Explained | Mapping India’s chip design ecosystem

The story so far:

As part of the second phase of the design-linked incentive (DLI) scheme for the domestic semiconductor industry, the Indian government, according to media reports, is considering a proposal to pick an equity stake in domestic chip design-making companies. The modalities and the timing of the policy are yet to be worked out, but senior government officials say the idea behind the scheme is to ensure a stable ecosystem alongside building a few “fabless companies”. (Fabless companies are entities that design chips but outsource the manufacturing.)

What are the broader industry dynamics?

Any policy directed towards the semiconductor industry, be it manufacturing, or design, requires a long-term strategy as the sector is capital-intensive and involves sizeable costs in setting up fabrication units, upscaling manufacturing capabilities and equipment (such as thermal stimulators, sensors), and pushing research. Moreover, returns from the investment are not immediate as setting up design and fabrication units involves long gestation periods.

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Industry body NASSCOM says it takes up to 2-3 years before the first product is out and chip designing requires higher investment than a traditional aggregator company. Further, as chipsets become smaller and functional requirements from them change, research and development become challenging in an already cyclic industry. Lastly, supply chain disruptions, like what happened during the COVID-relatedlockdowns in China, could dampen potential investor confidence in the sector.

What is the domestic chip industry scenario?

India is an important destination for global semiconductor companies primarily because of its highly-skilled talent pool of semiconductor design engineers, who make up about 20% of the world’s workforce as part of global teams or working independently. About 2,000 integrated circuits and chips are designed in India every year with engineers involved in varied aspects of design and verification. Global players operating R&D in the country include Intel, Micron and Qualcomm among others.

Notwithstanding the thriving manpower, India owns a much smaller portion of the intellectual property (IP) relating to the designs, which are mostly retained by the global companies. The DLI for chip designing introduced in December 2021 endeavoured to indigenise innovations. Among other things, it aspired to grow at least 20 companies in India scaling a turnover of more than ₹1,500 crore in the next five years. For product design, the scheme will reimburse up to 50% of the eligible expenditure to a ceiling of ₹15 crore per application. The deployment-based support, meaning using it in electronic products, extends the incentive by 4-6% of net sales turnover at an upper limit of ₹30 crore per application.

DLIs form part of the broader catalyst SemiconIndia futureDESIGN initiative. As recently stated by Minister of State for Electronics and Information Technology Rajeev Chandrasekhar, over 30 semiconductor design startups have been established in India following the initiative with five already having received government support.

What are some of the challenges?

According to Pranay Kotasthane, Chairperson, High Tech Geopolitics Programme at Takshashila Institution, the government’s attempt to become a venture capital firm for chip design companies is likely to be “ineffective and inefficient”. “Companies are naturally going to pick foreign buyers because it gives them higher valuation and also connects them to a global ecosystem of customers and investors,” he states, adding, the reported move is “unlikely to change the behaviour of the firms that aspire to be globally competitive. The opportunity costs are too high.” Separately, Mr. Kotasthane also pointed to the lack of venture capitalists in the private sector focused on semiconductors in India. Notwithstanding its share of the global workforce, the cumulative annual revenue of domestic semiconductor design companies is meagre at ₹150 crore. He said that higher gestation periods imply design firms are not able to attract potential investors and venture capitalists as software companies have. “There are indications that this situation is changing, but not fast enough,” he points out. Conversely, observers also held that the government’s participation would help with regulatory support. At the ‘Semicon India 2023’ conclave, Prime Minister Narendra Modi made a strong pitch to global investors, saying India will emerge as a global hub of semiconductor and chip-making industry.

Shivani Parashar, analyst at Counterpoint Research, told The Hindu that with an equity stake, the government offers an opportunity for design companies to align their interests with the project’s success, ensuring shared risk and reward. Further, the task entails not just designing or manufacturing the chip, but also selling it. “Equity will empower design companies to sell their chip-designing services more effectively and attract a broader client base in the market. It [proposed equity] would prevent companies from selling their majority stake to large global players to scale up the business,” she notes. Further, the equity infusion would be particularly encouraging for local, small and medium-sized firms who potentially face multiple hurdles to be part of the ecosystem.

What other considerations are we looking at?

Kathir Thandavarayan, Partner, Consulting at Deloitte India, points to two broad considerations at play. The first one is about intellectual property (IP). According to Mr. Thandavarayan, the realignment towards equity from the government requires consideration of who can keep the IP – the companies would ideally want to keep it with themselves. Second, the government must consider how it plans to link its investments to drive more innovation and employment generation in the sector. “The outcomes could be linked to sales or IP that would be residing in India. That could be one alternate arrangement that the government could think of,” he says.

Further, he pointed out that value-added activities (with respect to chip designing) are not significantly executed in India. Thus, it is essential that the value-added activities are brought into the country. In other words, moving up in the value chain and enabling the ecosystem must be one of the imperatives of the government.

Avimukt Dar, founding partner at INDUSLAW, says that unlike a tax subsidy, the equity support would be on a case-to-case basis. “Therefore, the government should put in place robust guardrails for the independence of the investment committee and a framework for target evaluation and governance to mitigate the moral hazard posed by politically driven equity investments,” observes Mr Dar.

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Ayush A. Mehrotra, Partner at Khaitan & Co, told The Hindu that the move would particularly help catalyse the industry which did not contribute much to intellectual property in the country. While the details are yet to be made public, he states, it is hoped that the reported scheme would live up to the expectations of the start-up ecosystem where the government would become a stakeholder in promising companies with a scalable potential to “create a state-of-the-art design ecosystem which will serve the national interest and also be a supplier to the rest of the world.”