MediaTek Inc., Taiwan’s biggest chip designer, had a tough year last year. It used to dominate the low-end mobile phone market. But its market share dropped significantly last year as its rival, Shanghai based Spreadtrum, launched a stable and lower price product. This year, it is hedging its bet on Android phone. Can it make a come back??

MediaTek used to supply 90% of the chip of the low-end mobile phone manufactured in China. But, something happened in the beginning of last year. One of the new models of Mediatek’s chips is not stable enough. More correctly, its rival, Spreadtrum, after years of trial, finally, came up with a chip that is stable enough for the phone manufacturers. With a low price, about 10-15% lower than Mediatek, Spreadtrum quickly gained market share. It had 25% at the end of last year. Mediatek’s market share shrank to 70% while privately held Taiwan based MStar had the remaining 5%.

To rebuild its long-term competitiveness, Mediatek is hedging its bet on smartphones running Google’s Android operating system. Its Android 2.2 solution has been gaining traction since it launched in last November. It will have better and faster Android products coming out in mid-2011 and again in late 2011. At the current pace of price drop, Android phone at US$100 retail price can be reached for the entry-level models by mid-2011. Mediatek hopes to sell over 10 million unit of chipset for Android phones this year.

An added benefit of going after Android market is higher profitability. “Semiconductor value is more than 3 times higher than feature phones, as application processor, touch screen controller, WiFi and GPS are going to be part of the standard package (for Android phone),” said Alvin Knock, analyst of JP Morgan, “Our checks suggest that the average selling price is more than US$15 currently, vs. feature phone at US$4-5.”

Its rivals, Spreadtrum and M-Star, have yet to launch any Android products. “Spreadtrum and M-Star are more keen on eating into Mediatek’s market share in feature phones right now,” said an industry insider.

If its effort pays off, Mediatek can be the leading supplier of cheap Android phones in the mass market. It will regain its profitability and it share price will rebound. JP Morgan’s price target for Mediatek is NT$540, or 57% more than its current price.

But there are challenges for its ambition. Lately, supply of the touch screen is in shortage. If Mediatek cannot secure a stable supply of touch screen for its customers, it might not able to sell as much as Android products as it wish.

Moreover, although not totally related, 3G makes the experience much better for Android phones. Most people like to use fancier applications with their Android phones, such as watching videos or viewing large photo of their friends, and that requires high bandwidth. However, China’s 3G penetration is still low. Only 6.4% of mobile users subscribe to 3G services by the end of February, according to China’s Ministry of Industry and Information Technology. And, the price of 3G packages from the three operators (China Mobile, China Unicom and China Telecom) is still too high for the mass market. This could also hinder Android phone development in China and Mediatek’s plan for making a comeback.