Yesterday, after the stock market closed, Apple announced its fiscal third quarter financial performance and Wall Street’s headline was immediately one of disappointment. This was despite reporting that profits had surged 38 percent from the year earlier period along with total revenues that grew 33 percent. Gross margin was reported as a whopping 39.7 percent which is extraordinary for the majority of today’s consumer electronics providers. Yet within minutes of the earnings report, Apple’s shares plunged 7 percent in after-hours trading and today, dropped as low as 21 points before a small rebound.
What the investment community is primarily concerned with is a perception that Apple is trending toward a one-product company, that being the iPhone, which with the latest results, accounts for 63 percent of Apple’s overall sales. That is a ten percentage point increase from a year ago, prompting concerns that other products such as the iPad are declining in sales, while new products such as the Apple Watch have yet to provide an offset. Unit sales of the iPad are believed to have declined 18 percent in the latest quarter, making a sixth consecutive quarter of year-over-year declines. Once more, the previously touted partnership among Apple and IBM, designed to provide more business applications leveraging the Apple tablet, do not appear to be stemming the declining trend.
In the fiscal third quarter, while Apple reported shipping 47.5 million iPhones, an increase of 35 percent from the year earlier quarter, that number was 23 percent lower than shipped units reported for fiscal Q2. According to a report by The Wall Street Journal, analysts noted previous quarter-on-quarter iPhone volumes fell by 19 percent and 17 percent respectively, and remain concerned for a steeper rate of decline. Apple attributed unit shortfall to the lowering overall inventory by 600,000 units during the quarter. Fiscal Q3 has traditionally been Apple’s slowest volume quarter.
In an interview with the WSJ, CEO Tim Cook indicated that he refuses to accept the thinking that Apple cannot sustain its existing growth rates. He further indicated that Apple has pried open the door to untapped markets such as China, and that the company is sensing a larger conversion rate from Android powered devices to iPhone.
Apple did not provide any breakdown of Apple Watch performance but CEO Cook indicated to analysts that the “sell-through” of the Watch was better than the iPad and iPhone at their product introduction phases. We will have to wait and observe what that means over the next two critical quarters.
From our supply chain lens, the upcoming quarters will provide Apple’s planning teams with added challenges. Earlier this month, we highlighted that Apple is now actively planning the ramp-up of the planned next release of iPhone. Reports indicate that the company is requesting suppliers to support between 85 million and 95 million iPhones for the all-important end-of-year holiday buying season that ends at the end of December, This is despite anticipated modest hardware changes.
Planners are obviously reducing existing model inventories but must be diligent to not impact Apple fiscal Q4 results. With expectations for increased sales of the Watch, as well as a newly introduced iPod Nano, additional effort will be focused on ramp-up production milestones. An added challenge has got to be focused on what to plan for inventory and fulfillment needs for the iPad, given that there may well be a product change coming.
And then there is that mega “elephant in the room”, what to do with $200 plus billion in cash.
The adage for Apple’s and indeed many other global supply chain teams is often, not what you did yesterday, but what are you going to do tomorrow, next month, and next quarter.
Does that resonate?
Seventeen months ago, business and social media was abuzz with electric automobile maker Tesla Motors’s audacious plans to build its own $5 billion electric battery “gigafactory within the United States, capable of supplying up to 500,000 electric vehicles per year. Plans indicated that the plant, would ultimately be able to produce batteries at 30 percent less cost, and when operational, would provide the capacity to be the single largest battery manufacturing volume plant in the world. To state the obvious, the strategy was a bold and savvy thrust involving vertical integration, given that of the entire value-chain and cost-of-goods sold (COGS) for an electric powered automobile, the batteries are indeed the highest portion of cost.
Since the February 2014 announcement, a far broader strategy has been unfolding, one that will extend beyond automotive supply chain needs. In September of last year, Tesla selected a site within the state of Nevada, just outside of Reno. Thus far, the steel structure and roof of the new factory have been completed. Tesla has partnered with Japan based Panasonic to assist in the setup of production processes within the new gigafactory. By autumn, Panasonic will dispatch hundreds of its employees to Nevada to assist in the plant internal design and setup.
In June, Tesla entered into a research partnership with a noted professor at Dalhousie University in Nova Scotia, known for his work in innovating lithium-ion batteries. The goal of this research partnership is to determine methods to incorporate more voltage as well as less cost of materials within batteries without eroding their longevity. According to a published report, Tesla is further investigating its own sourcing and processing of lithium, cobalt, graphite and nickel.
This week featured news indicating that Tesla has now increased its land holdings surrounding the new plant, purchasing an additional 2000 acres. The land purchases reportedly occurred during April and May with the majority of the land, according to Tesla, serving as a buffer zone in which solar arrays are to be constructed to provide internal power to the new factory.
According to a published report from The Wall Street Journal, battery cells will begin to roll-off production lines by the end of 2016, with plans for additional phased ramp-ups extending through the year 2020. Once more, up to 25 percent of the new plant’s capacity is expected to be allocated for production of static storage battery needs for homes, businesses and utilities. Tesla recently unveiled a new line of home storage batteries and the firm’s iconic founder, Elon Musk recently indicated that there has been positive interest from other industries in exploring potential battery supply agreements.
Tesla’s corporate culture of thinking big continues to extend across the supply chain and the new gigafactory will be the most significant testament to that boldness in supply chain vertical integration.
For added information regarding this new factory, readers can review Tesla’s conceptual design.
In 2012, The Economist described the dawn of the Third Industrial Revolution, an era that would feature the digitization of manufacturing and the use of new, stronger and more innovative composite materials. And indeed, that trend continues at a rapid pace. Competing in this new era requires manufacturers to invest in new technologies that can provide both product as well as process innovation. General Electric, through its GE Reports series, recently highlighted its billion dollar bet on ceramic super material as a basis of product innovation.
Ceramics has been utilized for many years for certain power and electrical based applications mostly used in kitchen appliances. A visionary GE engineer however, believed that ceramics, which can withstand higher heat than even the most advanced alloys, could be the perfect material for jet engines and other machines that burn fuel and must handle enormous temperatures. Nearly 30 years later, along with nearly $1billion in research investment, components made from ceramic matrix composites (CMC’s) are being incorporated in the next generation of aircraft engines such as CFM International’s LEAP model that will power the upcoming Airbus A320 neo (new engine option) aircraft. The concept of a new and highly more fuel efficient upgrade of the A320, with a shorter new product development time, was prompted by these newer innovations in aircraft engine technologies.
According to the GE report, unlike other alloys, CMC components weigh one-third the weight of metal and do not need to be air-cooled. A GE Research leader indicates: “CMC’s allow for revolutionary change in jet engine design.” This was a tremendous bet on innovation. Now, aerospace, military and industrial customers may soon experience aircraft, helicopters and industrial turbines made from more CMC material based components providing lighter weight higher performance and operational savings.
However, not all suppliers have the deep pockets of global-based manufacturer such as GE. Suppliers that currently exist in commercial aerospace supply chains experience constant cost-control pressures from respective aerospace producers seeking to improve product margins or overcome prior expensive aircraft program delays. Even now, as both Airbus and Boeing are planning for significant production volume ramp-up, there still remains the perspective of who pays for innovation, and who reaps the overall benefit.
So what is the key difference for GE and its joint partners, Italian based Turbocoating, France based Snecma. That difference is that airlines negotiate and contract for aircraft engines directly with engine manufacturers. These manufacturers can translate investments in innovation to bottom line financial outcomes. CFM International has thus far booked orders for 9550 LEAP engines valued at $134 billion at list prices. The margins achieved from this amount of orders are under the direct control of the aircraft engine manufacturers themselves, a benefit that the majority of other aerospace suppliers do not have.
From our lens, the takeaway is twofold. Manufacturers ultimately own the responsibility for overall product design innovation. It is not a task delegated to key suppliers without joint compensation. Several years ago, the industry embarked on a strategy of de-centralized innovation and cost-sharing, one that required key component suppliers to innovate in product and process dimensions but not necessarily harvest the benefits from longer-term production volumes. Principle aircraft manufacturers are investing heavily in final assembly process and test automation, yet seek to offset program costs within other areas of the supply chain.
Much continues to be written on the lessons learned by that strategy, particularly those related to design and cost implications. Now, as the industry faces its toughest test in terms of supply chain ramp-up, suppliers seek due compensation for their innovation efforts. Suppliers must also answer to investors who have a shorter-term horizon.
The Third Industrial Revolution will continue to lead to breakthroughs in many dimensions, and to a new breed of more agile, market responsive manufacturers. The notions of who owns and who is rewarded for innovation will be front and center in this race to the top and will lead to a return to vertical integration supply based strategies.
The manufacturing leaders of tomorrow will be those that master the risk and reward dimensions of product and process innovation.
Continuing with our Friday theme of information technology developments related to supply chain manufacturing and product management, Supply Chain Matters calls reader attention to what we believe are two recent noteworthy tech announcements with broader implications.
Cisco IoT System Annoucement
Earlier this month, Cisco announced its offering of an Internet of Things (IoT) technology platform targeted to support large-scale industrial networks. The announcement was somewhat unique in that this new Cisco IoT system includes a technology architecture consisting of six technology pillars and the technology providers Fog Computing System. The announced system further includes 15 new IoT focused products within these respective pillars, addressing support in areas of network connectivity, physical security, data analytics and overall data management.
The broader implication of the Cisco announcement relates to specific IoT industry vertical support and key strategic partners. Partners such as General Electric, OSISoft and Toshiba, among others, are porting their respective IoT applications to run on the Fog Computing network.
Perhaps the most significant partnership is that related to GE and that equipment manufacturer’s strategies related to its industrial Internet ecosystem of partnerships and its own Predix equipment intelligence platform. The GE and Cisco relationship has a focus to extend industry focused collaboration that includes oil and gas, transportation, healthcare and power generation industry sectors. This happen to be key industry verticals for the most promising IoT business focused applications.
GE has other key technology partners that include Amazon Web Services, AT&T and Intel. However, from our lens, the latest Cisco IoT System announcement provides evidence of Cisco’s commitment to provide turn-key technology components and provide added influence with GE and other Cisco industry and IT system integration partners.
Cisco obviously wants to be a power player in IoT.
Thin Film to Unveil Smart Wine Bottle
Thin Film Electronics announced a partnership with G World Group to undertake a trail of what is claimed as the first “smart wine bottle” utilizing printed electronics label technology.
Supply Chain Matters called prior reader attention to Thin Film’s application of a printed electronics label applied to premium liquor bottles for Diageo. This latest announcement provides added application of this technology for premium wines and opens further opportunities to combat or defeat counterfeiting of specific products.
The latest announcement indicates that G World and Thin Film will execute a field trail in collaboration with Fermgrove Wine Group, a Western Australia premium wine company. Fermgrove, owned bt the Chinese food group Pegasus, is a supplier of five-star premium wine in the Asia-Pacific region and exports more than 600,000 bottles of wine annually to China. Since counterfeit wine is pervasive throughout Asia, the new labeling technology will be tested to provide product authenticity as well as supply chain visibility.
G World has placed what is termed as a 7 figure unit order for Thin Film’s NFC Open Sense tags which leverage near field communications technology to authenticate the track products and detect the product’s sealed or open status. As noted in our previous commentary related to Thin Film’s smart label technology applied to Johnnie Walker Blue Label® bottles, the tags remain active after the factory seal is broken, allowing the brand to extend dialogue or strengthen relationships with customers through customer relationship management focused programs.
Once again, this singular smart label trial opens-up the possibilities among multiple supply chain related business process and/or brand marketing loyalty use cases. The reading or sensing of the label can be accomplished with NFC enabled devices, such as smartphones or other mobile devices, which opens up further opportunities to be able to leverage such capabilities without the addition of more expensive infrastructure or proprietary networking or label reading technologies as was the case with the initial phases of RFID labels. Thus far, there have been trials conducted within pharmaceutical, fresh produce and premium beverage use cases. We may well witness the commercial introduction of this new item-level tracking technology in the not too distant future.
Technology marches on.
The Wall Street Journal, citing informed supplier-based sources, reports that Apple is planning for a larger initial production run of the next iteration of iPhones. According to the report, Apple is requesting suppliers to support between 85 million and 95 million iPhones for the all-important end-of-year holiday buying season that ends at the end of December, despite expected modest hardware changes.
Last year, Apple planned its supply chain output for a range of 70-80 million phones, and actually shipped 74.5 million smartphones during the holiday quarter. That was a 45 percent increase from the year ago holiday surge quarter. The iPhone6 incurred its own set of production ramp-up challenges including a last-minute design change involving its larger screen displays. There was the usual production yield challenges associated with the fingerprint scanner and with the LCD displays. During its most recent fiscal quarter, Apple shipped 61.2 iPhones, fueled primarily by emerging market demand primarily from China, Hong Kong and Taiwan.
The WSJ indicates that hardware changes are expected to be less noticeable and that Apple is in-essence betting that consumers will flock to upgrade their existing iPhones. Display sizes and screen resolution are expected to be unchanged.
Further reported is that contract manufacturer Hon Hai Precision (Foxconn) is in the process of hiring additional workers for its Zhengzhou China facility, in anticipation of beginning volume production starting in August.
The report confirms that a third contract manufacturer, Taiwan based Wistron Corp. will supplement production needs this year. In an April Supply Chain Matters commentary, we echoed a published report from Taiwan based Digitimes indicating 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 indicated 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.
As noted in many of our past commentaries, the ability of the Apple supply chain to support steep new product introduction ramp-ups is predicated on active supplier risk management coupled with supply chain segmentation strategies focused on product margin and profitability goals.
The next test comes in the next five months.
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.