Contract manufacturer Hon-Hai Precision, better known as Foxconn, is once again in the midst of continuing labor unrest ? the most recent at their mega-factory in Shanxi Province 15 Kilometers South of Taiyuan. Populated by 79,000 workers, it is the most modern example of China as the ?Workshop to the World?. The nearby airport has a 3,600 meter runway capable of handling heavily loaded cargo aircraft trundling aloft with finished products bound for first world profit centers.

A spike in worker suicides at several Foxconn manufacturing facilities in 2009 heightened the company?s awareness of how deplorable conditions for the average worker had become. Foxconn resolved that it would be in both the company?s and the worker?s interest to move manufacturing facilities to inland locations so workers, hired locally, could be closer to their traditional family structures – providing an important psychological respite from the crushing drudgery of factory life and hopefully decrease the higher than 30% annual turnover in personnel.

Spreadsheet Motivation

Foxconn grudgingly grants pay raises after negative PR episodes that expose the company?s draconian HR practices. Foxconn CEO Terry Gou is on record referring to his employees as animals – ?To manage one million animals gives me a headache?.

More worrisome for Foxconn is the slide in the company?s margins. They have consistently been declining over the last decade reaching 1.4% in the second quarter of this year. Labor does not figure large in the total cost of an item like the iPhone – averaging around 2% of total cost. Apple?s profit is around 20 times the $15.00 manufacturing cost. So, if the costs are so low, why not manufacture the items in the countries of where they?re consumed? The devil is in the details.

Supply Chain Management

Setting up a manufacturing production line is no small feat and requires close cooperation of an assortment of suppliers delivering product ?just-in-time? to the receiving department of the manufacturing complex. The idea is to reduce the time value of money or inventory in process.

Choreographing high volume production is one of the more daunting engineering tasks and is accomplished using computerized manufacturing systems that interconnect between supplier and manufacturer in real-time. The rhythm of the build cycle begins months in advance of the initial pilot production. Exigencies are built into the build plan allowing for upside or downside forecast shifts as required. Formation of the manufacturing team extends far beyond just the contract manufacturer.

Designing production of items like the iPhone requires a fair amount of investment in time and money maintaining the manufacturing outsourced infrastructure. Again, it is entirely dependent on the internet and computerized manufacturing ? the real enablers of all off shore manufacturing. Apple contracts with Foxconn because it permits easy access to the Chinese supply chain within a well-developed industrial cluster.

A seldom-discussed topic, though one of extreme importance, is the high level of corruption practiced in China. Significant contract manufacturers have achieved a preferred status through the maintenance of cordial relations with the proper government channels. It goes far in explaining how the companies can expedite factory expansions that include upgrades to civic facilities that include power, water, and transportation ? last, but not least, it explains the immediate and sudden appearance of 5,000 People?s Armed Police for riot suppression upon occasion.

In short, many major U.S. companies have no other place to shop for outsourced contract manufacturing except in China at present.

Google

Although not engaged in a crusade, Google is manufacturing their Nexus Q in the U.S. Whether this is the beginning of ?reshoring? manufacturing to the U.S. is not entirely clear. A fully automated factory does not care where it is in the world, only that it has low cost power and efficient facilities to maintain low cost production. The portion attributed to labor becomes extraneous to the overall cost proposition.
Currently, there is an undercurrent of thought making the rounds regarding Google?s on-shore decision. A particularly virulent strain is that the risks of manufacturing in China may have severe downsides if the country sustains a hard landing economically. The carefully maintained manufacturing infrastructure is vulnerable to national unrest. Foxconn does not have the capability to transfer massive production outside of China at the present time making the company vulnerable to civil unrest.
Another interesting discussion centers on multinational corporations taking measures to insure corporate survivability by staffing key, safe locations in the world that also includes expansion of manufacturing capabilities. Certain risk management firms have been celebrating all time billing records lately.

BSN* Take

The cause of the problem at Foxconn?s Taiyuan facility was the temporary [or not so temporary according to employees] transfer of workers to meet upside demand for the iPhone5 from Apple, a few too many ?Revolutionizing Kampais? and a poorly led and trained ?hot dog? guard force. Unhappy with their ?temporary? relocation and long hours ended in an open revolt by a younger generation that has interests other than being a supplicant to Foxconn.

Events in the recent past have only increased the probability of one of those rare but consequential shocks to the world socio-economic system. Not that anyone can accurately forecast them ? it is now highly probable that conditions are nearing a critical point where a single event will cause a rapid and irreversible torrent, a domino effect if you will, of events ? most will be regrettable.

The setup conditions for such an event began with the fall of Lehman Brothers in 2008 continued on by the European Union?s continuing debt crisis and their inability to address the inherent problems. The U.S. faces their own ?Fiscal Cliff? on Federal spending that remains a complete unknown and is beginning to share many of the same attributes as the EU crisis.

Reduction in spendable incomes in both Europe and the U.S. is having a direct and dramatic effect on the order books of China based manufacturing. The economic loop is unraveling at a quickening pace ? a pace moving so fast that a full understanding and comprehension of downstream effects are occurring too late for any real rectification ? i.e. events are beginning to spin out of control.

This leads to a chicken and egg contradiction regarding contract manufacturing in China. China?s economy, based on the rapid expansion of manufacturing that draws on a rural workforce, has been successful over the last two decades. The county?s contract manufacturers based their bids on cheap and available labor drawing production away from North America and the European Union. This formula worked until the ?cheap? and ?available? showed signs of not wanting to be part of the formula any longer.

The contract manufacturers? answer is to automate. This led to the open question of why not manufacture regionally? Although implementation of the idea has begun, it will take time and will likely take on tones of ?Nationalism? as the argument progresses.

Where does this leave Foxconn and the likes of Apple? We believe they will remain devoted partners to the unaided eye for the immediate future though the first two quarters of 2013 will prove pivotal. Foxconn, by necessity, will begin relocation of automated manufacturing to regional centers if they are to survive. This may prove to be the company?s most difficult transition ever.

And Apple? Apple will go shopping ? remember NeXT? The NeXT factory in Fremont, California was the pride and joy of Steve Job?s company. The meeting room sat over the manufacturing floor for all visitors to see. There were only one or two technicians on the factory floor. They were extremely proud of this feat ? the year? 1987?,

Notes:
1)We believe that the iPhone5 will sell extremely well in China – everyone there knows it is actually a Chinese made/Asian content product

2)We are concerned that Apple will experience supply chain continuity problems beginning in the first quarter of 2013

3)Chinese New Year begins on February 10, 2013 ? It is the Year of the Snake

4)Apple plans to build a new world headquarters in Cupertino, CA