Who Will Pay for Apple Supply Chain Changes?

The changes {complink 379|Apple Inc.} 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 {complink 2125|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 {complink 6967|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.

20 comments on “Who Will Pay for Apple Supply Chain Changes?

  1. Eldredge
    February 21, 2012

    Does anyone know what percentage of Foxconn's cost are wages versus materials? I'm sure the added cost will end up being distributed over the supply chain, at least to some extent, and translated to higher consumer cost as well.

  2. bolaji ojo
    February 21, 2012

    Rich, Just new chains or the charger for an iPad. Apparently, the newly increased wages are still considered so low by the Chinese government that they are exempt from income tax.

  3. bolaji ojo
    February 21, 2012

    Elredge, Determining this is difficult, though not impossible. Companies typically don't break out wages so to get a range of what cost of goods sold (COGS) breaks out into one might have to look at inventory numbers on the balance sheet and figure out beginning and end inventory per quarter then guess or track back to what might be the labor portion in the COGs or in the SG&A (selling, general and administrative) costs.

    Foxconn does not report COGS and the inventory numbers it report represent only a fraction of its sales, which means it would be extremely difficult figuring this out. Notwithstanding what analysts say, Foxconn isn't about to break out the impact of this wage increases on its operations.

  4. Houngbo_Hospice
    February 21, 2012

     Apple will not survive without its suppliers. It is more likely that Foxconn will have to bear most of the costs, but the company will/can find a way to make Apple share some of the costs as well.  

  5. Houngbo_Hospice
    February 21, 2012

    Increased wages and better working conditions doesn't mean that chinese factory workers will become rich overnight. But the morality in all that story is that those workers will not be denying their rights anymore. But they will have to accept things to change gradually.

  6. Barbara Jorgensen
    February 21, 2012

    @Hospice: I doubt the wage increases will be passed on only to Apple. OEMs have a pretty good idea of what their competitors are doing, so Foxconn will not be able to keep that secret. Can you imagine what would happen if Foxconn raises it rates with Apple, but not with Dell? If Foxconn passes labor costs on to customers, it will be for all customers.

    What is more likely is that Foxconn will find another way to make up the difference. Foxconn probably gets huge volume discounts from suppliers on components it uses across its customer base. It could start ratcheting up those prices. Or, it could negotiate a better discount and not pass the savings on to customers.  This is pretty common with the EMS industry.

    There are even more underhanded ways, such as substituting a cheaper part for the one on the AVL and hoping the OEM doesn't notice. I'm not saying that Foxconn does this, but it does happen. I know of a distributor that had to tell a supplier its product didn't make it on to a printed circuit board. Needless to say, the supplier was livid.

    Unfortunately, with an operation as big as Foxconn's, a lot of things can be overlooked. Look at long it took for its labor practices to be flagged.

  7. bolaji ojo
    February 21, 2012

    Hospice, The chances for Foxconn to bear the entire cost is slim. It may for the current contract but once the contract is ready for renewal the discussion with Apple will have to include spreading the cost.

  8. bolaji ojo
    February 21, 2012

    Barbara, Considering how slim margins are at EMS what do you think will happen when contracts come up for renewal between Apple and Foxconn? It's certainly unaceptable to ask the EMS provider to add to its costs without getting reimbursed.

  9. burn0050
    February 21, 2012

    Frankly, it should be Apple's cross to bear. Their products carry a profit margin of anywhere from 20-50%. I think they can afford to take a hit in the manufacturing costs to help fix some unfair labor practices. While we own several Apple products, their cost tactics have always infuriated me.

    The upsell on their devices has always been memory. But the markup is RIDICULOUS. To go from 16Gb to 32Gb on a phone is an extra $100, while their cost is probably $5 (or less). A consumer can buy a 16Gb SD card for $15 (or less). Upsell something else that's worth the money. But, that would cut into those HUGE profit margins for them. The company was built on the ego of Steve Jobs (rest his soul), and its prices match. For him, I think, it was more about the product being elite – so he charged more, not because of a profit margin (read his biography, it's not about the money – although I doubt that didn't play a part).

  10. j-allen
    February 21, 2012

    People of conscience consideer the social and ethical consequences of their buying practices, even if it means paying extra, or sometimes doing without a product.   During Apartheid ethical people boycotted South African products, and while Jack Welsh was Chief of GE I wouldn't buy a light bulb from them to keep from falling down the stairs.  I would much rather pay a bit more for an Apple product made under fair and safe labor conditions than to know my purchase was making workers sick and miserable.  This is especially true since most Apple products are far from necessities.   

  11. Barbara Jorgensen
    February 21, 2012

    @Bolaji: Given the time that it would take to disengage from Foxconn–anywhere between 3 and 5 quarters by some estimates — and find a new partner (4 to 8 quarters) I would expect Apple to weigh the pros and cons. I think Foxconn will ask its OEM customers–including Apple–to pay more. In the end, I think Apple will stick with its partner and pass costs on to end-customers. They are a business, and that's what's in the best interest of Apple shareholders.

  12. bolaji ojo
    February 21, 2012

    burn0050, I feel your angst. As much as it might be nice to have an iPad, I have refused to buy one. I also don't own an iPhone. I do have an early edition iPod, which an Apple employee at an iStore once told me they wouldn't service because it was so old!

    In other words, I have moments when I think Apple's products are overpriced. The company gets extra dollar for the “goodwill” its products generate and for the perceived “quality” as well as the other thing analysts are crazy about — the ecosystem. Of course, some of this is hogwash but people have bought into it.

    Will Apple readily give this up in the new environment where bashing the company has suddenly become “cool”? I doubt it. Although I agree its margins are hefty and it can easily absorb the extra cost of the Foxconn wage hikes and other supply chain makeover it is implementing, it may be difficult for Apple to change its old ways of pushing costs onto its suppliers and extracting the most value from customers.

  13. bolaji ojo
    February 21, 2012

    Barbara, I believe you have put your finger on the first symbiotic relationships in the history of the electronics industry. Apple cannot dump Foxconn and neither can Foxconn dump Apple without both parties suffering major harm. They'll figure out ways to get along and share extra costs. I predict, though, that Apple will go back to its old ways of transferring costs to suppliers and selling customers the “ecosystem experience.” Why both suppliers and customers put up with it is the real puzzle.

  14. _hm
    February 22, 2012

    Is this applicable to Apple products only? Foxxcon and Chinese supplier assembles products for many others. All these organizations will have to pay more to compnies like Foxxcon.

    Will this bring back some work to USA?


  15. bolaji ojo
    February 22, 2012

    Rich, He's laughing in heaven (and his estate is ecstatic) that you bought an iPad. I didn't buy an iPad for a bunch of reasons, one of which is the price but also because there are alternatives that I am carefully considering. I like Apple products but won't buy any of them as part of a herd.

  16. bolaji ojo
    February 22, 2012

    _hm, The situation is not Apple-specific. All the companies that manufacture with Foxconn have the same problem. However, Apple is the most visible company and is receiving the greater attention as a result.

    You asked if the Apple changes will bring jobs back to the United States. I doubt it. The jobs Foxconn has won't be viable in the US or in other Western countries. At under $2 per hour, Foxconn's workers' pay wouldn't be considered living wage in the US. Plus, the dormitory condition won't be accepted here.

  17. dalexander
    February 22, 2012

    Bolaji, I think I read or heard that an IPhone cost somewhere in the neighborhood of $9.00 to manufacture. Even if the cost triple, won't Apple still make tons of money on each sale? I have the original IPad and just got rid of the original iPhone which I replaced with a Galaxy II Skyrocket Adroid phone from Samsung. All these phones will eventually mimick each other in features so the competitive nature of similar products will eventually determine market share for each competitor. The various Apps are becoming universal as well. There are just so many notepads or contact managers or PDF readers before you've been there, done that syndrome sets in.

  18. bolaji ojo
    February 22, 2012

    Douglas, Even if Apple gets Foxconn wages to triple, the US company will stay make billions in profit. Current wages as reported by NBC News for Foxconn workers come to $1.78 per hour. Few workers in the U.S. will think they've struck the motherlode if they make $10 per hour.

    And, as you indicated, all the smartphones are becoming in some ways generic. The idea Apple's ecosystem or Nokia's ecosystem or Google's Ecosystem is better than the competing system is becoming a failed argument. The ecosystem has become commoditized.

  19. Eldredge
    February 23, 2012

    @Barbara – I would tend to agree. Maybe Foxconn will absorb a token reduction in margin, but certainly won't bear the full cost increase on their own.

  20. Anna Young
    February 29, 2012

    The Apple & Foxconn story is dying out without a comment from the Chinese government. The story isn't over. Most of this will play out in a theater but that is not going to be in China because the government isn't really interested in the story.

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