It’s the biggest company in the world. It has cash reserves that put small nations to shame. It has social kudos and has sat firmly in the zeitgeist of the last two decades. But with shifting geopolitics and supply chain concerns, has Apple backed itself into a corner in China?
How healthy is Apple today?
Apple clearly did well over the pandemic and appears to have come out stronger than many rivals. Revenue has increased almost twofold since 2019. Its financial results for the quarter ended December 31, 2022 showed quarterly revenue of $117.2 billion. However, that is down 5 percent year-on-year. Significantly, this is only its second revenue miss since August 2017.
Tim Cook, Apple’s CEO, said, “As we all continue to navigate a challenging environment, we are proud to have our best line up of products and services ever, and as always, we remain focused on the long term and are leading with our values in everything we do.” In the same report, Luca Maestri, Apple’s CFO, commented, “We set an all-time revenue record of $20.8 billion in our Services business, and in spite of a difficult macroeconomic environment and significant supply constraints, we grew total company revenue on a constant currency basis.”
Services are clearly a growing and important category for the company. Indeed, Apple continues to expand its offerings and has recently announced new financial services in the US. Its long-anticipated buy now, pay later programme launched at the end of March in a challenge to incumbents including Klarna and Affirm. And in April it launched a new savings account with Goldman Sachs yielding 4.15 per cent a year.
However, it is the “significant supply constraints” mentioned by Maestri that are causing jitters. And not without warrant. Digging down into the report, there are two key lines that market-watchers should be interested in: China and iPhones.
What is Apple’s China problem?
Under the direction of Cook (first as COO, then CEO), over the last 25 years Apple has developed a supply and manufacturing chain of astounding complexity and cost in China. More than 95 per cent of iPhones, AirPods, Macs, and iPads are made in the country. This has undoubtedly been integral to its growth. It has also left the company exposed to market headwinds today. With international relations souring, and unlikely to improve for years, Apple is facing political, investor, and strategic pressure to dramatically cut its dependence on China.
On the political front, one need only look to recent comments in the US to appreciate the level of antagonism. Republican Senator Josh Hawley recently said, “When the communists in Beijing tell Apple to jump, it asks, ‘How high?’”
Shifting Supply Chains
In the face of growing geopolitical tensions, many businesses have already started to shift supply chains away from China. Samsung relocated the production of its televisions and smartphones to Vietnam in 2019. Similarly, Google and Microsoft have transferred some of their production to nearby countries. Dell now has operations in the US, Malaysia, Brazil, India, Poland, and Ireland. And Apple is not solely reliant on China. Production is moving to Vietnam for AirPods and Mac assembly, Malaysia for some Mac production, and Ireland for the relatively easy-to-produce iMacs and a range of simpler products.
The company is also looking at shifting semiconductor production away from Taiwan. A new plant in Arizona is due to start (very small numbers) next year. However, the technical complexity of chip production makes this risky and severely limits options moving forward. Given the potential for conflict in Taiwan this could also be one the most critical flashpoints for Apple. According to a recent Bloomberg report, one person with knowledge of its operations predicts that if chip production there went down, it would take almost a year to ramp component production back up.
The biggest push though, is into India where plans are afoot for increased iPhone and accessory production. And herein lies another potential issue which again highlights Apple’s “China problem.” In 2012, some iPhone models were produced in Brazil to avoid import tariffs. And in 2013, following domestic political pressures, Apple began making Mac Pro computers at a factory in Texas. Neither project went well. The question is, why?
Why can’t Apple move so easily?
Apple’s manufacturing operations in China go beyond anything other companies do. Years have been dedicated to creating an all-encompassing ecosystem that was developed through rigorous and lengthy on-the-ground input from Apple engineers. Massive resources were piled into procuring machinery. Technical knowhow and capabilities were taught by visiting US Apple engineers. Its biggest plant is the size of a small city. And none of this can be easily lifted and replicated elsewhere. So, is it really possible to move a sizeable chunk of production to India?
In 2022, Apple manufactured over 6.5 million iPhones in India (out of a global total of 200 million). Its goal for 2023 is to increase production there to 10 million units. According to insiders, the figure may surpass 15 million the following year, and if it adheres to the most ambitious timetable, it could transfer up to 25% of iPhone production to India by 2025. Preliminary talks about shifting production of iPad and Apple Watch too are said to be on-going. However, all this production has been of lower-end models. The premium handsets, like the semiconductor chips, are still beyond the capabilities of pretty much anywhere that isn’t the current plants in China. And it took 25 years to invest in and build up that capability.
Clearly, diversifying its supply chain and manufacturing base makes good business sense for Apple. This is especially true of iPhones. When a Covid 19 lockdown in China saw Apple’s biggest manufacturing centre, in Zhengzhou, drastically reduced in capacity, the ripple effect was immediate. Delays in the iPhone 14 hitting shelves across the globe hit sales and angered customers. It also exposed the grim working conditions of 200,000 Chinese workers. So, one plant affected has the potential to disrupt the lion’s share of its revenue, cause international consternation from consumers, and provoke political tensions back home…
Why are iPhones so important?
In Apple’s last quarterly report, iPhones accounted for nearly $66 billion in revenue. That represents a staggering 56% of net sales. And according to research from Counter Point, the almost $24 bn of sales in China was mainly down to iPhone sales – Apple sold the top 3 most popular handsets in the country in 2022.
In India, Apple’s sales are on an upward trend, growing by close to 50% from $4.1 billion to almost $6 billion in the year to April. It currently has around a 5% market share. Apple hopes that by moving production within the country, a 20% import duty can be avoided. This would allow it to lower costs at the same time as it profile increases. And in April, Cook himself attended the inauguration of its first physical store in an upmarket business district of Mumbai.
Growth projection by EY for India estimates its economy will reach a GDP size of US$26 trillion (in market exchange terms) by 2047. Per capita income is expected to increase to US$15,000, putting the country among the ranks of developed economies. The potential for Apple to shift units is there – but 2047 is a long way off. By way of comparison with the last 10 years, Chinese GDP per capita grew from $7,020 in 2013 to $12,556 in 2021. In India, that same period saw growth from $1,438 to $2,257. Both as a relative percentage and actual amounts, the numbers speak for themselves.
What does this mean for Apple?
There is also Apple’s wider public profile to consider across the West. While the world may be divided over China and the sense of direction it is going in, Western consumers are increasingly alert to where their goods come from. The recent Covid lockdown of Foxconn in China shone a light on Apple’s business there. Exploitative practices breed bad publicity. In this light, one has to consider the impact of Apple and Foxconn lobbying for the relaxation of labour laws in the Indian state of Karnataka. Yes, this opens the door to competing more effectively against Chinese dominance in manufacturing – but at what cost?
Simultaneously, China itself needs to be kept onboard. Apple has been allowed to grow and indeed flourish there, in stark contrast to other tech competitors. But again, at what cost? And as it moves production to new geographies, will China retaliate and make life more difficult, potentially impacting on nearly 20% of current revenue streams?
Apple’s next quarterly results are expected on 4 May. The company has the cash reserves to weather the storms ahead and invest intelligently as it has done in the past. But could geopolitics and supply chain issues cause so much disruption that none of that matters?
Author: Mike Davies
#Apple #Tech #China #India