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Two Contrasts in Contract Manufacturing Direction for Apple Suppliers

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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   Apple Logogoals   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.

Bob Ferrari

©2014, The Ferrari Consulting and Research Group LLC and the Supply Chain Matters Blog. All rights reserved.

 


When Market Dynamics Become the Obvious the Supply Chain has Lost an Advantage

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Organizations can sometimes suffer from symptoms of denial regarding external market forces which can adversely impact supply chain strategy and objectives. The reasons are often obvious.  An organizational culture that values short-term operational or tactical prowess over big-picture understanding, or management incentives too grounded in short-term performance objectives vs. critical thinking.

Supply Chain Matters has featured many commentaries related to supply chains within the smartphone and electronic tablet industry which has experienced explosive market and margin growth these past years. We all know that one of the top rated global supply chains has been that of Apple, followed by arch competitor Samsung. While each remains in a fierce battle, other players such as Lenovo and a host of other surging Chinese and India brands have been more responsive to the product needs of their specific targeted geographic market segments.

However, stronger warning signs appear among industry watchers in California’s Silicon Valley. For instance, a column published by the San Jose Mercury Times raises concerns that the best days of the prior booming smartphone industry may be behind. This commentary specifically cites Apple, Intel, HP and Samsung with the supposition that the smartphone segment may have seen its best days because much of any future growth resides in the emerging market sectors, where competition is fierce and price sensitivity is a critical factor for purchase. Further cited is a J.P. Morgan report concluding that the smartphone segment “has the hallmarks of the (current) PC market- slowing growth, vendor consolidation and limited technology differentiation.” Also declared: “Apple’s penetration of the higher-end segment of the smartphone market is reaching a saturation point

The authors poll analysts and industry observers that indicate that certainly the market is not going away, but rather moving toward a transition toward possibly two spectrums: a high end brand-driven segment with premium product features possibly characterized by lower volumes and a lower-cost and a high volume segment to drive sales and market-share penetration in emerging markets. There is a further belief that smartphones will morph into a more all-encompassing mobile device, with the combined features of a tablet, PC and mobile phone. Each of these spectrums drives different value-chain characteristics and business needs and that is where supply chain strategy can become conflicted.

Each of the individual supply chains associated to the market players will no doubt have to respond to these rapidly changing industry dynamics.  Supply Chain Matters previously observed that Apple has already begun transitioning its supply and contract manufacturing networks to deal with its perceptions of a changing market. Samsung has the advantage of already strategically positioned as a vertically integrated industry player with far more control relative to component product innovations across the various tiers of the value-chain. Lenovo has been making strategic acquisitions to take advantage of a market shift.

The takeaway of our commentary is that when business and general media concludes that your industry has seen its best days and that a significant industry shift is underway, it may well be too late to adjust. It is far better to foster a culture of strategic and predictive thinking where market and business assumptions are continually being reviewed and external signposts are embraced rather than dismissed. A supply chain that is fundamentally driven by cost advantage, may not necessarily be able to shift itself toward support enhanced product innovation. A supply chain that is driven by continuous product innovation may not necessarily be position for industry cost advantage.  In today’s rapid clock speed of business, supply chain must be able to adapt to different business needs where value-chain agility, critical thinking and more prescriptive planning are the basis of supply chain strategy.

Bob Ferrari

 


A B2B Network Provider that Gets the Importance for Connecting Product Management

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Supply Chain Matters continues to advocate that when considerations concern a goal for an end-to-end value-chain information integration strategy, supply chain teams that deal with complex, global-based process integration should give consideration to adopting an end-to-end B2B backbone platform. Such a backbone needs to transcend beyond mere EDI transactional or P2P procurement processes and include much broader supply chain process and information integration support that captures as much of the value-chain that is feasible.

As an industry analyst at AMR Research back in 2000 (not Gartner as it is today), I was one of a small handful of analysts that introduced the first iterations of so-termed trading or industry exchanges to the market.  Most of these were about transactional connectivity across supplier networks with some purchasing services.  Very view survived, mainly those that focused on solving broader supply chain information integration problems. Quite a lot has changed in over a decade, both on the vendor and technology innovation fronts.

For our part, Supply Chain Matters will continue to provide education and awareness to various B2B technology capabilities concerning such platforms along with the potential value that they can provide.

We recently had the opportunity to be briefed by SERUS, a one too many cloud-based B2B platform provider catering to the unique support capabilities for the needs of high-tech and consumer electronics supply chains. This provider started its efforts supporting needs among semiconductor industry supply chains where there are characteristics of complex value-chain routings within a primarily outsourced supply chain network that is intensely product-driven. Product information in the form of specifications, schedule milestones and engineering changes are in a constant state of movement.  The need is often to connect product design and management directly with mostly outsourced fab production, test and assembly partners. The platform must further be able to interface and provide structured and unstructured information insights among various existing planning and fulfillment applications. SERUS has now transitioned its experience in semiconductor to target other high tech industry customers and B2B value-chains. This provider currently cites approximately 400 suppliers on its network. Named lighthouse customers include Juniper, HP, Nvidia, Sun Division of Oracle, Qualcomm/Atheros, among others.

One of the more interesting capabilities of SERUS is its concentration in actionable intelligence and analytics capabilities.  Much of this functionality is provided by an OEM agreement with Tableau Software, which was recently ranked among other vendors in the leaders quadrant of Gartner’s Magic Quadrant for Business Intelligence and Analytics Platforms. According to Gartner, Tableau achieved above-average ratings for reporting and ad-hoc query, and a top ranking for dashboard, business user mash-up and data visualization capabilities.  Supply Chain Matters will provide a separate commentary concerning Tableau.

This platform provider has another partnership with GT Nexus to augment supply chain logistics and execution coordination and control needs, and go-to-market partnership with AT Kearney.

In addition to Visibility and Intelligence, other applications making up the SERUS Virtual Manufacturing and Supply Chain System are Design for Manufacturing and Supplier Contract Compliance application support.

In last year’s edition of our Supply Chain Matters Predictions for Global Supply Chains, we noted that products have become more technologically sophisticated and today incorporate broader combinations of physical hardware, bundled software and services components. Product design, customer fulfillment, satisfaction and service now umbrella many more functionally driven activities and the supply chain now finds itself involved, either voluntarily, or involuntarily, in each of these various dimensions. Retail, B2B, and B2C online fulfillment supply chains also find themselves dealing with many other moving parts in coordinating an on-time and complete customer shipment or responding to customer service requests. While suppliers are often reluctant to share certain information regarding quality and conformance, a product recall event is literally too late in the process and to damaging to the brand to experience a major component or process defect. For all the above reasons, and others, we predicted that in 2013, the executive level voice and shared accountability of the supply chain organization will further extend itself into the areas of product and service lifecycle management.

While we admittedly may have been slightly pre-mature in the timing, product innovation focused supply chains are clearly more challenged in the ability to integrate product information with manufacturing and other supply chain business process needs.  Having a B2B collaboration platform that considers such needs is a definite consideration. Our impression of SERUS is that they “get-it”, in the sense of integrating product management with other process coordination needs across a  primarily outsourced value-chain.

Bob Ferrari


Reports of Easing Tensions Concerning Work Stoppage at IBM Facility in Shenzhen

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This posting is an update to our previous Supply Chain Matters posting regarding Lenovo’ intent to acquire the x-86 hardware server business from IBM

Last week, approximately 1000 workers joined a labor stoppage at the IBM Systems and Technology production facility in Shenzhen China.  Reports indicated that workers were angered over reports of severance benefits that would be offered by IBM if workers elected not to join Lenovo, as well as the potential for lower wage rates when Lenovo takes control of the facility. The latest reports are indicating that the plant reopened yesterday, nine days after the employees walked off their jobs.

Today’s Wall Street Journal reports (paid subscription or free metered view) that IBM fired 20 of the strikers for taking part in unlawful assembly that led to the shutdown of the plant.  A written communication by IBM provided to the WSJ indicates that actions were within Chinese law and whether employees elect to work for Lenovo is an individual decision. Further stated is that while IBM is not required to do so, the company is ready to provide an equitable severance package to those workers who elect not to join Lenovo. The WSJ additionally reports that returning workers may have been offered a bonus payment to return to work during the period when the acquisition becomes finalized. The company indicated that growing numbers of workers are beginning to return to work.

A local Chinese labor union spokesperson is quoted as indicating that IBM’s approach has been “unyielding”, and that the workers do not understand how this situation is being handled.

For its part, Lenovo issued a position statement on its web site re-iterating that any integration of facilities will not be conducted until the acquisition is completed, and that the current work stoppage is an internal matter with IBM. Lenovo’s statement goes on to state that the intent of the acquisition is to gain the talent and experience of the existing x-86 business resources and that the company look forward to welcoming transitioning employees in several months’ time.

Obviously, this is a sensitive time of transition for both IBM and Lenovo.

Globalization brings on new dimensions of activism.  As a blog commenting on global B2B/B2C and supply chain management developments, we did not expect that we would be posting commentaries on labor work stoppages or trade union elections at Amazon distribution fulfillment centers in Germany and the United States.  Who can forget the incidents of worker suicides or rioting that occurred at Foxconn facilities in China, working on assembling products from Apple.  Now, a work stoppage at an IBM production facility in China.

These are extraordinary times across industry supply chains.


Report that Apple is on a Supply Chain Management Talent Binge Across Asia

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We along with other recognized supply chain thought leaders have been raising awareness to the current talent shortages regarding areas of supply chain management, particularly individuals with experience related to linking the introduction of new products and product management with overall supply chain ramp-up and ramp-down deployment needs.

One of globe’s top-ranked supply chains, Apple, has been under considerable pressure of-late because of the perception that its product innovation cycles have slowed and industry competitors are quickly narrowing the gap in surpassing such capabilities.

A newly published report from the Wall Street Journal (paid subscription or free metered view) places a poignant perspective to Apple’s growing need.  The report indicates that Apple is in the midst of hiring hundreds of new engineers and supply chain managers across China and Taiwan in its attempts to speed product development and introduce a wider range of innovative products. The report notes that current victims of this hiring blitz include the likes of HTC Corp. and other Taiwanese technology firms.  According to the report: “The total number of engineers and (supply chain) operations staff in China now exceeds 600…”

The report further outlines that while core research and development will remain in Cupertino, engineering and supply chain management talent investments within China pale in comparison to those in the United States, implying an ever more expanded presence in China. Further disclosed is that Apple has added contract manufacturers Wistron Corp. and Compal Communications to help produce upcoming versions of iPhones and iPads.

Supply Chain Matters has often commented how Apple’s purchasing clout and volume scale can lock-out smaller high tech and consumer electronics OEM’s from lowest cost pricing and favored supply agreements.  With this latest report regarding the current talent seeking hiring spree centered on China, the industry can probably add talent raiding and talent shortages to the impacts of Apple along with its competitors.

Talented and experienced cross-functional supply chain management professionals with experience in new product ramp-up and time-to-market, along with alleviating supply chain choke points are going to be in the catbird seat across global locations, since the talent war seems to be escalating across high-tech supply chains.


Tesla’s Gigafactory Announcement- Another Movement Toward Supply Chain Vertical Integration

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Supply Chain Matters has provided a number of previous commentaries regarding when is it appropriate to execute a more vertical integration strategy within a specific industry supply chain. Our commentaries on this strategy focused on General Electric in aerospace engines, Delta Airlines in airline service operations, Hon-Hai Precision in high-tech contract manufacturing services and Hyundai Motors in automotive manufacturing.

This week, general, business and social media as abuzz with the announcement that electric automobile maker Tesla Motors has announced audacious plans to build its own $5 billion electric battery “gigafactory capable of supplying up to 500,000 electric vehicles per year.  This strategy is fairly savvy, given that when one reflects on the entire value-chain and cost-of-goods sold (COGS) for an electric Telsa Motors Model Spowered automobile, the batteries are indeed the highest portion of cost.  The location of this factory is stated as somewhere within the U.S. Southwest, with locations in Arizona, New Mexico, Nevada and Texas all being explored.  The area of the U.S. is an obvious choice because of its proximity to the supply of lithium carbonate, a key raw material for lithium-ion batteries. Another neat aspect to the proposed 10 million square foot production facility are plans to have the factory green and sustainable, including solar and wind farms for supporting internal power needs. Tesls’s blog features a presentation that describes the conceptual plans for the proposed “gigafactory”.

According to published reports, the total cost of the plant is estimated in a range of $4-$5 billion, with $1.6 billion raised through a convertible bond issue and a $2 billion investment from Telsa. Panasonic is the current primary supplier for Telsa’s lithium-ion batteries and in its reporting, the Wall Street Journal indicated the possibility that Panasonic and other unnamed Japanese suppliers could contemplating a $1 billion investment in this proposed facility. Reports caution, however, that Panasonic’s plans are still fluid.

Telsa currently supplies batteries for the Toyota RAV4 EV and the Mercedes B-Class electric. In its reporting, the San Jose Mercury Times notes that Telsa’s prime assembly facility in Fremont California is directly located on a Union Pacific railway spur line and that the “gigafactory” will more than likely be serviced by rail as well, to control transportation costs in shipping batteries to the final assembly point.

Telsa expects that the new factory would reduce its current battery costs by 30 percent in its first year, which as we all know, is a significant contribution to COGS, and further opens up opportunities to produce electric cars for the mass market. The WSJ further reported that Telsa is attempting to break through the $200 per kilowatt hour cost point which affords the opportunity for these types of batteries to be economical as backup power supplies for electric utilities along with other forms of static energy storage. Telsa CEO and principal owner Elon Musk also is chairmen of SolarCity Corp., a solar energy provider, and that is fueling additional speculation among certain Wall Street analysts that Telsa could morph to become a power storage company.

From an industry value-chain perspective, reports that that the proposed facility will produce more lithium-ion batteries than the entire global supply for 2013 has incredible meaning with the implication for establishing a highly significant alternative energy value chain capability within the United States.  It is obviously an attempt to provide a more competitive lithium battery sourcing strategy from current areas such as China, South Korea and other countries. By our view, is a rather exciting and bold announcement, one that has the potential to add more to U.S. manufacturing and value-chain momentum for alternative energy, high-tech, consumer electronics and other industries.

Investors seem also impressed since Tesla stock has shot-up since the announcement.

Forms of vertical integration or closed supply chain strategies do indeed have their applicability and seem to be garnering additional favor.

Bob Ferrari


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