The Apple of Taiwan’s Eye – Taiwan’s Growing Role in Apple’s Supply chain

Taiwanese OEMs find it increasingly pays to be part of the iconic technology giant’s supply chain.

Taiwanese contract electronics manufacturers dominate the supply chain of Apple Inc., the most valuable company in the world. While iPhones and Apple computers are assembled in China with parts sourced from global suppliers, Taiwanese firms own many of the plants where the devices are manufactured, and in some cases produce the components themselves. The iPhone alone will comprise 68% – more than US$15 billion – of Taiwan’s total mobile phone shipment value this year, according to the Taipei-based Market Intelligence & Consulting Institute (MIC).

Chinese vendors, who compete aggressively with Taiwanese firms across the ICT sector, remain minor players in Apple’s supply chain. In its most recent supplier list published in February, Apple named just one Chinese firm – BYD – as a final assembler, and of accessories, not its main consumer electronics products.

“Chinese vendors are primarily concerned with keeping production costs as low as possible, while Taiwanese vendors insist on quality,” says Jamie Wang, a principal research analyst at Gartner in Taipei. Apple’s high margins give it room to pay a premium to Taiwanese vendors, helping to offset the considerable costs of doing business with the tech giant, she adds.

Three of Taiwan’s largest companies, all of which are in the Fortune 1000, are crucial links in the Apple supply chain. Hon Hai Precision Industry (also known as Foxconn), the world’s largest contract electronics maker, assembles about 60% of Apple’s smartphones and tablets. Asustek spin-off Pegatron Corp. handles assembly for another 30%. And Taiwan Semiconductor Manufacturing Co. (TSMC), the world’s No. 1 contract chipmaker, supplies a growing share of the CPU processors – computing brains – that power Apple handsets.

Smaller Taiwanese firms have become established Apple suppliers as well, including smartphone camera lens maker Largan Precision and metal-casing producer Catcher Technology.

With Quanta Computer making Apple’s PCs, iPods, and smartwatches, Taiwanese companies remain in firm control of Apple’s assembly lines.

The fortunes of Apple’s Taiwanese suppliers have risen in tandem with its own meteoric ascent in the global smartphone market. In the first half of its current fiscal year that ends in September, the Cupertino, California-based company sold 135.6 million iPhones, a 43% increase year-on-year. In its fiscal first quarter that ended December 27, Apple reported a profit of US$18 billion, the largest ever by a public company.

With demand for its handsets surging, Apple is asking suppliers to manufacture a combined total of roughly 90 million units of two new iPhone models with 4.7-inch and 5.5-inch displays – the same sizes as the iPhone 6 and iPhone 6 Plus, respectively – by the end of the year, according to Taipei-based Fubon Securities.

 

A TSMC factory in Hsinchu
A TSMC factory in Hsinchu

Symbiotic relationship

Apple’s top supplier Hon Hai has benefited tremendously from the popularity of the iPhone. The company’s net profit in 2014 rose 22% to NT$130.5 billion (US$4.1 billion), up from NT$106.7 (US$3.4 billion) billion a year earlier. That was a sharp increase from 13% growth in 2013 and 1.9% five years ago.

Hon Hai has unmatched production capacity, allowing it to fulfill mammoth orders from Apple. In Zhengzhou, the capital of China’s Henan Province and the main base of iPhone production, Hon Hai’s 200,000 workers assemble more than half a million iPhones per day.

Management of Hon Hai’s huge production facilities is characterized by almost military discipline. Critics blame the harsh management style for a rash of worker suicides that occurred in 2010. But that strictness also results in high worker productivity, enabling the company to consistently ship on time, says Eddie Han, a mobile communications research associate at (MIC).

The decade-long partnership between Hon Hai and Apple has strengthened with Apple’s increasing successes in the mobile-devices market, experts say. Beginning with the iPod and first-generation iPhone, the two companies established a strong working relationship, notes Wang of Gartner. “When you win Apple, you lose other business,” she says. “The capital investment required is enormous. Hon Hai has always been willing to make that commitment.”

For instance, before Apple’s iPhone 4 went to production, Hon Hai and Apple discovered that the handset’s specialized metal frame could only be manufactured by a costly machine used for prototypes. Apple’s designers refused to compromise, so Hon Hai chairman Terry Gou ordered over 1,000 of the US$20,000 machines from the Japanese manufacturer Fanuc, according to Bloomberg News. Most vendors possess only one of the machines, Bloomberg notes.

Hon Hai joined the Apple supply chain later than other OEMs like Quanta, but it was the first to produce the iPhone, notes a former executive from the company’s smartphone business group. The executive credits Gou with seeing Apple’s potential as a smartphone maker early on. “At that time – 2007 – Nokia led the global smartphone market, and they [Nokia] laughed at Apple. They said, ‘Apple doesn’t make phones.’ But Terry Gou believed in Apple,” the former executive says, adding: “He was right.”

 

Evolving supply chain

Surging demand for Apple’s mobile devices has compelled the company to diversify its supply chain. Pegatron has been one of the largest benefactors. The Taipei-based vendor began producing small numbers of iPhones in 2011 and the iPad Mini the following year. It now assembles nearly one-third of Apple’s smartphones.

Rising iPhone orders have sent Pegatron’s profits soaring. The company’s 2014 net profits rose 53.4% from the previous year to a record high of NT$14.7 billion (US$470 million). Due to resilient demand for the iPhone 6, Pegatron’s first-quarter profits reached NT$6.3 billion (US$200 million), up 11.4% from a quarter earlier and more than 130% percent year-on-year.

Apple has increased iPhone 6 order allocation to Pegatron, which will now receive 60% of iPhone 6S orders and 10-15% of iPhone 6S Plus orders, according to Fubon Securities.

Hon Hai’s share of iPhone production has decreased accordingly. But Apple’s addition of new suppliers does not signify strained ties between Hon Hai and Apple, says an analyst at a Taipei-based brokerage who spoke with Topics on condition of anonymity.

White_AppleWatch_with_ScreenRather, the addition of Pegatron to the tech giant’s supply chain is intended to manage risk and boost shipments, he explains. “[Apple CEO] Tim Cook is a supply chain guy. He understands the mechanics of it better than Steve Jobs did, and he knows it’s risky to let one company handle all the iPhone assembly. Apple needs more vendors to share the orders,” he says.

“I don’t see anything that can disrupt the partnership between Hon Hai and Apple,” says Wang of Gartner. “Neither company can afford to lose the other.”

Former Acer manufacturing arm Wistron became the newest iPhone assembler in the second half of 2014. Apple recruited Wistron, which primarily makes notebook computers, because of unexpectedly high demand for its iPhone 6 handsets, market observers say. As demand remains strong, Wistron’s iPhone orders will increase to 12 million units this year from 10 million in 2014, according to MIC.

 

Ascending the value chain

Increasingly, Taiwanese firms are not just assembling Apple products: They are making the devices’ most intricate parts. For instance, Taichung-based Largan supplies about 80% of the camera lenses in Apple smartphones. Because of its strengths in optical aperture and resolution technology, Largan is one of the few suppliers able to produce the technically complex camera lens, according to Nomura Securities.

Largan, which also makes camera lenses for Chinese smartphone vendor Xiaomi, had a banner year in 2014. Its profits jumped 102% to NT$19.4 billion (US$620 million), on revenue of NT$45.8 billion (US$1.45 billion), up 67% from 2013. Mobile phones accounted for nearly 90% of the company’s revenue.

Meanwhile, TSMC moved into Apple’s supply chain for the first time last year. The Hsinchu-based chipmaker elbowed aside Samsung, once the sole supplier of microprocessors for Apple handsets, and won an exclusive contract to produce the A8 CPU used in the iPhone 6 and iPhone 6 Plus. For the next-generation A9, which will power the forthcoming iPhone 6s and iPhone 6s Plus, Samsung and TSMC are sharing the orders in a 70/30 split, analysts say.

TSMC will likely win 80% of the orders for the iPhone 7’s A10 chip in 2016, an analyst at a local brokerage told Topics. “Apple would rather partner with TSMC, especially after the poor yield rate on Samsung’s A9 chip,” says the analyst, who requested anonymity, citing the brokerage’s compliance policies. “Apple also has security issues with Samsung, since they are archrivals in the smartphone sector,” he adds.

Indeed, with Taiwanese manufacturers asserting ever-greater control over Apple’s supply chain, only the Apple Watch – the company’s newest product – is proving problematic.

The overhyped and now much-maligned wearable device was entrusted to Quanta. Mistakes in the manufacturing process delayed the product launch by six months, analysts say. “The iPod team in charge of the Apple Watch had no experience manufacturing something so small,” says Arthur Liao, a downstream analyst at Fubon Securities.

Quanta’s blunder is not expected to damage its relationship with Apple, however. The company will continue to manufacture Apple computers and iPods, Liao explains. But Apple will play it safe on the next round of Apple Watch orders. “They will move the second generation to Hon Hai,” he says.

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