One of China's Semiconductor Industry Opportunities: Optical Communication Chips

Optical communication refers to the communication method of transmitting communication data information through fiber optic networks, including multiple links from devices to system manufacturing. The optical communication industry includes three departments: optical devices, optical network system equipment, and optical fiber cables. Optical network system equipment includes optical transmission equipment and optical network access equipment for end users. System equipment manufacturers integrate various optical devices and manufacture optical network system equipment, and build optical communication networks for operators. Optical system devices also require corresponding processor chips, such as system chips for PON devices.

Optical devices are divided into active devices and passive devices. They all require a variety of different optical communications chips. Optical active devices refer to devices that involve photoelectric signal conversion. Including lasers, detectors and optical amplifiers, laser drivers and so on. Optical amplifiers and laser driver chips are also called optical transceiver chips. The chips involved in active devices are mainly lasers, detectors, and driver chips. Optical passive devices refer to devices that have certain functions in the optical communication system and do not have a photoelectric conversion function. Passive devices include: planar optical splitters, couplers, optical switches, wavelength division multiplexers, and the like. Optical devices based on PLC (planar lightwave circuit or planar optical waveguide) technology are an important part of passive optical devices. PLC chip refers to the production of many lightwave circuits on a planar substrate to provide functions such as splitting/combining and optical switching (Optical Switching). These chips can be used to fabricate optical passive components such as optical splitters and couplers.

The rapid growth of China's optical communications chip market, 3G, and the convergence of the three networks have led to the proliferation of new types of network applications. The past network bandwidth has been unable to meet the demand. The communications industry is undergoing a major transformation from the previous voice communication business to the development of data services, and the amount of data transmission over the communications network has increased significantly. Due to the development of new services such as online video, high-definition television, IPTV, and P2P download, the end-user bandwidth demand has been upgraded to 100M/s. The development of new forms of applications such as cloud computing and mobile Internet will greatly increase the proportion of online users and online time. In terms of backbone network, China Telecom estimates that the backbone network traffic will increase by 56% to 80% every year in the next 5 years. Therefore, the backbone network bandwidth in China needs to expand 10-20 times. In terms of access network, according to statistics of CNNIC, as of the end of May 2010, the total number of netizens has reached 420 million, and broadband users are 113 million, of which FTTx[7] users only have 23.2 million lines, and the proportion is very low. Taking Beijing as an example, broadband users mostly use 1M ADSL, and the download speed is basically only 60-80K/S.

The construction of communications infrastructure was highly valued by the Chinese government, and all major operators have accelerated the construction of optical communications networks. The Chinese government has tied the next-generation Internet, digital television networks and third-generation mobile communications networks as major investment directions for expanding domestic demand. It is expected that total investment will exceed 600 billion yuan. In April 2010, seven ministries and commissions released "Opinions on advancing the construction of fiber-optic broadband networks." It will invest more than 150 billion yuan in the construction of fiber-optic broadband networks within three years. By 2011, FTTx subscribers will exceed 80 million. In July 2010, the trial of triple play was launched. By 2012, the broadband access capacity in the pilot areas will exceed 100 Mb/s per second. Optical fiber broadband will be directly deployed in new urban areas. In April 2010, the Ministry of Industry and Information Technology and other departments issued the "Opinions on Promoting the Third-generation Mobile Communication Network Construction." From 2010 to 2011, the total investment in the construction of 3G networks will reach 240 billion yuan.

Under the favorable conditions of policy promotion and cost reduction, major operators are also accelerating the construction of optical fiber networks. In recent years, the cost of EPON has been reduced by more than 50%. The cost per line of the PON+ADSL construction model is less than half of the cost of using the copper cable to build ADSL. China Telecom is currently launching 100M FTTH projects in major cities such as Shanghai. It will gradually complete the transformation of broadband optical fiber in the country within three to five years; Unicom and Mobile have already started network construction. The two-way reconstruction of radio and television operators and the nationwide network construction and the FTTH construction of the State Grid will also bring about the demand for optical communication equipment. It is estimated that in the next two to three years, under the impetus of factors such as 3G, FTTx, triple play, and smart grid, the optical communication industry will maintain a rapid growth of over 15% relative to other sub-sectors of telecommunications operations, services, and other communications industries. In the field of optical fiber communications, the Chinese market has accounted for 30% of the global market share in 2009, and in the next three years, the composite growth rates for the access network and transmission network are expected to be 57% and 21%, respectively.

As the global optical communications equipment and device industry is accelerating its transfer to China, the Chinese optical communications chip market is also driven by the growth in global optical communications market demand. Foreign communication system equipment manufacturers and optical device manufacturers have shifted production and R&D bases to mainland China in order to reduce costs and grasp China's rapidly growing optical communications market demand. Optical device manufacturers Bookham, Oclaro, NeoPhotonics and many other companies have set up branches. It is estimated that, based on the number of manufacturers, overseas manufacturers have accounted for 42% of the optical device market in China. China’s global share of the optical device industry has risen from 11% in 2005 to 25% in 2010 and is continuing to rise. After the financial crisis, many governments have taken the acceleration of broadband network construction as an important stimulus plan, and the global optical transmission equipment market has continued to grow in size. The United States plans to invest 7.2 billion U.S. dollars for high-speed broadband construction; Australia, Singapore, Germany, France, the United Kingdom, Italy, Portugal, Norway, Sweden, and other countries have also proposed plans to increase fiber access penetration rate and increase broadband speeds. According to estimates by Ovum-RHK, the global optical transmission equipment market will exceed US$13.5 billion in 2010 and will maintain a compound annual growth rate of about 5% over the next five years. According to iSuppli, by the end of 2014, the number of global FTTx subscribers will increase from 73 million in 2009 to 281 million in 2014.

Correspondingly, the acceleration of the construction of optical communication networks will drive the rapid growth of the optical chip market. It is estimated that the scale of the chip market in China's optical communication applications has exceeded 10 billion yuan, and it is still growing at a rate of 25% every year. In the first half of 2010, the major optical communications transceiver chip manufacturers have all experienced significant growth in the Chinese market, and the overall market is expected to grow by at least 50% this year. Optical transceiver chip maker Phywoks expects its growth in the Chinese market to reach 100% in 2010.

The main manufacturers of optical communications chips and Chinese companies’ optical communications chips that represent the Chinese market rely mainly on foreign suppliers. In terms of PON core chips, there are basically no domestic manufacturers. There are four major EPON chip vendors, including Cortina, PMC-Sierra, Teknovus (acquired by Broadcom) and Chinese manufacturer Opulan, but Opulan was acquired by Atheros in July this year. GPON chip providers are relatively decentralized, including Broadlight, PMC-Sierra, Broadcom, Marvel, Cortina, Infineon, Ikanos and other nearly ten vendors. In the field of optical communication transceiver chips, there are Phyworks, Mindspeed, Vitesse and other suppliers. Phyworks, the world's largest supplier of client-side optical modules for passive optical networks, is shipping about 2 million chips every month in China. The PLC chip based on the planar optical waveguide technology is also mainly imported, including NTT Electronics, Hitachi Cable, Neo Photonics, JDS Uniphase, Teem, Wooriro and others. In terms of optical active device chips, LD chips and APD chips at speeds of 2.5 Gb/s and below are mostly dependent on imports.

At present, a few Chinese companies have made breakthroughs in the field of chips, but they are still mainly low-end products. In the field of GPON chips, Huawei, ZTE and other equipment manufacturers have all participated in the design of the chips themselves, such as Huawei's use of its own Hisilicon chips. Leading domestic optical component companies have also begun to expand upstream and achieved certain breakthroughs in the chip field, but they have not yet reached scale. Wuhan Optotech is the largest optical device manufacturer in China. Its independently designed AWG chip based on PLC technology is in the process of commercialization. Wuhan Telecommunication Device Co., Ltd. (WTD) mainly manufactures optical active devices, and is also the only domestic manufacturer that can completely adopt the self-made DFB laser/APD detector die and scale production. WTD's optical chip not only meets 90% of its own optical module products, but is also expanding its chip production capacity and preparing for external sales. Specialized in chip R&D and design company Xiamen Youxun is the first company specialized in the R&D of optical transceiver chips, and the total chip shipments have exceeded 10 million pieces.

The insufficiency in the field of chips has had a certain impact on the competitiveness of downstream optical device companies. Taking the PLC chip as an example, the FTTx network construction brought about a huge demand for PLC devices and attracted a large number of enterprises to enter this field. In the process of centralized procurement of China Telecom's PLC devices in 2010, nearly 100 companies participated, but the chips in these companies were purchased from the outside. The entry of a large number of companies has led to an accelerated decline in the price of products. At the same time, due to the small scale of procurement and high procurement costs, the profitability of these device companies is limited. For smaller companies, procurement costs may be 20% to 30% higher than other companies because procurement costs are inversely proportional to purchases.

Capital restrictions and fierce market competition have made it difficult for China's chip manufacturing industry to achieve industrialization. The manufacturing cost of optical device chips is mainly composed of labor wages and equipment depreciation. China's labor force is of high quality and relatively low cost, so China has a cost advantage in chip manufacturing. China's optical communication chip has a level of laboratory research comparable to that of the international advanced level, and it also has a corresponding talent pool. However, the main problem is that it is difficult to realize the industrialization of chip technology. Due to the small size of the industry as a whole, chip R&D and production are mainly private SMEs, often unable to raise hundreds of millions of dollars to purchase machinery and equipment, build high-standard and ultra-clean plants, and respond to the rapidly changing technological environment. For Chinese companies, engaging in chip manufacturing often means facing fierce competition from foreign companies, and once the downstream demand cannot be guaranteed, it is often difficult for companies to survive. At present, foreign PLC chip providers generally have other main business, not only chip business, so they can provide support for chip business through other services.

Conclusions and Outlook The rapid growth of the global and Chinese optical communications market has driven the demand for optical communications chips. The development of the optical communication market has brought opportunities for the development of the Chinese optical device industry, and the global optical device industry has also accelerated the transfer to China. The production of optical devices is labor-intensive. Chinese companies have cost advantages and are mainly engaged in the packaging of optical devices. Since optical communication chips are mainly dependent on imports, China's optical device companies have a large profit margin while market demand is rising. Chips have become a constraint factor for the competitiveness of downstream companies.

The future development of China's optical communications chip industry may come mainly from the upstream upstream optical devices and system companies. In the case that the upstream chip and the downstream system equipment are relatively concentrated, the optical component manufacturers have a strong incentive to expand upstream, and some strong optical component manufacturers will make breakthroughs in the upstream. Leading companies in the domestic optical device industry such as WTD, Zhengyuan Photonics, FalconStor Technology, and Huamei Optoelectronics all believe that the key to future cost control is vertical integration capability, that is, the ability to extend upstream, especially chip production capabilities. Relatively speaking, it is a more reasonable choice for optical device companies with weaker capabilities to rely on external chip vendors. For system-level chips such as PON, system equipment manufacturers also have strong incentives to integrate them. For example, Alcatel-Lucent, Huawei, and ZTE all involved GPON system chips. For upstream chip manufacturers, more M&A activities will take place in order to respond to the competitive threats from the downstream.

In February 2010, Broadcom (Broadcom), a global leader in wireline and wireless communications semiconductors, acquired Teknovus, a leading provider of Ethernet Passive Optical Network (EPON) chipsets and software. In July 2010, Atheros, a communications chip provider, paid $72 million to acquire Opulan, a Chinese PON chip design developer.