Apple Inc. is aptly named. The iPhone maker is golden on Wall Street, venerated by fans and irresistible to enterprise partners, making it the most tempting and most sought after customer in the global electronics supply chain. Conversely, Apple can morph into a living nightmare for rivals, suppliers and contractors who defy it as some enterprises have found out in recent years.
The consumer electronics maker can claim credit for some of the industry's biggest scalps, including those of former No. 1 mobile handset vendors Motorola and Nokia, both of them now footnotes in the annals of the industry. Nokia sold its mobile phone division to Microsoft, which in July took an “impairment charge” of $7.6 billion against the deal, essentially writing off what it paid for the business. Motorola Mobility, meanwhile, ended up with Google, which sold the American icon to China’s Lenovo Group. Other Apple rivals in the smartphone market are barely viable: Researchers say Apple accounted for more than 90 percent of first quarter 2015 smartphone profits, leaving the rest to Samsung. Others broke even or declared huge losses.
Apple’s biggest impact has been on the electronics industry supply chain, however. With more than $100 billion in annual cost of goods sold, (COGS), it is the biggest influencer of capital expenditure and manufacturing expenses in the electronics market. Within a decade, Apple single-handedly turned Taiwan-based Foxconn International Ltd. into the world’s biggest electronics manufacturing services (EMS) provider. It has changed the fortunes of companies in many corners of the globe by signing them up as suppliers or contractors.
There’s a dark side to the Apple story, though. Just like Apple can make a company, it can also break an enterprise. A reversal of a supply contract with Apple can swiftly erode an enterprise’s value and even result in its demise. Never in its history has the electronics industry had so much power concentrated in the hands of a single enterprise. (See: How Apple Has the Power to Make or Break a Supply Chain Supplier).
Perhaps because it must uphold a high image and top-level performance amongst consumers and investors, Apple is often seen as a hard taskmaster by suppliers, none of which would complain about the company publicly. In fact, component suppliers and contract manufacturers who sell parts to Apple or make its products are forbidden from talking about their engagement with the Cupertino, Calif.-based company. Not a single supplier has dared to violate Apple’s disclosure wishes.
Take Jabil Circuit Inc., one of Apple’s EMS providers. The OEM accounts for one-quarter of Jabil’s annual sales and has been the primary growth driver for the contract manufacturer. Jabil reported sales of $17.9 billion for the fiscal year ended August, 31, 2015, up 14 percent, from $15.8 billion in the prior year. It is projecting revenue of approximately $20 billion for fiscal 2016. Apple is forecast to account for the expected sales jump. And yet, Jabil executives tried hard to avoid mentioning Apple by name until pressed by analysts during a recent conference call.
“I won’t go too close to that question, because I’m sensitive to our biggest customer,” said Mark Mondello, Jabil’s CEO, in response to a question about how Apple dominates sales in DMS, the contractor’s biggest operating division.
Apple commands such unflinching loyalty from its supply base because of how transformative a contract with the OEM can be for a supplier. A manufacturing contract or component “design win” with Apple could make a struggling enterprise hugely successful and assure immediate or even longer-term viability within a mere quarter. As Apple has grown so has the company’s clout with contract manufacturers and suppliers. Its huge COGS is attracting more suppliers and helping to keep current ones in line, as Apple acknowledges in its Supplier Responsibility 2015 Progress Report. To increase visibility across its supply chain and ensure external observers can track enterprises that interact with it, Apple annually publishes a list of its 200 biggest suppliers and regularly audits them, according to Jeff Williams, senior VP of operations at the company.
“To make impactful changes across our supply chain, it’s important to understand firsthand what’s happening inside our suppliers’ facilities,” Apple said in a report. “We directly gauge how our supplier facilities are doing by regularly visiting and partner with our suppliers around the world. And when we discover a problem, we work together to get it fixed.”
Apple’s influence on the supply chain is bound to increase as its revenue continues to surge. Analysts estimate Apple’s fiscal 2016 revenue will grow to $233 billion from $183 billion in fiscal 2015. In fiscal 2015, the company reported COGS of $112.3 billion, representing 61.4 percent of sales. If that percentage holds for fiscal 2016, this means Apple’s suppliers and contractors could be competing for materials, services and manufacturing contracts valued at up to $142 billion. Numbers like these make Apple a compelling customer for suppliers and one they would do whatever necessary to keep, including keeping mum about the terms and conditions of their engagement.
The Good, the Bad and the Ugly
The huge size of Apple’s COGS is the good news. Like many sweet things, though, a bite of Apple could also prove ruinous for the unwary. Dependency on Apple for a majority of a company’s sales can turn into a liability if the iPhone maker picks a different supplier or experiences a sharp sales decline. So far, though, most of Apple’s products in recent years have been either wildly successful. Even the Apple Watch exceeded the company’s initial projection during the June quarter despite some initial concerns, according to Timothy Cook, CEO.
“Sales of the Watch did exceed our expectations and they did so despite supply still trailing demand at the end of the quarter,” Cook said in a presentation to analysts. “In fact, the Apple Watch sell-through was higher than the comparable launch periods of the original iPhone or the original iPad. And we were able to do that with having only 680 points of sale. Beyond the very good news on sales, we're more excited about how the product is positioned for the long term because we're starting a new category.”
Anecdotes like this get suppliers even more intrigued about engaging with Apple but it is still cold comfort for companies that have been burned by a sudden termination of Apple’s patronage. Due to its huge components requirement, Apple sometimes pre-pay for parts and other materials. These arrangements can range from hundreds of millions to billions of dollars. The company has successfully managed most of the relationships but a few have also proven problematic.
A deal with GT Advanced Technologies Inc. was one of them. Last October, the supplier of crystal growth equipment for the electronics industry filed for bankruptcy following a disagreement with Apple. To resolve the dispute, GT exited the sapphire materials business which it entered into mainly because it expected to sell the products to Apple. Apple pulled the plug on the arrangement and was “provided with a mechanism for recovering its $439 million pre-payment to GT over a period of up to four years without interest,” GT said in a press statement.
Other companies have also been negatively impacted by their close relationship with Apple, sometimes for things they could not control. The market value of some Apple suppliers were crushed earlier this year, for example, when its iPhones sales failed to match investors’ outsized expectations. Companies impacted included Avago, Broadcom, Cirrus Logic, Jabil, Qualcomm, Skyworks Solutions, SanDisk, STMicroelectronics and TSMC.
A strong, unexpected surge in demand for Apple's products can also result in problems at suppliers. If a components vendor or contract manufacturer does not have production facilities primed to expand to meet the higher demand, it could potentially lose sales to rivals. This has happened in the past due to the perennial weakness of Apple's sales forecasts, which analysts often treat with disdain, preferring instead to rely on the so-called "whisper numbers" from other sources.
There’s another part to the Apple story that is not directly tied to potential sales fluctuations, strategic contractual actions or component supply relationships. Apple’s high visibility in the global economy makes it the poster-child for everything wrong with how companies manufacture products, treat workers, customers, the environment and any other subjects of interest to activists.
Apple has been repeatedly hammered in recent times by Human Rights and Labor activists for violations and other incidents at its contract manufacturers, including at Foxconn’s China plants where some workers had committed suicide. Apple was accused of “failing to protect Chinese factory workers” even though the impacted employees were not directly employed by the company.
Reports like this have resulted in closer scrutiny of Apple suppliers. In response, Apple, too, imposed stricter conditions on its supply chain. Furthermore, in order to avoid potential damages to its operations in the event of problems at a contractor or supplier, Apple has broadened its supplier list by adding secondary suppliers and contractors. Foxconn, once Apple’s EMS provider, is now seeing competition from Flextronics, Jabil and Pegatron.
Chipmakers are also not immune. Apple has added to or deepened supplier relationships with companies like Amphenol, 3M, Cirrus Logic, Corning, Fairchild, Intel, Kyocera, Micron, Murata, NXP, Panasonic, Samsung, SanDisk and STMicroelectronics to broaden its supply base. This has increased the uncertainty associated with partnering with Apple, according to observers.
In the case of Cirrus Logic, the loss of its contract with Apple could prove ruinous to the company since the OEM represents approximately three-quarters of its annual sales. Recognizing the danger, Cirrus Logic’s management have been trying to limit their exposure to Apple and reduced this to 72 percent of sales in fiscal 2015 ended March 28, from 80 percent, in fiscal 2014. Unwinding the relationship won’t be easy, though. There are few customers in the electronics market that can replace Apple in Cirrus Logic’s product portfolio.
The conclusion? Apple is sweet, addictive and potential problematic. Chew carefully.