Can Foxconn, the world s largest contract manufacturer, keep growing and
improve its margins now that cheap and willing hands are scarce?
Dec 15th 2012 | SHENZHEN | from the print edition
TO GET some idea of the scale of Foxconn s Longhua campus in Shenzhen, in
southern China, a visit to its massive central kitchens is all that is needed.
They lie at the heart of this sprawling complex of factories, dormitories,
sports facilities, banks and stores built by the secretive Taiwanese-owned
firm. The food-preparation centre, spread over 12,500 square metres on four
storeys, goes through three tonnes of meat a day as it prepares grub with
military precision.
The enormous scale is to be expected, given that Foxconn (also known by its
parent company s name, Hon Hai) is the world s largest contract manufacturer.
The Longhua campus, covering 2.5 square kilometres, employs 240,000 people.
Across China, it employs 1.4m on 28 campuses (see chart). Nor, given the firm s
prowess at churning out gazillions of gadgets like Apple s iPhones, does the
kitchen s efficiency come as a surprise. Tens of thousands on each shift pay
for meals swiftly by swiping cash cards loaded with 400 yuan ($64) a month in
food credits.
The only things more impressive than the size of the canteen s woks more than 1
metre wide are the firm s spectacular growth and outsized ambitions. In the
past decade it has gone from being one of many invisible firms in the
electronics supply chain to the world champion of flexible manufacturing.
Barclays, a bank, forecasts that the company s revenues will exceed NT$3.9
trillion ($134 billion) this year.
Foxconn is investing heavily to expand in the interior of China. By the end of
this year its newish facilities in Zhengzhou, in Henan province, will employ
more workers than the Longhua campus. It is also expanding in Brazil and
Mexico. There are rumours it might even open a factory in America, since Apple,
its biggest customer, has just declared that it plans to have some of its Mac
computers made at home. Rich-world companies looking to follow suit, reshoring
jobs back home, are struggling to find enough skilled manufacturing workers;
Foxconn could apply to Americans its extensive experience of training Chinese
workers from scratch. It admits it is exploring the opportunity .
More strikingly, Foxconn believes it can double in size yet again. Executives
talk of becoming one of the world s top 20 businesses. This is no fantasy:
Barclays foresees Foxconn s revenues growing by 15-20% a year in the coming
three years. There are two main obstacles to sustaining such growth: finding
and retaining good workers in China, and improving the firm s anaemic profit
margins. Both problems will only be aggravated by growth.
As good employees become scarcer, Foxconn is having to pay more attention to
working conditions an issue on which it has attracted much unwelcome publicity.
A lunchtime visit to the Longhua campus suggests that nowadays life there is
not so bad. Off-duty workers smoke and fiddle with their mobile phones on the
kerb outside the production halls, snooze on the campus s football pitch or sit
crocheting together in their dorms. Employees on an assembly line making
corporate IT equipment look bored senseless but the facilities are orderly and
spotless a far cry from South Asian firetraps.
When your correspondent requested an unscheduled visit to an assembly-line
workers dormitory, officials immediately obliged and remained outside the dorm
s entrance. The women inside, who bunk eight to a room in basic but decent
conditions, were unafraid and in good humour. People on campus dress in casual
clothes, not company uniforms, and seem only about as discontented as the youth
found in any Chinese city. Look closer, though, and you notice something
jarring: enormous safety nets hung on many buildings to prevent suicide
jumpers.
That hints at Foxconn s biggest challenge: demography. No longer can the firm
rely on a steady supply of migrant workers grateful for any escape from
grinding rural poverty. The country is rapidly ageing, and the pool of hungry
young workers is shrinking. Besides expecting ever better pay and conditions,
today s new recruits want more fulfilling lives than those their predecessors
put up with.
Until recently Foxconn was unyielding in its discipline and working practices.
But two years ago a spate of suicides led to a global outcry that shook the
firm. Since then, several outbreaks of worker unrest and noisy campaigns by
activists have further blackened its name. In response, Apple requested that
the Fair Labour Association (FLA), an American watchdog, audit its suppliers. A
report issued by that group in March found that although Foxconn s facilities
were no worse than any factory in China there were violations of the FLA s
code of conduct.
Peter Deng, a manufacturing director at the firm, recalls that a decade ago
Foxconn gave only one or two days off per month and there was no limit on
overtime and the workers didn t mind. Now, the firm claims to limit overtime
and to insist that workers take a day off every week. It is also increasing
wages and, after scandals, limiting the use of interns (about 2.7% of its
workforce). In August the FLA said that Foxconn was ahead of schedule in
improving conditions.
Fine, but if Foxconn wants to keep booming, it must do far more. The canteen
visit hints at three ways it plans to improve workers lives.
First, automation. It takes just three people to prepare the eight tonnes of
rice consumed at lunch. The assembly lines are next. Terry Guo, the company s
flamboyant chairman, has vowed to build one million robots in an effort to
eliminate mind-numbing tasks and move towards fully automated plants. The
challenge is that tastes change quickly in consumer electronics. By the time
bespoke robot kit is ready to automate a given factory line, the product mix
has changed, making it obsolete. Scepticism is warranted, but insiders believe
the firm is just a year away from breakthroughs that work at scale on
commercial lines. Such Foxbots , and related services, could even be sold to
other firms.
Second, a bit of freedom. Workers can now skip the canteen, instead swiping
meal cards at food courts on campus or going off campus to eat. They also now
get a housing allowance, letting them choose between staying in dorms or (as
70% now do in Shenzhen) living off campus. There is more of a social life, too:
a young employee, recently arrived from remote Xianyang, talks blushingly about
her evenings with handsome co-workers at the Cyberfox, the campus internet caf
.
Third, outsourcing. The dorms, catering, security and much else at Longhua are
now run by outsiders. Louis Woo, special adviser to Mr Guo, insists this is not
to save money but to improve workers quality of life: they simply do a better
job than us.
Going west
Foxconn s net margin has already fallen from above 6% a decade ago to around 2%
now. It risks being squeezed further as the firm splashes out to attract and
retain new workers. The trouble is, Foxconn is stuck in the hyper-competitive
middle of the electronics supply chain. Upstream, the designers of components
make enormous margins, as do the firms downstream that market the finished
products. But midstream gadget assemblers do not. In China, it costs Apple a
few dollars to have an iPod assembled, which it then sells for $299.
Could Foxconn s push towards cheaper inland provinces boost margins? Not for
long. Because of tax holidays granted to its new plants, the firm s effective
tax rate will drop from 25% in 2011 to 16-18% this year. But the gains will
soon be eroded by higher inventory and logistics costs (because of the more
remote locations), rising pay and fading subsidies. Within a few years, argues
Alberto Moel of Sanford C. Bernstein, an investment bank, the shift will bring
no net benefit to gross margins.
Dull work, but not dangerous
Still, Mr Guo does have a strategy for increasing margins. First, he is moving
upstream. In March he announced plans to buy a stake in Sharp, a troubled
Japanese technology firm, and to help finance Sharp s glass-panel research.
(When Sharp s shares later plunged, he waffled when asked to reconfirm the
stake-buying.) Already, almost everything Foxconn makes has glass display
screens and this week it was reported to be working with Apple and Sharp on a
new range of high-definition televisions. Foxconn wants to learn how to make
screens better and cheaper. By using its manufacturing savvy to scale up any
breakthroughs, it plans to boost Sharp s sales pocketing a share of the gains.
Other such deals are likely.
Mr Guo is also pushing downstream into retailing. He does not want Foxconn to
create its own consumer brands; the idea is to use the firm s supply-chain
muscle to help its branded customers promote their products, by guaranteeing
retailers that they will get their supplies on time and on demand. To help with
this, it has taken stakes in several retail chains in China, including the
local operations of Media Markt, a German electronics seller.
Foxconn says branded manufacturers, especially Western ones with poor
penetration in smaller Chinese cities, will benefit from its promotion of their
products, shops will be able to hold lower inventories and consumers will enjoy
lower prices. Analysts are doubtful. But if this takes off over the next five
years, the firm also plans to tighten its links further with retailers by
letting them tap directly into Foxconn s internal e-commerce portal.
These moves may pay dividends in the long term. But Mr Moel argues that quicker
returns are to be found in the company s core manufacturing operations, for
instance by making more parts in-house. Foxconn is increasingly making
components such as batteries, lenses, speakers and touch panels. It has scope
to improve the efficiency of its production lines, especially on new campuses
purpose-built for automation. The firm could also try demanding higher prices.
There are signs that it is ready to move away from a low-price strategy,
instead stressing reliability and high-volume capabilities.
Can Foxconn really persuade Apple, the world s most powerful electronics firm,
to cough up more money? That risks alienating a customer that accounts for
40-45% of its revenues. But as the world s largest outsourced manufacturer
grows even bigger, it is becoming ever more indispensable to Apple as well. In
the end, that is the best thing Foxconn has cooking.
from the print edition | Business