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A Potential Negative for Taiwan Semiconductor

Taiwan Semiconductor Manufacturing Company (NYSE: TSM) is the world's leading contract chip manufacturer by revenue. It manufactures chips for a broad range of clients, with its products spanning from low-power mobile processors all the way to ultra-high-performance data-center processors.

TSMC's biggest market segment by revenue, however, is the mobile market, which TSMC classifies as "communication." That segment made up 58% of the company's revenue in its most recent quarter.

On its most recent earnings call, the company explained some of the key competitive advantages it enjoys over its competition in making the case that it will maintain a high market share. Though those competitive advantages all appear to be intact, TSMC is, nevertheless, not immune to customers that want to multi-source their parts.

According to a report from Digitimes, MediaTek -- a major TSMC customer -- is planning to do just that.

Image source: MediaTek.

MediaTek's 28nm shift

Digitimes, citing "industry sources," says MediaTek "plans to transfer part of its 28nm mobile chip orders, including those for the Amazon (NASDAQ: AMZN) Echo Dot, to United Microelectronics (NYSE: UMC), starting [in] 2018 to lower costs."

TSMC's 28-nanometer technology makes up a large portion of the company's revenue. Last quarter, revenue from 28-nanometer wafers made up 27% of revenue in the quarter, making it the company's highest-revenue technology in that period.

United Microelectronics doesn't have the vast technology development resources TSMC has at its disposal, but, if this report is correct, the company is trying to compete on price to grab MediaTek's orders.

But wait -- there's more!

The Digitimes report had some additional information about MediaTek's chip-sourcing strategy.

In addition to moving some volume over to UMC, MediaTek is reportedly "mulling placing chip orders with Globalfoundries using the foundry's 22nm FD-SOI process designed for mid-range and entry-level smartphones."

And if that weren't enough, Digitimes also said that "a recent report from Taiwan's TechNews also indicated MediaTek may transfer half of its Helio P20 and P25 chip orders, built using TSMC's 16nm FinFET process, to Globalfoundries starting [in] 2018."

MediaTek's motivation for multi-sourcing, the Digitimes report says, is to "lower costs."

TSMC's tough fight

TSMC's corporate gross profit margin hovers near 50% these days, so it's only natural for smaller competitors to try to undercut TSMC on wafer pricing in a bid to capture business. And since the market for mobile processors is fiercely competitive, the customers of the contract chip manufacturers constantly face pricing pressure. They're thus motivated to find ways to cut product manufacturing costs -- even if doing so requires some additional up-front research-and-development spending to "port" a design from one technology to another.

TSMC's best bet, then, is to work to lower its own manufacturing cost structure with optimized chip manufacturing recipes and high manufacturing yields. That way, TSMC can offer its customers low total chip costs without having to sacrifice on wafer pricing and gross profit margin.

That's what the company's strategy seems to be, anyway, and it has worked well for it over the years. I expect it to be no different in the future.

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Ashraf Eassa has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has a disclosure policy.