Apple & Foxconn: Breaking Up Is Hard to Do

For the sake of argument, let's say Apple Inc. (Nasdaq: AAPL), after suffering criticism for the actions of one of its business partners, threw down the gauntlet and told Foxconn Electronics Inc. it had to change its labor practices.

Let's say Foxconn countered with "Or what?"

If you think the immediate consequence would be Apple taking its business elsewhere, think again. Untangling itself from Foxconn -- or any other EMS company -- would be tough for even Apple.

In general, EMS-OEM relationships are complicated. A company such as Apple bids out its business to any number of EMS providers. Not only does an OEM want the best possible price, but it's also sharing details of its product design, business strategy, bill of material, end-customer forecasts, and even technology roadmap. These decisions are not made lightly.

The EMS company bidding on such business has to look at a number of things internally. First, does it have the technical capability to make Apple's products? Does it have ample capacity? Does it have relationships with the correct suppliers? If it has a direct relationship with a supplier, it might receive a volume discount. But if Apple manages the supplier relationships, it may have a better discount. If Apple does manage the relationships, it may not want to share the price it gets with its EMS partner, so the partner's cost estimate would be based largely on guesswork.

Assuming those hurdles are cleared, Apple's next question is about confidentiality. EMS companies are not dedicated to one OEM -- to hedge their bets, they manufacture for many OEMs. How separate would Apple's lines be from, say, Dell's? Would workers overlap? How are designs, the BOM, and other deliveries transmitted and handled? What suppliers, if any, do Apple and Dell have in common, and is the EMS provider leveraging the combined volume? If so, are the savings being passed on to one or both OEMs? How would the OEM even tell?

Next is the question of scale. If Apple had a massive ramp-up in demand, would the EMS be willing to move manufacturing capacity from, say, Dell to accommodate Apple? Would workers be willing and available? Who would approve the overtime? If Apple had a sudden drop-off in demand, would you lay people off? Would there be labor contracts to honor? How easy or difficult would it be to put people out of work? Would you pass those costs on to the OEM?

Once the OEM and EMS have established a partnership, issues such as customization may come along. Maybe a new manufacturing process is unveiled, and Apple wants the EMS to use it. The EMS has to create a manufacturing line (or lines) to take advantage of this. But there is always a risk involved. What if Apple changed its mind? Would the EMS stick Apple with the cost of adding the lines? Or would it use the new process for other customers? Could the EMS do this, if the process were developed for Apple?

These issues are just skimming the surface of OEM-EMS relationships. Apple's deals with Foxconn are no doubt hundreds of times more complex. And here is the big question: Where would Apple go if Foxconn refused to budge? Sure, there are other EMS companies, but picking up a customer like Apple takes time.

Charlie Barnhart, principal of the EMS consulting firm Charlie Barnhart & Associates, told EBN in an e-mail that it takes just over five quarters -- from the first internal talks to the first delivery of product -- for the typical OEM to implement a new EMS relationship. "Obviously there is a big range around this average depending on the scale, approach, and complexity of the project and the experiential level of the OEM."

In the EMS industry, Foxconn is the 800-pound gorilla. It's so big that analysts such as Charlie Barnhart & Associates have created a new category (Goliath Fringe) just to describe it. Foxconn is one of the few companies in the world that might be able to stare down Apple.

If Foxconn saw the light and began to change, you can be sure that the prices of products -- not just Apple's -- would rise. If Foxconn called Apple's bluff and sent it elsewhere, not only would there be a shortage of Apple products, but its already-premium prices would hit the roof. The idea that outsourcing gives OEMs more flexibility is true only to a certain extent. When you are as enmeshed as Apple is with Foxconn, a breakup wouldn't just hurt the companies -- it would hurt everyone.

Related posts:

• What Did Apple's Supply Chain Audit Uncover? Part 1
• How Will Apple Fix Its Supply Chain Problems? Part 2
• China: The Threat & the Opportunity
• Who's on Apple's Supplier List?
• Does Apple Have a Foxconn Problem?
• Why Apple Is an Arbiter of Right & Wrong