Has Apple Been Negligent About Its iPhone Manufacturing Reliance on China?

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Apple Inc. (NASDAQ: AAPL) is one of the world’s top brands and also one of the world’s most valuable companies. For all of its great achievements and the wealth the company has created after the iPhone and other product launches, Apple also suffers from sluggish decision-making and a slower ability to pivot, similar to what other behemoths experience in a global manufacturing situation.

The problem facing Apple, and which has been having a perceived future impact on operations, is that the company is overly reliant on manufacturing in China. Apple products contain components that are made all over the world, but the company has been especially wedded to factories there that churn out its end products.

While the surprise came in May that China has backed away from its half-year negotiating points to prevent tariffs, the first round of a trade war began. The reality is that Apple has now had more than a year to decide where else and how else it should be manufacturing its finished products. An easy argument to make is that Apple CEO Tim Cook was relying on too much on the hope that the team assembled under the Trump administration and the negotiators for Xi Jinping in China would reach a trade deal.

Maybe the higher-ups at Apple thought that iPhones wouldn’t get hit with a tariff. Maybe they thought that China wouldn’t press back against Apple, while the U.S. is putting a squeeze on Huawei. And maybe there was a general expectation that a “national pride for brands” would not become a serious issue in which Americans want to buy as American as they can and the Chinese would buy Chinese brands, rather than companies that would be sending their profits back to America.

A media report from Nikkei has suggested that Apple is now seriously contemplating a move of as much as 15% to 30% of its iPhone production out of China over a period of time due to trade tensions. While Apple has its past success to prove that it can always think its decisions can be justified, it seems rather easy to say that Apple was negligent to not at least set up contingency plans. Apple uses supplier diversity whenever it can and it gets inside of supplier models to drive down prices when it can (look at the caveats in a recent Broadcom pact and the long fight with Qualcomm). Why on earth would the company be this dependent on China for iPhone manufacturing when it has had a year to line things up?

According to Daniel Ives of Wedbush Securities, which has been discussed in research reports for months now, Apple has proverbially “bet the farm” on its flagship China production factory to produce the vast majority of iPhones globally. It also is said to represent the “hearts and lungs of the Cupertino ecosystem.” A report from Wednesday had this to say:

The Foxconn factory in China is the linchpin of Apple’s iPhone production and speaks to why Cook & Co. have become the poster child for this US/China trade war battle, which we believe has resulted in a “$20 to $25 overhang” on Apple’s stock. With trade tensions heightened and Apple shaken from more tariff threats from the Beltway despite some optimism heading into the G-20 talks next week, now it appears the focus is trying to diversify production out of China.

Here is where things get tricky versus targeting 15% to 30% of its production. Ives believes that a best-case scenario would be Apple moving 5% to 7% of its iPhone production to India in the next 12 to 18 months — and moving 15% of its iPhone production away from China to elsewhere (to India and Vietnam or both), which would take at least two to three years.

Ives further opined about Apple’s “all-in” approach:

We believe this is all a poker game and Apple will not diversify production out of China overnight and certainly a long-term US/China trade deal is key for Cook & Co. to sleep well at night. The jury is still out on the timetable on these strategic moves for Apple, but ultimately with 1.4 million Chinese employed by the company, Cook and Cupertino have some big decisions ahead on the China front with both Beijing and D.C, closely watching these developments over the coming months.

Apple can try to use the points brought up by Wedbush in its defense to support the “all-in” approach to Foxconn and China. The problem is that Apple should have been making backup plans all along, whether the world had a President Trump administration or not. Apple shouldn’t feel singled out here, and even Steve Jobs once told the then-President Obama during the first of two terms that the jobs (making iPhones) would not be coming back to America. A Herald-Tribune report from 2012 addressed this matter and gave an estimated tally that U.S. wages alone (and in 2012 dollars) would add roughly $65 to the cost of each iPhone.

Admittedly, it is not fair to say that Apple should have thought about bringing all of its overseas work back to America. That ship has sailed. It’s also a silly notion to even consider that iPhone manufacturing would return to the United States,outside of true global chaos like World War III, massive damage from natural disasters, or other doomsday scenarios. Coming back to America is not the point here.

So what if Apple’s China overhang really is worth $20 to $25 per share. With shares trading just under $200 now, that would be a $220 to $225 stock and put Apple back within striking distance of its $233.47, an all-time high. It would also theoretically add about $100 billion in market capitalization and put Apple instantly back up in the $1 trillion market cap club to challenge (or re-challenge) Microsoft as the world’s highest market cap.

It used to be that every almost analyst and investor was a so-called perma-bull on Apple, but now, as the company has matured, analysts are mixed. Warren Buffett’s strong holding of Apple might have been worth a phone call for advice on this matter as well.

There is no law in America that anyone in any company or position has to like and agree with their own politicians. And most companies might not agree with the politics, laws, and trade practices outside of their country, even where they do business. But managers need to make plans around all sorts of geopolitical scenarios, particularly the scenarios that could adversely impact the company and its shareholders.

Apple has had plenty of time to make contingency plans to move at least some of its iPhone manufacturing elsewhere. The company never did have to act immediately on a contingency plan, but  being a company of its size with such reliance upon iPhones for revenues and earnings means that Tim Cook should have always been able to communicate that it has had contingency plans all along. That just doesn’t seem to be the case. Not at all.

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