Foxconn Outfoxed

The rising tide at {complink 379|Apple Inc.} isn't lifting all boats. {complink 2125|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?

18 comments on “Foxconn Outfoxed

  1. Anna Young
    April 30, 2012

    “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.

  2. Himanshugupta
    April 30, 2012

    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?

  3. Houngbo_Hospice
    April 30, 2012

    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.

  4. bolaji ojo
    April 30, 2012

    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.

  5. bolaji ojo
    April 30, 2012

    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.

  6. Barbara Jorgensen
    April 30, 2012

    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.

  7. bolaji ojo
    April 30, 2012

    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.

  8. Barbara Jorgensen
    April 30, 2012

    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.

  9. Anna Young
    April 30, 2012

    Yes, I agree. Who should Foxconn pass the higher cost to?

  10. Taimoor Zubar
    April 30, 2012

    I doubt Apple will be able to find a cheaper alternative to Foxconn, though”

    @Barbara: I don't think it's all about cost in this Apple's case. Foxconn has been there since Apple started producing iPhones and iPods. Part of the success that Apple has got is because of Foxconn. On papers it may just seem to be another EMS that Apple has a contract with, but I think it's a very risky move if Apple decides to make a transition away from Foxconn. There may be lots of factors that go against Apple which cannot be predicted in advance.

  11. prabhakar_deosthali
    April 30, 2012

    At one time we were saying that Foxconn is forcing their labor force to work at below par wages .

    Now we are saying that Apple is not sharing a proportionate amount of its profit with its suppleirs

    So it is not Foxconn but Apple to be blamed isn't it?

    I am confused.

  12. Daniel
    May 1, 2012

    Anna, I think they have to share from the profit. Apple is a customer of Foxconn and if they increase the selling price, Apple may look for alternate sources. So I don’t think Apple may share a part of it.

  13. Daniel
    May 1, 2012

    Prabhakar, this is like two sides of a coin. They want to get maximum profit at one end and other end they don’t want to shell out anything for other reasons.

  14. bolaji ojo
    May 1, 2012

    Prabhakar, Apple has obligations only to its shareholders. It's not the company's job to protect suppliers. During negotiations, a supplier must look to present a case that is in its own shareholders' interest. Did Foxconn negotiate its contract with Apple with that in mind, that is, to maximize shareholder value? If it failed to make that case because it just wants to get the contract then the management has a problem.

  15. t.alex
    May 2, 2012

    Apple prices its products not just base on cost but other factors such as ecosystem (appstore, iCloud, etc.).  I think it should absorb the cost, and not pass down to customers.

  16. Wale Bakare
    May 2, 2012

    t.alex, i dont think you should expect Apple taking it but to consumers's. Apple would probably pass it onto its product prices.

  17. t.alex
    May 2, 2012

    Wale,yes I think there is some possibility here. But that would make Apple's products less competitive to Android equivalent.

  18. Cryptoman
    May 4, 2012

    Foxconn's increased costs will need to be reflected to Apple at the end of the day. It may not be ideal for Apple but that is the bitter truth. Apple will then have to pass the added cost to its customers. This may make Apple products a bit less desirable and less competitive, however Apple has already been reaping the benefits of really low costs of manufacturing for a long time now. The profits will take a hit but all in all the game will be a much fairer one for all those involved I think.

    It's hard to sympathise with Apple who has banked $98B already !! I am sure it will survive. As a matter of fact, this development will heat up the competition and as result, the end users will benefit.

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