Alibaba aims to undercut US chipmakers’ dominance

Alibaba aims to undercut US chipmakers’ dominance

Alibaba entered the club of webscale network operators (WNOs) developing their own chips recently, joining Amazon, Apple, Facebook, and Google. The Chinese e-commerce giant announced plans, in September 2018, to develop its own customized neural network chip, called Ali-NPU, to aid its growing cloud and IoT businesses. But unlike its WNO peers who want more flexibility and cost-efficiency in their operations by running in-house chips, Alibaba’s move is motivated by a grave external risk: the US-China trade war fallout.

A series of trade disputes set alarm bells ringing for Alibaba

Alibaba views its move as a precautionary response to a series of hostile trade events this year, starting with the leading US carriers, Verizon and AT&T, deciding to halt selling phones of the Chinese handset maker, Huawei, in January 2018.

Multiple factors were involved but there’s no doubt that the carriers felt pressure from the US government over national security concerns. This was followed by an even bigger move: an executive order issued by the US President, Donald Trump, prohibiting the Qualcomm-Broadcom deal in March 2018.

The order was driven by national security concerns over the deal’s (mainly indirect) benefits to Huawei and other Chinese institutions. The US Commerce Department’s April 2018 crackdown on the Chinese telecom giant, ZTE, seemed to be the final “wake-up call” for Alibaba. The Commerce Department imposed a seven-year ban on chipset exports to ZTE. The ban was based on some serious misbehavior at ZTE, not just a political stunt. While it was resolved in July 2018, for several months ZTE was forced to essentially cease operations.

ZTE’s problems highlighted how dependent Chinese tech companies remain on US firms in specific markets, including parts of the semiconductor industry. The aftermath of these events prompted Alibaba to pull back its overall presence in the US in June 2018, followed by scaling down expansion of its cloud business, AliCloud, in September 2018.

Alibaba goes rogue

Also at the end of 3Q18, Alibaba started to formalize its chip self-development plans.

The main one involves the recent launch of a semiconductor subsidiary, Pingtouge, that will start manufacturing AI-based chip, Ali-NPU, along with quantum computing processors in the second half of 2019. The subsidiary set-up comes close on the heels of Alibaba acquiring Chinese chipmaker Hangzhou C-SKY Microsystems in April 2018, to boost its chip production capacity.

Earlier this week, the US Commerce Department issued another export ban affecting Alibaba indirectly, this time on the Fujian Jinhua Integrated Circuit Company. Whether well-founded or not, this ban pushes Alibaba (and other Chinese WNOs) further down the road of self-development.

Global expansion unaffected

There are no signs that its supply chain headaches are slowing down Alibaba’s cloud construction efforts.

In fact, following its decision to scale back expansion in the US, Alibaba is looking at South-East Asia, India, and Europe as the “new target markets” for its cloud business. And the company has been aggressive about it – in 2018 alone, Alibaba launched five cloud data center operational sites across three international locations: the UK (2), India (2), and Indonesia (1). That explains the spike in annualized capex and capital intensity for the period ending 2Q18 in the figure below.

The capex growth trend is expected to continue in the medium to long run, given Alibaba’s data center buildout plans along with its efforts to disrupt industries such as hospitality, smart cities, and logistics. (For a complete analysis, see MTN Consulting’s Webscale Playbook: Alibaba, published October 2018).

US-based chip vendors feel the heat

With some semiconductor-related goods in the tariff list, the mounting trade friction between the US and China is making US-based chip developers nervous. That’s understandable as China buys chips more than any other nation in the world, accounting for 29% (US$100 bn) of the global demand for semiconductors, according to a 2016 study by the US Department of Commerce. The threat of new competition from China intensifies concerns.

One US-based vendor facing direct fallout from the ongoing trade dispute is Qualcomm. After the Qualcomm-Broadcom deal fallout in March 2018, another big-ticket merger deal involving Qualcomm became victim to the US-China trade spat. This time, China played spoilsport due to its failure to approve Qualcomm’s US$44 billion deal to acquire the Netherlands-based NXP Semiconductors in July 2018. Adding salt to the wounds, Qualcomm had to pay a massive US$2 billion termination fee to NXP Semiconductors for scrapping the deal.

Another issue is the US chipmakers’ high exposure to Chinese markets that makes them even more vulnerable to the situation. Qualcomm features here again, topping the list with a huge revenue exposure of 65% in FY17. Intel’s biggest market by revenues is China, deriving close to a quarter (23.6%) of revenues in FY17, while NVIDIA accounted for about a fifth (19.5%) of revenues from China during the same period.

US-based webscale operators (Amazon, Facebook, Google, etc.) efforts to design their own chips has already made some vendors nervous, and the trade dispute has only worsened this. Alibaba’s response with its chip push could just be the “tip of the iceberg” as more Chinese companies could follow suit; case in point being Baidu launching its own AI chip, Kunlun, in July 2018.

Beijing’s technology ambitions complement Alibaba’s move but challenges remain

China is looking to use its supportive domestic policies to close the technology gap with the US in the medium to long run. In line with this, it is investing billions of RMB in homegrown chipmakers such as Fujian Jinhua (from this week’s ban) and Tsinghua Unigroup. It also announced plans to create a US$47 billion fund in May 2018 to boost semiconductor industry, and is seeking to surpass the US as the global leader in AI by 2030. Alibaba wants to play a big part in effecting the transition. But this transition will require foreign technology and scarcely available talent.

(Photo credit: Alibaba)

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