Who Will Pay for Apple Supply Chain Changes?

The changes Apple Inc. (Nasdaq: AAPL) is making to its supply chain management practices will cost millions and may even run into billions as Chinese wages skyrocket, but who will foot the final bill? Will Apple successfully pass the extra costs of the initiatives it has introduced recently to its contract manufacturers and suppliers; will the company itself absorb the cost, or will it successfully pass these onto customers?

These are critical questions for the high-tech industry as Apple, the de facto bellwether for the consumer electronics market, tries to deflect labor criticisms leveled recently against it by injecting greater clarity into its operations. Recently, Apple announced a list of its top suppliers and followed up with an agreement to let the Fair Labor Association "audit" conditions at its contract manufacturers.

The audit started on February 13 at Apple's leading contract manufacturer Foxconn Electronics Inc. , but the pressure is on other suppliers who -- having been publicly identified by the consumer electronics company -- now find themselves operating under the floodlight of labor and human rights activists as well as government regulators.

Perhaps taking a cue from Apple, contractor Foxconn last week said it would hike wages 16 percent to 25 percent for its workers in China, lifting the total wage increase over just the last two years to more than 300 percent, in response to shrill criticism about some of the company's practices. The rate of increase may accelerate in coming years as pressure mounts on Foxconn to improve conditions for its hundreds of thousands of workers in China.

Which brings me back to the question asked earlier: who will foot the bill for these changes? Apple will definitely have to write a bunch of checks itself, and according to recent press reports, it has already issued the first batch. To join the FLA, for instance, the company paid $250,000 and has also paid the labor association "well into the six figures" to audit Foxconn and the other suppliers, according to a report scheduled to air today on ABC News. The show will air at 11:35 p.m. EST.

Apple can certainly afford the extra cost of the FLA membership and supplier audit. What it cannot ignore is the swelling negative PR it has garnered over the last month as repeated reports point to alleged labor violations at its contract manufacturers and some component suppliers. The company had $30.2 billion in cash as at the end of the December quarter and $67 billion in long-term investments, making its bank account the fattest in the electronics industry.

The same cannot be said of its suppliers, all of which will see their costs increase as Apple takes step to correct the alleged violations in an effort to pacify labor and human rights activists. Foxconn's payroll is swelling, but not fast enough, according to workers quoted in the ABC News cited above. Even candidates seeking a position at Foxconn are banking on the company jacking up wages under pressure from Apple and activists.

This should be a concern for Foxconn investors, since the electronics manufacturing services (EMS) market has traditionally endured slim margins. Contractors like Foxconn survive and make money by layering services and extending themselves deeper into the supply chain. A UBS AG analyst believes the recently announced wage increase of between 16 and 25 percent could put a 5 percent dent on Foxconn's operating profits, although the investment firm said the impact would be "limited."

Higher wages aren't the only extra costs Foxconn will have to shoulder, though. The FLA and Apple might mandate the company reduce overtime at its factories, limiting working time to 60 hours per week. Since Apple's sales are growing at a double-digit clip, Foxconn will have to hire more workers, increasing its overall costs. Plus, the recent controversy and publicity regarding working conditions at its facilities have already imposed additional costs on a company that had hitherto tried forcefully to stay out of the limelight.

Others in the electronics supply chain will see their costs rise, too. Suppliers to Apple and other high-tech firms may also have to increase wages at their facilities in China to match Foxconn salaries. The China cost looks set to go up, but it's not just OEMs that will feel the pain.