Supply Chain Matters has previously noted a series of strategic investments being made from Qualcomm Hon Hai Precision and Samsung in Japan based LCD provider Sharp Corporation. The company literally reached the precipice of imminent bankruptcy before a rescue came forward.  The company is expected to again report a sizeable operating loss for its fiscal year ending this month. Further, nearly 200 billion yen in outstanding debt is scheduled to mature at the end of September.

Sharp provides consumer electronics OEM’s an important asset, being a pioneer in advanced manufacturing capabilities to produce leading edge electronic display devices for television, tablet and mobile phone devices.  Sharp has pioneered in LCD screen based technology, the latest being the use of high resolution indium gallium zinc oxide screen technology (IGZO) that is thinner and less power consuming than conventional displays. The latest investment from Samsung was extremely significant since it was not too long ago that both of these companies were strong market rivals, and the deal was seen as an indication that Sharp needed to exercise desperate measures to insure infusion of needed cash.

This week comes word that Qualcomm will not proceed with the second progress payment due at the end of March, as originally planned. According to Bloomberg and other published reports, the previously planned $53 million installment is being held because Sharp could not develop production technology for its Micro Electro Mechanical System displays, a previous milestone established to occur by the end of March.  The same report indicates that both companies are now working toward a June 30 deadline.

Qualcomm, who produces communications microchips for Apple’s mobility products, had previously agreed to invest $120 million in Sharp, including ownership of up to 5 percent of Sharp stock.  Qualcomm made its initial $60 million investment in December.

This latest report of investment delay again casts doubts on Sharp’s ability to secure needed cash and supply commitments to satisfy its bankers for the scheduled debt refinancing by the end of September.

To add more confusion, DigiTimes commented this week that although Sharp president Takashi Okuda hinted at a press conference on March 14 that talks over investments from Foxconn Electronics (Hon Hai Precision Industry) are already in a status of being cancelled, Foxconn has emphasized that the two sides are still in negotiation for the long speculated longer term equity investment.

Qualcomm and other strategic investors in troubled Sharp will continue to hold that supplier’s feet to fire in terms of expected milestones and assurances.  Thus, Sharp will face additional tough challenges in the months to come as it continues to shed assets and resources, while still delivering on strategic milestones. The open question is how long will these white knights remain before Sharp’s ship takes on too much water.

Bob Ferrari

Yesterday, Samsung unveiled its latest model Galaxy S smartphone, and by today’s headlines among business media, created a lot of new buzz regarding its ability to be a strong innovator and competitor in the smartphone arena. In this hubris of smartphone and other consumer electronics OEM’s such as Samsung and Apple, are the continuing challenges in requiring proactive labor rights policies among various suppliers.

Last week, three French labor rights groups along with a noted human rights lawyer filed a lawsuit against Samsung Electronics accusing the company of misleading consumers and investors amid allegations of labor abuses occurring among its supplier factories in China. This suit centers on a series of reports from the New York based China Labor Watch organization that alleges systemic labor rights violations among Samsung’s external suppliers in China.

According to last week’s report published by The Financial Times, Samsung denies all claims of labor rights abuses at its factories, but does acknowledge employees at external suppliers sometimes work excessive amounts of overtime.  In September of 2012, Supply Chain Matters noted that after a series of stated findings from China Labor Watch, Samsung was initiating an unprecedented amount of  supplier audits involving all 250 of its China based suppliers within its supply chain. Samsung promised to terminate a supplier contract if any violations were found that breached the company’s supplier agreements. Our expressed view at the time was that Samsung was wielding a rather significant stick, the outright declaration of supply contract suspension if suppliers were found to be in violation and corrective actions were not taken to the satisfaction of Samsung.

According to last week’s FT report, the head of China Labor Watch indicated that the labor rights organization felt that Samsung’s response to his group’s findings declaring strong evidence of underage labor practices were not as proactive as those concerning Apple. This included a finding in December of underage workers at a Samsung supplier factory, and two weeks after Samsung rejected a previous separate finding involving another supplier.

Readers of this blog are probably well aware that the issues of labor rights abuses involving high tech manufacturing factories in China have been far reaching.  While Apple has taken on the brunt of investigations and proactive calls for action, other high tech manufacturers are now being called to task.

In February, Hewlett Packard issued tightened labor standards among its China based suppliers regarding the use of temporary and student based labor.  These new guidelines stipulate that all work must be voluntary, and comply with local regulations regarding minimum working age and designated working environments.  HP developed these guidelines in tandem with China’s Center for Child Rights and Corporate Social Responsibility and according to its announcement, go beyond regulatory expectations for suppliers.

What seems to be perplexing regarding reports of this latest Samsung lawsuit is the premise that a company has purposely misled investors by tolerating underage labor practices among suppliers.  We are certainly not lawyers, and thus can only opine, but it seems that the outlined premise may be rather  difficult to prove in a court of law. In its reporting, the FT rightfully points out that: “If successful, this lawsuit could open up a new legal risk for companies whose suppliers breach labour laws.”

To its credit, Apple has taken rather proactive and open commitment in its actions to have the Fair Labor Association conduct an open audit of its entire China based supply chain for any labor rights abuses, including underage workers. Apple provides open access to audit findings.  Samsung, on the other hand, has been more behind the scenes in its approach to these alleged conditions, openly stating strong consequences for those suppliers found in violation, but not as transparent on reporting of auditing progress. As a consequence, Samsung is now being targeted for its alleged tolerance of practices. The time has probably come for Samsung to open its China supply chain to an open and visible third party audit process similar to what Apple has launched. Samsung’s supply chain management teams may well believe that clear labor standards and implications for violation are clearly communicated, but often times a transparent and open process has far more effectiveness in driving change.

In a separate Supply Chain Matters commentary in late September 2012, we stated that change and reform is long overdue and the high tech and consumer electronics industry can no longer turn a blind eye to what may be occurring among suppliers and contract manufacturers. The notion that an OEM can dictate unplanned changes or insist that virtual capacity exists is now being challenged by the realities of supplier social responsibility. Whether the objective is a new product launch, the peak consumer buying season, or an extraordinary market opportunity, there are new realities occurring in global based supply chains, and as community, we need to be aware of these implications, from both operational and legal consequence.

Bob Ferrari

In November of 2012 Supply Chain Matters made note that Apple had begun to actively pursue its own supply chain risk mitigation plan. Apple elected to dual source some of its contract manufacturing needs with the use of Pegatron, one of Taiwan’s largest contract manufacturers, as a second assembler of the iPad Mini, along with the iPhone 4 product. As is often the case when suppliers get to leverage the massive scale of the Apple supply chain, some positive financial results can accrue.  A strategic decision to diversify beyond the manufacture and assembly of laptops and PC’s can also prove to be very timely.

Pegatron’s net revenues in 2012 have grown over 53 percent to roughly $26 billion.  Net income jumped to roughly $111 million with a demonstration of record earnings per share in the final quarter of 2012. That is quite a contrast to August 2012 after Pegatron forecast a 15- to 20-percent quarterly drop in its notebook computer shipments for the third quarter. The company shares were rising at the time because of the rumors of being selected by Apple as a second source contract manufacturer. Monthly revenues have increased 53 percent since September.

In its reporting of Pegatron results on Monday, The Financial Times quotes Pegatron’s CEO refusing to comment on any specific customers, but forecasting that shipments of tablets would double to 20 million.  FT further quotes sources at investment firm Nomura as estimating that half of Pegatron’s revenues in 2013 will come from Apple. There is also continued speculation that this contract manufacturer may garner additional Apple business in the months to come. Rumors and speculation continue to note that the iPad Mini is outselling its larger cousin.

Timely diversification and being selected by Apple is turning out so far to be a wise decision for this contract manufacturer.

Bob Ferrari

Disclosure: This author is a recent current stockholder of Apple.

Supply Chain Matters has often reinforced the importance of identifying and investing in key strategic supplier relationships.  Investing takes on many dimensions including co-innovation in product and component development, deeper collaboration in business processes, and sometimes financial investments to insure longer-term continuity of supply.

We have provided through our various blog commentaries some specific industry examples of such investments.  One that has been of high interest in the high tech and consumer electronics sector is that of Sharp Corporation, a television and LCD display supplier that has pioneered in LCD screen based technology, the latest being the use of high resolution indium gallium zinc oxide screen technology (IGZO) that is thinner and less power consuming than conventional displays. The significance was rather important since Sharp supplies LCD displays to a number of prominent high OEM’s including Apple.  Sharp is second to LG Display as a supplier of LCD displays for Apple including the supplier for the iPhone 5 screen. However Sharp ran into initial production ramp-up difficulties with this new technology, causing some drag to Apple’s supply chain momentum in Q4.  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.

Sharp literally reached the precipice of imminent bankruptcy before a rescue came forward. In early November 2012, Sharp forecasted a near doubling of operating losses to $5.63 billion and was struggling to make some form of operating profit to justify a bailout from either Japanese banks or key customers. In order to secure fresh working capital loans, 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.

Earlier in 2012, there were many business and social media reports indicating that Hon Hai Precision Industry Corp., the parent of global contract manufacturer Foxconn, was prepared to take an equity stake in Sharp’s LCD development and factory operations, but with implications that Hon Hai would become Sharp’s largest shareholder and have the ability to assume some strategic management control of Sharp.  The implication was that Apple, through its relationship with Hon Hai and Foxconn, was willing to invest in Sharp’s longer term supply, but that component strategies would cede to Hon Hai.  The Hon Hai investment did not occur in 2012, because of Sharp’s deteriorating stock price and the threat of too much outside control.

In December, Qualcomm, who produces communications microchips for Apple’s mobility products agreed to invest $120 million in Sharp, including ownership of up to 5 percent of Sharp stock.  Reports indicated that the two companies would collaborate on developing even newer next-generation displays for mobile phones and tablet computers, while the new cash infusion would assist in ramping up IGZO display production. Qualcomm also acquired start-up LCD supplier Pixtronix, and the Sharp investment deal calls for an exchange of technology with Sharp. It seemed as though Qualcomm was a more suitable strategic partner.

This week features an even more interesting and thought provoking announcement indicating that Apple rival Samsung will itself provide a $110 million lifeline investment for Sharp. The deal is reported to provide Samsung with a 3 percent stake, along with gaining access to IGZO and other technology.  According to a published Reuters report, this is the first time Samsung has taken an equity stake in a Japanese based rival.  The byline headline for the Reuters report is that this deal could check Apple’s influence at Sharp. Reuters notes: “Although Sharp is one of Samsung’s smallest suppliers, its importance to the Korean company will likely grow as demand for large-screen TV’s over 60 inches burgeons, analyst say.”  That in our view is a rather important indicator.  Keep in mind that there have been continuous rumors and reports indicating that Apple is working on a new breakthrough dimension of Apple branded televisions. Samsung’s investment in Sharp may tap some future large screen LCD capacity or yield more favorable pricing.

The Reuters article further speculates that this strategic investment in IGZO screen technology will allow Samsung to concentrate on its own existing OLED screen technology for both mobile devices and televisions, without having to invest additional capital investments in alternative display technology.

Reuters quotes a Hon Hai spokesperson as indicating that the Samsung deal would not alter that company’s relationships with Sharp on LCD screen products, and that the previous added investment talks were continuing.

An even more interesting perspective came from Taiwan based DigiTimes which speculated that the latest Sharp investment deal may imply that a previous alien Foxconn-Samsung may be realized in the future. That speculation really captured this author’s interest.

Thus Sharp, a supplier that was on the financial brink is now infused with cash from a set of new investors with different strategic supply goals. The strategic picture 6-12 months ago is now dramatically different with far more interesting scenarios, including supply to another huge global supply chain.

The takeaway for sourcing, product management and procurement teams, especially those in the high tech sector, is fairly obvious.  Suppliers need to be evaluated not only on their current financial health, or opportunistic pricing, but on long-term market and product technology strategy needs.  Your reluctance to invest could be trumped by an industry competitor who views a pearl in a bed of oysters.

Bob Ferrari

From time to time, Supply Chain Matters will call attention to reports or articles which we feel should definitely be included in your reading list, especially when it concerns small to mid-sized supplier businesses.  This commentary references an article worthy of both a good read and reflection on how component suppliers can demonstrate industry diversification in supply chain support strategies.

Today’s edition of The Wall Street Journal features the article: Meet the Smartphone Arms Dealers. (paid subscription or free metered view) This article describes the efforts of two Japan based suppliers, Murata and TDK, both of which have managed to successfully leverage continuous product innovation and industry targeted support toward business excellence. While Japan’s major electronics OEM’s have fallen on difficult business times, these two suppliers are performing very well. In terms of overall business and financial performance, the WSJ reports that both of these suppliers posted profits for the first nine months of their fiscal year’s, fueled by healthy demand for products.

Murata is one of the largest providers of ceramic capacitors and wireless communications modules. TDK is a leading global supplier of electronic inductors.  The WSJ points out that both suppliers have been able to maintain dominance in the electronic circuits’ area by keeping R&D and leading-edge production in-house. Each further designs and builds the manufacturing equipment used at their factories, maintaining a manufacturing process edge. A Murata senior executive is quoted as indicating that one always needs to be one or two steps ahead of the competition.

In the 80’s and 90’s when Japanese electronics OEM’s dominated the global market, the customers of Murata and TDK were domestic. According to the WSJ, today Japanese customers amount to little more than 20 percent. Both suppliers have reached out to supply components to major smartphone and electronic tablet OEM’s including the lucrative supply chains of both Apple and Samsung. Both suppliers are working on longer-term efforts towards expanding their diversified industry presence. TDK is focusing on components utilized in electric and hybrid automobiles along with energy distribution systems for buildings. With a trend for more and more electronic circuits used within cars and trucks, Murata is building a presence in that industry.

Upon reading this article, we thought of the past history of U.S. automotive supply chains in terms of Tier 1 and other component suppliers.  At one time, the big three OEM’s owned their own Tier 1 component suppliers, and later under severe financial stress, were forced to spin them off as independent companies owned by various outside investors. During the severe recession of 2008-2009, when the market tanked, the ripple effect impacted U.S. automotive suppliers quite heavily.  Some diversified in supplying adjacent industries or non U.S. OEM brands such as Toyota or Honda. Others were unfortunately forced to be acquired, some by non-U.S. interests also seeking product innovation or market diversification.  That was the initial entry of China based suppliers into U.S. automotive supply chains. Some smaller suppliers unfortunately perished, running out of options.

In 2008-2009 we were publishing commentaries highlighting successful product innovation and diversification strategies as a means to share learning. We therefore remain much attuned toward highlighting successful efforts of component suppliers in practicing sound business and diversification in supply chain support strategies.

Understand and learn from others.

Bob Ferrari

The Financial Times is today reporting that global contract manufacturer Foxconn has imposed recruitment freeze across most of its factories in China because of production slowdowns involving Apple’s iPhone5. The current freeze is in effect until at least the end of March. In its reporting, FT indicates that hiring has stopped for both the iPhone and iPad production lines in Shenzhen and Zhengzhou. Both iPhone and iPad component parts plants in Taiyuan and Chengdu is additionally mentioned. FT attributes this hiring freeze as an indication of weakening demand for Apple products. The fact that this announcement is timed after the Chinese Lunar New Year holiday, when migrant production workers typically do not return to factory jobs is being taken as an indicator that headcount reductions could be more pronounced in the coming weeks.

Naturally, Wall Street investors responded negatively to this development.  Of late, Apple stock has been rather volatile as many investors have bailed from the peak highs of just a year ago. The spin seems to be that Apple’s supply chain is communicating a general slowdown in production orders and output volumes, which resonates as negative news.

Supply Chain Matters is of the view that this announcement of a hiring freeze at Apple’s prime contract manufacturer has more to do with responding to a broader strategy that is underway.  The supply chain community is well aware that direct labor costs have been accelerating across China for a number of reasons. Increased social pressures among China’s workforce to seek gains in China’s wealth coupled with increasing tensions over labor and social responsibility practices have led to a more an active and vocal workforce.

Foxconn had already indicated that it would aggressively invest in more robots and factory automation across its production facilities to increase productivity. It is no secret that Apple has boatloads of cash, much of which is tied up in non-U.S. accounts. One of the smart uses of some of that cash is supporting increased investments in factory automation, allowing Apple products to be produced in multiple geographic regions. Foxconn earlier announced an effort to support more open union representation across its factories in China.  We interpreted this move toward more open union representation and an active worker voice as an effort to ease some of the tensions that will surely come over the coming months, also signifying the laying the groundwork for increased factory automation.

Thus, we believe these announcements are signs of broader strategies at play within Apple’s supply chain, strategies that will continue to unfold in the coming weeks. Rumors persist of potential new Apple products in the pipeline, including a lower cost iPhone with a greater range of sizes and colors, a potential launch of an electronic watch line and Apple’s possible entry into televisions. These are all signs pointing to the need for increased factory automation and longer-term shifts in factory sourcing.

Watch for even more announcements in the coming weeks.

Bob Ferrari