No doubt, this week is turning out to be an incredibly active week in terms of supply chain related news and developments. There are implications to the monster storm that impacted the Eastern Seaboard of the U.S., a major merger announcement involving two best-of-breed supply chain technology providers, and a slew of quarterly earnings announcements that provide supply chain-related consequences. In commentary through the remainder of this week, Supply Chain Matters will touch upon these developments.
A significant earnings announcement involves the world’s largest contract manufacturer, Foxconn. In its first nine months, net profits have risen 24 percent to $1.9 billion, based on a 20 percent revenue increase. Gross margin were reported as an increase to 4.6 percent, vs. a 3.7 percent level a year earlier.
Dwell on that gross margin number for a moment. How many firms can successfully manage that level of margin when physical manufacturing services are concerned?
The answer is obviously making every cost expenditure count and having massive scale and volume to leverage physical assets. Having the globe’s most popular consumer electronics provider, namely Apple, fuel that scale, obviously makes the formula work. Having other large volume customers and global-scale is also essential to grow profitability over the longer term.
In its reporting of Foxconn earnings, the Financial Times discloses (paid subscription or free metered view) the impact that Apple actually has. While Foxconn does not dare disclose anything related to Apple for obvious reasons, FT quotes equity analysts as indicating that Apple represents 40 to 50 percent of Foxconn’s current revenues. We believe that that number is probably highly conservative.
In our Supply Chain Matters previous commentary related to Apple’s latest quarterly earnings we noted the total volume of quarterly unit output as well as the signs of constrained supply. Yet in spite of ongoing Apple supply constraints and a number of troubling workforce-related incidents, Foxconn marches on and defies classic business case thinking. The FT article is quick to also point out that with the two most recent Apple product introductions, the new iPhone 5 and iPad Mini, and the holiday buying season yet to unfold, the prospects for continued volume growth look good for Foxconn.
Longer-term, however, Foxconn must focus on its broader strategic plan. Worker demands for higher pay and better working conditions obviously lead toward the need for increased automation of repetitive and monotonous production tasks, which imply increased capital costs. The trick is influencing primary customers like Apple to share the bulk of that burden. Then again, Apple needs to put some of its hoards of foreign-based cash to good use.
Apple has also begun to exercise its own supply chain risk mitigation strategy by dual sourcing of the assembly production of the iPad Mini among two contract manufacturers, the other being Pegatron. Foxconn must therefore seek to offset continued needs for added margin with increased scale, further supply chain vertical integration while recruiting additional customers.
In the end, however, we believe that the contract manufacturing business model will have to significantly change, since sustaining single-digit margins, while bearing the brunt of labor, capital and social responsibility burdens is not sustainable over the long-term.