The end of Apple’s deal with China

On a dusty stretch of the deafening road from Chennai to Bangalore are three colossal and anonymous buildings. Inside, away from the din of traffic, is a high-tech facility operated by Foxconn, a Taiwanese manufacturer. A short drive away, Pegatron, another Taiwanese tech company, has erected its own vast new factory. Salcomp, a Finnish gadget maker, installed one nearby. Further west is a 500-acre campus run by Tata, an Indian conglomerate. What these jealously guarded facilities have in common is their client: a demanding and secretive American firm known locally as “the fruit company”.

The proliferation of factories in southern India marks a new chapter for the world’s largest technology company. Apple’s extraordinary success over the past two decades – revenue up 70 times, share price up 600 times, market value $2.4 billion – is in part the result of a big bet on China. Apple has banked on China-based factories, which now make more than 90% of its products, and courted Chinese consumers, who in some years have contributed up to a quarter of Apple’s revenue. However, economic and geopolitical changes are forcing the company to embark on a hasty decoupling. Its hijacking of China marks a big shift for Apple, and is emblematic of an even bigger shift for the global economy.

Apple’s packaging proclaims “Designed by Apple in California,” but its gadgets are assembled along a supply chain that stretches from Amazonas to Zhejiang. At the center is China, where 150 of Apple’s largest suppliers operate production facilities. Tim Cook, who was Apple’s chief operating officer before becoming chief executive in 2011, pioneered the company’s approach to contract manufacturing. A regular visitor to China, Cook has maintained a good relationship with the Chinese government, obeying its requirements to remove apps and keep Chinese user data locally where it is available to authorities.

Now a change is afoot. Mr Cook, who has not been seen in China since 2019, is courting new partners. In May, he received Vietnamese Prime Minister Pham Minh Chinh at Apple’s futuristic headquarters in Cupertino. Next year, Apple is set to open its first physical store in India (where Prime Minister Narendra Modi is a fan of gold iPhones).

Both countries are the main beneficiaries of Apple’s strategic shift. In 2017, Apple listed 18 major vendors in India and Vietnam; last year it had 37. In September, to much local fanfare, Apple began manufacturing its new iPhone 14 in India, where it previously only made older models. The previous month, it was reported that Apple would soon start manufacturing its MacBook laptops in Vietnam. Some of Apple’s new gadgets show how things are done. Nearly half of its AirPods are made in Vietnam and by 2025, two-thirds will be, JPMorgan Chase predicts. The bank estimates that while today less than 5% of Apple’s products are made outside of China, by 2025 that figure will be 25% (see Chart 1).

As Apple’s production system evolves, its suppliers are also diversifying outside of China. A crude measure of this is the share of long-lived assets that Taiwanese tech hardware and electronics companies have located in China. In 2017, the average figure was 43%. Last year, that number had fallen to 31%, according to our estimates based on company and Bloomberg data.

The most pressing reason for the scramble is the need to spread operational risk. Two decades ago, the garment industry ramped up operations outside China following the SARS outbreak, which crippled supply chains. “sars has made it clear to everyone operating in China that there needs to be a ‘China+1’ strategy,” says Dominic Scriven of Dragon Capital, a Vietnam-based investment firm. Covid has taught the same lesson to tech companies. Lockdowns in Shanghai in the first half of this year temporarily closed a factory operated by Quanta, a Taiwanese company, which was supposed to make most of Apple’s MacBooks. Customers had to wait months. According to JPMorgan Chase’s Gokul Hariharan, avoiding this kind of chaos is the “main driving force” of Apple’s supply chain moves.

Another motive is cost containment. Average salaries in China have doubled over the past decade. In 2020, a Chinese manufacturing worker typically earned $530 a month, about twice as much as a worker in India or Vietnam, according to a survey by JETRO, a Japanese industry body. India’s heavy infrastructure, with poor roads and an unreliable power grid, has held it back. But it got better and the Indian government sweetened the deal with subsidies. Vietnam also offers tax breaks and holidays, as well as free trade agreements, including one recently signed with the European Union. Bureaucracy around visas and customs remains a pain. But the work ethic is similar to China’s: “Confucius always gets them out of bed in the morning,” says a foreign executive in Vietnam.

Apple is also increasingly considering locals as potential customers, especially in India, the world’s second-largest market for smartphones. Apple’s gadgets are too expensive for most Indians, but that’s changing. In July, Apple announced that its revenue in India had almost doubled in the last quarter, year-on-year, driven by the “engine” of iPhone sales.

This diminishes the relative importance of China as a consumer market. At its peak in 2015, China accounted for 25% of Apple’s annual revenue, more than all of Europe. Since then, its share has steadily declined, reaching 19% so far this fiscal year (see Chart 2). At the sound of it, Xi Jinping, the Chinese president, would like him to fall more. During a Communist Party shindig on Oct. 16, he called for “self-reliance and strength in science and technology,” suggesting foreign importers may face stiffer competition from domestic champions Chinese. He repeated the phrase five times.

This highlights the final, but potentially most important, reason for Apple’s change: geopolitics. Growing tensions between China and America have made China an increasingly difficult place to do business. Heightened Chinese political sensitivity has added friction on many fronts. This summer, for example, Apple should have asked Taiwanese manufacturers to label their products “Made in Chinese Taipei” to appease the new fussy Chinese customs (at the risk of angering the Taiwanese).

America, for its part, has become more aggressive in its competition with China’s domestic tech industry. On October 7, America announced a ban on “us” from working for certain Chinese chipmakers. On the same day, he added 30 Chinese companies to a list of “unverified” companies that his officials had been unable to inspect. Apple has reportedly been close to signing a deal to buy iPhone memory chips from one such company, ymtc, which can offer low prices thanks in part to a Chinese government subsidy. Following US export controls, that deal was frozen, according to Nikkei, a Japanese newspaper.

The question is whether physically moving production out of China will be enough to avoid future crackdowns. Even though Apple manufactures more of its gadgets outside of China, it still depends on Chinese companies to build them. Chinese manufacturers such as Luxshare, Goertek and Wingtech are taking an increasing share of Apple’s business beyond China’s borders.

Luxshare and Goertek are said to manufacture AirPods in Vietnam, helped by the fact that some Taiwanese rivals, such as Inventec, have reduced their work for Apple in recent years. Indian media reported in September that the Indian government may allow some Chinese companies to establish production facilities in India. Chinese companies’ share of iPhone electronics production will rise from 7% this year to 24% by 2025, estimates JPMorgan Chase, which predicts that over the next three years Chinese companies will increase their production share in the Apple product line.

Could Chinese manufacturers outside of China be targeted by US sanctions? For now, that is unlikely, said Nana Li of Impax, an asset manager. “There is no practical alternative [suppliers] available with the same level of experience, efficiency and profitability,” so cutting them would hurt American businesses, she points out. Over time, this could change. Countries like India and Vietnam want to develop their own suppliers. Tata is said to be in talks with Wistron, a Taiwanese manufacturer, to manufacture iPhones in India. Indian manufacturers report that the “fruit company” is quietly looking for local suppliers.

Given the direction of America’s relationship with China, it certainly makes sense for Apple to make some side bets, before the restrictions go any further. Chinese companies outside China are safe for now, says Western investor in Asia. But “the noose is tightening”.

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