Supply Chain Matters has featured a number of commentaries regarding the challenges for being selected as a key component or contract manufacturing supplier to Apple. On the one hand, the designation for being a key supplier in the Apple value chain can lead to enormous revenue potential and scale along with providing much cache for landing additional industry business. On the other hand, Apple aggressive product margin goals coupled with steep and constantly changing production volume ramp-up or ramp-down requirements can challenge any supplier organization. Apple sets high expectations and expects total responsiveness and virtual flexibility from its key suppliers, especially those residing in lower-cost manufacturing regions such as China.
The past two weeks have provided two interesting contrasts in terms of strategy and financial results among two of Apple’s key contract manufacturers.
In May of 2013, Supply Chain Matters reinforced and amplified the observation that Apple had begun to actively pursue its own supply chain risk mitigation and supply chain segmentation plan by electing to dual source some of its contract manufacturing needs with the use of Pegatron, one of Taiwan’s largest contract and original equipment manufacturers, in addition to longstanding CMS provider, Foxconn. We cited a Wall Street Journal report indicating that Pegatron was willing to accept thinner profit margins in courting Apple’s massive business.
However, Pegatron was put to the test with last year’s massive pre-holiday production ramp-ups and ramp-downs to support the changing volume production requirements of the new iPhone 5c and iPhone Mini. The market reception for iPhone 5c was not as originally planned, prompting Apple to cut-back on original pre-holiday production forecasts. The iPad Mini however, experienced high consumer acceptance. Pegatron had other challenges and there were reports indicating the alleged use of underage workers in some of this company’s factories in China, along with allegations from China Labor Watch related to excessive working hours and challenging working conditions. At the time, China Labor Watch alleged that worker conditions at Pegatron factories were worse than those of previous Foxconn conditions.
Last week Pegatron reported fiscal fourth quarter results and posted a 22 percent jump in net profits even though its overall revenues fell slightly from year ago results. Revenues derived from the manufacturing of communications products, gaming consoles, smartphones and tablet computers rose 20 percent while those associated with PC’s and consumer products including televisions, declined. In its latest reporting regarding Pegatron’s earnings, the WSJ cites a KGI Securities analyst as indicating that Apple now represents upwards of 40 percent of this company’s revenues, which is significant considering the brief history of relationship. Further cited was that initially low yield rates in producing Apple’s products have now improved. Operating margin improved to 1.9 percent from a previous 1.6 percent, but how many firms can sustain at such a low margin? Once more, without any planned launches of new Apple products in the first-half of 2014, Pegatron is forecasting that shipments of smartphones, tablets and game consoles will likely decline in a range between 15 and 20 percent in the current first quarter.
The parent of Apple’s other longstanding prime contract manufacturer Foxconn, which is Hon Hai Precision Industry, last week reported that its profits rose 13 percent, boosted by increases in iPhone and iPad sales. Total revenues increased slightly to 3.95 trillion new Taiwan dollars. It is estimated that Hon Hai garners more than 40 percent of its revenues from its various supply relationships with Apple.
However, this company continues to exercise a broader diversification strategy as revenues and margins derived from contract manufacturing continue to decline. In a Supply Chain Matters posting in July 2013, we observed that Foxconn continues in its process for diversifying by moving downstream and upstream in the consumer electronics value-stream, possibly resulting in some Foxconn branded consumer electronics devices.
Last week, Hon Hai announced investments of $90 million in various strategic manufacturing related projects with a focus toward higher value chain activities along with advanced automation. These investments include $42 million to establish a trading and manufacturing unit for China based components, $30 million in a new software development unit and $15 million in a robot manufacturing and sales unit. In early February, Supply Chain Matters commented on Foxconn’s current collaboration with Google in the area of advanced robotics.
Foxconn is once again shifting some of its manufacturing presence into lower-cost, more interior regions of China. According to a WSJ report, facilities will be built in the central and western provinces of Chengdu, Wuhan and Zhengzhou where direct labor rates are as much as two-thirds less than those in the coastal regions.
Wall Street and business media has increasingly been skeptical of Apple amid stronger competition in smartphones, tablets and other consumer electronics devices. Doubt has been raised as to whether Apple has lost its mojo in product innovation cycles. In exercising a supply diversification and segmentation strategy among its contract manufacturing supply base, other dynamics are underway. While Pegatron has pinned its fortunes on Apple to offset other areas of declining business, Hon Hai is exercising a broader diversification strategy that will likely lessen its dependence on Apple. How both fare in these different strategies will be certainly worth observing in the coming months.
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