Japan's Chip Equipment Slump in China: Export Controls Backfire as AI Demand Reshapes the Market

Japan's export controls. Beginning July 2023, Japan's Ministry of Economy, Trade and Industry (METI) added 23 types of advanced semiconductor manufacturing equipment to controlled export lists, requiring licenses for all destinations under the Foreign Exchange and Foreign Trade Act . These restrictions, coordinated with U.S. pressure, block sales of cutting-edge tools to China and effectively act as a de facto ban on the most advanced equipment .

At Tokyo Electron (TEL), the impact is stark: China sales fell from ¥279.4 billion to ¥175.5 billion in Q3 FY2026 alone, and China's share of TEL's revenue dropped 8.5 percentage points to 31.8% . Between FY2025 and mid-2026, TEL's China revenue share has fallen from around 44% to roughly 30% .

How Companies Are Responding: AI Demand + Geographic Shift

Firms are offsetting the China shortfall with surging demand for AI-related production equipment and a pivot toward South Korea and Taiwan.

AI-driven demand is booming. Global semiconductor equipment sales hit a record $135 billion in 2025, up 15% year-on-year, driven by investment in advanced logic and high-bandwidth memory (HBM) for generative AI . Tokyo Electron reports "very strong" demand for leading-edge AI servers and expects DRAM investment to grow double digits through late 2026 . The company forecasts that AI-related demand will reach 40% of revenue by FY2026 .

Disco, which makes grinders and dicers used to cut silicon wafers, has become a key player in the global AI chip supply chain. For the nine-month period ended December 31, 2025, its net sales grew 11.5% and net income rose 8.7%, fueled by capital spending from TSMC, SK Hynix, and Samsung .

Regional rebalancing is accelerating. TEL's Q3 FY2026 results show South Korea's share of net sales rose 6 percentage points quarter-on-quarter to 27.1% . In FY2025, Korea and Taiwan shares rose 4.9 and 2.4 percentage points respectively to 22.4% and 20.7% . Screen Holdings and Disco are following similar patterns .

Technology leadership as a moat. TEL deployed cryogenic etching for 2-nm chips in early 2025, raising precision and entry barriers for Chinese competitors . The company maintains near-monopoly positions in key equipment segments—approximately 88-90% global market share in coater/developers—providing pricing power that Chinese alternatives struggle to match .

Risks: Permanent Displacement by Chinese Self-Reliance

Analysts see a structural risk that Japanese suppliers may be permanently displaced from the Chinese market:

Accelerating self-sufficiency. China is targeting 40% self-sufficiency in semiconductor equipment and materials by 2026 and has added 40 Japanese companies to its export control and "unreliable entity" lists . Chinese experts characterize Japan's curbs as "backfiring" — strengthening the very domestic industry Japan sought to slow .

Retaliatory controls. In January 2026, China's Ministry of Commerce (MOFCOM) imposed immediately effective export controls on dual-use items destined for Japan, banning shipments to Japanese military end-users and broadly restricting material flows . The measures cover rare earths and other critical materials where China dominates global processing, threatening disruption to Japanese supply chains .

A narrowing window. The share of China in Japan's equipment makers' revenue is declining structurally, and analysts warn that once Chinese domestic alternatives reach maturity, recapturing market share will be difficult . The question is no longer whether Japan loses share in China, but how much of it comes back if controls ever loosen.

The Bottom Line

Japan's chip equipment makers are navigating a historic inflection point. The 10% China sales decline is not a blip but a structural shift driven by policy, geopolitics, and industrial competition. The industry's ability to pivot toward AI and diversify geographically is keeping revenues afloat for now. But the risk of permanent displacement from China — the world's largest semiconductor equipment market for six consecutive years — remains the defining threat.

As China's domestic ecosystem matures and retaliatory controls escalate, Japanese suppliers face a strategic challenge that no amount of AI demand alone can fully resolve.