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Electronics Production | June 07, 2010

The True Cost of Outsourcing

Foxconn and Apple have been in the national business press recently over human rights issues related to worker suicides. CBA has commented on several occasions on the topic, including recently in a response to our 5Q/5A column.
The stories have focused on the secrecy of Foxconn, the low wage rates, and the overall unhappiness of workers, who are primarily young, single Chinese men and women from rural areas who are isolated from friends and family in complexes and are forced to sign exploitative labor contracts.

In one video, a Financial Times journalist was allowed to enter the compound in Shenzhen and film never-before seen shots of palm tree-lined boulevards, restaurants and shops filled with smiling, neatly dressed Chinese youth that are now flooding the blogosphere. A young woman is interviewed while she peacefully works on needlepoint.

She says through a Foxconn translator that she's very happy working at Foxconn and looking forward to earning enough money to go back home and get married soon. Since it doesn't look that bad to most people – kind of like a college campus in San Diego – the human rights furor is subsiding. Foxconn announced they will raise labor rates by 30% (!!) and so we're betting the public relations crisis is over, iPads are selling at record-breaking pace, and all is right in Cupertino.

We predict the net impact of the story will be, once again, to focus on the effect of all this on labor rates. OEMs will start worrying that China is no longer cheap enough for their electronics manufacturing projects and start looking at Vietnam, Tunisia, or some other exotic location where workers can be exploited with impunity.

This thinking is wrong, wrong, wrong, on several fronts.

Front one: Human Rights Let's be realistic about what happened with the spin doctors. Chinese managers are masterful at manipulating Western reporters, so it is inconceivable that the FT video is typical of worker conditions at Foxconn. And the issue isn't what certain parts of the facility look like. It's the experience of the typical worker, who stands jammed up against hundreds of other workers doing one narrowly defined task for 12 hour shifts with no break, day after day and then goes to a dormitory with 100’s of other workers to sleep.

Neither the wages nor the working hours allow for any social life; a 30% increase on next to nothing is still just slightly more than nothing. The extra dollar a day won’t solve the underlying problem. Humans are not robots; they need community, relaxation, freedom. The Foxconn facilities – unlike similar enterprises in most other parts of the global – regulate workers 24/7. That's how most people define prison.

Front two: labor rates In electronics manufacturing, wages paid to direct labor employees account for only a tiny fraction of what an OEM pays for outsourcing services (i.e. materials account for the vast majority of their spend). Our case-studies prove that once the other elements of cost are introduced into the equation, OEMs almost never save a substantial amount of money in a cross-hemispheric solution no matter how low the labor rate is.

This has always been true for lower volume, higher mix electronics but is now becoming more commonly true with higher volume electronics. Costs in China (and what OEMs spend internally in support of their outsourcing initiatives) have been rising dramatically, and it has nothing to do with the cost of labor in Foxconn’s factories.

Front three: the elephant in the room Concurrent to the Foxconn human rights stories were the announcements of the Chinese knock-off 'iPed' and the Chinese version of the iPhone that have both gone on sale in the vast Chinese consumer market. This serves to remind OEMs of the near total lack of intellectual property protection afforded to companies doing business in China, promises to the WTO notwithstanding. For those C-level executives expecting to capture domestic demand through use of the Chinese national supply base: think again. If Apple can't protect its IP in China, no one can.

There are still situations where a Chinese-based manufacturing solution makes sense, but the days of the wholesale transfer of the electronics manufacturing industry are over. We have the reality-based data to show you exactly how to configure your global electronics manufacturing program to optimize competitive advantage, innovation and cost effectiveness. But it can’t be done via a one-dimensional analysis based on cheap labor rates.
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Author: Charlie Barnhart

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