Nvidia's most advanced AI chip it developed for the China market has got off to a weak start, with abundant supply forcing it to be priced below a rival chip from Chinese tech giant Huawei, according to sources familiar with the matter.

The flattening prices underscore the challenges Nvidia's China business faces amid U.S. sanctions on AI chip exports and heightened competition, casting a cloud over its future in a market that contributed 17% to its revenue for fiscal 2024.

The growing competitive pressure in China also adds a cautionary note to investors in the U.S. semiconductor designer as its shares extended a stunning rally following Wednesday's bumper revenue forecast.

Nvidia, which dominates the market for artificial intelligence (AI) chips, introduced three chips tailored for China late last year after U.S. sanctions prevented it from exporting its most advanced semiconductors.

Among those chips, the H20 is the most closely watched as it’s the most powerful Nvidia product sold in China, but the three supply chain sources told Reuters there is an abundant supply of the chip in the market, signalling weak demand.

That has seen H20 chips being sold in some cases at an over 10% discount to Huawei’s Ascend 910B – the most powerful AI chip from a Chinese company – two of the three sources told Reuters, declining to be identified due to the sensitivity of the issue.

Analysts said while Nvidia was trying hard to capture share in a market it cannot afford to lose, the outlook is increasingly uncertain.

China’s global share of the AI industry is projected to exceed 30% in 2035, according to a report by Chinese market research firm CCID Consulting.

“Nvidia is walking a fine line and working on a balancing act between maintaining the Chinese market and navigating U.S. tensions,” said Hebe Chen, a market analyst at IG. “Nvidia is definitely preparing for the worst in the long term.”

During Nvidia’s first quarter earnings on Wednesday, senior executives warned that the company’s business in China is “substantially” lower than in the past due to the sanctions.

“Our data centre revenue in China is down significantly from the level prior to the imposition of the new export control restrictions in October,” said CFO Colette Kress. “We expect the market in China to remain very competitive going forward.”

Analysts said the H20’s performance will be a major factor for its business in China, while longer-term prospects will depend on how it competes with home-grown tech giant Huawei.

Huawei only began to challenge Nvidia last year and the sources have said the Guangdong-based company will dramatically increase its shipments of its Ascend 910B chip this year, which the sources said outperforms the H20 in some key metrics.

Huawei did not immediately respond to a request for comment.

In the past six months, just five state or state-affiliated buyers have expressed interest in purchasing H20 chips, compared with over a dozen for Huawei’s 910B in the same period, according to Reuters’s checks on available government procurement data, which is not exhaustive and may not reflect the full extent of market demand.

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Nvidia’s H800 and A800 are banned in China due to U.S. sanctions aimed at limiting China’s capabilities in becoming a tech powerhouse. Its other advanced product lines, including H100 and B100, have also been banned.

Another major stumbling block to the success of Nvidia’s H20 chip in China has been a directive by Beijing for companies to buy Chinese chips, although two of the three sources said those orders had eased in recent months.

The H20 became widely available in China last month, with deliveries to clients in little over a month, the sources said.

Some of China’s technology giants have already made orders, with Alibaba ordering over 30,000 H20 chips, according to two of the sources. Alibaba did not immediately respond to a request for comment.

Server distributors in China are selling the H20 at prices around 100,000 yuan per card, and the eight-card server for around 1.1 million yuan to 1.3 million yuan per server, the sources said.

In comparison, distributors are selling the Huawei 910B at above 120,000 yuan per card, while its eight-card server equivalent starts at 1.3-1.5 million yuan per server. The sources added that prices for both the H20 and Huawei’s 910B can fluctuate depending on the size of orders placed.

Dylan Patel, founder of research group SemiAnalysis, said close to a million H20 chips will be shipped to China in the second half of 2024 and Nvidia must compete with Huawei on pricing.

“The H20 cost more than an H100 to manufacture due to its higher memory capacity,” Patel said, adding that it is being sold, however, at half the price of the H100, referring to the powerful Nvidia chip banned from export to China in 2022.

“This is a dramatic decrease in margin.”