The rising tide at Apple Inc. (Nasdaq: AAPL) isn't lifting all boats. Foxconn Electronics Inc. should be getting a financial boost from being a contractor to the world's biggest consumer electronics company by market value, but that has not been the company's experience in the last several quarters.
Foxconn, which is also known as Hon Hai Precision Industry Co. Ltd., is the world's biggest electronics manufacturing services provider, largely because it is the main manufacturer of iPhones, iPads, and iPods. According to a Reuters report, Apple accounts for about 45 percent of Foxconn's sales, but that relationship has been largely unequal to say the least.
Today, Foxconn announced disappointing first-quarter results. Profits of $509.2 million were well below analysts' forecasts, and the company's operating margin slipped to 0.9 percent. Contrast Foxconn's results with the numbers Apple published last week, including revenue of $39.3 billion and a quarterly profit of $11.6 billion. When Apple announced its record-breaking results, its share price surged above $600 after falling more than 10 percent over the previous week. Today, however, shares of Foxconn International fell almost 3 percent in regular trading in Hong Kong.
Foxconn has been hit hard by reports about its hiring and compensation practices in China. In recent months, the company has had to increase salaries for many of its workers (as much as 25 percent in some cases), and this has hit its margins hard. Foxconn is also being forced to hire thousands of workers while it adds plants in China's hinterland to keep costs down and reduce the psychological problems for employees working thousands of miles from home.
The Reuters report indicates that Foxconn has yet to transfer much of its higher costs to its customers, including Apple. Until it does, the margins will remain under pressure, analysts told Reuters.
This situation is not isolated to Foxconn. Many suppliers to Apple have not benefitted strongly from the company's huge growth. This reinforces the notion that Apple has prospered at the expense of its supply chain. Foxconn needs to be able to transfer some of its added costs to Apple and other customers. Apple needs to protect its margins while being seen as fair to suppliers. What's the best solution for all parties?
I agree there is not a lot of maneuvering room for any EMS in terms of profit margin. I doubt Apple will be able to find a cheaper alternative to Foxconn, though. Few EMS are as vertically integrated and those cost savings are considerable. Foxconn also is involved in a lot of other businesses it could trim if it is in such dire straits: the company is building shopping malls, for one thing. Maybe that's a higher-margin business, but there is such a thing as being too diversified. But Foxconn's problems will have an impact on Apple, and I believe it will take the form of higher prices all around.
Correct. This is a Foxconn problem but is it possible that a Foxconn problem may eventually become a problem for Apple? Gross profit margins in the contract manufacturer business can be as low as 4 or 5 percent and there isn't that much room for a supplier to add on to its costs or allow the OEM to transfer additional costs to it. So, when a contractor's costs go up it would seem to make sense it would try to transfer some of these to the OEM.
In the case of Foxconn, though, the company has grown by offering the lowest pricing for its services. That, in my opinion, is the only reason it was able to grow so rapidly that its annual sales today now dwarf those of its next five competitors. It marketed itself as a low-cost provider and took advantage of its understanding of the Chinese environment to further reduce costs. OEMs signed on with Foxconn because it can assure the manufacturing scale and low costs they want.
In order for Apple to agree to take on the extra costs from Foxconn increasing wages paid to its employees, the two companies will have to sign a new contract. At that point, Foxconn's offer may not be as attractive anymore to Apple.
I think this is a Foxconn problem. Foxconn accepted the risk when it concentrated so much of its business in Apple. The EMS business model should be balanced enough so that an upswing or downswing in any one customer or market can be offset by others. In this case, Foxconn isn't benefiting from Apple because Foxconn does not share in Apple's stock. It provides a service. If Foxconn hasn't passed higher costs on to customers, that is a problem, but I'm not sure it can be traced back to only Apple.
The solution is not profit sharing but cost-sharing is certainly necessary in this situation. A contract manufacturer must not subsidize the OEM's operation and when its costs rise, the increase should be passed on to the customer unless the contract expressly forbids this. And even when it does, the relationship between the two could be impaired by a heavy-handed "we-don't-care" attitude by the OEM.
This is a Foxconn problem that is connecting the contract manufacturer too closely to Apple. I believe Foxconn needs to get on these issues rapidly and Apple should be pressuring it hard to change the situation.
The company might just have to "transfer some of its added costs to Apple and other customers". Apple's huge profits show that the company is either overpricing its products or it is underpaying their production costs. But it might also be that Foxconn was making more profits that it should.
It can be suicidal for Foxconn to ask for profit sharing from Apple given that 45% of the service belongs to them but this seems like a logical step. After reading this story, i cannot blame Foxconn for a tight grip on its money. Apple and other such companies are equally to blame. With soring profits, if the supply chain is nearly inhumane then who to blame?
"The Reuters report indicates that Foxconn has yet to transfer much of its higher costs to its customers, including Apple. Until it does, the margins will remain under pressure, analysts told Reuters"
Why is Foxconn not passing on the higher costs to its customers? Apple is obviously not feeling any pinch in its profit margins.
In addition the link below indicates that there might be further trouble for Foxconn.
By moving to the core of the industry and offerings services that keep the system humming, a group within the electronics market has rendered irrelevant the question of ownership and control of the supply chain.
EBN Dialogue enables and encourages you to participate in live chats with notable leaders and luminaries. Not only editors and journalists, but the entire EBN community is able to comment and ask questions. Listed below are upcoming and archived chats.
Archived Dialogues
Thailand Stages a Comeback Join EBN contributor Jennifer Baljko on Thursday August 23, 2012, at 11:00 a.m. EST for a live chat on how electronic manufacturers in Thailand have shored up their supply chain to reduce the impact of future natural disasters.
Euro-Crisis: What It Means for High-Tech Firms Join EBN Editor in Chief Bolaji Ojo and Contributing Editor Jennifer Baljko on Thursday, July 12, at 10:00 a.m. EDT for a Live Chat on high-tech and Europe's economic difficulties.
Microsoft Surface: Potential Winners & Losers What are the implications for the electronics industry supply chain of Microsoft Corp.'s decision to launch its own tablet PC? Join industry veteran and EE Times' systems and OEM expert Rick Merritt on Tuesday, July 3, at 12:00 pm EDT for a Live Chat on this subject.
Join EBN contributor Jennifer Baljko on Thursday August 23, 2012, at 11:00 a.m. EST for a live chat on how electronic manufacturers in Thailand have shored up their supply chain to reduce the impact of future natural disasters.
Peter Drucker famously said "Trying to predict the future is like trying to drive down a country road at night with no lights while looking out the back window." Yet in the razor's-edge world of electronics—with a lean supply chain and just-in-time demands—the need to know the future is vital.
You've heard the saying "the No. 1 supply chain risk is your people." That hasn't always been the case. But today's complex global supply chain requires a new type of multitalented employee. It's one who understands, finance, marketing, economics, is savvy with technology, graceful with relationships and can think analytically.
Where are these people? Are universities properly preparing the next generation supply chain professionals? How do train your existing workforce for these new, demanding positions?
Brian Fuller, editor-in-chief of EBN, will lead a 60-minute Avnet Velocity panel discussion that will ask and answer these and other questions swirling around today's supply-chain talent challenges.
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