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Tuesday, July 06, 2010, 05:55 am PT (08:55 am ET)

Apple's iPhone supply chain faces sharply increasing costs in China

A close look at the iPhone 4 supply chain demonstrates how contract manufacturers, including Apple partner Foxconn, are fighting rising costs in China in order to stay competitive and profitable in today's market.

A new report this week The New York Times used Apple's iPhone 4 as an example of rising costs in the Chinese supply chain for global consumer electronic devices. It spoke of impending increases in manufacturing costs in China, noting that "soaring labor costs caused by worker shortages and unrest, a strengthening Chinese currency that makes exports more expensive, and inflation and rising housing costs" could significantly increase production costs for the Cupertino, Calif., electronics company.

Although estimated labor costs comprise just 7 percent of the overall final cost of the iPhone 4, analysts note that many of the companies in Apple's supply chain also rely on efficient, low-margin Chinese factories to keep their costs low. The report also said that Apple's high margin products should be able to absorb the increased costs with minimal disruption, while other brands may face a bigger challenge.

A large percentage of Chinese factories are located in the southern part of China, especially Shenzhen, which, as a Special Economic Zone, provides special government-endorsed incentives to manufacturers, with unique laws that are more relaxed than in the rest of China. Despite these incentives, Foxconn Technology, a division of the Taiwanese-based Hon Hai Group, recently announced its intention to move "hundreds of thousands of workers to other parts of China" in response to rising costs. Moving its operations inland would reportedly save Foxconn 20 to 30 percent in labor costs.

The report said that wages in China have increased by more than 50 percent since 2005. Salaries are expected to increase another 20 to 30 percent this year, as workers continue to feel they are being underpaid, and those employees have the support of local governments.

Foxconn has 800,000 supply chain workers in China alone, with contracts to supply major electronics companies including Apple, Dell and HP. Foxconn is the biggest name in the $250 billion industry, which the report noted is "invisible to consumers."

The report draws heavily from a teardown report of iPhone 4 from market research firm iSuppli. The El Segundo, Calif., firm placed the total bill of materials for the new smartphone at $187.51, but does not include labor and manufacturing costs. According to the Times, the combination of sharply rising wages, continued appreciation of the Chinese currency, and unsustainable labor practices are threatening both the margins of contract manufacturers and major brands and the stability of China's manufacturing boom.

In June, it was reported that Apple was giving back some of its profits to workers who assemble its products. Foxconn had already promised a 20 percent raise in the wake of investigations into several highly publicized suicides that took place at the manufacturing giant's Shenzhen plant. In response, Apple conducted an independent investigation into the working conditions at the plant, which employs over 400,000 workers.