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.
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.
© 2015 The Ferrari Consulting Group and the Supply Chain Matters© blog. All rights reserved.
In our prior Supply Chain Matters commentary we touched upon the huge benefits for being a supplier of a strategic component for Apple’s products. In prior commentaries, we have also highlighted the drawbacks. Such drawbacks include not being on the leading edge of technology or not flexible or agile enough to meet Apple’s constantly changing product development and time-to-market requirements.
One such supplier has been Sharp Corporation, one of three current LCD screen suppliers for Apple. LCD screens are highly strategic for Apple, and consumer electronics giant has elected to initiate strategic supply agreement among all three to insure both leading-edge technologies, the ability to scale to Apple’s flexible volume requirements and as a mitigation of supply risk.
Sharp has a track record of innovation in LCD technology but a rather rocky financial history as well. One such innovation was in early 2013 with the application of high resolution indium gallium zinc oxide screen technology (IGZO) that is thinner and less power consuming than conventional displays. In a March 2013 commentary we highlighted that Sharp ran into initial production ramp-up difficulties with this new technology, causing some drag to Apple’s supply chain momentum in Q4 of 2012. A report in September indicated that a shortage of the new and larger LCD displays, and the lack of contribution from specific supplier Sharp, may have cost Apple a million or more in initial sales.
On the financial side, Sharp reached the precipice of imminent bankruptcy in early 2012 before a rescue came forward. In order to secure fresh working capital loans at the time, Sharp was compelled to mortgage most of its offices and factories in Japan, including the specific factory producing LCD displays for Apple’s iPhone and iPad. In late 2012, Qualcomm, whom produces communications microchips for Apple’s mobility products agreed to invest $120 million in Sharp that included ownership of up to 5 percent of Sharp stock. The second progress payment of $53 million of that investment was held back by Qualcomm in March of 2013 because of reported non-performance. In March of 2013, we highlighted a report that Apple competitive rival Samsung would provide a $110 million lifeline investment, reportedly the first time Samsung had ever taken an equity investment in a Japanese based rival. That fueled speculation at that time from business media that Sharp could become a more strategic partner for Samsung. Reports now indicate that the soon to be released Samsung Galaxy S6 smartphone will feature a curved LCD screen being produced by LG Display, a rival to Sharp.
Earlier this week, The Wall Street Journal reported that Sharp was now 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. This funding unit previously invested in Japan Display, which was created from the remnants of three other Japan based LCD producers with declining output and troubled finances. However, a Sharp spokesperson indicated to the WSJ that various restructuring options for the LCD business are being explored and no final decision has been made. According to this report, banks currently hold in excess of $5 billion of Sharp debt. In February, Sharp indicated it would report a significant loss instead of a previously expected profit for its fiscal year that ended March 31. The WSJ report hints that with the involvement of Innovation Network Corp. LCD industrywide supply consolidation may yet occur.
Sharp is turning out to be yet another example of the risk and reward aspects for being a strategic supplier to Apple when being on the cusp of leading-edge product and manufacturing based technology clashes with the dynamics of supplier relationships. Eventually, lifelines can run the course.
A published Bloomberg report citing sources with direct knowledge has disclosed that Samsung Electronics will produce the main processor chip related to Apple’s next iPhone model, replacing TSMC, the supplier of the iPhone 6 A8 processor chip.
According to the report, Samsung will start making the new processor chip at its Giheung South Korea plant, with additional orders going to Samsung’s production partner, Globalfoundaries Inc. Neither Apple nor Samsung were willing to confirm such news.
Make no mistake, the competition for being the prime source of Apple’s processor chips is a big deal with implications for billions in revenues. If this report turns out to be accurate, than the fact that Apple has returned to arch competitor Samsung for sourcing of its processor chips is a significant announcement. It is a further testimony of the high-stakes involved in being on the leader-edge of the latest chip fabrication technologies. The report quotes Gartner numbers indicating that Apple spent a whopping $25.8 billion on chip processors in 2014, accounting for nearly 8 percent of industry demand.
Further noted was that Samsung and TSMC both indicated intent to invest more in advanced production capabilities in order to attract Apple’s business. TSMC alone reportedly budgeted $12 billion for plant and equipment investments this year in order to compete with Samsung.
As we have noted in many of our high tech and consumer electronics focused supply chain commentaries, the purchasing influence of Apple looms very large for many industry suppliers. The scale and sheer volume scale can make a break a supplier’s business plan, and that influence alone causes continued information leaks across the high tech supply chain ecosystem. It can further motivate fierce competitors to put differences aside when manufacturing technology and functionality are at stake.
We are often reminded that one of the most common traits of industry disruptors is that they think differently. They challenge the notions of industry norms, current practices and business processes or the leveraged use of technology in product and service delivery.
Over the coming weeks, Supply Chain Matters will feature a series commentaries focused on industry disruptors and their implications to existing customer fulfillment.
Fast becoming one of the icons of disruptive thinking approaches is Elon Musk with his current ventures in the automotive and space exploration and aerospace sectors. The two companies he leads, Tesla Motors and Space Exploration Technologies have each challenged legacy industry practices.
Supply Chain Matters has featured a number of prior commentaries specifically focused on Tesla and how this automotive producer has challenged existing norms in is driving re- thinking in supply chain vertical integration, advanced manufacturing practices, service and distribution strategy. Tesla’s fundamental approach is that an automobile serves as a transportation device that is primarily powered by computer intelligence and the user experience. There is little need for intermediaries or after-market providers.
This week, Tesla has invigorated both social and business media on the news of its latest series of software upgrades planned for the Tesla Model S. At a recent automotive industry conference, Musk declared that it will soon become illegal for humans to take the wheel once the technology of self-driving cars have proven themselves. If you sit in a Tesla vehicle, it’s visually striking that the huge 17 inch LCD screen takes-up more driver attention than a traditional automobile dashboard. It was designed as such.
Last October, IHS reported on its initial analysis of a teardown of the components of the Tesla Model S with the headline: Is it a Car or an iPad? The article is impressive and worth a read.
What is extraordinarily impressive is that Tesla’s software upgrades are delivered wirelessly to individual owned consumer vehicles in the truest form of cloud delivery. There is no need for the traditional automotive industry dealer visit. Musk views such upgrades in the same context as updating a laptop computer or a smartphone. He further categories autonomous driving as a “solved-problem”. Last year, Tesla began equipping its Model S with on-board cameras and sensors to be powered by a sophisticated system termed “autopilot”.
Over the coming weeks and months planned upgrades will include functionality that completely puts the driver at-ease regarding the existing range of the car’s battery power. The software analyzes the current driving route, road conditions, topography and location of available battery charging stations. If the car is going to exceed the range and distance to the nearest charging station, a real-time warning is issued along with GPS coordinates to the charging facility. According to Musk, “it makes it almost impossible to run out unless you do it intentionally.”
In an upcoming release 7.0, a new user interface will provide the ability of the car to operate with complete autonomy on highways when the driver lets go of the steering wheel.
In the context of the consumer experience, like Apple, Tesla delivers on design elegance and the interactive user experience. The car you may have purchased one or two years ago, has newer functionality and user experience features delivered by the cloud than when you purchased that vehicle.
For the remainder of automotive related industry, a disruptor such as Tesla will elicit more accelerated innovation in applied technology and the driver experience. Suppliers are already working on more sophisticated processors, sensors, embedded systems and driving aides.
Is it any wonder that when news broke that Apple was working on its own secret development of an electric vehicle, that social media lit-up like fireworks and the automotive industry shuttered.
In today’s industries, change is constant and the termed clock speeds of product innovation are indeed accelerating. Supply chain teams will invariably be either on-board facilitators or unfortunate obstacles to these changes.
Note: This author is not a current owner of a Tesla automobile nor a stockholder, rather an observer and enthusiast of automobiles.
In October of 2014, there was a report that the leading global contract manufacturer Foxconn, had entered into preliminary talks to build a high-end LCD display factory within China’s northern city of Zhengzhou. According to that report, Foxconn and Hon Hai Precision Chairmen Terry Gou visited Zhengzhou in August and met with government officials to discuss an investment proposal estimated to be upwards of $5.59 billion.
Earlier this week, The Wall Street journal cited a statement from a local development agency and reported that discussions concerning the Zhengzhou facility are progressing and may be nearing finalization stages.
This announcement is significant since it would represent Foxconn’s largest investment in component manufacturing thus far and would be an additional sign of further diversification within key downstream strategic components of high tech and consumer electronics supply chains. The Zhengzhou region is also the home of an Apple iPhone assembly facility. Both represent the high tech supply chain ecosystem’s movement into far more interior regions of China.
In its reporting in October, the WSJ stated that it remains unclear as to whether Apple or other investors are being approached to invest in the proposed display plant.
In July, Foxconn disclosed plans to build a new environmentally friendly production complex in one of China’s most rural and pristine provinces. According to a published Bloomberg BusinessWeek at the time, a 500 acre park would be built in the province of Guizhou, on the outskirts of the provincial capital, Guiyang. Plans called for an environmentally focused facility to produce smartphones, large-screen televisions and other products employing upwards of 12,000 workers. Production processes within this new plant were to include new methods for mold based painting, carbon nanotube film for touchscreens and other innovations. The Guizhou plant was slated to be operational this month.
These developments indicate Foxconn’s continued investment in downstream electronics supply chain component manufacturing capabilities as well as this CMS’s continued commitment toward China based production presence. Being Apple’s and other high tech OEM’s prime contract manufacturer, that is an indicator of potential future strategic sourcing strategy.
Missing however, is any announcement of a substantial manufacturing investment in North America.