From ‘Apple’ to ‘Foxconn’ - Is Moving Operation to China Strategically Correct?
Posted in Operations & IT Articles, Total Reads: 3112
, Published on 02 January 2014
Most of the manufacturing companies give high importance to cost efficiency in China. China is getting efficient day by day and operating cost in China is reducing constantly. Yes, why not!!! China has a pool of low cost labors which play a major role in any of the manufacturing industry and they (labors) are continuously migrating from their coastal area to development zone in the hope of to uplift their livelihood. The major part in cost of manufacturing has always been wages for labors, managers, engineers, workers making process machinery etc. The western countries might be the finest in their lean system but cost of production in either China or India has always been lower. So do they really need to relocate their manufacturing from their homeland to other cheap labor countries?
Many managers overlook to consider the hidden cost behind this relocation and think only about the short term gain (because some of the latter costs are harder to calculate and they are sometimes very large). A report from AMR in 2012 suggested that 56% of companies outsourcing their production to other countries faced problem of increase in cost against their expectation of cost saving. Common saving are visible and immediate but the hidden cost, both direct and indirect, comes in to the picture later on. The companies who are facing these problems are now coming to know more about the hidden direct cost. If the workers in lower economies are less productive they need to hire more to compensate the same task or if the employees are not efficient they will end up using more raw materials which will again cost them much. Some of the indirect cost includes extra supervision and training, more local security which increases as time goes on. The direct and indirect costs, both increase continuously sometimes drastically. The wage inflation in most of the emerging economies frustrated those managers who thought that they would be enjoying by saving the labor cost. From 2006 to 2011 the wages of average Shanghai line production manager increased by 125% while middle management salary wages increased in India by 13% in 2011 alone. The high rate of personnel turnover (Either in China or India) leads to lowering the productivity and raising the hiring and training cost.
Apple decision to handover the manufacturing to Foxconn, how effective is that decision? Apple, in 1984, made a huge mistake by setting up factory in Fermont, California which was closed after two years. They installed huge capacity for higher production of their original Macintosh. The company was not flexible enough to handle fluctuating volume and product mix. They did not consider the rapid changes in technology and the low life cycle of technical gazettes. For their new product mix (i-Pad, i-Phone, i-Pod, Kindle, PlayStation etc) they made contract with Foxconn keeping in mind their key manufacturing tasks as flexibility, quality and cost which Foxconn delivers excellently. Foxconn uses long assembly line with little automation and having a very small work time for each process like Henry Ford did 90 years ago. Each employee does a small and repetitive task again and again. For product mix, Toyota suggests that you must have skilled and motivated people to work on assembly line but Foxconn uses a different approach. The lines are simple and they have modular equipment which makes very easy to rearrange the line and make separate line for each product which makes them flexible. The costs are really low because they hire low skilled labor and ask them to do a small and repetitive task which does not cost them too much in training. Quality is highly taken care by Foxconn, particularly problem related to ESD (Electrostatic discharge).
Although Apple is getting benefitted in every aspect but Apple is really ignoring the hidden cost of Currency risk, Country risk, and Connectivity risk. Being an autocratic country, the Chinese Yuan are “substantially undervalued” as per IMF and a movement towards valuing the Yuan can drastically harm the profitability of Apple. Apple also pays a high cost for transporting its product (raw material from US to China and then the final product from China to US).
Till when Apple would enjoy the benefit from low labor economic world? One day Foxconn will face same challenge which Ford has faced in 1930 after initial success. China will grow and become prosperous which will filter down the labor force. As opportunities for new generation will increase, China will be not able to address the issue. This will increase collective bargaining, change in working condition and higher wages. In this condition, Foxconn would not be able to deliver the same flexibly and costs which will make Apple bleed.
Americans can build Boeings and BMWs and so they can certainly build i-pad but the question here is not that whether they can make products in US but whether they should? US is making huge money in short term by selling expensive products build on low cost. In reality, it is letting go all the technology and basically losing its own competitive advantage. US is creating a situation where it is losing its expertise in making electronics component. The situation will be worsening if it fails to generate employment to engineers, how will it survive in this dynamically changing world economy?
This article has been authored by Sandeep Agrahari fom SIBM Bangalore
• Book: The Toyota way by J. K. Liker
• Book: The Black Book of Outsourcing by Douglas Brown, Scott Wilson
• Article: Apple Shifts Supply Chain Away From Foxconn to Pegatron by Eva Dou, WSJ, 30 may 2013
• Case study: http://www.cabrillo.edu/~cclose/docs/Case%20Study%20Sp12%20-%20Mill.pdf
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