The attention given to Foxconn (OTCPK:FXCNY) over the past several years has largely concentrated on its role as Apple's leading supplier in Asia. What we have missed in all of that juicy coverage, however, is the longer-term picture. While it is tempting to believe that Apple will always be strong, that it will always rely on offshore outsourcing for its production, and that Foxconn will be content to play Sancho Panza to its client brands, there are several factors that suggest otherwise. In fact, in as little as a decade from now, Foxconn may itself be a global brand.
Hon Hai Precision built its business as a supplier to the world's computer and consumer electronics brands. Most of us still see the company a contract manufacturer, an assembler of devices and machines. Yet over the past seven years, the company has quietly added to its capabilities to the point where it is one step away from becoming a fully integrated brand-name electronics company.
Making Nice with Consumers
First, it added a name people outside of Asia could recognize as a brand - Foxconn. You could argue that the brand is tarnished, but the one thing it still has going for it is recognition. Think Oscar Wilde: the company has been talked about a lot, and despite the bad press (much of which has landed on Apple), the scale of the brand recognition alone - and the cost of building recognition for a new brand - might tempt the company to stick with it. If not, building a new brand would be a relatively modest investment for the $25 billion company.
Next, Foxconn began experimenting with selling to consumers with a line of branded high-performance computer components. Even though the target was small - gamers, pro-sumers and specialty computer builders - it gave the company a glimpse of what would be required in a wider consumer marketing program. As a part of this experiment, Foxconn then built the rudiments to of a customer support network, again, providing the company a gut-level understanding of what would be involved in supporting a global consumer effort.
Steel Goes In, Cars Come Out
Equally, if not more important, the company slowly built out a vertically-integrated manufacturing capability. The original thinking was to offer customers faster time-to-market while controlling for costs and capricious upstream suppliers - the latter a perpetual, frequently overlooked headache in China. The company began making its own cases, then its own electronic components. Next, it added product design and development and even the basics of a research capability. As of 2006, the company had over a dozen R&D centers worldwide, and 30,000 patents either granted or pending.
To control the variables in supply chain, it built in a logistics and supply chain management team that focused on keeping customer inventory costs low and prepared it to work with the largest retailers in the world, and built a channel sales organization to support the sale of its own branded components and as an extra spiff to smaller customers.
All told, Foxconn could probably start experimenting with selling its own branded consumer products in a matter of months once it made the decision to go ahead.
Gnawing on the Hand that Feeds
The perceptive reader will ask "why?" Why would Foxconn risk upsetting the Apple-cart, risking the custom of the very companies that put it where it is today? There are several answers to that question, none of which alone would be sufficient to make Foxconn take the leap. Taken together, however, they form a compelling case.
First is profit pressure. Foxconn is probably at the point in its development where it has squeezed as much as it can out of its costs, and costs are rising. Inputs aren't getting cheaper, labor is getting more expensive, and the company faces a major investment in automation, not to mention the additional expenditures every time Apple (NASDAQ:AAPL) or HP (NYSE:HPQ) needs to offer something newer, cooler, and harder to make. Cost pressures on customers, even Apple, remain acute, so Foxconn is unlikely to see much relief from that front. The only way to turn the profit equation around is to start going around its weakest customers directly to retail.
Second, many of Foxconn's customers - HP being a prime example - are facing headwinds of their own. The computer industry has matured, people aren't replacing devices as often, and the field is starting to narrow to two or three industry leaders far ahead of everyone else. The opportunity to find a tempting niche and then burst in to exploit it will grow, especially as Lenovo starts to expand its market share. If Lenovo can do it, Gou will reason, so can we.
Even Apple is not immune to headwinds, and if there is one thing that must keep Gou awake at night, it is his growing dependence on this single customer and the decisions made by its leadership team. And if that company starts making strategic errors and the numbers begin to fall, Foxconn needs a Plan B. What is that Plan B? Samsung? Probably not.
Third, for all of the advantage of working from behind the screen, Foxconn's fortunes are almost entirely beyond its control, resting in the hands of distant executives making decisions that are none of Foxconn's business. Don't underestimate the degree to which this frustrates not only Gou, but every Chinese contract manufacturer who ever dealt with an importer. Your can only grow as quickly or consistently as your customer lets you. Again, if the customers start blowing it, the urge to give up and go around them becomes overwhelming.
At the same time, Foxconn's customers are arguably as locked in to Foxconn as they are to it. For reasons of speed (time to market) and scale (time to ramp up volume), customers don't have many choices. Short of the most grievous provocation, few could afford to walk away from Foxconn.
How It Will Go Down
For all of these reasons, Foxconn's move would have to come under circumstances where it could credibly say to its customers that it had no other choice.
There would need to be a trigger event, the three most likely being that a major customer either goes under, stumbles badly, or takes back production. At this point, Foxconn's continued growth (if not its survival, if the stumbler is Apple), would be at risk, and Foxconn would need to respond.
Foxconn would likely use a production facility with idle capacity to produce products that it could credibly say did not threaten a current customer (say, Apple), and that possibly was aimed at weakening the grip of a rival on its market share. If Foxconn could make a case that it was going after Samsung (OTC:SSNLF) or LG, for example, Apple's objections would likely be few. Foxconn could even offer to forge an entirely new brand and build new factories so that the new venture was plausibly firewalled from customer business.
To be sure, the company needs to fix its reputation and build a global marketing capability. The former is underway in earnest: the company has hired PR counsel (not yours truly) to fix the reputation and to lay the foundations of a global branding and marketing effort. It has also built a worldwide sales force that could be expanded quickly to forge the relationships with retailers that it would need to get shelf space in stores.
But make no mistake that Foxconn's breakout is both plausible and, given the history of business, inevitable. The timing will be soon - Terry Gou is no longer young, and he would want the transition to global brand to at least begin under his watch, and arguably it will either happen under Gou or it will never happen.
If Foxconn could pull it off, however, the company would have a shot at a long-term future free of dependency on other companies, and set up to compete against Samsung, Lenovo, Huawei, and - if it so wished - Apple.
Watch carefully. The shift will start small, but once underway we will watch the birth of a new global brand.