has been able to get around this [restriction] initially by redesigning their base stations and some of their other products. But there’s no real alternative once the U.S. has basically restricted [chipmakers’] ability to produce these cutting-edge semiconductors [for Huawei].
For example, the leading Chinese domestic foundry, [Semiconductor Manufacturing International Corporation], is just not at the same level. They’re two or three generations behind leaders like [Taiwan Semiconductor Manufacturing Company], Samsung, and Intel. And the U.S. has acted to cut off their ability to acquire advanced lithography equipment, for example, so [SMIC can’t] move to more advanced nodes in semiconductor manufacturing. Huawei has nowhere to turn here. There’s no domestic champion that’s going to come to Huawei’s rescue on the semiconductor side. So that’s existential.
The company, in my sense, is going to have to reorganize, potentially spin off parts of the company. They’re still competitive, of course, in things like software and cloud services. But all those things still require semiconductors at some level. So all parts of their business are eventually going to be affected.
For the U.S. to exploit this technological monopoly and threaten the existence of a $100 billion company feels almost like going for the nuclear option. What options does Beijing have to counteract this threat?
Senior leaders in Beijing are sort of trying to run the clock out…hoping that if they got a change of administration in November, some of these policies would be reexamined under a Biden administration. So they’re being very careful and disciplined in responding.
On the other hand, they’re taking a lot of steps domestically to shore up the industry. Already there’s a huge national [integrated circuit] investment fund, which has been providing subsidies to Chinese semiconductor companies. In May there was a big announcement of the new infrastructure initiative, which is designed to focus on 5G and mobile edge computing to encourage domestic companies to take part in that. They’ve been beefing up the Star Market in Shanghai, the high-tech [stock] market, encouraging semiconductor companies to list on that. They’ve changed some of the [initial public offering] requirements and are trying to get companies in China to raise funding through both the Star market and the Hong Kong stock exchanges.
The problem is these are tough technologies to master. It’s not really a function so much of funding as it is of talent and technology know-how. That’s going to take time. Certainly China has come a long way in the last five years, in terms of design and manufacturing of semiconductors. But this is a global industry that’s taken 20 or 30 years to develop some of the division of labor. And it’s just really hard for China and Chinese companies to re-create these global value chains that took so long to develop, and cutting-edge things in the software services side or in the semiconductor manufacturing side. So China [is facing] a real uphill battle.
Let’s talk about global technology supply chains. In a recent report, you foresee the emergence of a “red chain” and “blue chain.” What do you mean by that?
We’re seeing it as a result of the recent series of U.S. government policies—the attempt to really force countries and companies to choose sides in this U.S.-China conflict. We’ve seen this very clearly, for example, with this new clean initiative that the Trump administration is pursuing. In August, [Secretary of State Michael Pompeo] announced an expansion of this so-called clean network, which really includes things like 5G [and] cloud services. Now it includes mobile application stores. And you know, “clean” means really free of Chinese technology.
We saw this initially with Huawei, which was a path that the U.S. followed over the last two years to convince allies, in particular in Europe and in Asia, to exclude Huawei from their 5G network rollouts. Initially, that looked like it wasn’t going to gain a lot of traction. But over the last two years, over the last year in particular, it’s gotten traction in part because the U.S. has also implemented these other restrictions on Huawei, passing doubt over the ability of the company to succeed in those markets.
Going forward, the clean initiative has really expanded into every part of the technology stack. That really is an attempt to sort of force the world into either the “blue supply chain,” which is the U.S. and other Western democracies in Europe and in Asia. And a “red supply chain,” one that China would lead.
This story is part of Eastworld Spotlight, a series of conversations on matters of business, tech, and finance with executives, experts, entrepreneurs, and investors in Asia. Subscribe to Fortune’s Eastworld newsletter to get them in your inbox.
