The news that a Chinese company named TCL was taking control of the venerable RCA brand of televisions in November 2003 caused barely a ripple in America's public consciousness, unlike the fuss that accompanied the sale of IBM's PC business to Chinese conglomerate Lenovo last December. The apathy was understandable. After all, the RCA brand had been sold to the French electronics firm Thomson in 1987, when American firms virtually abandoned the consumer electronics sector.

But TCL's takeover of Thomson's TV business should have Americans cheering. Why? Because it is part of a backdoor return of American companies to consumer electronics—and at a much deeper level than having an American brand name slapped onto a box produced in Asia. The growing global presence of Chinese consumer electronics firms is hand in hand with the shift from analog to digital technology in consumer electronics. And, to a large extent, it is American (and some European) chip companies that are supplying the digital guts of these gadgets.

Whereas the large Japanese companies that have dominated consumer electronics for the past generation built many of their chips themselves, the Chinese are buying nearly all of their chips from outside vendors, at least for the moment. "The Chinese manufacturers have been looking to American companies for chip sets, reference designs and software for these products," says Shyam Nagrani, principal consumer electronics analyst for market research firm iSuppli. Sales to Chinese companies are not only lifting the fortunes of established giants such as Texas Instruments, Analog Devices, LSI Logic and Qualcomm but they are also a boon for a new generation of fabless startup companies, says Nagrani.

To take full advantage of this trend, chip suppliers will have to nurture their ties to the Chinese manufacturers. The Chinese got into manufacturing digital goods by relying almost entirely on kits and designs produced by the chip companies and Korean and Taiwanese electronics firms. But now they are rapidly gaining marketing and design expertise and are looking for chip companies willing and able to meet their demands for specific features and capabilities. "China is going to be the battleground for consumer semiconductors," predicts Will Strauss, president of Forward Concepts, which tracks the digital signal processor (DSP) market.

TCL was founded in 1981 in Huizhou, in China's southern Guangdong province. Like many other Chinese companies, it is heavily backed and still partly owned by the Chinese government. Unlike many other Chinese companies with political connections, TCL is well managed, according to analysts and business partners. "TCL has a strong team of managers that is extremely aggressive, smart and results-oriented," says Christian Kermarrec, vice president of RF and wireless systems for Analog Devices, which set up a joint development effort with TCL in China last year.

TCL started with home appliances, but its forte proved to be TVs and mobile phone handsets. The TCL brand name is one of the best recognized in China. The company claims to have increased sales at an average annual pace of more than 42 percent for the past 12 years, making it one of China's fastest-growing companies. (Such claims are hard to verify, because the company didn't go public until December 2003 and most of its public information is available only in Chinese.) In 2003 TCL had revenue of $3.4 billion and earned $68.8 million in profit. The company didn't respond to requests for an interview for this story.

"China is going to be the battleground for consumer semiconductors."
—Will Strauss, president, Forward Concepts

With its solid success at home, TCL was eyeing the international market when it had two extraordinary opportunities to quickly extend its global reach. In 2003 Thomson went looking for a partner to help bolster its struggling TV operations and courted TCL. The two agreed to merge their TV efforts into TCL-Thomson Electronics (TTE). Headquartered in Shenzhen, TTE has more than 29,000 employees and factories around the world producing about 18.5 million TVs a year, making the company the largest TV manufacturer in the world. TCL owns a controlling 67 percent of the venture, and Thomson 33 percent. It officially started operations in July 2004. The following month, TCL inaugurated a second joint venture, with France's Alcatel, that will develop and sell mobile handsets and related products. Alcatel wanted help with its handset business, so it could concentrate on selling equipment to telecom carriers and large corporations. The TCL group holds 55 percent of TCL-Alcatel Mobile Phone Co. (TAMP), with Alcatel holding the rest.

The shift from analog to digital presents an opportunity for TCL and other Chinese companies to get into consumer electronics in a big way. Videotape recorders, Walkman-type audio players and camcorders all have very complex mechanics that require sophisticated design and manufacturing skills. Acquiring such skills was a high barrier to entry that helped Japanese manufacturers dominate the consumer electronics market. But now that most of these gadgets are digital and use widely available standardized components, such as hard disk and DVD drives, the Chinese can jump in and do what they do best: churn out very high volumes and drive down prices.

"The barriers to entry have diminished over the last few years," says Julian Hayes, vice president of marketing for Edinburgh-based Wolfson Microelectronics, a company that makes audio and video chips. At first Chinese manufacturers simply built digital consumer electronics products such as DVD players entirely to the specifications of others, relying on reference designs provided by chip companies or building to order for major American retailers and brand-name companies such as Wal-Mart, Fry's Electronics, Hewlett-Packard and Dell. "But over the last few years, that model has changed quite dramatically," Hayes says. The Chinese have acquired design and engineering expertise, which is changing their relationships with chip suppliers. "The leading Chinese manufacturers know where they want to go and are actively looking for partners that are prepared to work with them on their next-generation devices," Hayes says.

To meet the needs of these increasingly demanding customers, Wolfson—whose chips turn up in digital cameras, DVD players and mobile phones—has been increasing its presence in China. In 2000 Wolfson handled its nominal China sales from a regional office in Taipei, says Hayes. But in November 2003, the company opened a sales and application support office in Shenzhen, where many of China's electronics firms are based and/or have factories. Last year the company also started consigning some chip fabrication to Wuxi-based CSMC Technologies, to better supply the China market. Wolfson's sales in Asia, excluding South Korea and Japan, have grown from about $3.4 million in the first half of 2000 to $36 million in the first half of 2004. Wolfson needs people on the ground to build long-term relationships, says Hayes. "We work closely with many companies to establish what they are looking for and build that into our product road map," he says.

Chip sales shift to China

Wolfson's story is hardly unique, and the trend is showing up in overall semiconductor sales. Forward Concepts' Strauss says that in 2002, 41.9 percent of the $4.9 billion global DSP market was in the Asia-Pacific region, which includes Taiwan, South Korea and China. By 2004 that region likely accounted for 51.9 percent of the estimated $7.8 billion DSP market. He doesn't have figures for China alone, but Strauss believes that increased demand there accounts for the largest part of the jump in sales in the Asia-Pacific region. The major driver, Strauss says, is booming growth in wireless applications, which accounts for 72 percent of those DSP sales. And this is a market in which U.S. makers have strong positions. "Analog Devices, Texas Instruments, Freescale Semiconductor and Qualcomm are all selling into China big-time right now," he says.

This shift can be seen in iSuppli's 2004 ranking of the top 10 suppliers of semiconductors for consumer electronics. The top slots are still dominated by the Japanese, but a 65 percent increase in consumer electronics chip sales propelled Texas Instruments up to 7th, from 12th in 2003. (See "Top Suppliers of Consumer Electronics Chips 2004," below).

The most interesting developments in consumer electronics chips appear farther down in the rankings. The shift from analog to digital "has enabled many startups to enter the market," notes iSuppli's Nagrani. He points to OmniVision Technologies, which provides digital image sensors; Pixelworks and Trident Microsystems, which design digital TV chips; PortalPlayer, which offers controllers for hard disk MP3 players; and SigmaTel, which designs chip sets used in flash-memory music players. "Most of these companies have come into the market only in the last five to 10 years," he says. And the importance of the Chinese market is not lost on these companies. "Every one of them has support activities with application engineers in China. Some even have designers there," he says.

In some product areas, a partnership, not just a presence, is needed to secure future business. In March 2004, TCL Mobile Communications, a TCL subsidiary, and U.S. chip supplier Analog Devices set up a joint development laboratory to work on both present and next-generation wireless technologies. Analog's Kermarrec says the venture is intended to enable TCL to move products to market faster, to give TCL an inside look at what Analog technologies will be available in six months and for both companies to jointly define and develop features for phones due in one to two years. Financial and other details are not public, but Analog is expected to become TCL's major supplier of chip sets for mobile phones worldwide.

Kermarrec says contacts between the two companies go back to the late 1990s, when TCL got into the handset business by rebranding a phone supplied by a Taiwanese maker that used Analog chips. TCL was intent on manufacturing its own and turned to Analog for chip sets and reference designs. Within two and a half years, TCL was making most of its own handsets, relying on reference designs from Analog. The next hurdle, Kermarrec says, will be developing handsets for the international market. "TCL is still on the learning path toward understanding export needs," he says.

TCL also needs help in establishing a brand name outside of China. Although it has a thriving OEM business, particularly in TVs, few consumers in the U.S. and Europe would recognize its name. Its partnerships with Thomson and Alcatel were at least partly motivated by TCL's desire for a respected brand name. Under the Thomson joint venture, TVs will carry the TCL brand in China and the developing countries of Asia, but they will continue to carry the RCA brand in North America and the Thomson brand in Europe. The handset venture will follow a similar pattern, using the TCL brand in Asia and the Alcatel brand in Europe and Latin America, where it has been established. Neither TCL nor Alcatel sells into the North American handset market.

But the joint ventures have not produced many tangible results so far and, in fact, appear to have hurt TCL, at least in the short term. TCL saw a dramatic drop in profitability in the third quarter of 2004. Although revenue rose a smart 68 percent year on year, to $1.33 billion, net profit slumped 69 percent, to $4.1 million. Quoted in the Chinese press, the company blamed unforeseen difficulties in integrating the operations of its new joint ventures as well as a steep drop in its sales of mobile handsets in the Chinese market.

Regardless of short-term bumps in the road, chip vendors that have their foot in the door at a major Chinese company need to do everything they can to cement that relationship, because as the Chinese companies globalize, they are starting to consolidate their procurement, according to Nancy Dang, a senior analyst at iSuppli. In fact, TCL is now in the process of centralizing procurement of TV components in Shenzhen, she says. She predicts that TCL will cut the number of suppliers it deals with, giving bigger orders to a smaller number of chip makers. She adds that with the shift to digital TVs, TCL and the other Chinese makers are looking at more than price and performance from their chip vendors. "Especially in the initial stages of production for digital TVs, technical support from chip suppliers will be a critical factor. Price will be secondary," she says.

For semiconductor suppliers, winning orders from major customers such as TCL is crucial, not only because the Chinese are expanding internationally but also because chip vendors need to win a dominant spot with a company that will survive a coming shakeout in China's gigantic domestic market, which for TVs and mobile phones is already the world's largest. There are currently dozens of TV makers in China, many of which are destined to be "scraped out of the market because of price competition," says Dang. And Forward Concepts' Strauss sees similar consolidation due in mobile phones. "More than 20 companies have been licensed to make cell phones in China, and there is room in the market for no more than five or six," he says. The bottom line for semiconductor suppliers will be fewer, bigger companies driving harder bargains.

For the moment, the competition in China will be primarily among established U.S. and European chip makers. But that is not likely to last long. "Not only are Chinese consumer electronics OEMs growing quickly but the semiconductor companies are matching the pace," says George Liao, managing director of the Asia-Pacific region for LSI Logic's DSP Products Division, which licenses DSP technology to Chinese companies. It has already licensed DSP cores to several Chinese telecom and networking companies (see "Chinese Telecom Companies Come Calling," February 2005), which are incorporating the cores into their system-on-a-chip designs. The Chinese government is supporting this work as part of its push to develop an indigenous semiconductor industry, says Liao. "Processor intellectual property, especially for DSPs in the consumer segment, is exactly what China wants," he notes.

Some Chinese chip companies have already gone beyond licensing intellectual property. One such is Vimicro, a Beijing-based fabless chip company made very much in the mold of U.S. startups, which is not surprising, because the company's cofounders—John Deng and Dave Yang—are Silicon Valley veterans. Founded in 1999 with funding from China's Ministry of Information Industry, the firm claims that its multimedia DSP chips were in more than 45 percent of PC cameras shipped worldwide in 2003. It is also supplying chips to support video and audio functions in mobile phones. It is partnering with Intel and Microsoft on development efforts and claims Samsung, Nokia, Fujitsu and HP as well as all the leading Chinese electronics firms among its customers.

Vimicro is a company to watch, as is China's nascent semiconductor industry as a whole, especially because the Chinese government is so intent on promoting its growth to cut the country's reliance on outside suppliers, notes Strauss. Nagrani estimates that there are more than 200 Chinese companies designing chips, many of them no more than half a dozen engineers with an idea. "A lot of them will disappear, but at some point, there will be Chinese companies that emerge as players," he says. In addition, some of the largest Chinese companies have started funding their own semiconductor design houses. Haier Group, for example has funded Haier IC Design, a fabless company that is designing set-top box ICs, according to a recent report on China's semiconductor industry from PricewaterhouseCoopers. The challenge for the Americans and Europeans will be staying on their toes. "The market is like a treadmill: As long as you're running along, you're doing fine, but as soon as you start to slow down, you fall off."

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