China is ramping up its own chip industry amid a brewing tech war. That could hurt US firms

A Huawei Technologies Mate20 Pro smartphone displays an image of the company's Kirin 980 chip.

Krisztian Bocsi | Bloomberg | Getty Images

China is pushing ahead with the development of its own chip industry as major firms like Huawei face the threat of losing access to American technology.

Experts say the world's second-largest economy could still be at least a decade off from catching up with U.S. technology. Still, if China successfully develops its own semiconductor industry, that could ultimately hurt American companies that have reaped big profits in the country.

Last month, Chinese tech giant Huawei was placed on a U.S. blacklist that required American firms to obtain government permission to sell to the company. The telecommunications equipment maker relies on some key components from U.S. firms and software from Google and Microsoft. Washington has granted a 90-day reprieve for now, but the threat remains a major problem for the company.

Other firms, including Chinese surveillance titan HikVision, are reportedly also being targeted. Huawei rival ZTE faced a similar situation last year, which significantly damaged the company.

While China has made no secret that it wants to develop its own semiconductor industry in the past couple of years, experts said that recent events have given new priority to that drive.

"The Huawei incident has indeed stimulated the development of China's domestic chip industry," Gu Wenjun, analyst at China-based semiconductor research firm ICWise, told CNBC by email. He wrote in Mandarin and his comments were translated by CNBC.

Government push

Beijing highlighted semiconductors as a key area of the Made in China 2025 plan, a government initiative that aims to boost the production of higher-value products. China aims to produce 40% of the semiconductors it uses by 2020 and 70% by 2025. That's backed by tens of billions of dollars of investment from Beijing into the country's chip industry.

Last month, the Chinese government also announced tax breaks for homegrown semiconductor companies and software developers.

Currently, only 16% of the semiconductors used in China are produced in the country, and only half of those are made by Chinese firms, according to a report by the Center for Strategic and International Studies. In other words, the country is still reliant on foreign, largely American, technology.

That fact, along with Beijing's backing, has helped kick China's tech companies into action. Huawei has its own "Kirin" series of processors for its smartphones and even a 5G modem that can allows devices to connect to the newest version of the mobile internet. Huawei's chips are designed by its subsidiary HiSilicon, which has said it's prepared for such a move by the U.S. and can weather the storm.

China's other technology giants are considering their own silicon. Smartphone maker Xiaomi told CNBC last year that it was exploring developing a chip that could power artificial intelligence products and Alibaba has begun work on its own AI processor.

Design is one part of the puzzle in creating chips. The other is getting the manufacturing right. For example, Huawei's chips are designed by HiSilicon — the largest semiconductor company in China, according to market research firm International Data Corporation — but then they're manufactured by a separate company in Taiwan. There are signs, however, that China is even ramping up manufacturing of semiconductors.

"I expect the current tension between the U.S. and China will only invigorate the spending in China on technology including software over the next five years," said Mario Morales, program vice president for enabling technologies and semiconductors at IDC.

The US could feel the heat

The development of China's own chip industry could hurt U.S. companies, according to ICWise's Gu. He said the world's second-largest economy could build closer ties to other countries like Japan and South Korea and create its own semiconductor "ecosystem" — in which America would play only a small part.

"At present, the global industrial system is dominated by the United States, and there may be a parallel ecosystem ... where the United States is not dominant. This is very unfavorable for the long-term development of the U.S. industry," Gu told CNBC.

"If the United States blocks the Chinese industry for a long time, it will inspire China to lead another ecosystem, which in turn will be a long-term disadvantage to the U.S. semiconductor industry," he added.

Already some U.S. firms have reported worries about the potential results of Huawei being on the U.S. blacklist. Qorvo, a maker of radio frequency products, said sales to Huawei and its affiliates accounted for $469 million, or 15% of its total revenue, in the fiscal year that ended on March 30, 2019. It lowered its revenue outlook for the year, citing Washington's actions against Huawei.

Lumentum, another Huawei supplier, said sales to the Chinese firm accounted for 18% of total revenue for the three months that ended on March 30. Lumentum also revised its revenue guidance lower for the subsequent quarter.

China 'a decade or two' away

Despite all its advances, China's semiconductor industry won't overtake its competitors anytime soon.

One of the biggest challenges for China will be finding and developing new suppliers if American firms remain off limits.

For one, Huawei's HiSilicon still relies on basic chip design from Softbank-owned Arm. Even though HiSilicon produces processors for its devices, the architecture is from the British firm. The chip designer recently suspended business with Huawei to comply with the U.S. blacklist of the Chinese firm. Huawei will need to find an alternative to Arm, which is the biggest chip design firm by market share.

The next biggest companies are Synopsys and Cadence, but both are American and so are likely to be off limits for the Huawei unit, too.

For Gu, that all adds up to China only closing the gap with the U.S. on semiconductors "within a decade or two."

Other analysts projected that more investment and an expanded talent pool may grow China's semiconductor industry.

"This will not be easy, it will be a long journey but I do not underestimate the Chinese ecosystem given the talent that continues to move back into the region to drive more innovation and scale," IDC's Morales said.

And, eventually, China might be able to wean itself off of U.S. technology.

"If China as a whole is able to acquire the right human resources talent, companies, and partnerships, it should still be on track to create a homegrown semiconductor industry over the next decade without access to American tech," said Neil Shah, research director at Counterpoint Research.

—CNBC's Hilary Pan contributed to this report.

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