Once more, Apple has rocked Wall Street and financial media with spectacular fiscal Q1 financial results, again fueled by the company’s supply chain capabilities.  However, with each passing quarter, that supply chain becomes subject to more visibility, not all of which will remain complimentary.

The numbers are staggering even in context to the fact that the quarter included the holiday selling period. They included a 118 percent year-to-year increase in profits amounting to $13.1 billion on sales of $46.3 billion.  There is commentary that Apple could once again overtake Exxon Mobil as the world’s most valuable company in terms of market value. Internationally based sales accounted for 58 percent of the quarter’s revenue indicating the increased tapping of emerging markets as consumers around the world succumb to the Apple experience.

In terms of output volumes, Apple delivered 37 million iPhones and 15.4 million iPads during the quarter, sustaining an average fulfillment volume of over 402 thousand iPhones and over 165 thousand iPads per day. These are volumes that can challenge any global based supply chain. The iPhone 4S is now available in 90 countries across multiple channels. Company executives also admitted that the company struggled to meet demand and could have done better if it could have ramped production. The iPhone was noted as on ‘significant’ backlog at the end of the quarter, and the unavailability of supply has been cited as a cause of rioting at Apple’s new Beijing outlet as consumers and black market profiteers sought new iPhones.

Gross margin was equally impressive growing to 44.7 percent compared with 38.5 percent one year ago. Wall Street has been taken back with the fact that the company generated $16 billion in free cash flow during the quarter, along with a near $100 billion cash balance. In its reporting, the Wall Street Journal made note that Apple not only benefitted from strong demand but also lower component costs, highlighting how the company’s supply chain remains a distinct advantage. Keep in mind that the consumer electronics industry has been dealing with certain supply shortages brought about by the compounding effects of the Japan tsunami and Thailand floods. Apple’s influence over suppliers made its mark and volume remains a considerable influence.

The lens on Apple naturally turns to what comes next and how can it sustain these spectacular results.

For its supply chain, the lens is of course maintaining a steady stream of supply while supporting a new edition of the iPad later this year. As the company’s distribution turns more toward international channels, the risks will increase. Company officials see China as a huge untapped opportunity but the reality of being the most expensive smartphone implies either more prepaid plans and distribution channels or a scaled-down version. The lens on supplier social responsibility policies has also widened considerably.

Supply Chain Matters provided previous commentary related to Apple’s recent release of its 2012 Supplier Social Responsibility Report.  This weekend, New York Times columnists Charles Duhigg and Keith Bradsher penned one of the most revealing articles in our memory concerning the supply chain capabilities of Apple.  The article, How the U.S. Lost Out on IPhone Work, (paid digital subscription or free metered view) extracts observations from former employees and others as to why Apple elects to source all of its major manufacturing operations in China. It describes one incident where 8000 workers at one of Apple’s contract manufacturers were awakened after midnight and started a 12 hour shift fitting last minute re-designed glass screens into frames to support iPhone volume production.

Bottom line, Apple believes that China provides far more speed, flexibilities and far more skills than can be garnered elsewhere, including the U.S. Corning’s CFO is quoted: “The consumer electronics business has become an Asian business. As an American, I worry about that, but there is nothing I can do to stop it.   Asia has become what the U.S. was for the last 40 years.”

The Times article raises some profound conclusions as to the definition of supply chain flexibilities, and we urge our readers to absorb all that is within the article.  Apple employees and management appear to demand total flexibility without regard to the worker ramifications associated with such directives. At the same time, they enjoy the healthy financial benefits in corporate profits, bonuses, and over $2 billion in stock awards. Apple CEO Tim Cook, the architect of the current supply chain received a 2010 compensation package valued at $59 million, while the average Chinese factory worker garners $17 per day. Not many of these Chinese factory workers could afford to buy a new Apple product.

From our perspective, the most profound cited quote came from an unnamed current Apple executive who states that the company does not have an obligation to solve America’s problems, but rather making the best product possible. Having its pile of cash grow even more each quarter only leads to more perceptions of greed and lack of national or social responsibility as U.S. job growth continues to falter.

Readers no doubt are aware of the technology vendor hype concerning the need for supply chain flexibility.  The looking glass into Apple’s supply chain is perhaps revealing a real-world definition.

The Times columnists began their article by citing an event last February and the question that President Barrack Obama posed to Steve Jobs: What would it take to make iPhones in the United States?  We believe that Apple, and all of us in the supply chain community need to think long and hard on that question.

What’s your view? Have countries such as the U.S. any realistic opportunities in closing the supply chain capabilities gaps in consumer electronics and high tech?

Bob Ferrari

©2012, The Ferrari Consulting and Research Group LLC and Supply Chain Matters.  All rights reserved.

In all of the distractions leading up the Christmas holiday in the U.S. and other countries, readers may have missed the headline regarding another explosion occurring at an Apple supplier plant.

Reuters reported that an explosion occurred on December 17 at a manufacturing facility of Ri Teng Computer Accessory Co., a subsidiary of Pegatron Corp, located in Shanghai’s Songjiang Industrial Park.  According to a statement from Pegatron’s CFO, 61 workers were injured with 23 having to be hospitalized.  Reuters noted a report from the Shanghai city government noting that the explosion occurred at about 3:40pm on December 17, at a workshop on the fourth floor of the factory. The facility was designed to manufacture backplanes for upcoming Apple’s iPad products.

The facility itself was reported to under pre-operation inspection and had not started high volume production support operations for Apple.  According to China’s Yi Cai Daily, the Pegatron facility was slated to produce back panel components for the iPad. As reported by Reuters, the incident involves the third explosion in the last 15 months involving Chinese factories belonging to Apple suppliers.  A previous incident in May involved Apple’s prime contract manufacturer, Foxconn, when an explosion killed three people and injured 15 others.  Similarly, the explosion involved the igniting of aluminum dust particles, a byproduct of the manufacturing process.

While some reports speculate a disruption of supply, the real open question is whether this facility was destined to support new product ramp-up for Apple’s pending release of the new version of the iPad.  Pegatron officials report some damage to production equipment but further indicate that adjustments will be made to minimize any disruption. We would concur with other industry analysts that the impact to Apple supply chain flows should be minor.

The explosion however is sure to ignite even more concerns regarding Apple’s supply partners and their track record concerning both worker safety and the safe control of hazardous production processes, and will fuel more legitimate concerns from worker safety groups regarding overall workplace safety.  Apple provides a very high profile target for these efforts.

Apple’s sourcing and procurement teams will no doubt remain busy over the coming weeks in following-up with supplier inspections including reviews of worker safety and handling of hazardous processes. Having been recognized as one of the top global supply chains comes with a responsibility to have teeth to policies directed at supplier responsibility, worker safety and code-of conduct.

Bob Ferrari

In yesterday’s international business headlines were reports that China’s Intermediate People’s Court of Shenzhen  rejected the claim by Apple that it owned the iPad ©trademark in China.  This was the culmination of a long-running dispute between Proview Technology (Shenzhen) who claimed it had registered the trademark in many countries before Apple came along in China.

An article in Businessworld reported that Proview Technology (Shenzhen) is a subsidiary of Hong Kong headquartered Proview International Holdings Limited which also has a branch in Taipei. It reported that Proview Taipei registered the ‘iPad’ trademark in a number of countries as early as 2000, and Proview Technology (Shenzhen) registered the trademark on the Chinese mainland in 2001, before the launch by Apple. Proview is a contract manufacturer concentrating on flat-screen displays but has since fallen on financial difficulties.

An article in the Financial Times noted that Apple is usually on the receiving end of intellectual property infringements in China, with counterfeits a plenty, and now, by this ruling, the reverse has occurred. It reported that Proview had made an unsuccessful attempt to sell a tablet computer in 2000 and had registered the ‘IPAD’ trademark in seven countries and the EU. According to the FT article, in 2006, Proview Electronics (Taiwan) agreed to sell Apple the “global trademark” for the IPAD name, but the two companies have since disagreed about whether that deal included China.

Apple now faces two dilemmas.  In order to continue selling its tablet computer in China, which it is currently selling very well among Chinese consumers, it must either deal with Proview’s demands for 10 billion yuan ($1.5 billion) compensation for copyright infringement, or come up with another trademark or naming solution.  The second dilemma is the more obvious; IP protection and enforcement works both ways.   The company’s huge success and arrogance comes with certain liabilities, particularly when dealing in international markets where patent laws and legal arguments may differ.

It should remain as no surprise that intellectual property and trademark protection remains as the single overriding concern of many international firms conducting business within China.

Bob Ferrari

The following commentary can also be viewed and commented on the Supply Chain Expert Community web site.

Recently, George F. Brown, the CEO of consulting firm Blue Canyon Partners, Inc. penned an article featured in Industry Week titled Early Birds and China’s Mice.  This article is an important one for the Supply Chain Expert Community.  While we do not agree with all of the article’s conclusions, we recommend it for your reading, especially if your role involves strategic sourcing, product management or global supply chain strategy and operations.

Brown traces some of the history of product and production sourcing within China where many companies invested in the country, including the necessary joint-partnerships, in order to gain a foothold on China’s emerging growth and market opportunities.  Brown coins the term, “Second Mouse firms” which are Chinese firms that were exposed to western product technology and design as well as the learning of solid manufacturing and business process competencies from their western partners.

He refers to the saying “The early bird gets the worm, but the second mouse gets the cheese,” With access to low-cost labor pools and with intimate knowledge of China’s broader middle markets where the ultimate growth for the next decade will be found, these companies can be a competitive threat. He notes that many western companies entered China’s markets targeting the top end, where western brands would prove to be most attractive for Chinese customers. Second Mouse companies have focused on the broader middle market with a willingness to engineer out unnecessary features from the cost structure and compete on ‘good enough’ buying motivations. Named examples include Haier, in the appliance segment, Geely, in automotive and Sany, in construction equipment. The notion is that each of these firms evolved from solid manufacturing and efficiency competencies who have been quick to learn and adopt.

Brown’s conclusion is that: “Ceding these (broad middle) markets to the Second Mouse firms not only most likely hands over global leadership to them, but also enhances the abilities of the Second Mouse firms to compete in the west, both as a result of the earnings from emerging markets and from their continued access to the world’s best laboratory from which to evolve products than can compete and win across the globe.” He notes that future growth will require western companies to develop the ability to compete in the broad middle segments of emerging markets like China, and with their “good enough” products, Second Mouse firms will be able to penetrate both emerging and western markets.

While the article provides some solid food for thought, our view is that the author did not take a broader perspective as to required competencies and existing environments, including constant product innovation, global based product marketing and supply chain capabilities.

If readers dwell on the companies that are truly succeeding in China and in other emerging markets today, firms such as Apple, BMW, Caterpillar, Procter and Gamble, Nestle or Volkswagen, to name just a few, they have done so from integrating all of their broad based competencies, not the least of which has been product marketing and global supply chain business process integration. It has taken Lonovo many years and some stumbles along the way to develop such competencies. Some such as Apple and BMW continue to grow exponentially because their products are attractive to many levels of Chinese and other consumers.  Other such as P&G, Nestle or Volkswagen have nurtured partnerships, local design teams and supplier sourcing to be able to competitively   compete in the broad middle market, or quickly adjust to changing consumer needs.

Western companies also have to deal with the reality of protected currencies and favored trade policies.  They also need to protect their own intellectual property which may prompt a need for different product strategies in different countries or regions.

While the notion that the second mouse gets the cheese seems so straight forward, in today’s challenging markets and hyper competitive economies, companies need to view strategies in the broadened lens of integrated sales, product development, marketing and global supply chain competencies. Rising to the challenge of up and coming companies and “good enough” products requires a market-driven enterprise that can leverage any number of sales, marketing and global supply chain fulfillment capabilities.

What’s your view regarding these market trends and required competencies?

Bob Ferrari

There is yet another milestone event regarding ongoing supply chain impacts concerning the alternative energy industry.

Readers may recall our recent Supply Chain Matters commentary regarding consolidations occurring in solar panel manufacturing.  Intense competition, overcapacity and certain economic advantages have caused China based producers to continue to benefit from global consolidation and more compelling economics that favor supply chain capabilities within China. We previously noted the events leading up to the bankruptcy of Evergreen Solar, and since that commentary, we can now add the bankruptcy intent of Fremont California based Solyndra, at the cost of 1100 jobs. Each of these companies cited their inability to compete with Chinese producers in an environment of global overcapacity and eroding market prices.

Evidence of similar trends, albeit early stage, are now starting to occur in battery production but with a different twist.  Xconomy reported this week that Boston Power, a developer of advanced lithium-ion battery technology announced a new round of strategic funding.

The company announced that it raised an additional $125 million of funding, but with a new twist to its business model.  That revision caused the company’s existing CEO, CFO and vice president of marketing to resign at the time of the announcement. Beijing based GSR Ventures is leading the current round of funding, and the deal is reported to include other funding from the Chinese government.

The company’s new strategic plan calls for a product direction weighted toward the powering of electric vehicles while production operations and most of product marketing are to be shifted to China, where Boston Power is currently building a new factory.  However, Xconomy reports that research and development, product design and sales will initially remain in the U.S. while hundreds of jobs will be added in China. Boston Power’s original founder and now international chairmen, Christina Lampe-Onnerud will also remain in the U.S. while GSR managing partner Sonny Wu will now chair the company’s board of directors. One of Boston Power’s current strategic customers is Hewlett Packard which utilizes its battery technology in its portable electronics.

In essence, this is an example of a westernized  venture capitalist model with a China thrust.  With R&D and design resources remaining in the U.S. while high volume production and global distribution sourced within China, the Boston Power has the opportunity to leverage lower labor costs, lots of governmental incentives and U.S. developed product technology.

Replication is the best form of flattery.  However, this development is yet another warning sign for existing North America and Europe based producers who continue to compete with Chinese producers for market share and long-term supply contracts. All of this is important since many auto industry observers, including ourselves, anticipate a glut of excess electric battery production capacity over the next 3-4 years.  Such situations always tend to favor the lowest cost, most efficient supplier with the strongest OEM supplier ties.

Once again, as U.S. and European politicians make hay of out-of-control spending without the context of a strategic economic growth plan, China continues to show signs of building out the high volume production and distribution expertise to sustain a long-term presence in important strategic growth markets.  We now must add a venture-capitalist model that favors China’s strategic interests.

Bob Ferrari

Bruce Spurgeon, a Supply Chain Matters guest blogger and current supply chain industry professional called my attention to a Fast Company.com article, Only 3 Percent of What You Buy is made in China; But It’s the Most Important 3 Percent.  It is an article worthy of your reading time.

The premise of the article revolves around a debate, sponsored by The Economist magazine with the premise:  “An economy cannot succeed without a big manufacturing base.” The two debaters were Ha-Joon Chang, a student of industrial policy, and Jagdish Bhagwati, a free trader advocate. Greg Lindsay, the author of the Fast Company article exclaims that the debate was not even close, that as America has stopped manufacturing goods, it has sacrificed the ability to innovate, along with the know-how to come-up with new ways to manufacture goods. A San Francisco Federal Reserve report released earlier pointed out that goods labeled “Made in China” make-up only 2.7 percent of U.S. consumption, with two-thirds of consumer spending on services rather than goods. The notion of the Federal Reserve is that employment growth is not driven from manufacturing that was shifted oversees to places such as China.

This is such an important topic that we wanted to call its attention to our readers and seek an ongoing interchange of discourse on the topic.

Supply Chain Matters is in the camp of Fast Company, that manufacturing does matter, and as we have noted on many occasions, the existence of innovative and vibrant value and supply chains is the real engine for a vibrant economy that fuels healthy job growth. A look at what has occurred in China over the past 8-10 years is a clear indicator of the building of vibrant suppliers across many industry sectors. China’s leaders are purposely steering supply chain capabilities away from low-margin, low-cost goods to strategic, higher growth industries that will fuel economic growth in the coming decades. The Fast Company article points out that America is in serious danger of losing its edge in the cutting-edge technologies that would lift the economy out of recession. American companies may have outsourced some of their crown-jewels of technology and capability.

According to Lindsay, during the debate, Chang pointed to the example of Apple in the computer tablet space.  “Just ask Apple’s lagging competitors in the tablet race. Not one designs its own products in-house, having long-ago outsourced even that task to Taiwanese OEMs. The reason Apple has a media, retail, and service industry empire and they don’t is because it could design an MP3 player, smartphone, and tablet when it needed to–and they couldn’t.”  We found that to be a profound observation in light of last week’s stunning announcement from Hewlett Packard that it was abandoning the tablet and smartphone market after only two months of a product presence. Also noted within the article was that Taiwan ending-up to be the global focus of high-tech manufacturing was no accident, but rather a concerted long-term strategy.

Last week, Internet entrepreneur and investor Marc Andreessen penned an Op-Ed appearing in the Wall Street Journal (metered view may be required), titled Why Software is Eating the World.  Andreessen’s premise, among others, is that companies like Apple, Amazon, FedEx and Netflix are really software companies, fueled by digital capabilities that will eventually subsume physical distribution capabilities.  The premise is that we will all eventually live in a digital world where software and cloud services satisfy all needs. He also points out that many people in the U.S. and around the world lack the education and skills required by these great new companies, which are starved for talent. There lies the conundrum of the argument, software displacing physical manufacturing, displacing supplier innovation and the ability to produce something, and by-the-way, these new software innovators cannot find talent. Andreessen laments Wall Street investors for constantly questioning the valuation and earnings multiples of these new software companies. There is no job growth substance to Andreessen’s arguments, only the premise that consumers will have the wealth and where-with-all to consume a universe of digitally based services. That brings the reader back to the original Federal Reserve premise, a services-based or a manufacturing-based economy?

The debate and the discourse need to continue, so please add your views.  Can an economy succeed without robust manufacturing and vibrant supply chain networks?

Is product innovation, namely the design and production of physical goods, the key to long-term economic growth?

We believe the supply chain community has some answers.

Bob Ferrari