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The Ins and Outs of Apple Inc.'s Contract Manufacturing Model

By Motley Fool Staff - Jun 3, 2016 at 8:04PM

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Apple embraced a model that outsourced its manufacturing about two decades ago, and has never looked back. Dylan Lewis and Evan Niu explain why Apple went that route, and how it benefits the business.

In the 1990s, Tim Cook shifted Apple (AAPL -0.91%) away from the in-house domestic manufacturing model it was using to a much more operationally efficient contract-based model that works with manufacturers overseas. Taking all those jobs out of the U.S. was part of what allowed Apple to grow as it has.

In this segment from the Industry Focus: Tech podcast, Dylan Lewis and Evan Niu explain the main reasons why the company made the shift, and how the contracts work today. Also, they take a look into Apple's main parts manufacturer, Foxconn, and the fascinating existence of the "campus-like" Foxconn City, where many of its employees live. Though Foxconn is the best-known contract manufacturer for Apple, there are other names you should now know too.

A full transcript follows the video.

This podcast was recorded on May 27, 2016. 

Dylan Lewis: Evan, I've seen estimates that roughly 90% of the iPhones come from outside the U.S., you think that's about right?

Evan Niu: Yeah it sounds about right. I know it's a lot, very little of it comes from inside the U.S. these days. They have other products that are made here like the Mac Pro, but as far as the iPhone goes, it's mostly abroad, yeah.

Lewis: I don't know how much that really is different than the component breakdown in the past, maybe in the early '90s, mid '90s for standard consumer tech stuff, but one of the major changes that Apple underwent really with Tim Cook, was this idea of changing from having their own in-house manufacturing, their own in-house warehouses, company-owned, to moving to this contract-manufacturing type relationship.

Niu: Yeah they did that I think in the late '90s or so. They used to make Macs in the U.S. in California. They just realized that it was way too expensive in-house. A lot of it is also the engineering and manufacturing talent you can get now. Because of course a lot of people criticize that they won't bring those jobs back in the U.S. but Apple's defense nowadays is, it's not just about low-cost labor, it's also about, you don't have as many mid-level manufacturing engineers available in the U.S. anymore, just because, as an economy we don't have as many of those types of jobs. That's not the type of education that we focus on anymore, and there's a ton of that over there.

Including the lower-cost labor, they have more people that are within the specific skill sets that they need to ramp up the manufacturing. I think, a long time ago, they said you could fit every single manufacturing engineer within a baseball stadium. In the country, that's just how many there are now. Over in China, Foxconn can get hundreds of thousands of engineers within a couple hours if they need them to make some change, or tweak some processor. There's a lot of sides to the story why they do it like that.

Lewis: This pivot, this decision by the business to go to this contract-manufacturing relationship. It was really something that Tim Cook pushed aggressively. For all the praise that Steve Jobs gets as this design, branding, user-experience mastermind. This is where Tim Cook's expertise really is, in operational efficiency and just running a business extremely well from a supply chains point of view. He has really pushed the business to where they are now, where they rely heavily on Foxconn and Pegatron, to name two, as these contract manufacturers. Listeners, just so you have an idea if you don't know what this term means. Basically, Apple doesn't own any of the facilities where iPhones are being assembled.

Niu: Well they own, let me just add in that they own a bunch of the manufacturing tooling and the equipment. A lot of their capital expenditures these days are, they buy the actual infrastructure and the gear, and then they put that inside of the facilities that they don't own. They kind of own a lot of the stuff, and Foxconn owns the factory and then they hire the people, and then they operate that stuff. I mean their capex is like 10 million yuan, which is insane. Majority of that goes to this product tooling that sits in Asia inside a factory facility.

Lewis: Yeah. I'm glad you hopped in and clarified there. But, largely they're paying these manufacturers to put together their devices and then ship them over, right?

Niu: Right.

Lewis: Foxconn is the name that you will hear the most, and when you hear that name you often think of Foxconn City. Which is the company's largest manufacturing plant, and that's in Shenzhen, China. So chances are, if you're holding an iPhone -- or listening to this episode on an iPhone -- it was put together in China. On that one campus alone, and when I say campus, I mean that that's kind of the vibe that you get looking around. If you ever see pictures of this setup, it's incredible.

They have hundreds of thousands of employees working there. It's over a square mile, and they have dorms for employees, its own shopping center, I think they have their own cable network there. The executives there are likening it to this college experience -- I think it's kind of a stretch. You have people working 12 hour days, 6 days a week, putting together iPhones. That one Foxconn City location is just one of the 12 that the company has in China. Actually, folks following tech might have heard earlier this week, Foxconn announced it automated 60,000 jobs in one of its factories. Going back to that idea of providing some of the tooling, I'm sure Apple had something to do with that.

Niu: Yeah, I wonder if they helped fund some of that affair. If they're going to be using those robots for primarily iPhone production, it would make sense that Apple helped them pay for some of that.

Lewis: Yeah. We don't have firm details on that, but it wouldn't be a stretch by any means.

Niu: Right.

Lewis: More recently, Apple added Pegatron -- that's a name I mentioned earlier -- as another contract manufacturer. I think this was maybe 2012 or so, 2013. I think there were two big reasons for this. One of them was diversification, to downplay the risk of relying solely on one contract manufacturer so heavily like Foxconn. I think maybe another was in a response to the company's increasingly complex, fragmented product offering. They wanted to have that split among a couple different suppliers, just because of some of the specialization required to produce the different sizes and models, and form factors. If you're listening to this show on an iPhone, chances are it started out in a Foxconn or Pegatron factory, most likely in China, which I think of as a testament to the growth and diversification strategy among their contract manufacturers. Recently, they've added another Taiwan-based company to this list: Wistron. Just another thing to keep an eye out for.

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