Qualcomm's Latest Move to Conquer the Chinese Smartphone Market

Qualcomm's going local to win the hearts of local Chinese smartphone vendors.

Jul 13, 2014 at 2:06PM

Qualcomm (NASDAQ:QCOM), the leading vendor of smartphone processors, recently signed a deal to have its chips built at Chinese semiconductor foundry Silicon Manufacturing International (NYSE:SMI). Though Qualcomm wins by virtue of the fact that it diversifies its suppliers, there's another key benefit here for the chipmaker.

Some background
Back before China began its transition toward LTE, there was a chipmaker known as Spreadtrum Communications that was solidly profitable selling low-cost apps processors/modems into the local Chese handset market. Not only did the company benefit from the growth of the low end of the market, but it also claimed that being a Chinese vendor helped it gain favor at many of these local handset vendors. 

Qualcomm is generally regarded as having a technological edge over other smartphone chip makers, but it typically builds its Snapdragon processors at Taiwanese foundry Taiwan Semiconductor (NYSE:TSM). By moving some production -- and given that the deal is for 28-nanometer technologies, it looks like this is for lower-end Snapdragon processors -- to a Chinese foundry like SMIC, Qualcomm could gain incremental business with handset vendors that prefer to use more locally sourced chips. 

Don't forget that multisourcing helps Qualcomm
For the past several years, Qualcomm has really had one viable source for 28-nanometer wafers -- Taiwan Semiconductor. The company enjoyed the pricing power that typically goes along with being the only real game in town, and that most likely hurt Qualcomm on the gross margin side of things for its chip business. 

Going forward, the majority of Qualcomm's output is still likely to be 28-nanometer based for quite some time as it doesn't make much economic sense to move low-cost smartphone chips to the latest and greatest foundry technologies. In fact, with the cost per transistor going up at the post-28-nanometer nodes, it'll be a longtime before the low-end and mid-range products from the fabless companies will have the luxury of moving to those nodes. 

With that in mind, having multiple sources at 28-nanometer, with Silicon Manufacturing International being the latest vendor to build Qualcomm's signature Snapdragon products, ultimately helps keep its wafer costs in check, potentially providing a longer-term gross margin tailwind. 

Foolish bottom line
Qualcomm is a very smart company that tends to make business moves that pay off well. Given that China is a very fast growing and very large market for smartphones, and given that this market has many local vendors, it makes perfect sense for Qualcomm to want to have the chips it sells into this market built locally. Further, having multiple sources for wafers never hurts, particularly as it both mitigates the risk of shortages as well as helps keep its suppliers' prices in check. 

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Ashraf Eassa has no position in any stocks mentioned. The Motley Fool recommends Apple and owns shares of Apple and Qualcomm. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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