Labor Costs and the Impact on the iPhone Supply Chain

Includes: AAPL, DELL, HPQ
by: The Operations Room

by Gad Allon

For those of us that have to get their new iPhone fix every year, the New York Times has bad news – iPhones (as well as laptops and electronic devices) may get significantly more expensive due to increasing costs in the supply chain (“Supply Chain for iPhone Highlights Costs in China“)

The article follows-up on a “teardown” report, which tries to estimate the cost of producing an iPhone:

What the latest analysis shows is that the smallest part of Apple’s costs are here in Shenzhen, where assembly-line workers snap together things like microchips from Germany and Korea, American-made chips that pull in Wi-Fi or cellphone signals, a touch-screen module from Taiwan and more than 100 other components. But what it does not reveal is that manufacturing in China is about to get far more expensive. Soaring labor costs caused by worker shortages and unrest, a strengthening Chinese currency that makes exports more expensive, and inflation and rising housing costs are all threatening to sharply increase the cost of making devices like notebook computers, digital cameras and smartphones.

I think one has to separate here between the OEM’s problem, the sub-contractor's problem and China’s problem.

Regarding the OEMs (whether we are talking about Apple (NASDAQ:AAPL), Dell (DELL) or HP (NYSE:HPQ)), the article itself is not very concerned, and predicts that the big brands will find new innovations to improve profitability. Manufacturers of electronic components have been moving plants from the US to the Pacific Rim in pursuit of labor savings for the last 30 years. The process is often called “island hopping,” since, in its earlier stages, firms would build and operate plants in Taiwan until labor rates rose, then move to Malaysia, then on to the next island. Now the plants are about to shift from the coast further inland. Not something that the average iPhone user has to be concerned about.

Regarding the sub-contractors:

When a company is operating on the slimmest of profit margins as contract manufacturers are, soaring labor costs pose a serious problem. Wages in China have risen by more than 50 percent since 2005, analysts say, and this year many factories, under pressure from local governments and workers who feel they have been underpaid for too long, have raised wages by an extra 20 to 30 percent.

For these subcontractors the issue is more complex. Given the pressure to increase salaries these will most likely face new dilemmas. Realizing that they are already fairly operationally efficient I am not sure that more cost cutting is possible unless they move to a new location to keep labor costs down. At the same time, one may think about a new opportunity for more automated processes. Several years ago, people were talking about “lights out plant”. While labor costs stayed low, the incentives to move to such high-investment factories were low, however, one may expect these to gain steam as costs increase.

As for China, the issues are more complex (and more interesting as well)

But within the crowd, there is growing skepticism about China’s manufacturing model after years of pressing workers to toil six or seven days a week, 10 to 12 hours a day…This type of low-end assembly work is also no longer favored in China, analysts say, because it does not produce big returns for the companies or the country. “China doesn’t want to be the workshop of the world anymore,” says Pietra Rivoli, a professor of international business at Georgetown University and author of “The Travels of a T-Shirt in the Global Economy.”

This is very much related to a previous posting of Marty's (“Frisbees & crappy jobs“.) We also have to remember that as the GDP and labor costs increase in China, there also are more consumers for these products. Did I mention the new Apple store in Shanghai?