I am getting questions from friends and acquaintances about whether the US’s supply chain woes are over. Afterall, port congestion has cleared, transportation costs have gone down, we are seeing far fewer product shortages, and the looming recession will likely take some of the pressure off hiring and retention woes. The people I talk to are surprised when I say supply chain challenges are not going to disappear any time soon. There are of course the challenges from a potential recession and the increasing severity and frequency of climate change disruptions. But by far the biggest impediment to smooth running supply chains is how difficult it will be for many companies to disengage their supply chains from China. Apple provides a prime example.
The China Problem
When the US agreed to a free trade agreement with China in 1999, the theory was that as more and more Chinese entered the middle class, China would become more democratic. That did not happen. What happened instead was massive theft of intellectual property, huge trade deficits, the hollowing out of the middle class in Europe and North America, and the rise of nativist politics.
The US responded. First, there were the China tariffs of the Trump years. These tariffs remain in place under the Biden administration. The theory was that duties would lower trade deficits. Trump was successful in bringing down the bilateral trade deficit with China, as result of the tariffs he imposed on more than $350 billion worth of Chinese goods. Final figures show the trade gap with China totaled $311 billion in 2020, down sharply to the record high of $419 billion in 2018. But the combined U.S. goods and services trade deficit increased to $679 billion in 2020, compared to $481 billion in 2016. Partly this was because Chinese companies diverted their exports to other nations and those products were then imported into the US.
Next came, the Uyghur Forced Labor Prevention Act, was signed into law by President Joe Biden in December of 2021 and then went into effect in June of 2022. This legislation was the U.S. response to the Chinese government’s systemic use of forced labor against Uyghurs and other ethnic minorities in the Xinjiang province. The importation of any goods into the US that is produced – wholly or in part – in the Xinjiang Uyghur Autonomous Region is now prohibited.
In October of 2022, the Biden administration published a tough set of technology export controls. These controls included a measure to cut China off from certain buying semiconductor chips made anywhere in the world with US tools. The US is greatly expanding its attempt to slow Beijing’s technological and military advances. It is not just US tool manufacturers that are affected. Both American and foreign companies that use US technology are being required to cut off support for some of China‘s leading factories and chip designers. The goal is to set China’s chip manufacturing industry back by at least a decade.
Then in January, in a rare instance of bipartisanship, the House voted overwhelmingly to establish a new select committee to address the multifaceted threats posed by China. This committee’s powers will be largely investigative, not legislative. But it will put pressure on the Biden administration to get even tougher.
China, of course, is likely to react to these measures in ways that may be hard to predict. However, trade barriers are apt to increase. We are beginning to move from a world of “free trade” to one of bilateral trading blocs. In this new world, democracies will increasingly do business with each other. Similarly, dictatorships and pseudo democracies will increasingly trade with each other.
Apple is Heavily Reliant on Operations in China
Apple, headquartered in Cupertino California, sells smartphones, personal computers, tablets, wearables, and accessories, along with a variety of related services. Apple is the world’s most valuable company. The company had revenues of nearly $400 billion in their last fiscal year.
There were two excellent articles in the Financial Times (FT) on the Apple supply chain. The articles were based on interviews with supply chain experts including nine former Apple executives and engineers. The opaque operations of Apple’s supply chain were explained in some detail.
In their Annual Report, Apple admits that “business can be impacted by political events, trade and other international disputes” and that “the Company’s manufacturing is performed in whole or in part by outsourcing partners located primarily in Asia, including China mainland, India, Japan, South Korea, Taiwan and Vietnam.”
This is disingenuous at best. More than 95% of iPhones, AirPods, Macs and iPads are made in China. By October 2010, Foxconn’s factories in Shenzhen alone had as many as 500,000 workers. Foxconn is Apple’s key contract manufacturing partner.
Apple tightly directs partner processes and activities. Apple would dangle a commitment to buy a custom component – a part no other company would be allowed to buy – in massive quantities in return for taking effective control of the supplier’s R&D. In some cases, Apple would not just specify the production equipment to be used by the supplier on their factory floor, they would buy it and own it. There are also an array of specialized production and supply chain processes jointly developed by Apple and their partners. Specialized sub-suppliers and contractors have grown up to support Apple’s partners. FT points out that “if Foxconn, for example, needs to install sonic welders — a process to merge different metals or plastics with ultrasonic energy — it can call up any number of firms to run the line and hire the labor.”
As a result, China offers labor with specialized skill sets hard to find anywhere else. “Cook,” FT reported, in “explaining why Apple couldn’t manufacture at scale in the US, once told an audience that if every tool and die maker in America were invited to the auditorium where he was speaking, they ‘wouldn’t fill the room’. Whereas in China, ‘you would need several cities to fill with tool and diemakers’.”
Moving Final Test & Assembly to nations like India, which Apple is starting to do, is a band aid. Final Test & Assembly is labor intensive but does not require skilled labor. It might be possible to get some Chinese manufacturing and sourcing partners to open operations in nations like Vietnam and Malaysia. Local labor would be used, but the skilled management and key personnel would be Chinese. Other companies are making this transition. But this is a slow process and it takes years to build up a similar level of expertise. Meanwhile some of these nations have their own challenges. Vietnam, for example, has poor transportation infrastructure and an organized crime problem.
Clearly, in the new political and trade environment, Apple will face a massive challenge in disentangling itself from China. While Apple’s China problem is more severe than other Western companies, the problems are far from unique.