Wednesday, May 8, 2013

iPhone manufacturer Foxconn plans future beyond Apple

Terry Gou did almost everything thatApple could ask for. He made all those iPhones - and he made them cheap. When Apple was subsequently criticised for low wages and poor working conditions at his factories in China, it was Gou's company, the Foxconn TechnologyGroup, and not Apple, that caught the most heat.

But now Foxconn, a potent symbol of the perks and perils of globalisation, is taking a step that, not all that long ago, would have seemed unthinkable: It is contemplating life far, far beyond Apple.

Foxconn, which is based in Taiwan but does most of its manufacturing in mainland China, wants to reduce its reliance on Apple. Its new strategy is a shift away from making products that other companies design, and toward developing products of its own, with an especially aggressive push into designing and manufacturing large, flat-screen televisions."Foxconn senses that the Apple aura isn't as invincible as before," said Jamie Wang, an analyst at the research firm Gartner. "So they are worried that they need something besides Apple's business that will allow them to grow."

As the biggest contract manufacturer for US electronics companies like Apple, Dell, Hewlett-Packard and Amazon, Foxconn has been faced with labour unrest, worker suicides, industrial accidents and complaints about working conditions and labour practices. It has been working with many of its client companies to improve conditions, raise pay and improve labor standards.

On a drizzly April afternoon at the headquarters of Foxconn Technology, 300 employees gathered to burn incense and fake money in front of a statuette of Lord Guan, a Tao deity. Gou, the chairman of Foxconn and a Taoist, had the statuette flown in from Shanxi province in mainland China, carrying it himself to the door of his manufacturing empire. In Chinese tradition, Lord Guan is considered the go-to god for good business.

Good business is something Foxconn, one of the world's largest contract electronics manufacturers, needs right now. Last month, Foxconn, also known as Hon Hai Precision Industry, reported that first-quarter revenue was dragged down 19.2% compared with the same period last year because of declining iPhone and iPad orders from its main customer, Apple.

Apple representatives declined to comment on the developments at Foxconn. But analysts estimate that Apple contributes at least 40% of Foxconn's revenue. Moving beyond Apple could prove tricky; it's hard to make money in TVs these days, as many of the Japanese electronics companies can attest. And only 20,000 of Foxconn's 60-inch TVs have been sold in Taiwan, according to Simon Hsing, Foxconn's spokesman, who declined to disclose sales volumes from any other partners.

Foxconn's predicament mirrors a common problem faced by Taiwanese contract manufacturers, whose fortunes depend heavily on those of their clients. A handful of manufacturers, like HTC and Asustek Computer, have managed to shed their contract manufacturing businesses altogether to develop branded products. But as they began competing with clients, those clients began deserting them.

Here is Foxconn's problem captured with two sets of statistics. Global demand for LCD televisions declined 1 percent in 2012 compared with the previous year, and demand for all TVs dropped 6 percent, according to NPD DisplaySearch. Worldwide PC shipments fell 13.9% in the first quarter of 2013, compared with the same period a year earlier, according to IDC.

As a result, profits for many manufacturers are slumping.

"Taiwan companies have always relied on being a contract manufacturer and outsourcing manufacturer," said Luo Huai-jia, vice president at the Taiwan Electrical and Electronic Manufacturers' Association. "Now we need to start looking at original design manufacturing and directly matching the needs of consumers."

Kay Chiu, vice president of Foxconn's consumer electronics division, said in response to emailed questions that consumer interest and vertical integration - controlling all the steps in the supply chain - were behind the shift in production. "We still need to leverage business development partners' advantage to provide an attractive and most competitive product to the market," Chiu said. Other top Foxconn executives declined several requests for comment.

Since last year, Foxconn's investment choices have reflected its new strategy. Gou personally spent about $840 million on a 37.6% stake in Sharp's LCD panel factory in Sakai, Japan. Sharp needed a quick cash infusion and Gou's purchase gave his company a quick way to control a component that accounts for more than 50% of the production cost of a TV set.

Foxconn then released a 60-inch television in October with 90% of the components, like the LCD panel, backlighting and mechanical parts, made in-house, according to Hsing.

The company also recruited two companies, RadioShack in China and Vizio in the United States, to sell the television under their brands. "The decline in the business of our partners, such as Apple and Nokia, does affect us," Hsing said. "We don't want to just wait for orders. We are actively talking with many clients and asking if they can fully utilise what we make." He said that the company had no intention of becoming its own brand and instead planned to use its partners' marketing and distribution networks.

"Hon Hai is the largest electronic manufacturing service company in the world," said Chiu, the Foxconn executive. "We are the platform for all the brand-name customers, and to have our own brand does not suit the company policy."

Over the last six months, Foxconn has gradually found other willing partners. It has recruited several cable and internet TV operators in Taiwan and China to subsidise the cost of the television for their subscribers in the same way that smartphones are subsidised by mobile operators in some markets. With Chunghwa Telecom in Taiwan, for instance, a consumer can buy a 60-inch television for as little as 33,800 Taiwan dollars, or about $1,150, as long as the customer also pays 1,158 Taiwan dollars a month for a two-year television service contract.

Analysts say Foxconn's strategy satisfies two seemingly contradictory goals. The company does not want to compete with clients directly, because it has TV assembly orders from Sony, Sharp and Toshiba. (The company also assembles personal computers for companies like Hewlett-Packard and Dell, game consoles for Nintendo and the Kindle for Amazon.com.) But it needs to absorb excess LCD panels produced by the Sakai factory to take advantage of the lower manufacturing cost per unit. Therefore, Foxconn negotiates with partners to sell the TV at or below its production cost.

"So what do you do in the meantime after spending about $840 million buying a plant?" said Thompson Wu, an analyst at Credit Suisse. "You just say, I have to decide whether I'm better off making TVs at a discount and make less money incrementally or having manufacturing not doing anything."

Kirk Yang, managing director of Barclays' Asia Technology Research, said, "Taiwanese companies will do this all the time."

"They will sell at loss just to get their foot in the door," he said. "With larger volume, better scale and more experience, they eventually make a small profit."

Adding to that pressure is a commitment Gou made to buy half the Sakai plant's output when he purchased his stake, said Wu.

The research firm NPD DisplaySearch estimates Sakai makes 6.7 million to 6.8 million 60-inch panels a year.

Its partner Vizio could help move some of those TVs, but only somewhat. In the first three months of 2013, Vizio sold 30% of flat-panel TVs measuring 60-inch or more in the United States, more than any other company, with Sharp in second place with 29%, according to NPD Group's Retail Tracking Service. Yet in the important holiday-filled fourth quarter, it shipped 4,03,000 sets in that size in North America, according to an NPD DisplaySearch analyst, Paul Gray.

Most analysts say they believe Foxconn needs a larger TV customer. Televisions represent less than 5% of Foxconn's business, far less than its revenue from Apple. And some analysts think Foxconn is just biding its time, waiting for Apple to figure how to create a game-changing TV product that will increase demand once again.

Representatives of Apple and Foxconn said they did not comment on speculation.

Analysts say Gou's efforts to buy an LCD factory and vertically integrate his TV manufacturing represent anticipation that orders for an Apple television product will come his way.

"Their gamble now is if Apple will put out a TV, and they should know better than anyone else in the world," said Wu, the Credit Suisse analyst. "They're making a bet that it'll work."

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