What's at Apple’s core? Control.

Every time Apple brings out a new iPhone, the critics are poised. Is it too weighty, too large, too fat or too slim? Will the battery hold up? Will it bend in your pocket?

Few realise what goes into making one of the most complicated pieces of high-tech consumer equipment ever assembled, says Dr Neale O’Connor FCPA.

An associate professor at Hong Kong Baptist University’s School of Business, O’Connor has been studying supply chains in China for several years and says the logistics of putting together Apple’s iPhone and iPads are mind-boggling.

To meet global annual demand of 150 million iPhone and iPad units, Apple requires 156 official suppliers and many hundreds of lesser “unofficial” component suppliers.

The latest iPhone 6 and 6 Plus each have 200 separate components requiring 90 individual steps in their assembly, not all of which can be automated. All of this would be impossible without absolute control, O’Connor observes.

 

"Third-party reports and an annual visit are not enough to build a relationship,"

 

“Not only does Apple monitor Foxconn and Pegatron – the two biggest product assemblers – it monitors their suppliers, even telling them what materials to use,” O’Connor says.

Apple is the ultimate production control freak – its 600-plus technicians on the ground in China and Taiwan will not only check quality control, but the number of inputs, the volume of outputs and total yields from even the most insignificant of widget makers.

In some cases, Apple will install its own machine which the component supplier is obliged to use.

“It will then tell the factory it expects 60 per cent of the capacity from the machine. The rest is theirs,” O’Connor says.

Apple will also expect the cost to drop, on average, 5 per cent across different sectors every three months. So a supplier making a component for US$10 one quarter will be expected to produce it for US$9.50 the next. This goes on for the lifecycle of the product.

Almost all suppliers are channelled through to Apple’s major component assembler, Foxconn. Its biggest factory in Zhengzhou, China, has around 250,000 workers. During peak production of the latest iPhones, workers were organised into 100 production lines running 24 hours a day.

Foxconn (and by proxy, Apple) suffered reputational damage back in 2012 when an audit by the US Fair Labor Association found Foxconn workers were doing excessive overtime, often without proper remuneration.

There were also health and safety issues. Apple and Foxconn have since rectified working conditions, but Apple also contracted Taiwan-based Pegatron (which it initially rejected on price comparison), which produced about half of the 50 million iPhone 6 units.

“I believe Apple engaged Pegatron to ensure it was not totally dependent on Foxconn,” O’Connor says.

O’Connor says Apple leads the way in large scale supply chain management. Most buyers ask suppliers to send samples. Apple will examine the entire production process and possibly assess company management.

There’s never one component manufacturer – Apple makes sure it can switch to alternatives as a bargaining point for quality and price.

O’Connor adds that it will build into contracts a buffer for defective goods and an option to negotiate discounts for late delivery. It inspects components at various stages, including just before shipment.

“Third-party reports and an annual visit are not enough to build a relationship,” O’Connor says.

“An established line of communication that includes feedback is necessary to avoid misunderstandings and address issues before they become crises.”

With such an effective supply chain in place, what is the bottom line result for Apple?

By O’Connor’s reckoning, making and delivering an iPhone costs between US$120 and US$150. On average, Apple’s suppliers make a mere 10 per cent margin on their products, he says. The latest iPhone 6 sells for US$649. That’s a 450 per cent margin.

Total control looks like it pays very, very well.