Patrick McGee has written the definitive book on Apple’s relationship with China.
The short story goes something like this.
Apple has always sought to build a deep moat around its products. It pursued a manufacturing strategy in China that followed this principle. Its design focus meant that many of its components were bespoke.
Therefore, unlike its smartphone rivals, who used generic components off the shelf and could therefore hand over the design and outsource the entire manufacturing to contract manufacturers, Apple had to work very closely with its suppliers and contract manufacturers. Its obsessive focus on quality also made this an imperative. Accordingly, it sent its product designers and manufacturing design engineers from Cupertino to embed themselves with its contract manufacturers and suppliers, and transfer knowledge, skills, work practices, and work ethics.
It set a very high standard for the deliverables from suppliers, who in turn acquired a reputation for being the best in class. This also meant that the employees in Apple’s supply chain had to undergo training and acquire a higher level of skills than was the case for others.
Given the high employee turnover in the industry, Apple’s supply chain became a training ground for millions of manufacturing workers at all levels. McGee points to Apple’s own estimate that since 2008, a staggering 28 million workers have gone through Apple’s rigorous training, a number greater than the entire labour force of California! It may well be the single biggest skilling program that the world has ever seen, one that involved an American company imparting knowledge, skills, and practices to the entire Chinese electronics industry.
Apple was not outsourcing as the word was commonly understood. Instead, it was sending its top product designers and manufacturing design engineers from California and embedding them into suppliers’ facilities for weeks or months at a time. There they’d whip local suppliers into shape, co-invent new production processes, and stay until the operations were up and running. “The think that really stood out was not just that it’s all in China, but that it’s the most vertically integrated manufacturing system in the world and yet they don’t theoretically own anything,” he says… Instead of selecting components off the shelf, Apple was designing custom parts, crafting the manufacturing behind them, and orchestrating their assembly into enormously complex systems at such scale and flexibility that it could respond to fluctuating customer demand with precision. Just half a decade earlier, these sorts of feats were not possible in China. The main thing that had changed, remarkably, was Apple’s presence itself. So many of its engineers were going into the factories to train workers that the suppliers were developing new forms of practical know-how.
Apple was also investing heavily in the production process to build moats around its manufacturing innovations, while rivals were just giving suppliers spec sheets and saying, “Build this.”… Apple did something totally novel. It purchased hundreds of millions of dollars of machinery, placed it in the factories of its supply partners, and ‘tagged’ it for Apple use only… The investments allowed its suppliers to operate at a level they’d otherwise be incapable of… As a former Apple manufacturing design engineer puts it: “The model we had developed was: We’re going to use your factory. We’re going to use your people. But we’re going to go in there and use them as our arms and legs. You know, ‘You do this, and you go do this,’ and ‘You set the dials here.’”… Apple’s engineers were deep in the weeds building, and even inventing those capabilities. Apple was doing this on such a scale that it created an entire organisation within Ops dedicated to the procurement, planning, and deployment of this capital-intensive machinery.
All this also meant that Apple had complete control over its supply chain. In fact, it may not be incorrect to say that it did manufacturing, but without owning any factory!
In return for the capabilities development and tight guidance (plus, of course, the large volumes and the privilege of supplying Apple), Apple’s procurement division, headed by Tony Blevins, negotiated cut-throat deals that paid the lowest margins. Counterpoint Research has estimated that in 2016, even as Apple had a profit margin of 33%, its Chinese rivals Oppo, Vivo, and Xiaomi had 7%, 6%, and 2% margins. Foxconn’s margins fell to just 2.4% in 2011, and while its revenues more than doubled from $53 bn in 2007 to $107 bn in 2011, its profits barely rose from $2.41 bn to $2.53 bn. Apple’s suppliers realised that the skill acquisition, the massive volumes, and the reputation that comes with working for Apple compensated for the low margins. They could charge a premium for supplying to other smartphone makers.
Apple actively encouraged diversification among its suppliers by requiring that none of them should have more than half of their revenues from Apple. This was also for derisking since its models often involved radical shifts that obviated certain components that would have closed down suppliers, with all the negative press around job losses. This effectively meant that Apple’s suppliers were cross-subsidising their manufacturing for Apple by charging higher prices for their supplies to Apple’s rivals.
McGee describes this relationship between Apple and its suppliers and contract manufacturers in terms of the Apple Squeeze
Apple’s engineering and operations teams would rigorously train local partners, in the process giving away manufacturing knowledge, in particular how to efficiently scale while maintaining the highest quality standards. In exchange, the local supplier would work for soul-crushingly low margins with the understanding that it could profit from the incredible volumes Apple demanded. It could also use these skills to win orders from other clients, charging them more for similar work.
Importantly, this condition also may have contributed to the birth of the Chinese smartphone industry.
In 2009, the majority of smartphones sold in China were produced by Nokia, Samsung, HTC, and Blackberry. But as Apple taught the supply chain how to perfect multi-touch glass and make the thousand components within the iPhone, Apple’s suppliers took what they knew and offered it to homegrown companies led by Huawei, Xiaomi, Vivo, and Oppo. Result: the local market share of such Chinese brands grew by leaps and bounds, from 10% in 2009 to 35% by 2011, and then to 74% by 2014. It’s no exaggeration to say that the iPhone didn’t kill Nokia; Chinese imitators of the iPhone did. And the imitations were so good because Apple trained all their suppliers… Apple became the developer for China… Apple, in other words, set in motion a series of events that helped Chinese suppliers win more orders and advance their understanding of cutting-edge manufacturing. At the same time, Western manufacturing of electronics atrophied.
It also birthed a high-quality Chinese contract manufacturing industry. By shifting orders from its Taiwanese contract manufacturers, Apple has allowed Luxshare, BYD Electronic, Goertek, and Wingtech to take significant shares of Apple’s supplier network. More than half its component suppliers are Chinese firms, and many of the rest manufacture in China. The spectacular success of China’s electronics manufacturing ecosystem owes no small measure to Apple. I have blogged here about iPhone’s domestic value addition in China.
Given its bespoke components, obsession with quality, and the massive volumes involved, Apple often invested in the equipment and machinery for its suppliers. As McGree writes,
The value of its “machinery, equipment and internal-use software” – namely the instruments placed in third-party factories for production – totalled less than $2 billion in 2009, but then soared beyond $44.5 billion by 2016 – more than four times the value of “land and buildings” owned by Apple – as the company took unprecedented control of its supplier network.
All told, Apple invested a staggering $55 billion a year for five years from 2015, for a total of $275 billion, more than double the entire post-war Marshall Plan. In addition to the investments in equipment to suppliers and construction of its retail stores, this estimate includes a sizeable part of wages that Apple paid to workers across its supply chain as training costs for teaching new skills and processes to refresh its multidimensional product portfolio.
I’ll let McGee summarise the Apple story
By investing in and teaching local suppliers, Apple was inculcating a corpus of hands-on knowledge, both in tangible skills and abstract concepts, which applied well beyond serving its own needs. True, this was fairly unintentional; Apple hadn’t designed its supply chain to spur innovation at its suppliers. Yet that’s exactly what it had accomplished. And Apple’s investments weren’t just large, they were ruthlessly efficient and narrowly targeted in the advanced electronics sector… Thinking of Apple’s investment like a government program is instructive. Year in, year out, China didn’t have the talent or expertise to build the products that Jony Ive’s studio conceived, but the engineers Apple hired out of MIT, Caltech, and Stanford, or poached from Tesla, Dell, and Motorola, routinely got them up to speed. Apple could send a calibre of talent to China – what one Apple veteran calls “an influx of the smartest of the smart people” – that no government program ever could. And the culture was such that the Apple engineers would work up to 18 hours a day. Moreover, whereas a government program could at best train a workforce to engineer products, it wouldn’t have the ability to actually purchase the goods. But Apple could and did.
In economic terms, Apple was creating the whole market – supplying inputs in the form of worker training and machinery, then purchasing the outputs. The suppliers who won Apple contracts were given a massive order book and were taught to ramp up at a pace none had ever experienced. Better still, Apple had put so much design, brand image, and superb marketing into its products that even without commanding a dominant market share, it nevertheless attained a dominant market style. A new Apple product would set into motion the look, feel, and substance of what a laptop or smartphone should be. So the processes it often co-invented with China-based suppliers were in great demand…
What Apple had realised was that, unwittingly, its presence in China was enabling technology transfer on an extraordinary scale… Apple wasn’t just creating millions of jobs in the country; it supported entire industries by facilitating an epic transfer of “tacit knowledge” – hard-to-define but practical know-how “in the art of making things, in organising practical matters, and in the way people produce, distribute, travel, communicate, and consume,” as the China-born Federal Reserve economist Yi Wen defines it… The technology transfer that Apple facilitated made it the biggest corporate supporter of Made in China 2025, Beijing’s ambitious, anti-Western plan to sever its reliance on foreign technology.
Some thoughts:
1. While China’s manufacturing prowess undoubtedly arose from multiple factors, it may not be incorrect to highlight the point about the central role played by Apple’s iPhone manufacturing to claim that China made the iPhone, and the iPhone made China!
2. When history is written, Apple will be considered an icon of efficiency and profit-maximising capitalism. The cost-minimising contracts with suppliers, low-margin outsourcing, the transfer of inventory to the contract manufacturer, the tight oversight of its suppliers and contract manufacturers, and the concentration of everything in China meant that Apple could harvest economies of scope and scale in an unprecedented manner, and thereby maximise its profits.
3. The other side of efficiency and profit maximisation is that Apple will also be considered a totemic example of risk concentration. It has yoked itself so deeply and intimately to China that any exit is near impossible, and it’s now virtually at the mercy of the Communist Party and President Xi Jinping. McGee compares Tim Cook to Jack Welch, who laid the foundations for GE’s demise.
4. As McGee writes, unlike Japan, Taiwan, Korea, and China, which first made components before getting into SMT, assembly, testing, marking, packaging, and higher value-added activities, India has jumped straight into SMT and ATMP. Manufacturing of components is hard and requires the development of several critical capabilities, besides a workforce with high productivity that can also produce with high quality. These tasks are not amenable to the kind of learning by doing skill and knowledge spillovers like actual manufacturing, even if of components.
5. Finally, the book is a story about how conventional theories of institutions and the rule of law to attract foreign investors break down completely in the context of China. If anything, as McGee highlights with several examples, China followed the opposite model of Rule by Law, where everything was subordinate to national interest as defined by the Party. Western multinational corporations invested and remained in China despite these problems.
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