The end of Apple’s romance with China

The end of Apple’s romance with China

On a dusty stretch of the deafening highway from Chennai to Bangalore stand three colossal anonymous buildings. Inside, away from traffic noise, is a high-tech facility operated by Foxconn, a Taiwanese manufacturer. A short drive away, Pegatron, another Taiwanese tech company, has built a large factory of its own. Salcomp, a Finnish device manufacturer, has installed one not far away. Further west is a 500-acre campus run by Tata, an Indian conglomerate. What these closely guarded facilities have in common is their client: a secretive and demanding American company known locally as “the fruit company.”

The proliferation of factories in South India marks a new chapter for the world’s largest technology company. AppleThe extraordinary success of the past two decades (70x revenue, 600x share price, $2.4 trillion market value) is in part the result of a big bet on China. Apple opted for factories based in China, which now produce more than 90% of its products, and appealed to Chinese consumers, who in some years contributed as much as a quarter of Apple’s revenue. However, economic and geopolitical changes are forcing the company to initiate a hasty decoupling. Its move away from China marks a big shift for Apple and is emblematic of an even bigger one for the global economy.

Apple’s packaging proclaims “Designed by Apple in California,” but its devices are assembled along a supply chain that stretches from Amazon 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 CEO in 2011, pioneered the company’s approach to contract manufacturing. A regular visitor to PorcelainCook has maintained good relations with the Chinese government, obeying its requirements to remove apps and keep Chinese user data local, where it is available to authorities.

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

The two countries are the main beneficiaries of Apple’s strategic change. In 2017, Apple listed 18 major vendors in India and Vietnam; last year it had 37. In September, with 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 newest devices show how things are going. Nearly half of its AirPods are made in Vietnam and by 2025 two-thirds will be, JPMorgan Chase predicts. The bank calculates that, while today less than 5% of Apple products are manufactured outside of China, in 2025 the figure will be 25% (see figure 1).

As Apple’s production system is changing, its suppliers are also diversifying outside of China. A rough measure of this is the proportion of long-term assets that Taiwanese technology and electronics companies have located in China. In 2017 the average figure was 43%. Last year it had fallen to 31%, according to our estimates using company and Bloomberg data.

The most pressing reason for the fight is the need to spread operational risk. Two decades ago, the garment industry stepped up operations outside of China after the SARS epidemic paralyzed supply chains. “Sars made it very clear to everyone operating in China that a ‘China+1’ strategy was needed,” says Dominic Scriven of Dragon Capital, a Vietnam-based investment firm. Covid taught tech companies the same lesson. Closures in Shanghai in the first half of this year temporarily shut down a factory operated by Quanta, a Taiwanese company, which was believed to make most of Apple’s MacBooks. Customers had to wait months. Avoiding this kind of chaos is the “primary driving force” of Apple’s supply chain moves, according to JPMorgan Chase’s Gokul Hariharan.

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

Apple is also increasingly looking to locals as potential customers, particularly in India, the world’s second-largest market for smartphones. Apple devices are too expensive for most Indians, but that is changing. In July, Apple reported that its revenue in India had nearly doubled in the latest quarter, year over year, fueled by the “engine” of iPhone sales.

This is diminishing 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, their share has steadily declined, to 19% so far this fiscal year (see chart 2). From the looks of it, Xi Jinping, the president of China, would like to see it fall further. At a Communist Party party on Oct. 16, he urged “self-reliance and strength in science and technology,” suggesting that foreign importers may face tougher competition from Chinese domestic champions. He repeated the phrase five times.

This points to the last, but potentially the most important, reason for Apple’s change: geopolitics. Rising tensions between China and the United States have made China an increasingly uncomfortable place to do business. Increased Chinese political sensitivity has added to friction on many fronts. This summer, for example, Apple reportedly had to ask Taiwanese manufacturers to label their products “Made in Chinese Taipei” to appease newly finicky Chinese customs officials (at the risk of angering Taiwanese).

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

The question is whether physically moving production out of China will be enough to prevent future crackdowns. Although Apple makes more devices outside of China, it relies no less on Chinese-owned companies to make them. Chinese manufacturers like Luxshare, Goertek and Wingtech are taking a growing share of Apple’s business beyond China’s borders.

Luxshare and Goertek are reportedly making AirPods in Vietnam, helped by the fact that some Taiwanese rivals, such as Inventec, have scaled back their work for Apple in recent years. Indian media reported in September that the Indian government may allow some Chinese companies to set up production facilities in India. Chinese companies’ share of iPhone electronics production will rise from 7% this year to 24% by 2025, believes JPMorgan Chase, which predicts that in the next three years Chinese companies will increase their share of production of the entire iPhone. Apple product range.

Could Chinese manufacturers outside of China be subject to US sanctions? For now this is unlikely, believes Nana Li of Impax, an asset manager. “There is no practical alternative [suppliers] available with the same level of expertise, efficiency, and profitability,” so removing them would hurt U.S. companies, he says. Over time, that could change. Countries like India and Vietnam are willing to build their own providers. Tata is reportedly in talks with Wistron, a Taiwanese manufacturer, about manufacturing iPhones in India. Indian manufacturers report that “the fruit company” is quietly hunting for local suppliers.

Given the direction of US-China relations, it’s surely wise for Apple to make some side bets, before the restrictions go any further. Chinese companies outside of China are safe for now, says a Western investor in Asia. But “the rope tightens”.

© 2022 The Economist Newspaper Limited. All rights reserved.

From The Economist, published under license. The original content can be found at https://www.economist.com/business/2022/10/24/the-end-of-apples-affair-with-china

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