Foxconn Keeps Growing in Apple’s Shadow

Foxconn Admits Employing 14-Year-Old Interns
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When scuffles broke out among stressed Foxconn workers on an iPhone 5 assembly line last year, it sparked fears among Apple devotees waiting for the gadget and investors in the world's largest contract manufacturer waiting for higher margins.

In the end, Foxconn, also known as Hon Hai Precision Industry, delivered – tens of millions of phones, record high annual revenue and, in the last quarter of 2012, its highest operating margins in three years.

Since then new concerns have emerged about slowing growth at Apple, Foxconn's main customer, while workers and recruiters at some of the Taiwanese group's factories say the company has slowed hiring and asked workers to do less overtime.

Further slowdowns at the U.S. group will pinch Foxconn's sales, especially if the new phones Apple is expected to reveal soon do not sell well or are so low-priced as to do significant damage to Apple's own margins, as some analysts fear, given the disappointing sales of the iPhone 5.

However, in spite of these concerns, analysts expect Foxconn's recent progress on profitability to be sustained as it maintains its key role in Apple's supply chain and outstrips its PC-focused competition.

"The biggest change in terms of Hon Hai in the course of last year is . . . its margin profile actually improved," says Jenny Lai, head of Taiwan research for HSBC.

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In one year, the company tripled its operating margin – from 1.1 percent in the fourth quarter of 2011 to 3.7 percent for the fourth quarter last year.

It also recently picked up one prominent new customer in Google, which placed an order, albeit a tiny one, for Foxconn to make its Google Glasses at a factory in California.

By contrast, most of its smaller competitors, particularly other Taiwanese assemblers Quanta, Compal and Wistron, recently reported that their margins had fallen as their core PC businesses slid and they struggled to find new customers with greater exposure to the growing mobile device segment.

One big factor underpinning Foxconn's recent recovery is the conclusion of one of the biggest migrations yet of manufacturing capacity. The company started in the 1980s in Shenzhen, near Hong Kong. Since then, and starting as early as 2008, rising wages prompted the company to build new facilities closer to the hometowns of its mostly migrant workforce, in inland cities such as Zhengzhou, where the iPhone 5 is made.

(Read More: Apple's Apology Wins Respect of China Media)

Now, the company's employees are thought to be split nearly evenly, with half a million at its inland factories and half a million at its factories on China's eastern coast including Shenzhen.

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In the long run, moving the assembly lines will help it keep wage costs down. The decision, however, required Hon Hai to spend money on keeping capacity in its old factories while the new lines got rolling.

Another factor, analysts say, is that Foxconn has been able to eke out better margins from Apple, which is notorious for driving a hard bargain.

While Hon Hai and Apple rarely comment on the financial relationship between the two, Apple said it would compensate the Taiwanese group for the higher wages it had agreed to pay, following an audit by labor rights groups last year.

Apple also remains dependent on Hon Hai's capacity. While Apple is working with a second assembler, Taiwan's Pegatron, to produce some of its iPads, it has struggled with production issues.

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"At least for now, Hon Hai has all the leverage," says Kirk Yang, an analyst with Barclays.

Beyond bargaining power is Hon Hai's increasing ability to include smaller components made by its many subsidiaries into the final products it assembles.

Those affiliate companies sell components for a higher margin than Foxconn sells its final assembly services for. This has boosted margins at the parent company, wrote Alberto Moel, an analyst with the broker Bernstein, in a note.

GIS, an unlisted Foxconn subsidiary that makes touch screen components, started contributing to Apple products late last year, says Ms. Lai.

The low-end iPhone, anticipated later this year, could give Hon Hai a new opportunity to use some of its components, in particular camera parts, wrote Kevin Chang, of Citigroup, in a research note.

(Read More: Apple Must Reveal New Product Soon, or Else)

Yet Apple's anticipated slowdown is expected to hit Hon Hai hard, particularly in the beginning of next year as consumers wait for the launch of new Apple products.

Despite having suspended hiring in its factories earlier this year as Apple orders for iPhone 5 fell below expectations, recruiters for Foxconn in China say it has resumed taking on workers but is doing so less aggressively than usual. Workers at its factories in Shenzhen told the Financial Times they are working less overtime than before, prompting some workers to leave.

That would be one of the first times that Hon Hai has made such aggressive labor reductions, says Daniel Chang of Macquarie.

That slower than usual hiring pattern suggests Hon Hai has a "more conservative . . . outlook than before", however, Mr. Chang says, it will help it sustain its margin growth even if Apple's sales slip.