Why Apple can’t leave China

This is an audio transcript of the Behind the Money podcast episode: ‘Why Apple can’t leave China’

[MUSIC PLAYING]

Michela Tindera
It’s December 2022 and the CEO of Apple, Tim Cook, is in Washington, DC, to meet with lawmakers when he’s approached by a reporter.

Reporter
Mr Cook, do you support the Chinese people’s right to protest? Do you have any reaction to the factory workers that were beaten and detained for protesting Covid lockdowns?

Michela Tindera
Cook doesn’t respond. He keeps walking, stone faced, and he even tries to move to the other side of the hallway away from the reporter.

Reporter
Do you regret restricting AirDrop access that protesters used to evade surveillance from the Chinese government?

Michela Tindera
This exchange happens not long after protests erupted at a Foxconn factory in China that makes iPhones.

Patrick McGee
Apple had literally just, you know, finished their fiscal year with record revenue. Things were looking really good. And then Covid breaks out in the most important factory for assembling their most important product at the most important time of the year.

Michela Tindera
That’s the FT’s San Francisco correspondent, Patrick McGee. He’s been reporting on Apple since 2019. And he says that after years of China’s zero-Covid policy, this Covid outbreak late last year signalled a breaking point for the workers inside the factory.

Patrick McGee
And so what happens is you have people who don’t want to live in these high rise dormitories, you know, next to the factory in a period where they’re all going to be quarantined. And so you have hundreds of people running from the factory, jumping the fences, and the people that do stay in the factories end up being beaten by police because they’re rioting. They don’t have proper food supply. They don’t have proper medical supply. It becomes this media spectacle.

Michela Tindera
It didn’t take long until protests against China’s zero-Covid measures spread to other parts of the country.

Patrick McGee
And, you know, quite literally, the biggest protest against communist rule since Tiananmen Square.

Michela Tindera
And this media spectacle also became Cook’s own media spectacle when that reporter approached him.

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

Michela Tindera
Now, a lot of CEOs confronted by a reporter like this might choose to give them the silent treatment. And Apple can point to a November statement where it said it was working closely with Foxconn to ensure their employees’ concerns were addressed. But in the months since, Cook still hasn’t really answered these questions, and Patrick thinks he knows why.

Patrick McGee
It’s a very awkward video to watch. Um. And we all know why he has to be silent or why he is silent. You know, I mean, everything I know about Tim Cook leads me to believe that, of course he supports, you know, the Chinese having rights and having the ability to protest their government. I mean, those are just fundamental rights that every American enjoys and believes that the rest of the world should enjoy. But of course, he can’t voice that. And we know why he can’t voice that. And if I need to spell it out, it’s that 80 per cent of revenues are coming from hardware and the vast majority of its hardware is assembled in China.

Michela Tindera
This encounter is just one example of the quandary that Tim Cook has found himself and Apple in. Over the last couple of decades, Apple has developed arguably the most controlled and sophisticated supply chain in the world, and China plays a central role. But it’s also getting trickier and trickier to do business there. Apple knows it needs to diversify its supply chain away from China. And we’ve seen some news about this recently. The headlines have been all about how Apple has started the process of leaving China. That’s what got Patrick interested.

Patrick McGee
The whole reason I got into this whole issue was I think it was a JPMorgan note that had said, you know, we expect 25 per cent of iPhones to be built in India by 2025. I sort of thought, well, that’s a big deal, but it doesn’t strike me as all that possible to just move those operations. And so the more that I looked into it, the more that it just didn’t make a whole lot of sense, because I think there’s this underappreciation of what China has contributed to this relationship. And so I guess my point is, the more you peel back the onion, the more you realise that it’s China all the way down. (laughter)

[MUSIC PLAYING]

Michela Tindera
I’m Michela Tindera from the Financial Times. Today on Behind the Money, we’re gonna explore how Apple’s supply chain became so tied to China, whether it will ever be able to leave, and if it does, will it remain the tech juggernaut that it is today?

[MUSIC PLAYING]

Jeff Goldblum
The PC. Perpetually complicated, profusely corded . . . 

Michela Tindera
Picture this. It’s the late 90s. You’re watching TV and see this commercial that’s being narrated by the actor Jeff Goldblum. And the camera pans over a big, clunky PC. It’s all very beige. And then this other brilliant blue computer appears in front of you.

Jeff Goldblum
Oh, and then there’s the new iMac, which is about as un-PC as you can get.

Michela Tindera
In the early and mid 1990s, Apple’s a struggling company. But then its founder, Steve Jobs, returns and releases the new iMac desktop computer. And this commercial signals the dawn of Apple’s comeback.

Patrick McGee
So when Apple comes out with the candy coloured iMac, they essentially faced a problem they haven’t faced in years: customer demand. And it basically saves the company from bankruptcy.

Michela Tindera
The iMac becomes the bestselling computer in America, which is great. But with massive customer demand comes a new challenge.

Patrick McGee
Essentially, they don’t have the scale and resources to actually fulfil the customer orders. Apple had long prided itself, and Steve Jobs in particular had prided himself, on manufacturing in its own facilities and often in America. Not exclusively in America but that’s just because Apple is a global company. And, you know, Apple really cares about control, right? They really want to own the hardware, the software and the operating system. And for at least the first two decades of Apple’s existence, manufacturing felt fundamental to that. In other words, they were not comfortable using outsourcers to build their computers because they wanted control over that.

Michela Tindera
And it’s around this time that Apple’s history changes forever. And that story begins with Tim Cook. Cook built up a reputation as an operations guru working at PC makers like IBM and Compaq. And in 1998, he leaves his Compaq job to come over to Apple, and he brings a very important relationship with him. That relationship is with a Taiwanese businessman named Terry Gou, the founder of the contract manufacturer Foxconn.

Patrick McGee
But then when Tim Cook moves to Apple, Terry Gou seems to pick up on the significance of that. And so when he hears that Apple is having problems manufacturing the iMac, Terry Gou goes to Tim Cook and says, Give me a chance. I can do this for you.

Michela Tindera
To Patrick, this is a key moment for the rest of Apple’s trajectory into the 21st century.

Patrick McGee
Everyone understands the meeting of the minds between Jony Ive and Steve Jobs in creating the iMac, the iPod, the iPhone and the iPad. The meeting of the minds between Terry Gou and Tim Cook and actually building those products at scale, at margin, is just as significant to Apple’s success. And if that sounds like a contestable or debatable point, it’s not. Apple is this operations Goliath that we still treat as a design company because their designs are so good. Jony Ive and Steve Jobs made Apple products unique. Terry Gou and Tim Cook made them ubiquitous.

Michela Tindera
So Steve Jobs, pretty much for good, has to put aside his wishes about manufacturing products in the US. They try making the iMacs in a few different countries. But it doesn’t take long for the top execs at Apple to start to think, hey, what about China? And Apple wasn’t the only company that was thinking this.

Patrick McGee
In the early 2000s, Washington has a big role to play and why electronics outsourcing becomes a big deal in Asia. They encourage China to enter the World Trade Organization, which means, you know, collapsing or getting rid of tariffs, opening up all sorts of trade. And the whole notion is this idea that by building up China’s economy, by letting them manufacture at scale with American corporations, you’re basically going to sort of collapse the authoritarian system the way that the Soviets have collapsed. So I think it was really best put by Thomas Friedman. He called it the Golden Arches theory of diplomacy. And his stipulation was that no two countries that had McDonald’s had ever gone to war with each other. Right?

Michela Tindera
And so Apple, in a partnership with Foxconn, starts making iMacs in China.

Patrick McGee
Terry Gou and Tim Cook work together to build it at scale. And what happens is Apple revenues shoot up by 30 per cent.

Michela Tindera
From there you might say the rest is history. Foxconn receives contracts from Apple to build the iPod, then the iPhone, then the iPad. And this deal is lucrative for both companies. Just listen to these numbers. In 2000, Foxconn has revenues of $3bn. Over the course of ten years, making Apple’s products, Foxconn’s revenue jumps to 98bn. Around the time Apple becomes the world’s most valuable company. And that sort of mammoth growth just kept going.

[MUSIC PLAYING]

Patrick says there are a few reasons why Apple has become so intertwined with China.

Patrick McGee
So if we’re looking at the Apple-China partnership, I guess the question is like, what does China bring to the table? And, you know the answer really is a labour force that’s unprecedented. Apple says it has trained around 24mn people since 2008 to build their products. That’s a bigger population than all of Taiwan.

Michela Tindera
Patrick says the reason why Apple has needed that many people is because the day in, day out labour required to assemble an iPhone is gruelling.

Patrick McGee
It’s just tedious work that after four months or so it can be incredibly difficult to keep doing. You’ll have 800 to twelve hundred people in the line and these small little, you know, cubicle sized areas where you’re doing the same monotonous task. You know, fitting the camera into the upper left hand corner or whatever, all day, every day for 12 hours.

Michela Tindera
But it’s more than just Foxconn hiring enough employees for Apple to churn through. It’s the Chinese government that’s been involved in getting so many of its citizens into jobs at these iPhone and iPad factories.

Patrick McGee
China also has this authoritarian government, which sort of removes obstacles, right? It removes checks and balances. A supply manager once said that if Apple needed to hire 3000 people for the following day in China, they could do it, right, at an individual factory.

In the earliest years of Apple building the iPod in just enormous volumes and then the iPhone coming out and having such volumes that, like, literally entire manufacturing hubs had to be built to support it, the leverage in the relationship between Apple and China was clearly on Apple’s side, meaning that Apple needed to do X and, you know, Chinese provincial governments, companies and Beijing were bending over backwards to win these orders because it was instrumental to China’s rise as a manufacturing electronics powerhouse.

Tim Cook
For us, the, uh, number one attraction is the quality of people.

Michela Tindera
That’s Tim Cook there. And he’s talking about China on stage at a conference in 2017. Like Cook saying in that clip, it’s more than just the sheer quantity of potential employees. It’s the, quote unquote, “quality” of highly educated and skilled employees that makes this partnership such a success.

Patrick McGee
I think people have the sense of if you have low paid workers assembling iPhones in a line, well, you could just do that in any country that has a large number of unskilled workers. But Apple products are very sophisticated. And what Foxconn offers is not just unskilled workers. I mean, they have cutting-edge PhDs working on the factory lines. You’ve got people that are still there that worked on the first iPhone, right? There’s a sort of institutional knowledge, you know, and knowledge in the air that China has that it’s gonna be really difficult to replicate anywhere else.

Michela Tindera
And for years and years, Apple helped facilitate that sort of institutional knowledge in its own ways too.

Patrick McGee
Former engineers of Apple have told me that like the secret sauce to the company innovating year in, year out, particularly hardware, really, is that planeloads of designers, you know, lawyers, engineers fly from Cupertino to either Shanghai or Hong Kong on quite literally a daily basis. And some of them will be at the factories for weeks. Some of them will be there for months. They sent their top engineers, which is really a way of saying they sent America’s top engineers to these countries to help them build all the necessary skills.

Michela Tindera
But there’s one more factor. The actual machinery that Apple’s built and set up inside the country.

Patrick McGee
The iPhone is assembled by hand to some degree. Right? But there’s also a lot of automation that takes place, just like building the frame and things like that. So Apple spends incredible sums on the machinery that builds the iPhone.

Michela Tindera
That’s because Apple uses something called a CNC machine, which lets a designer with a 3D image file create complex parts. Patrick says that Apple buys these types of machines and then puts them in Foxconn’s facilities. And Apple buys so many of them in the tens of thousands that they basically cornered the market on them for years.

Patrick McGee
By 2012, the value of Apple’s machinery that is building its products is worth more than all of its real estate and Apple stores in the US combined.

Michela Tindera
So the labour force, the support of the Chinese government, the expensive machinery. In short, Patrick says all of this has come together to make Apple what it is today.

Patrick McGee
They don’t outsource in any meaningful sense of the term. They offshore. Right? The manufacturing is definitely happening in another country, but they are playing an extremely obsessive role. So, yes, it’s not Apple employees actually assembling the iPhone, but all the machinery that is allowing this to take place is owned by Apple. And to some degree, this comes out of Apple’s obsession for wanting to control everything. But it’s also because they were designing stuff that didn’t have any precedents. So nobody had this expertise.

Michela Tindera
For a while, things were working fine, especially because in the earliest years of this relationship, like Patrick said, China would bend over backwards to give Apple whatever it wanted.

Patrick McGee
That pretty clearly changes around 2017, where China has become more authoritarian under Xi Jinping, the Trump administration has made the US-Beijing relationship more contentious, and China is just exerting more control on how Apple can operate. And Apple, I think they’re having to acquiesce on sort of what’s available on the iPhone. You know, something like the New York Times app is banned. Social media apps are banned. Data of customers that’s in the cloud has to be stored in Chinese data centres. There’s just a number of moves that China asks for. And Apple doesn’t have much choice but to acquiesce or to oblige. And so what you’ve seen is an increasing number of areas where it’s Beijing calling the shots and they have to make these changes without upsetting Beijing, because one-fifth of their revenue these days comes from selling to China.

Michela Tindera
Apple isn’t necessarily alone in this. Patrick says that other US companies that moved their manufacturing to China in the early 2000s have found themselves in a similar situation.

Patrick McGee
What makes Apple unique is just that nobody has Apple’s sophistication, size and complexity of exposure, right? And, you know, if that’s a contentious point, I would just say it makes $400bn of revenue a year. 80 per cent of that is hardware and more than 90 per cent of that hardware is coming out of China. So find me another company with those figures. (laughter) You’re not going to.

Michela Tindera
Patrick says that Tim Cook often gets asked in places like Apple’s earnings calls about their manufacturing concentration in China.

Patrick McGee
And Tim Cook gives an answer that’s really unsatisfactory. He says, We have a global supply chain with 50 countries, so I feel really comfortable about our diversification, and he’s not wrong about that. So, sure, a bunch of components are made in Germany and Israel and America. It’s technically true that some phones are built in India and some phones are built in Brazil. But all roads lead through China before it gets to your hands.

Michela Tindera
Now, you may have heard some headlines about how Apple’s moving away from China.

News clip
Apple speeding up plans to shift manufacturing away from China.

News clip
India and Vietnam are said to be the top locations under consideration for new Apple factories.

Michela Tindera
But Patrick says these other options just aren’t viable right now. First, there’s India.

Patrick McGee
India is part of the discussion, honestly, because it’s a country of more than a billion people. Right? If you need something on the scale of China, there’s literally only one other country on the planet that ostensibly has everything you need to get it done. So it’s not that phones can’t be, quote unquote, “assembled” in India. Of course, they can be. They could be assembled anywhere. But the everything that’s around assembly is so far really only found in China. That’s what I think people don’t understand. They just think, well, why don’t we just set up a factory that assembles phones somewhere else? OK, that’s the easy part. The difficulty is, is how do you have everything taking place in China that sort of orchestrates everything, quote unquote, “just in time” to sort of do this at a massive scale?

Michela Tindera
Second, there’s Vietnam. The country already has a sophisticated industry for making electronics. But Patrick says that can only go so far.

Patrick McGee
One, there’s an inherent limit. I mean, there are more factory workers in China than there are people in Vietnam. So just in terms of how many people you need, Vietnam clearly just isn’t in a position to rival China. So a), there’s just a size constraint. But b) is that the reason all the manufacturing of electronics in Vietnam is in northern Vietnam is because of its proximity to China. So that really questions or calls into question how much of this is true diversification if the assembly that’s happening in Vietnam is all based on components being shipped from China just across the border and actually still largely being done by Taiwanese and Chinese companies. It just seems to me that we’re kind of stretching the definition of diversification.

Michela Tindera
Patrick says Vietnam and India are absolutely going to receive new business from Apple in the coming years.

Patrick McGee
The vast bulk of iPhone assembly is all happening in China. They absolutely will be shifting that. My contention is that I think it’s gonna be a lot more difficult than even Apple understands. The reason I say that is because Apple deserves enormous credit for how they built their manufacturing chain over the last 20 years. But China gave so much to this relationship.

Michela Tindera
Thinking back over the last couple of decades, these years of give-and-take between Apple and its partners in China have tied the knot that may now seem impossible to untangle.

Patrick McGee
You know, there’s a sense in which 20 years ago it might have been a massive mistake to allow China into the World Trade Organization. The hope there was that you would sort of liberalise an authoritarian country. But in fact what happened is we really just gave a bunch of cash and manufacturing sophistication to a country that’s become a chief geopolitical rival, a sort of successor to the USSR to some degree in terms of a Cold War rival. Did Apple make some sort of moral error? I don’t really know, and I’m sceptical of anyone having too harsh of a judgment.

[MUSIC IS PLAYING]

Michela Tindera
Behind the Money is hosted by me, Michela Tindera. Saffeya Ahmed is our producer. Topher Forhecz is our executive producer. Sound design and mixing by Sam Giovinco. Special thanks to Ryan McMorrow and Murad Ahmed. Cheryl Brumley is the global head of audio. Thanks for listening. See you next week.