China and iPhone prices

Fascinating article in the Times that highlights the cost break-up of branded electronic goods which are predominantly assembled in low-wage countries like China using intermediate inputs manufctured elsewhere. It points to a recent study (see its abstract here) which showed that the total cost of the materials used on an iPhone 4 which sells for is $187.51 (more than a dozen integrated circuit chips account for about two-thirds of the cost of producing one phone), the assembling cost of these inputs (from Germany, South Korea, US and Taiwan) $6.54, and the net profit for Apple is $360.



Though labor forms a small share of the overall manufacturing cost (just 7% of the cost of an iPhone), thanks to ultra-low wage countries like China, it has become an important price-determining component. Apart from the final assembly, even manufacturers of intermediate inputs - contract manufacturers - for electronic devices like cellphones depend on their Chinese suppliers to hold down prices and compete fiercely on price.

In many ways, Chinese factories, with their low wage and military-disciplined workforce, form the basis of a massive low-margin, high-volume business model prevalent across the suppliers for various manufacturing intermediates. Unlike, fat margin, premium product makers like Apple, the makers of computers, cellphones and other electronics may find it difficult to cope with the increased cost of manufacturing in China.

However now, much to the relief of its trade competitors, soaring labor costs (wages have grown by 50% since 2005, even without the recent increases) caused by worker shortages and unrest, strengthening Chinese currency, and rising inflation are all threatening to sharply increase the cost of manufacturing in China.

As the Times article writes, on the positive side, this means that China looks set to move up the manufacturing value chain. This will leave others to occupy the space to solder, assemble and package electronic goods for the world's leading manufacturers. The flying Geese model would thereby move on to its newest generation.

Update 1
Jiggs made the point about R&D, marketing and other fixed costs incurred by Apple which are to be covered within the $360. I agree. But even including all of them, the broader point about massive margins holds good.

Update 2 (22/7/2011)

A bill of materials (BOM) analysis of the $499 version of the iPad tablet reveals that the cost of goods inside Apple's 16 GB Wi-Fi-only iPad totals $290.50, including service costs. The most expensive component on his price list was the 9.7-in. LCD touch-sensitive display, which he tagged at $100. The 16GB of memory and the aluminum case cost about $25 each, while the Apple A4 chip was listed at $15. Since the model will sell for $499, Apple's profit margin is 42.9% or about $208 on a piece.