China Calls on Asean, Gulf States to Create ‘Big Market'
'We should firmly expand regional opening up and develop a big market,' Li said at a meeting with leaders from Southeast Asia and the Middle East in Kuala Lumpur on Tuesday. 'We should effectively manage differences in the spirit of mutual understanding.'
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That pledge was exceeded. The sophisticated supply chain Apple built in the country, with suppliers that Apple nurtured, is now being leveraged by Chinese companies, notably Huawei, to build sophisticated electronics products. Huawei's Mate XT is a more expensive phone with alluring features than the iPhone. Apple isn't expected to match these product capabilities until 2017. Apple has gone from leadership in design in this market, with the margins to match, to having serious competition. How could Apple have been so stupid? A fundamental concept of risk management is that you don't put all your eggs in one basket. Patrick McGee explains how this came to be in his outstanding book. McGee interviewed over 200 people, mostly Apple employees, to provide insights on this 'famously secretive company.' Apple's Historic Supply Chain Historically, Apple manufactured its own products across several regions. In 1983, Apple opened a highly automated plant in Fremont, California, to produce the first Macintosh computers. Apple established a presence in Europe with a plant in Cork, Ireland. This plant, which opened in 1980, later manufactured customized Macintosh computers for European markets. This is the historic way of hedging your bets and managing risk. Apple understood this principle. But as contract manufacturing emerged as an alternative to a company owning its own manufacturing plants, Apple experimented with this model and achieved positive outcomes. The theory behind contract manufacturing is that companies should focus on what they do best, their core competencies. In Apple's case, that was design. Initially, they were working with American firms and had plants in the US. But Taiwanese headquartered Foxconn proved to have better capabilities than its US rivals, and Foxconn won an increasing share of Apple's final assembly business. You can still practice effective risk management using contract manufacturers with plants in different regions of the world. Foxconn, at Apple's behest, did experiment with manufacturing in other regions of the world in addition to China. But Foxconn, a tremendously harsh taskmaster when it comes to their labor force, struggled to achieve the same level of quality, cost, and scalability anywhere but in their facilities in mainland China. Foxconn then committed to relying on production based in China. As Foxconn delivered better results than its competitors, they gained a larger and larger share of Apple's business. Apple's Strategy in Procurement Apple does not believe in win/win procurement or vested outsourcing. McGee points out that the iPhone accounts for fewer than 20% of smartphones sold globally, yet it garners more than 80% of industry profits. 'In no other market does a minority player command this kind of dominance.' 'Insofar as this statistic was discussed at all, it was chalked up to Apple's brand appeal.' This is not entirely true, says McGee. Apple was able to get suppliers to work for a pittance. As the design leader, suppliers came to believe that other electronics OEMs would copy the cutting-edge features in Apple phones and that they would be the leading contenders to win deals with Apple's competitors. These deals would command much higher margins. The Taiwanese contract manufacturer Foxconn was the first to come to this conclusion. They bet big on this model. And they grew to be the world's largest contract manufacturer based on this bet. A Different Approach to Contract Manufacturing Companies can differentiate their products in different ways. Differentiation can be based on price, a broad set of product choices, service, or market-leading product capabilities. Being on the cutting edge of design is how Apple has always differentiated itself. This led to a fundamentally different kind of supply chain for Apple. Apple's electronics rivals sell a limited number of units across dozens of different models per year. The follow-the-leader strategy employed by these companies was based on using standardized parts with wider tolerances. 'But Apple was different,' McGee wrote. 'Apple's product portfolio remained radically simplified. Even by 2015, Apple was only releasing two new iPhones a year. They were hand crafting luxury phones but doing it in mass market quantities. In their search for suppliers, Apple gravitated toward quality, not price. To reach that quality, Apple had to come up with new processes to make the phones; but until Apple chose a new design these processes wouldn't exist. So it had to work far more intimately with suppliers.' This supplier intimacy model included designing and purchasing the equipment that the suppliers used. This is very different from standard contract manufacturing, where the contract manufacturer purports to have better manufacturing capabilities than the companies they work for, and their clients take a hands-off approach to managing production. 'Apple took extraordinary control over its suppliers to ensure it was getting the appropriate prices,' McGee explained. 'It demanded access to every detail about the suppliers' operating costs, from the wages of its workers and the cost of its dormitories to the bill of materials and expense of the machinery.' Apple also procured components on behalf of the suppliers. 'In fact, Apple often had a better sense of the supplier's operation costs than the supplier itself.' And as Foxconn concentrated on manufacturing in China, an industrial cluster of suppliers would grow up around these plants. Apple engineers would teach these suppliers, competing suppliers for different components, how to do quality manufacturing on a huge scale. China Subsidized Manufacturing in China Foxconn concentrated on manufacturing in China not just because of the low wages of the Chinese workers, but because the state subsidized and promoted export-led production in numerous ways. If you want to build a new factory in the US or Europe, obtaining the necessary building permits and complying with other regulations can take years. In China, authorities could make this happen in months. China would give Foxconn and some of the suppliers the land on which the factories would be built and then build the road infrastructure at no cost to Foxconn or their suppliers. Initially, China even bought new machine tools for companies like Foxconn. Local regions often lacked the necessary workers. China facilitated getting these workers from other, poorer regions of the nation. Are there rules about the number of hours workers are allowed to work, overtime, or environmental compliance? China prioritized building a sophisticated manufacturing base over the enforcement of these pesky regulations. Apple Has Been Captured by China McGee concludes that for Apple to extricate itself from production in China will be tremendously difficult. Suppliers with the requisite skills don't exist in other regions, and there is no guarantee that China will permit its indigenous suppliers to produce outside the country. The Chinese government can also make diversification painful. Beijing has deployed a number of tactics against other companies to make this point. Electricity suddenly becomes available for only a few hours a day. Raw materials can be stopped before they arrive at the factory. McGee concludes that there is no way Apple could diversify from China in any meaningful way within the next five years. 'It's just impossible.'
