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Apple Business Model

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3. The difficulties of Foxconn International Holdings
If we shift from macro aggregates to company cases, it is much more difficult to be optimistic about Chinese manufacturing prospects for upward mobility towards competing on brand with established Western firms. The resources of generally favourable national ratios in manufacture are an advantage that can be negated in key sectors by Western firms which aim to relegate their Chinese partners to permanent junior assembler status by leaving them with nothing to invest in or no investment funds. This can be done in two ways. The first option is illustrated by the Sino-foreign joint ventures in car assembly (like SAIC) which hold more than
75% of the Chinese domestic car market and make almost no exports. Here, the dominant
Western partner retains the intellectual property and know how in product and process, so that the Chinese subordinate may make profits but has no easy pathway to upward mobility through own account strategic investment in, for example, power train manufacture. The second option is illustrated by electronics assemblers like Foxconn International Holdings (FIH) which can derive little benefit from assembling premium products like smart phones for sale in
Western export markets. The instrument of subordination here is the contract with the dominant Western partner which ensures the assembler makes little profit so that the Chinese
Apple Business Model: Financialization across the Pacific
16 | subordinate again has no easy pathway to upward mobility because, just as in a failing Western firm, reinvestment finds are limited and defensive restructuring takes priority.
The story of the development of Sino-foreign joint ventures in car assembly has been told in
Eric Thun’s (2006) book, so we will concentrate on the case of Foxconn International Holdings
(FIH) in electronics assembly which usefully provides a purer illustration of the logic of financialization. FIH is the assembler of choice for hand held smart devices; its customers include Apple Inc. and other Western companies including Amazon, Nokia and Motorola so that five large Western companies account for more than 90% of sales. As background, FIH is a subsidiary of Taiwan’s Hon Hai, which is the world’s largest contract assembler, employing over
1 million people in total. FIH is domiciled in the Cayman Islands and listed on the Hong Kong stock exchange. It is Hon Hai’s principal handset manufacturer and assembler, with the vast majority of their 126,000 workforce located in China, and with most of those in the Guangdong
Province. FIH is a separate company from Foxconn which manufacture computers and consumer electronics and Foxconn Technology who are a light metal and thermal manufacturer and assembler. The key point here is that FIH are in a different power relation to the Japanese firms of the 1970s and 1980s whose supply chain was principally nationally based. Chinese firms like FIH generally assume a subcontractor role for a large US brand, so the supply chain is trans-Pacific not national, and their position within that chain is a subordinate one to that of lead US firms like Apple.
Chinese manufacturing has a generally low LSVA ratio and FIH is engaged in production for export in a fast-growing and innovative market segment where skills are required for production for export, so it is not unreasonable to expect the company to post impressive profits. But, if we turn to FIH’s report and accounts, the Chairman’s statement in the most recent FIH annual report reads as though this was a mature US or Japanese company under pressure to restructure:
“Several factors challenged our business in 2010 and disappointing financial results have created a deep sense of urgency for the management team and across the Company. We have taken drastic measures to better cope with market dynamics and barring any extraordinary event, I believe we are well positioned to return to profitability in 2011”.
(FIH Annual Report, Chairman’s Statement, p.4)
Such a downbeat assessment came off the back of five profit warnings issued by the company between August 2008 and June 2010, and a share prices which fell from a high of 27.55HK$ in
October 2006 to just 5.78HK$ by the start of 2011.
All this is not what we would expect from traditional ways of understanding market power.
Porter (1980, 1985) emphasised the importance of corporate size and industry concentration as a key ‘force’ in understanding the relative profitability of a sector, but he never really had an explanation for how this played out for subcontractors locked into dependent relations. By the
CRESC Working Paper No.111
17 | measure of size, new corporate giants like FIH should be well positioned since the parent, Hon
Hai is the world’s largest electronic component manufacturer and FIH its subsidiary is the world’s largest contract handset assembler, competing against a maximum of five other companies that can combine both scale and price that FIH offer. But this is a dependent relationship, with their status as corporate giants secondary to their ability to bargain with
Western businesses largely dictating price and insist that the burden of adjustment in the fast moving competition between final products are borne downstream.
The first and most important exhibits are the set of ratios in table 2 and figure 3. In a period in the 2000s when, as we saw in the last section, LSVA was generally falling towards 25% in
Chinese manufacturing, FIH’s LSVA was increasing from just above 25% towards traditional
Western levels of 70%.
Table 2: Foxconn International Holdings financial, productivity and profit performance 2005-
2010
Sales Value
Added
Pre-tax profit Value added per employee Pre-tax profit on sales Employees Sales to the 5 largest customers
Sales to the Largest customer $mill. $mill. $mill. $ % No. % %
2005 6,365 813 419 13,765 6.6 59,070 n/a n/a
2006 10,381 1,321 786 11,929 7.6 110,697 94 59
2007 10,732 1,030 356 8,310 3.3 123,917 94 39
2008 9,271 1,188 197 10,971 2.1 108,237 93 43
2009 7,214 878 71 7,398 1.0 118,702 93 29
2010 6,626 799 -176 6,306 -2.7 126,687 91 28
Notes: Data includes a small number of non-PRC subsidiaries.
Source: Foxconn International Holdings (Cayman Islands) annual reports.
By any measure, the assembler’s productivity performance was dire as both sales and value added fell by around one-third after 2006-7 while numbers employed were not reduced. The result is collapsing productivity: in sales per employee terms, FIH’s productivity falls from
$107,753 per employee in 2005 to $52,302 per employee in 2010; and in terms of value added per employee from $13,765 per employee to $6,306 per employee over the same period. This halving of productivity relates to sudden shifts in the market and the rise of smart handheld devices which were more sophisticated and time consuming to assemble under contracts which effectively penalised FIH for spending more time on assembling each device. The
Apple Business Model: Financialization across the Pacific
18 | changes also meant increased specialisation which forced FIH to abandon non-smartphone production, which lost them a market segment that had been cash generative.
If the Western companies that designed and marketed their devices passed the burden of assembling more complex devices onto FIH, then FIH passed the burden of adjustment onto its workforce in ways which created problems about work intensification, health and safety which became a problem for FIH’s highest profile customer Apple. Most of the workforce lived in dormitories in factory towns built entirely by FIH, and which also contained shops, restaurants and other services. The pervasive presence of the factory across all areas of life created the anomic conditions under which suicides proliferated – so that by 2010 this had become a material concern, not just for FIH but also for Apple as it received much negative publicity (FT,
17 July 2010). Responsible health and safety procedures also became difficult to operate in an environment of squeezed margins and intensification. The disastrous results included an explosion in Foxconn’s Chengdu plant which killed three workers; while 137 workers at another
Apple supplier Wintek were poisoned; and Apple’s Chinese sub-contractors were accused of widespread pollution (FT, 8 September 2011).
At the same time as FIH was being pressured on the demand side through unfavourable contracts which increased LSVA, Western firms were also pressuring FIH to pay higher wages.
This push came from two sources. First, the negative publicity around the suicides and explosions meant reputational damage for Apple, who subsequently pushed FIH to improve conditions and boost wages without apparently offering any leeway on contract prices to accommodate the rising costs (FT, 8 June 2011). The Chinese state also pressured FIH to increase wages as a response to the global economic slowdown and the shrinkage of end markets in the West because higher wages would help build a home market for their domestically manufactured goods. FIH therefore increased wages by 30% for the majority of workers, and 66% for workers with particularly desirable skills (FT, 27 October 2010).
CRESC Working Paper No.111
19 |
Fig. 3: Foxconn International Holdings value added to sales ratio, labour’s share of value added and pre-tax return on sales
Source: Foxconn International Holdings (Cayman Islands) annual reports.
They also began to recognise Trade Unions, allowed workers to elect their own officials and accepted some local wage bargaining in their factories (FT, 6 January 2011). This is the background to the profits warnings and the financial crisis of 2010 which pushes FIH to further cost saving strategies, such as moving production inland to provinces like Anhui, Jianxi and
Hubei where labour costs are even cheaper (FT, 18 November 2010) or offshoring to Indonesia and Vietnam where wages are now lower than at some Chinese sites (FT, 10 February 2011).
They are also trying to substitute capital for labour by investing in automated robots, which will rise from 10,000 to an estimated 300,000 by 2013 (FT, 2 August 2011).
If the contract or joint venture deal is a means of control by Western firms, the Chinese state
(central and local) must also take some of the blame because it has never sought a balanced relation between the domestic and export markets. The contrast here is with Japan in the
1970s and 1980s where the development of Japanese manufacturing was geared to two brandled goals which would provide a secure and steady revenue base for their producers: to provide low cost alternative manufactures to Western export markets, and to produce low-cost goods to stimulate local demand in the domestic market (Williams et al., 1995). China, by comparison, has concentrated on the one goal of developing exports. Until recently, the government has opted for a policy of restraining domestic demand through fears that rising labour costs would both undermine their national competitive advantage and inject
36.7%
28.5%
45.2%
56.6% 55.2%
70.8%
0.0
10.0
20.0
30.0
40.0
50.0
60.0
70.0
80.0
90.0
-4.0
-2.0
0.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
2005 2006 2007 2008 2009 2010
Labour's share of value added (%)
VA/Sales ratio and pre-tax return on sales (%)
Labour's share of value added (%) Value added to sales ratio (%)
Pre-tax profit on sales (%)
Apple Business Model: Financialization across the Pacific
20 | inflationary pressures into the domestic market. For this reason China has kept wages low: wages and salaries as a percentage of GDP fell from 57% in 1983 to just 37% by 2005 through to 2010 – one of the lowest in the capitalist world (FT, 4 June 2010). Whereas Japan always had a domestic demand base for final products, China has instead tended to produce intermediate
‘white label’ goods or components for a variety of brands or retailers in the West, rather than develop branded goods for their domestic market; in autos, the relation is reversed and the de facto outcome is import substitution through local assembly. These government policies fitted well with the strategies of Western firms aiming to lever profit from outsourcing production to low wage assemblers or tapping the Chinese domestic market.
But, when all this has been said, there is nothing new about the subordination of suppliers through power relations which is a familiar theme throughout the history of the textile and garment industries. Remember the textile manufacturing “putter out” of the industrial revolution period that, in Marglin’s (1974) classic article, held the business in his head and gained advantage over his subcontractors by operating a political division of labour. Or consider the CMT model (cut, make, trim) traditionally found in the garment industry. The relation between FIH and Apple is much like that between a CMT firm which controls assembly while the lead firm controls design, purchasing, distribution and retail. For the subcontractor this model narrows the scope for productive intervention and squeezes margin because the subcontractor cannot lower the cost of external inputs or bypass the lead firm to reach retail.
The onus therefore is on the subcontractor to control internal costs and find internal productivity gains to increase margin or absorb rising costs. The precondition for success is volume and full capacity because lower demand has a dramatic effect on costs and profit and all the risk falls on the subcontractor. FIH faces such a situation: increased wage costs which cannot be passed onto the customer and there are few simple productivity gains that will negate these pressures. The novelty of course is that ‘putters out’ or dress designers do not ordinarily become hugely profitable giant companies like Apple.

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