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Reflecting on Supplier Management Practices Related to the Apple Watch

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In our prior Supply Chain Matters commentary concerning Sharp Corporation, we reiterated the two sides of supplier based relationships involving the most recognized supply chain, that being Apple.  On the one hand, being chosen as an Apple supplier can provide enormous scale, global reach and financial rewards.  However, Apple is a demanding customer with unique and exacting processes that can test any supplier.

Apple further practices very active supplier risk mitigation, insuring that this global consumer electronics provider has at least two or more supplier agreements in-place for key components.

In a May commentary, Supply Chain Matters highlighted a report indicating that one of the key technology components within the Apple Watch had experienced reliability issues. The taptic engine component, which controls the sensation of tapping the watch while transmitting heart-rate data, was sourced among two key suppliers.  Citing people familiar with the matter, The Wall Street Journal reported at the time that reliability testing has discovered that the taptic engines supplied by a China based supplier demonstrated reliability problems, with Apple electing to scrap some completed watches. Engines produced by Japan based Nidec Corp., the backup supplier, reportedly had not experienced the same problem. Apple subsequently moved all remaining sourcing of this component to Nidec.

Today’s WSJ report regarding Sharp also makes mention of the Apple Watch component issue in the context of how manufacturers can discard faulty products when design issues or production snafus are evident. The report again noted how Apple subsequently turned to Nidec for nearly all of its taptic engine production needs, but it took time for this other supplier to ramp-up its own production processes to be able to accommodate Apple’s overall production volumes. Thus, for our readers who were wondering what was causing the delay in the delivery of their new Apple Watch, now you know.

The obvious takeaway is that active supply risk mitigation is essential for key technological components, as well as the ability to lend a helping hand to suppliers in time of product or business crisis. Such risk mitigation is especially critical in new product ramp-up stages as volume production processes are tested for volume scale.

There are two-sides to supplier loyalty and management, and how they are practiced goes a long way in the determination of overall supply chain agility and responsiveness.

In November of last year, the WSJ stated in a report related specifically to Apple’s supply chain: “If you cut a deal with Apple, you better know what you’re getting into.” That statement continues to sum it all.

Bob Ferrari


The Implications of Sharp Corporation’s Ongoing Financial Crisis

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Supply Chain Matters has featured several prior commentaries specifically related to Sharp Corporation, one of three current liquid crystal display (LCD) screen suppliers in Apple’s supply chain.

Sharp has a track record of innovation in LCD technology but a rather rocky financial history as well. Our last commentary in early April, Perils of an Apple Supplier- Sharp Corporation, highlighted continuing reports of severe financial crisis surrounding Sharp. The Wall Street Journal reported at the time that various restructuring options were being considered but no final decision had been made. One reported option was that this supplier was moving to spin-off a portion of its LCD panel business unit with intent to seek a new capital injection from Innovation Network Corp. of Japan, a governmental entity overseen by Japan’s Ministry of Economic Trade and Industry. One of the tenets of Japan’s high tech industry is to rely on government funded agencies to bridge times of financial crisis. Since our April commentary, Sharp’s bankers agreed to provide an additional $1 billion plus lifeline, the second in three years, in exchange for restructuring measures that included a 10 percent workforce reduction. Also since that time, the market prices for LCD panels remain in significant decline as other suppliers turn more to China based smartphone manufacturers for revenue needs. The WSJ cites data stemming from market research firm IHS indicating that 5 inch HD smartphone panel components prices have dropped nearly 60 percent from Q1 2013 through the current quarter.

Today, the WSJ featured a report (paid subscription required) indicating that Sharp has warned that its survival could be at-stake, and that it is now pushing suppliers for deeper price cuts and that it further considering sourcing of display components from new China based suppliers rather than its former Japan based suppliers. At its annual meeting for shareholders held this week, sales directly attributed to Apple accounted for 20 percent of Sharp’s fiscal year revenues.

For the fiscal year that ended in March, Sharp racked up a loss reported to be $1.8 billion, due to write-downs of its LCD operations. Yet, this supplier maintains a public confidence that it can implement steps to maintain its ongoing viability, despite its share price haven fallen upwards of half over the past year.

LCD screens are highly strategic for Apple, and the consumer electronics juggernaut has elected to initiate strategic supply agreement among three different suppliers to insure both leading-edge technologies as well as the ability to scale to Apple’s flexible volume requirements.

All of which leads back to the perils of being an Apple supplier. In a recent Spend Matters sponsored webinar (no relation to this blog), chief research officer Pierre Mitchell observed that Apple imposes very strict contract terms among its supplier base, shifting considerable risk on the backs of suppliers while preserving major rights to product based intellectual rights. So much so that GT Advanced Technologies recently elected to seek voluntary bankruptcy in order to gain leverage with Apple over what was described as onerous contract terms.

The conundrum for Sharp and other Japan based high tech component suppliers is that bankruptcy is culturally looked upon as a  major failure and embarrassment of senior management. So much so that the most optimistic financial forecasts are stubbornly held to up to just prior to the formal reporting of the bad news. On the other hand, firms such as Apple that practice active supply risk mitigation for key components will often have contingency options to buffer the shortfalls or stumbles of any one key supplier.

The financial challenges involving Sharp will most likely linger and through its ongoing re-structuring efforts, this supplier could introduce even more risk into its ability to deliver to customer needs.

The takeaway for the broader high-tech supplier community is to insure you understand all the terms and risk implications of your supply and technology agreements.

Bob Ferrari

 

 


Report of Sustainable Method to Mine Rare Earths

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Our readers among high-tech and consumer electronics supply chains are well aware that the supply and costs of rare earth minerals continues to be a supply chain.  China has positioned itself to the primary global supplier of such strategic materials and has in the past exercised export quotas to favor its own domestic high tech industry needs. Supply Chain Matters touched upon this challenge in a 2011 commentary related to Phillips Electronics.

Bloomberg recently reported that a closely held miner from the country of Chile, Mineria Activa,  has come up with a far different, green-mining and perhaps more sustainable approach for the mining of rare earths. The report indicates that elements such as neodymium and dysprosium are contained in clay soils near the city of Concepcion in concentrations similar to China.  The difference, however, is rather than pumping chemicals into the ground for extracting these minerals, methods have been derived to dig out the clay, place it in a tank-leaching process with biodegradable chemicals and return the clean clay to the ground, while replanting displaced vegetation and trees.

The bet here is that certain manufacturers and OEM’s such as Apple, ThyssenKrupp or Raytheon are willing to pay a premium knowing that the supply is not destroying the planet.

Bloomberg points out that given the current recent capacity glut resulting in declines in the prices of certain rare earth materials, the timing of this development may not be ideal. The again, companies such as Apple with strong commitments to sustainability and green supply chain practices may be willing to consider a strategic supply alternative.


Fire Incident at Apple Facility in Arizona

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Yesterday, a fire broke out at an Apple facility located in Mesa Arizona, just outside of Phoenix,  which initially made lots of news. According to a video report from a local news channel, the fire spread rather fast and was believed to have been ignited by solar panels on the roof of this facility. Various news reports indicate that a dozen people were evacuated from the facility, and it took 35 minutes for the fire department to put out the flames. The Deputy Chief of the  Mesa Fire Department is quoted as indicating that the fire spread rather rapidly at the 1.3 million-square-foot plant but was confined to a section of the roof over a loading dock.

What is somewhat significant is that this facility was previously designated by former supplier GT Advanced Technologies to be a high volume plant for the production of sapphire glass. That plan was abandoned with the sudden bankruptcy of GT Advanced and Apple has since taken possession of the facility. In February, Apple announced that it would instead convert the Mesa facility into a world class, sustainable data center. At the time, Supply Chain Matters voiced its disappointment that Apple did not consider sourcing more manufacturing at this facility.

Such an incident involving an Apple facility was assured to garner both traditional and social media coverage.  As we pen this posting, Google had indexed nearly 100 different reports related to yesterday’s fire.  Apple stock also took a hit yesterday on the news.

It is not likely that this incident will be of any major concern to Apple’s supply chain teams but perhaps Apple’s facility teams will seek an in-depth investigation as to whether the solar panels contributed to the cause of the blaze.  Investing in the most modern, state-of-art energy and sustainably efficient mega data center probably needs assurances that solar panels will not erupt into flames.

Bob Ferrari

 


A Highly Visible Week for Apple and its Product Supply Chains

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This has been a highly visible week for Apple and its supply chain ecosystem.  Included was Apple’s announcement of obscene earnings for its latest fiscal quarter and perhaps too much visibility to supply chain related information related to the newly introduced Apple Watch.

On Monday, Apple reported operating results for the March-ending quarter reporting a 27 percent increase in revenues and a startling 33 percent increase in profits. Gross margin climbed to 40.8 percent above previous Wall Street estimates of 38.5 – 39.5 percent. The overall business media headline was that Apple’s iPhone line-up is gaining market-share while commanding higher prices. The average selling price of an iPhone has risen to $659, up $60 in the last year, while iPhone shipments were up 40 percent from the year earlier period to 61.2 million units. Emerging market demand, in particular China, Hong Kong and Taiwan is reportedly fueling this latest iPad sales volume increases. Revenues associated with the Mac personal computer lineup trended positively, up 10 percent in the latest quarter, bucking an overall industry trend of declining PC sales. Apple closed its latest quarter with over $193 billion in cash, up $15 billion from December.

However, there are some warning signs. Sales for the iPad declined by 23 percent in the latest quarter, an indication of a further sales decline trend.

Yesterday, The Wall Street Journal reported (paid subscription or free metered view) that one of the key technology components within the Apple Watch has experienced reliability issues. The taptic engine component, which controls the sensation of tapping the watch while transmitting heart-rate data, was sourced among two key suppliers.  Citing people familiar with the matter, the WSJ report indicates that reliability testing has discovered that the taptic engines supplied by AAC Technologies Holdings of Shenzhen China, have demonstrated reliability problems, with Apple electing to scrap some completed watches. Engines produced by Japan based Nidec Corp. have reportedly not experienced the same problem, with Apple reportedly moving all remaining sourcing of this component to Nidec. However, it may take more time for the new prime supplier Nidec to increase production volumes.

Although the WSJ indicates that it is unclear whether the tactic engine reliability has contributed to short supply, by our lens, this may explain why existing orders for Apple Watches have been in a backlog condition since product launch. On Monday, Apple CEO Tim Cook confirmed that “demand is greater than supply” for the Watch.

The WSJ further indicates that Apple has now communicated to other watch component suppliers to slow delivery volumes until June, without explaining why, which has surprised suppliers who were in full blown ramp-up. Neither AAC Technologies nor Nidec elected to respond to the WSJ in a request to comment.

The WSJ cites additional sources as now indicating that Apple is further considering the addition of a second final assembly contract manufacturer to supplement Taiwan based Quanta Computer. That second CMS is rumored to be none other than Foxconn, Apple’s principal go-to contract manufacturer when supply chain volume output challenges occur. However, even if Foxconn is brought online, it will be several months before the CMS can make its contribution to boosting output. The WSJ sources indicated late 2015 as an estimate.

As Supply Chain Matters has frequently pointed out, Apple practices dual-sourcing of key technology components as part of its supply chain risk mitigation strategy. This is especially prevalent in new product introduction and ramp-up phases. There are currently three prime suppliers for Apple’s existing iPhone LCD screens with reports indicating the introduction of another for the next model iteration of iPhone. In the case of the tactic engine report, the dual-sourcing strategy has obviously proven effective.

Finally, today’s Wall Street Journal calls attention to IHS Technology’s recent teardown analysis of a 38-millimeter Apple Watch Sport, the entry level model for the product line-up. (Paid subscription or free metered view)  The IHS teardown analysis indicates that overall costs of component materials and manufacturing labor cost amount to $83.70 contrasted to a retail selling price of $349. That according to IHS equates to a 24 percent ratio for parts and manufacturing cost, lower than the average 29-45 percent equivalent cost for Apple’s other product lines. This is an indication that the Watch is a product line with even higher profitability potential.  The taptic engine component noted above has an estimated cost of $16.50, the second most expensive component. The touchscreen and display module was estimated to cost $20.50, the most expensive component.

In two weeks, analyst firm Gartner will again unveil its annual ranking of the Top 25 Supply Chains. Apple has consistently commanded the number one ranking for many years, and with these latest operating results, we suspect that the Apple supply chain will again command the top spot.  Financial performance alone is compelling and when considering supply chain risk mitigation and segmentation strategy, the result is obvious.

Bob Ferrari


Apple is Once Again Practicing Supply Chain Segmentation and Risk Mitigation

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Supply Chain Matters has in the past provided our readers examples of supply chain segmentation and/or diversification strategies that are directed at providing enhanced customer fulfillment as well as the ability to support expected business outcomes. High tech and consumer manufacturers were the first to demonstrate such capabilities but other industry supply chains continue to adopt such practices.

One of the top-ranked supply chains, that being Apple, has an active and changing supply chain segmentation strategy directed at both customer fulfillment as well as mitigation of supply chain risk.  In 2012 and again in 2013, Supply Chain Matters called attention to reports of Apple augmenting its prime contract manufacturing supplier Foxconn with augmented contract manufacturers. As we have noted in many prior commentaries, the sheer output volume that Apple can command from suppliers can be both a blessing as well as a risk. Any stumble can be a cause for concern.

During 2012 and 2013, a response to the pending lower cost product offerings in both the iPhone as well as iPad product lineup prompted both diversification and segmentation efforts. With the addition of Pegatron and other contract manufacturer’s supplier, Apple had the ability to leverage a lower-cost manufacturing capability as well as mitigate dependency on any single supplier.

Now there is new news leaking from Apple’s supply chain universe.  Taiwan based Digitimes, citing sources, reported last week that Apple was expected to adjust its lower-tier supplier Q3 order volumes for both the iPhone 6 and the newly released Apple Watch to minimize the risk of too much volume dependency on any one single supplier, as well as to meet or maintain targeted gross-margin goals. Noted was that Apple had invited both Compal Electronics and Wistron, noted contract manufacturers in laptops and other consumer electronics, to join its supply chain as augmented suppliers. The report further indicates that Apple’s two major PCB partners, Zhen Ding Tech and Flexium would have their order rates adjusted while suppliers Largan Precision and Advanced Semiconductor Engineering, which reportedly have advantages in advanced technology, will benefit from increased orders. Earlier this week, the publication further cited a TechNews report indicating that AU Optronics will soon sign an agreement to supply LTPS In-cell screen panels for future models of the iPhone expected in 2016.

Since the Digitimes report, other Apple community blogs have amplified the report.  The Cult of Mac blog opined that the obvious reason for augmentation is that Apple does not run the risk of leaning too heavily on one supplier, as occurred with the bankruptcy of sapphire producer GT Advanced Technologies.

Regarding the newly launched Apple Watch, a recent posting appearing on Apple Insider cites KGI analyst and highly followed Apple observer Ming-Chi Kuo as indicating that existing production bottlenecks related to the watch’s haptic vibrator and advanced OLED display screen are restricting initial product rollout fulfillment. Kuo predicts that given current supply chain bottlenecks, output should reach 2.3 million units by the end of May with total shipment volumes expected to be between 15-20 million units in 2015. That is reportedly below current Wall Street expectations. Also disclosed is that LG Display is the Watch’s sole display supplier, an indication of Apple’s pattern for depending on a single supplier for market innovating technology, diversifying later when the technology reaches mature production volumes.

Fulfilling customer expectations, assuring customer retention and meeting expected financial outcomes is challenge shared by many industry supply chains.  In the specific case of Apple’s supply chain strategies, balancing supplier risk coupled with segmentation are exercised to manage both new product introduction and volume production phases.

Bob Ferrari

© 2015 The Ferrari Consulting Group and the Supply Chain Matters© blog. All rights reserved.

 


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