Apple (AAPL 0.52%) has long depended on a small number of Chinese and Taiwanese factories to assemble most of its ultra-popular iPhone devices. In mainland China, Foxconn's assembly lines churn out Apple products at an immense scale. Foxconn's main plant in Zhengzhou employs 200,000 people, and the company is ultimately responsible for around 70% of global iPhone production.
There have always been massive risks associated with Apple's manufacturing strategy, and they have been well known for years. For one, depending on such a small number of suppliers for something as critical as iPhone assembly puts Apple at risk of major disruption if something goes wrong at one of those massive plants.
That concentration risk is supercharged by the fact that these plants are largely located in China and Taiwan. Relations between the U.S. and China are tense, and Taiwan is caught in the middle of that souring relationship.
From hypothetical to reality
So far, the risks Apple has taken to scale up iPhone production have paid off. The company generates more than $200 billion of revenue from the iconic devices each year. About half of the tech titan's total revenue comes from iPhone, and likely a higher percentage of its profit. For the most part, Apple has been able to keep iPhones flowing out of China and Taiwan and into the hands of consumers around the world.
The fragility of Apple's approach to manufacturing didn't matter until it suddenly did. China has taken extreme measures to keep COVID-19 under control, including harsh lockdowns. Factories can stay open under these lockdowns, but workers must live and work on-site.
Nearly three years into the pandemic, the Chinese government and Chinese factories are getting some real pushback on these measures. Some workers have reportedly fled Foxconn's main factory, and the company has reportedly offered bonuses in an attempt to retain employees. Protests have at times turned violent.
Reuters revealed in late October that production of iPhones at Foxconn's main plant could tumble by 30% due to the impact of harsh COVID-19 policies. On Monday, Bloomberg reported that Apple could fall short on production of its pricey iPhone Pro models by around 6 million units. That's around $6 billion worth of iPhones.
The situation could get substantially worse if Foxconn can't get its main plant running at full capacity soon. The Chinese government isn't backing down on its COVID-19 policies, creating immense uncertainty for iPhone production in the coming weeks and months.
Few options for Apple
Apple has been taking steps to shift some production away from China, but the scale and concentration of iPhone manufacturing has posed challenges. The company is now making some iPhone 14 units in India after a few years of manufacturing older models in the country, but shifting meaningful production capacity will be a slow process. Analysts at JPMorgan see around 25% of iPhones being produced in India by 2025.
That doesn't help Apple right now as production comes under pressure. Apple's manufacturing strategy is centered around efficiency, which has helped the tech giant produce impressive profits. But efficiency is fragile. Under the worst-case scenario, Apple will be unable to meet demand during the holiday season and perhaps beyond.
Shares of Apple have dropped this year, but the stock is no bargain. Trading for around 24 times earnings, investors may not be accounting for the short-term risk of production shortages or the long-term risk of implementing a less efficient manufacturing strategy. Apple's profits have surged over the past two years, but there's a real chance that some of those gains will be unwound as the company grapples with challenges posed by its extreme dependence on China.
