How China Tricked Apple

Shipping delays, worker protests, and massive political pressure to pull out of China. This is the frustrating reality for Apple, which has had so many problems with its manufacturing that their CEO Tim Cook, is now getting publicly accosted by reporters.

Do you think it's problematic to do business with the Communist Chinese Party when they suppress human rights?

China's manufacturing capabilities have been absolutely essential to Apple's growth into one of the world's largest companies. But that same manufacturing strength has now turned into a cancerous dependency. And it's put Apple into an impossible situation. To understand why Apple has become completely dependent on Chinese manufacturing, we have to ask the following. What made China so appealing to Apple executives in the first place? In the 1990s, Apple manufactured most of their products in the United States. That changed when Tim Cook joined the company. Cook started at Apple in March of 1998 as a senior vice president for worldwide operations. Right off the bat, Steve Jobs needed him to solve an important problem. Apple was just about to launch the first imac. It was the first big release for Apple since Steve Jobs had returned to the company after 11 years away. He was confident it would be a hit, so he needed assurance that Apple could fulfill hundreds of thousands of holiday orders. Tim Cook's solution was to call up air freight suppliers and pre purchase $100 million worth of shipments in advance. This was a huge gamble. If the imac launch went poorly, Apple would lose tons of money on these prepaid shipping fees. Tim Cook certainly wouldn't be the CEO today. Steve Jobs probably would have fired him. And Cook's bet paid off in a big way. The imac was a huge success, and Apple was one of the only computer manufacturers that could fulfill every order that holiday season. This early move made Tim Cook a hero in the eyes of Steve Jobs. After years of struggling to scale supply chains, Apple finally had someone with the competence and risk appetite to really grow the business. Cook developed a reputation for ruthlessness, calling inventory fundamentally evil and working tirelessly to squeeze more and more efficiency out of Apple's supply chain. For years, Cook optimized Apple's domestic operations. But over time, things changed. For one thing, products got smaller and required more specialized manufacturing. The other thing, which Cook quickly realized is, is that Apple was starting to pull away from its rivals. When he joined the company, only about 3% of people used Apple products. But the ipod was a runaway success, selling tens of millions of units every year. Apple needed to press home this advantage it had built up. But to do that, it needed to massively scale up its supply chains. That's when China came into the picture.

Thank you for coming. We're going to make some history together today. She is the 2007 Australian Open champion.

Oh my God.

What is it?

We are calling it iPhone.

The first woman speaker in our history, Nancy Pelosi.

I ingested my ancestor.

Yes. The iPhone was just about to be released in stores, and Steve Jobs noticed a big problem. He had been carrying a prototype iPhone in his pocket and the screen was getting scratched. So he called a meeting. He took his phone out of his pocket and then he pulled out his keys. This was going to be a normal user experience, he pointed out, and everyone was going to be carrying their phone with their keys, so the screen couldn't be made of plastic. Jobs told his executives that he wouldn't sell a product that got easily scratched. He wanted a glass screen and he wanted it perfect in six weeks.

Fix it.

I can't. It was a herculean task, one which most supply chain experts thought would be impossible. But companies like Apple thrive on achieving the impossible. So an Apple executive booked a flight to Shenzhen and told the plant to start working. The factory immediately directed 8,000 workers to replace the screens. They worked 12 hour shifts to get it done. But within a few days, the plant was producing over 10,000 iPhones with glass screens per day. That hard work was worth it. Helped by China's manufacturing capacity, the iPhone went on to become the best selling product in history. This ability to mobilize massive amounts of human labor is what makes China so important to Apple and thousands of other companies. Wages in China are much lower than in America. But the equation that companies like Apple must solve when considering where to manufacture their products products is much more complicated. Manufacturing in China isn't always a good decision for American companies. Lots of inexperienced entrepreneurs have been burned by shoddy Chinese manufacturers who over promise and then under deliver. People often joke about Chinese manufacturers offering what's called a 5050 partnership, where the American company loses half their money in the first year and then the other half in the second year. How does this keep happening time and time again? The answer is that Chinese manufacturers have a playbook for tricking American companies into over committing. It goes something like this. Let's say you're running a company that makes coffee cups. You've been manufacturing them in America, but you simply can't keep up with the competition anymore. It seems like every other brand is able to slash their prices and still make a decent profit margin. So you start looking at cheaper manufacturing options. China is an obvious choice since so many Companies make products there. So you visit a manufacturer and and the product sample looks amazing. They've been able to perfectly match what you've been making in America. Plus they're willing to do it at a fraction of the cost. It sounds perfect. So you sign up, place a purchase order, and start shipping the products to your customers. No one can tell the difference, and you're starting to make a healthy profit margin again. But this is where things take a turn for the worse. See, your Chinese manufacturer needs to make a profit for themselves, and the price they originally quoted you was too good to be true. They can't raise their prices because you might take your business somewhere else. So they start looking for other ways to squeeze out a profit. They might switch to using cheaper materials. The plastic in that coffee cup might now contain toxic chemicals. And in some cases, they will actually make subtle changes in the product design. You might have specified that the walls of the coffee cup lid need to be at least 1 millimeter thick. But over time, the manufacturer will send you thinner and thinner coffee cups to save money on raw materials. This process is called quality fade. It allows the manufacturer to increase their margins, all without raising prices or even telling the customer what's happening. It's a huge problem because companies usually don't have quality control systems in place to prevent this from happening. If you aren't already testing your products for toxic chemicals and the manufacturer starts secretly switching materials on you, you might not find out for years. This quality fade strategy works well for Chinese manufacturers who work with smaller businesses. The products slowly get worse over time, and as long as no one notices, the manufacturers can book the profits. But the quality fade strategy could never work with Apple. The iPhone is simply too complex to secretly start switching out components. And Apple engineers have a rigorous set of quality assurance practices in place. If Apple's manufacturers wanted to maximize their profits, they'd have to come up with a more subtle workaround. The solution they found is one I call morality phase. And it's nearly impossible for Apple to detect. See, while Apple can easily test their iPhones to make sure that they were made with the right materials and to the right specifications, it's much harder to verify that they've been made to the same human rights standards. If a manufacturer has a fixed price contract with Apple and they want to increase their profit margins, the only option is to reduce their labor costs. And the easiest way to reduce labor costs is to use workers you can exploit.

Seven Apple suppliers in China are using forced labor from Xinjiang. They participate in state run programs the same ones that are allegedly part of China's campaign of genocide against the Uyghurs.

Uyghurs are the dominant ethnic group in Xinjiang. Unlike every other region of China, where most inhabitants are Han Chinese, Uyghurs have their own distinct culture. Most practice Islam, and they had a historically strong independence movement. For years, under the banner of fighting terrorism, the Chinese Communist Party has been forcing Uyghurs to work in factories.

We see workers every 50 of them are watched by one minder. They're surveilled online and in person. They have to attend these Mandarin studies after work and political indoctrination sessions. And these factories have bubbled fences.

One of those factories was a Foxconn facility which manufactures up to half of all the world's iPhones.

Some companies are directly using Uyghur labor to manufacture their product and other companies, you know, in a long, complicated supply chain. And they might not know.

It's one of the clearest examples of the morality fade strategy. There are undoubtedly others which just haven't seen the light of day. And it's a huge problem for Apple and Tim Cook. Apple has a playbook for addressing negative stories about the conditions inside the factories that Manufacture iPhones. Apple CEO Steve Jobs says he's very troubled by a string of suicides at Foxconn. Apple has been championing itself as a perfect enterprise, but it is all a facade. They categorically denounce the situation and make plans to audit their supply chain to prevent this in the future.

Apple does one of the best jobs of any companies in our industry of understanding the working conditions in our supply chain. We go into these suppliers and we go into their secondary and tertiary suppliers, places where nobody's ever gone before and audited them before. And we're pretty rigorous about it.

It's Crisis Communications 101. And that strategy has worked for the most part. Apple really does want to avoid a major public relations backlash. So they constantly push their suppliers to follow Chinese labor laws and avoid taking shortcuts to save money. Faced with the morality fade scenario I just described, the obvious solution for Apple would be to pull out of China. But it's easier said than done. Apple hasn't really outsourced production to China in the traditional. Instead, they've built one of the deepest cross border relationships in business history. Throughout the iPhone era, Apple has embedded top product designers and manufacturing engineers directly into their suppliers facilities. These are Apple employees, but they will often live in China for months at a time to make sure that new production processes get designed Properly. In a typical manufacturing relationship, the designer will often hand off a product to a manufacturer and let them figure out how to actually produce produce it at scale. Apple takes a completely different approach, working much more closely with its manufacturing partners. They've spent billions of dollars on custom machinery and developed cutting edge expertise that sets them apart from the competition. And why have they gone to all this trouble? Because of the iPhone itself. This is a deconstructed iPhone 4S to show you how intricate the internal components are. The iPhone4 was assembled by Foxconn and Pegatron, another Taiwanese electronics company. It sold 4 million units in its first three days on the market and more than 60 million over its lifetime. Remember, the iPhone 4 was released in October of 2011. At this point, it's almost 12 years old, and it's only gotten more complex. The point is that assembling the iPhone has never been easy. Every generation has been made with the latest technology in both software and hardware. China didn't have the capabilities to scale up iPhone production before Apple showed up. Tim Cook and the Apple team brought those skills and helped build up the competency over many years. As a result, they turned the iPhone into the most profitable and best selling product in history. The best selling car of all time is the Toyota Corolla, with 50 million vehicles delivered. The best selling toy of all time is the Rubik's Cube. At 400 million units sold. The best selling book series is Harry Potter, with 500 million copies sold. The iPhone has sold more than 2 billion units. It's not just the best selling mobile phones. It's also the best selling music player, the best selling camera, and the best selling computer of all time. The iPhone was only possible because of China. But even though China made Apple the biggest company in the world, it now poses a massive risk. Apple is completely reliant on China. More than 95% of iPhones, AirPods, Macs and iPods are made there. And China makes up nearly one fifth of the company's revenues. This dependency means that as tensions escalate between Beijing and Washington, Apple is caught in a tough place. Apple wasn't the first computer company to embrace the Chinese manufacturing opportunity. Both Hewlett Packard and Compaq made PCs there throughout the 1990s. But Apple took a very different approach from these earlier companies. If you look at the parts of an iPhone, you'll notice that nearly everything is custom made. This allows Apple to regularly deliver new features at every major keynote. But the trade off is that it requires requires a much deeper integration with the Chinese supply chain. Instead of handing over specifications to suppliers and letting them decide how to build devices, Apple would buy the relevant equipment and install it in the factory themselves. They were so dedicated to scaling the production of the iPhone that by 2012, they had over $7 billion of assets in China. To put that into perspective, Apple's machinery in China became more valuable than all of Apple's buildings and retail stores combined. No other tech company was pursuing this strategy, but Tim Cook realized that these huge investments in physical equipment could unlock new opportunities. Now, what's interesting about Cook, though, isn't just that he had the confidence to throw money at a problem when the time was right. It's also that he had instituted an extremely rigorous process for vetting suppliers. Apple engineers were constantly dispatched to meet with Chinese suppliers in person. And while they were on site, they would drill the CEO with technical questions until they could no longer get answers. Then they would move deeper and deeper into the organization until they were talking to the most technical people at the supplier to understand their full capabilities. Apple would only move forward with a contract if the company's engineers signed off on the supplier's organization. It was an exhausting process for anyone bidding for Apple's business. But landing a contract could be completely transformative. Not only not only would the suppliers revenues immediately start tracking with Apple's growth trajectory, but Apple engineers would effectively take over the research and development roadmap to make sure that the supplier was hitting key milestones. Just look at how Apple completely transformed Foxconn. In the year 2000, Foxconn started making imacs for Apple. They did a total of $3 billion in revenue that year. Ten years later, Foxconn had grown to nearly $100 billion in revenue, more than its five biggest competitors combined. The Chinese government was quick to realize how important the Apple relationship would be for economic development. After the 2008 global financial crisis, Beijing issued over $1 trillion in loans, and over half of that money went toward infrastructure spending. This meant bigger apartment buildings to house millions of migrant laborers, as well as more reliable highways, airports, and warehouses. China was betting that Apple would continue to dominate the global electronics market. In 2010, they released both the iPhone 4 and the first iPad to great reviews. And just as Tim Cook had bet big on the success of the iMac, in 1998, the founder of Foxconn, a guy named Terry Guo, was ready to double down on Apple. He met with Tim Cook to plan the launch of that year's products and argued that Apple was massively underestimating demand he could tell that the combination of the iPhone4 and the iPad were going to mark an inflection point for Apple, and they needed to scale up. It was an easy pitch to Cook, since Foxconn was gonna foot the bill for the new facilities. That sounds like great news for Apple, but it's also a huge headache.

How many tool and die makers do you know in the US now? We could have. I could call a meeting around the United States and say, would every tool and die maker come to this room tonight? We wouldn't fill the room in China. You would need several cities.

China is no longer the best option for Apple. It's become the only option. So what's the solution? Can Apple actually pull out of China right now? The answer is no. In 2019, Tim Cook stood next to Donald Trump at a manufacturing facility in Austin, Texas. The goal of the photo op was to let the world know that Apple was committed to making products in the United States. Again, it was a win win for both of them. Trump could say that he was bringing back manufacturing jobs, while Tim Cook could say that he was getting ahead of the China issue. But that event was mostly smoke and mirrors. The facility had actually been in operation since 2013. It didn't represent any real shift in Apple's manufacturing Strategy. Back in 2012, Steve Jobs was very direct with Barack Obama about Apple's manufacturing plans. He told him point blank that those jobs aren't coming back. That might have been a reasonable economic decision to make. Back then, further globalization looked inevitable, but things have gotten so much more complicated. So since then. COVID lockdowns wreaked havoc at Foxconn and created a shortage of 6 million iPhones this last holiday period. But shipping delays are much more tolerable than human rights abuses. And when factory workers started protesting the restrictions, Apple's response was telling. In the past, Apple had generally been supportive of improving working conditions in Chinese factories. But not this time. Instead of supporting the protesters or issuing a statement about the importance of free speech and democracy, Apple started restricting the use of airdrop to share information about protests. This led to harsh criticism from American politicians on both sides of the aisle. On the left, you had Senator Mark Warner saying that Apple was doing the bidding of the Chinese Communist Party. And on the right, you had Senator Josh Hawley saying, quote, when the Communists in Beijing tell Apple to jump, it asks how high. It's always dangerous to be in a position where. Where you have no allies. In Washington, Democrats and Republicans don't agree on much, but right now, they both agree that Apple needs to pull out of China. So could Apple actually do it? Where could they go? India would certainly be a logical choice. It's a democracy of more than a billion people, and English is officially the second language. There are far fewer geopolitical risks, and Indians are starting to buy more and more iPhones each year. As incomes rise, the country is accelerating in manufacturing as well. In 2014, India was responsible for just 2% of global smartphone production, but that grew to 16% in 2022. Geopolitical situation, especially between China and US, it is a great opportunity for us. Samsung has been able to build 120 million phones annually in India, and the government is dedicated to improving infrastructure. Apple has actually been manufacturing iPhones in India since 2017. But. But that headline is a little bit misleading. The vast majority of the Apple supply chain is still in China. And even though India is starting to produce smartphones in large volumes, they are still years behind the cutting edge. Of the 20 million phones made in India last year, most were budget phones that sell for $250 or less. The country just isn't ready to start manufacturing flagship iPhones yet. India does have over a billion people, but they don't have the skilled technicians and migrant laborers who are critical to iPhone production. The infrastructure is still years behind too, which makes transportation, utilities, and communication networks all more difficult. So, not India. Well, what about Vietnam? Vietnam has truly become one of the great miracles of the world. After all, the average Vietnamese worker earns half as much as their counterparts in China, so there are significant labor cost savings. Apple has been pushing hard to make Vietnam work. It's planning to make more than 50% of AirPods there by 2025. But it's unlikely that the numbers will ever really add up. By some counts, China has more factory workers than Vietnam has people. So much of hitting the ruthless iPhone production schedule revolves around hiring tons of people and quickly ramping up manufacturing. China's migrant workers are critical to this effort, and there are nearly 300 million of them. Vietnam, by comparison, has fewer than home, 100 million residents in total. Decoupling from China will be a massive task for Apple. They've invested so much into the country, and it's impossible to just pick up and leave. In 2016, Tim Cook personally signed a five year agreement to spend more than $275 billion in China. Instead of preparing for an exit, Apple is doubling down on China and moving even deeper into the country. The end result is that Apple isn't really looking at an alternative manufacturing sector center. At best, they're pursuing a China one strategy where they will add additional capacity elsewhere without pulling back in China whatsoever. Apple will probably just wait until the media attention dies down and then keep investing. But this story is far from over. In order to understand how the US China relationship will evolve over the coming years, it's important to learn the history of China's leader, Xi Jinping. If you want to know everything about his rise to power, just watch this video next. Thanks a lot.