When China started to outproduce the US in integrated circuits, there was a lot of concern among American companies. But now that it’s been confirmed that Chinese chipmakers have produced fake chips designed specifically for government surveillance, some are thinking about whether they can compete with China at all.

The “startups” are two Chinese companies that tried to catch up to the makers of advanced computer chips. They failed and now they’re trying to sell their products in a different market.

Two Chinese Startups Tried to Catch Up to Makers of Advanced Computer Chips—and Failed

In recent years, China has invested billions of dollars attempting to catch up to the world’s most sophisticated semiconductor manufacturers.

Two foundry initiatives, one of which was driven in part by a little-known entrepreneur in his 30s at the time, demonstrate why China has yet to achieve success.

The projects in Wuhan and Jinan, China, were meant to produce semiconductors that were almost as complicated as those produced by industry heavyweights Taiwan Semiconductor Manufacturing Co. and Samsung Electronics Co., both of which had decades of chip-building expertise.

Hundreds of millions of dollars were donated by Chinese authorities to help the upstarts. However, it became evident that the plans were too ambitious, and that local leaders had overestimated the difficulty—and cost—of producing complicated high-end semiconductors.

The two foundries, Wuhan Hongxin Semiconductor Manufacturing Corp. and Quanxin Integrated Circuit Manufacturing (Jinan) Co., spent a lot of money but never manufactured any chips for commercial use.

In June 2021, HSMC officially closed its doors. QXIC is still up and running, but it has ceased operations and has not responded to calls for comment.

According to business announcements, official media, local government papers, and Tianyancha, a corporate registration database, at least six new significant chip-building projects have failed in China in the last three years, including HSMC and QXIC. According to the papers, at least $2.3 billion was invested in these initiatives, with the majority of it coming from governments. Some companies never made a single chip.

The Wall Street Journal met with a guy who claimed to be one of the HSMC and QXIC programs’ coordinators. In the Tianyancha database, he is described as the former CEO of QXIC, a former board member of HSMC, and a former substantial stakeholder in both companies. For this report, the Journal consulted with former QXIC workers and others acquainted with the situation.

Beijing’s officials and investors are sifting through the ruins of failing semiconductor companies in the aim of recovering some components while simultaneously enacting stricter regulations to avoid future waste.

According to persons familiar with the situation, although the government has informally urged that some chip firms seek clearance for new projects for years, approval is now compulsory for projects totaling more than around $150 million in fixed asset investment.

Tsinghua Unigroup Co., a Chinese chip behemoth that defaulted on billions of dollars in debts last year, said in December that it had found a strategic investor in a consortium formed by two state-backed semiconductor venture capital companies.

The speed with which we can drive a vehicle off the lot or purchase a new laptop is being hampered by a worldwide chip scarcity. The Wall Street Journal visits a fabrication factory in Singapore to learn about the complicated process of chip manufacturing and how one company is attempting to solve the shortfall. Photo courtesy of The Wall Street Journal’s Edwin Cheng.

China’s semiconductor production is a top priority. According to International Business Strategies Inc., an industry consulting and research organization, Chinese chip manufacturers create just around 17% of the chips the country requires, leaving China dependent on foreign suppliers.

Experts warn China, which has been affected by US sanctions preventing certain businesses from accessing key chip-making methods, might slip farther behind when it comes to creating the most modern chips, such as those used in smartphone and computer processors.

The National Development and Reform Commission of China and the Ministry of Industry and Information Technology, both engaged in China’s semiconductor regulations, did not reply to requests for comment.

Evidence of China’s societal dissatisfaction with its reliance on foreign chips erupted in late December, when Intel Corp., the world’s largest semiconductor company, sent a letter to suppliers asking them to avoid sourcing from the Xinjiang region, where the Chinese government is waging a forcible assimilation campaign against religious minorities.

Two-Chinese-Startups-Tried-to-Catch-Up-to-Makers-of

After ordering vendors to avoid purchasing from the Xinjiang area, Intel was chastised in China; the company visited ChinaJoy, a digital-entertainment extravaganza in Shanghai last summer.

Photo courtesy of REUTERS/Aly Song

Chinese social media users were enraged by the perceived insult, with some bemoaning China’s lack of adequately sophisticated homegrown processors to replace Intel’s.

Intel issued an apology and said that the letter was made only to comply with US law.

Around 2014, Beijing started announcing industry-support measures, including the Big Fund, a $22 billion central-government fund for semiconductor investments. Similar funds have been established by local governments. In 2019, the state launched a $30 billion second national semiconductor fund.

Chip money was soon strewn over China. According to the Tianyancha database, tens of thousands of Chinese enterprises have listed their operations as semiconductor-related, including those whose primary activity include restaurants and cement manufacturing.

China has progressed in certain elements of chip manufacturing, particularly chip design. However, several businesses failed due to a lack of knowledge or funding, according to industry analysts.

According to corporate literature and government records, the Wuhan and Jinan initiatives were designed to start by creating chips with circuitry measured at 14 nanometers or smaller—a market dominated by TSMC and Samsung—before moving on to 7 nanometers in a few years.

As chief executive, HSMC hired a former top TSMC executive. According to former workers, QXIC hired hundreds of skilled engineers from Taiwan, notably from TSMC, with unusually large compensation packages.

1641732889_902_Two-Chinese-Startups-Tried-to-Catch-Up-to-Makers-of

In 2020, during the World Semiconductor Conference in Nanjing, China, a chip from Taiwan Semiconductor Manufacturing Co. will be on display.

Agence France-Presse/Getty Images photo

According to official media, it was soon evident that HSMC lacked the necessary funds to create sophisticated semiconductors, which may cost billions of dollars to produce commercially.

Work at QXIC moved slowly, according to former staff. Although the engineers QXIC hired were knowledgeable in technical elements of chip manufacturing, one of the sources said that QXIC lacked the ability to combine such talents.

According to official media, Wuhan’s local administration announced in August 2020 that the HSMC project had been stopped owing to financial concerns, and it was legally shut down in 2021.

According to those acquainted with the situation, Jinan’s government took over QXIC and started laying off its staff after numerous other government-sponsored chip initiatives failed.

The company’s activities have been halted, according to a representative from Jinan Innovation Zone, a Jinan government-run business sector where QXIC is situated.

Through a phone number connected with one of QXIC’s primary stockholders in the Tianyancha database, the Wall Street Journal was able to find a guy who identified himself as one of the organizers of the two initiatives.

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The individual said that his true name was Bao Enbao, and that he had adopted the name Cao Shan in business records. He claimed to have played a key role in assembling technology and people for the projects, and he went under the alias Cao Shan to avoid any possible problems while recruiting in Taiwan, which has been cracking down on mainland talent poaching.

After launching a chip-design business in 2005, he claimed he had roughly 15 years of expertise in the field and had built relationships at TSMC after purchasing chips to be fabricated there. “Do you believe local governments are so easily fooled?” he remarked when questioned about domestic media stories that claimed his behaviour wasn’t always aboveboard.

He departed the Wuhan project in October 2018 following a disagreement with management over how it should be developed, he claimed. He quit the Jinan project in December 2020 as Beijing tightened its grip over semiconductor ventures, and Jinan’s government drove the business he leads out as a major stakeholder in May, he claimed.

The governments of Wuhan and Jinan did not reply to demands for comment.

As problems arose at projects like HSMC, Beijing adjusted its strategy. The National Development and Reform Commission, China’s economic planner, said in October 2020 that firms without expertise, experience, or adequate technology had set up semiconductor projects on the spur of the moment, and that authorities who promoted such ventures would be held accountable.

—This article was co-written by Raffaele Huang.

Yoko Kubota can be reached at [email protected]

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A: Intel Corporation is the company that makes computer chips.

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A: China produces the most computer chips.

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