Bad Apple in the China Barrel

Apple Inc. has been grabbing all the wrong headlines lately, and the NYTimes piece How the U.S. Lost Out on iPhone Work and the BusinessInsider.com commentary summarize one part of the problem. Apple isn’t the first company to build corporate strategy around supply chain considerations – it’s been a mainstay of Taiwan’s very successful business planning ever since the mid-1990s. But outsourcing has always been a controversial strategy for US companies, as demonstrated by the auto industry when it started shuttering Detroit factories in the 70s in favor of cheaper Mexican labor – and ended up enabling its own biggest competitors like Toyota and Datsun (predecessor to Nissan).

There are three problems with Apple’s corporate strategy, and the damage being done to its reputation is only the first to manifest. Apple has gone from being the corporate underdog who made good to the poster child for Evil Inc. remarkably quickly – largely due to the management policies of its Taiwanese OEM partner Foxconn (and its parent Hon Hai). Foxconn is a B2B outsourcer and doesn’t need a consumer-friendly brand image, but Apple can’t continue using the reverse Nuremberg defense, “it’s not our fault – we are just giving orders”. We all know how the products are made.

But I’ll let the PR pros weigh in on the benefits and costs of being an evil corporate monster. It hasn’t hurt Apple’s sales, and plenty of other companies and industries sell great products while behaving beastly to their workers and suppliers.

Apple does, however, have two other problems that will eventually pose a greater threat to its bottom line.

1. It is way too exposed to supply chain risk.  We’ve seen this before, and it doesn’t end well. Apple has given all the power to its suppliers but retained all the profit for itself. Its designs are in the hands of an engineering team it controls only indirectly. While Taiwanese OEM firms have a good reputation and track record for protecting their client’s intellectual property, Apple is giving up an important competitive competency by outsourcing it’s complete production cycle to a small group of companies that it doesn’t control. Foxconn is in a very powerful negotiating position, and it may not be satisfied with razor thin margins forever .

2. Apple is equally exposed to negotiating risk with China – and that may end up being even more dangerous. Beijing giveth, and Beijing retains the right to take away. Right now the considerable power of the Chinese government is flowing Apple’s way, making it easy for Foxconn to do business. But that can change without warning – as it has for so many in the past. If Apple finds itself out of favor with Beijing policy makers, its supply chain is vulnerable to the Chinese bureaucracy. The same is true if a Chinese competitor finds itself in possession of Apple’s proprietary technology. Right now China’s flexibility and ability to mobilize resources is drawing Apple in. China can be famously rigid and immobile when it wants to be.

All China has to do is find Apple (or its suppliers) guilty of violating PRC law – which is almost certainly happening – to shut down Foxconn production for a couple of days. Apple’s share price will tank, and management will find itself in a very weak negotiating position.  Beijing probably won’t, unless it stands to gain something – like technology or customers.

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Background articles on BusinessInsider.com:

This Article Explains Why Apple Makes iPhones In China And Why The US Is Screwed

Steve Jobs Freaked Out A Month Before First iPhone Was Released And Demanded A New Screen

Your iPhone Was Built, In Part, By 13 Year-Olds Working 16 Hours A Day For 70 Cents An Hour
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