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Terry Gou's Apple Challenge

Keeping the Hon Hai Empire Together

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Keeping the Hon Hai Empire Together

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Employee suicides. An explosion at an iPad 2 production facility. Hon Hai's empire is being stretched to the limit. Can the company and its iron-fisted chairman Terry Gou meet the challenge?

Keeping the Hon Hai Empire Together

By Jimmy Hsiung
From CommonWealth Magazine (vol. 473 )

When Genghis Khan went out on expeditions of conquest 800 years ago, he would rotate between two horses to maximize his speed and surprise his enemies. That left them little time to fortify their positions, consigning them to inevitable defeat.

Hon Hai Precision Industry Co. chairman Terry Gou, known to be an admirer of Genghis Khan, also values speed in battle and has rapidly built his own Hon Hai Empire. But "two horses" seem no longer enough to cover a rapidly expanding battlefront where fighting has intensified, keeping Gou constantly on the move.

On May 20, an explosion occurred suddenly at a plant in Chengdu in western China operated by Foxconn Technology Group (Hon Hai's trade name in China). According to sources, Gou was in a car traveling from Zhengzhou in Henan Province to his ancestral home in Jincheng, Shanxi Province, when the incident occurred. As soon as he was informed of the explosion, he immediately ordered his car to return to Zhengzhou and jumped on his private plane to Chengdu to take command of the situation.

Over the past year, Gou has been busy expanding the frontiers of his empire. At the beginning of last year when a string of suicide attempts among Foxconn employees was just picking up momentum, Gou accelerated the relocation of his production facilities to western and northern China.

From Langfang in Hebei Province and Zhengzhou in Henan, to Wuhan in Hubei, and then further south to Chongqing and Chengdu in Sichuan, Hon Hai's great migration in China is nothing less than a blitzkrieg.

Chengdu: Paying the Price for ‘Speeding'

Hon Hai's Zhengzhou cell phone plant is a good example. It was not officially registered until July 5 last year but was already up and running by August 2. Foxconn Technology Group vice president Lin Cheng-hui told the Xinhua News Agency that the speed at which the plant became operational was unprecedented in company history.

In comparison with the rented Zhengzhou facility, however, the Chengdu plant, built at breakneck speed, set an even more amazing "world record." Dedicated to iPad 2 production, the Chengdu factory was up and running only 76 days after ground was broken on the site.

"Chengdu's speed is in fact Hon Hai's speed," Gou proudly declared to reporters.

But contrary to Gou's expectations, the facility that had him boasting suddenly revealed flaws in terms of safety. Although local public security authorities have yet to reveal the results of their investigation into the cause of the explosion, one senior executive with a NT$100 billion company in the notebook contracting sector suspects it was triggered by aluminum dust generated from polishing aluminum alloy casings.

An executive with one of Hon Hai's suppliers says that the aluminum and magnesium dust produced during the polishing process is highly combustible, and if the dust extraction and piping system are not properly designed, the material can easily catch fire or even explode.

A senior Hon Hai executive privately conceded that dust may have been involved, but also contended that the role of factory design was not clear.

"A dust explosion is a type of safety incident that is sometimes hard to figure out. Of course, you can't say that if the design had been really good, you wouldn't have had a dust explosion," said the executive. He said it was similar to people who drove more often having a higher chance of getting into an accident than those who rarely went out.

Former UMC vice chairman Ing-dar Liu described it as a consequence of rushing things.

"This is the price of overseas Taiwanese businesses trying to use speed to replace other things," Liu said, cautioning that many initiatives to strike first also carry substantial risk, as Hon Hai has found out.

Indeed, as the incidents continue to mount – from employees committing suicide by jumping off factory buildings, to the Chengdu factory accident – many people are now asking, "What's up with Hon Hai?"

Diluted Management

A vice president at one of Taiwan's top five notebook computer OEMs gave his theory on the biggest challenge Hon Hai is facing: "Its management is being diluted."

Behind his theory is Hon Hai's "terrifying" relocation and expansion moves over the past year. In the past, Hon Hai had a huge vertically integrated operation in Shenzhen, enabling the company not only to impose strict discipline, but also to benefit from the effectiveness of the "Changshan snake" strategy – a term popularized by Asustek Computer chairman Jonney Shih, in reference to a passage from Sun-tzu's The Art of War: "When the head is attacked, the tail comes to the rescue. When the tail is attacked, the head comes to the rescue. When the body is attacked, both the head and tail come to the rescue."

Even though the scale of the company is as imposing as ever, it faces the problem of an increasingly dispersed troop deployment. As Hon Hai rapidly expands to inner China, it needs to urgently resolve problems related to the decentralization and lack of concentration of its workforce.

"It's not just about building factories and production lines. The key is people. The Hon Hai team's advantages of the past may not necessarily be completely transferable," says an executive in the industry. The source points specifically to its edge in notebook computer assembly, which Hon Hai had not yet fully maximized before the relocation of its manufacturing operations.

So what is Terry Gou thinking?

In Gou's mind, the dilution of Hon Hai's management seems far less important than speed. One former Hon Hai middle manager says Gou's management philosophy has always placed the greatest priority on speed.

Fast for Fast's Sake

In fact, Gou has no choice but to move quickly. Among Taiwan's big five electronics companies (Hon Hai, Quanta, AsusTek, Acer, and Compal), Gou is known to be the CEO most attentive to serving his customers. In particular, he is eager to meet the demands of Apple.

"Terry Gou has almost completely redeployed the company's resources for Apple," observes Wang Wan-li, the head of research at RBS Asia Limited, Taipei Branch, even though Apple accounts for only 30 percent of Hon Hai's overall revenues.

Ji-ren Lee, a professor of strategy and management at National Taiwan University, says that unlike the PC and notebook computer battlegrounds, where size was the key to victory, the mobile phone market emphasizes speed. Tablet computers and mobile phones are seeing a constant flow of hardware and software innovations in a winner-take-all battlefield.

Sales of the iPhone, for example, have driven App Store software applications that have become an important profit center within Apple's business model and helped cast aside competitors. Hon Hai, which manufactures products on an OEM basis for many brands, is fully aware of the market's volatility. The decline in performance of subsidiary Foxconn International is directly related to weakening demand for the products of Nokia, its main customer, in the end-user market.

The flexibility and determination of "Terry on Whom the Sun Never Sets," who moves with the speed of Genghis Khan, is why Hon Hai was the only company in the world that could have been the exclusive contractor of the iPad2 and a major supplier of the iPhone.

In the era of digital convergence, Apple is fighting a war in which the only thing that defeats speed is faster speed. And to help Apple win, Gou rushed to set up production capacity in inland China, to ensure that labor shortage threats would not affect Apple shipments.

To meet Apple's aesthetic demands, Gou was willing to spend two years to develop a one-piece precision mold, irrespective of cost, and quote a price based on future quantity expectations rather than costs, enabling the iPad 2 to be launched on the market for as little as US$499.00.

Gou also responded to the concerns American customers expressed over the Asian supply chain following Japan's massive earthquake in mid-March by planning his biggest investment in years, the development of a US$12 billion production facility in Brazil.

The Chances of Victory in China

Though Gou is stretching his company thin, he is not fighting a battle he is not confident of winning. His lightning-quick inland relocation of the company's factories has also fundamentally helped China solve one of its most serious social problems – labor shortages. According to Zhao Xiao, a professor at the School of Economics and Management at the University of Science and Technology, Beijing, even though basic wages have risen by double-digit levels in recent years, this still is no match for Foxconn, which doubled its wages after the spate of suicide attempts that hit its plants.

A survey by China's National Bureau of Statistics found that the average monthly income of migrant workers was 1,455 renminbi in eastern China, 1,389 renminbi in central China and 1,382 renminbi in western China in 2009. With wages in the affluent east only 5 percent higher than in the west, Zhao says it is not surprising that many migrants are "voting with their feet" and electing to return to their hometowns to find work.

Hon Hai is helping expedite the process. Of the company's more than 1 million employees worldwide last year, roughly 150,000 were from Henan, a province of 100 million people. By deciding to set up a factory in Henan's Zhengzhou, Hon Hai was both able to take advantage of its strong base of workers from the area and also to accelerate its move away from its facility in Shenzhen.

At the same time, moving inland does not necessarily guarantee an increase in costs. In most cases, the relocation actually helps reduce costs. One Taiwanese entrepreneur who recently relocated his business to Chongqing revealed that labor costs have only a minimal impact on total expenses, estimating that wages account for only about 1 percent of an OEM's costs in producing a notebook computer.

"The key factors are the conditions negotiated with the local government, with taxes being the most important of all. They can easily make a difference of over 10 percent," says the businessman. Freight subsidies for transporting components are also often included in the package of preferential investment conditions, so producing a notebook in western China is sure to be cheaper than making it near China's eastern seaboard.

Moving inland has another crucial value-added element that cannot be ignored: making money off land. "The value of developing the land where Foxconn's old Longhua plant sits is an incentive for Hon Hai to relocate its production facilities," says a senior manager with a Taiwanese notebook manufacturer OEM, speculating on Gou's strategic considerations. 

Cornering Apple's Business

May 27 was the official launch date of iPad 2 in Taiwan. Outside the flagship store of electronics retailer Tsann Kuen, dozens of people lined up to buy the second-generation tablet device. The person at the front of the line had been there since the previous day.

As expected, the 5,000 iPad 2s allocated to Tsann Kuen were sold out by late afternoon. When the original iPad was first launched in Taipei last November, the 2,500 units allocated to Tsann Kuen also sold out on their first day on the market.

Hon Hai's real intention in establishing itself as the sole supplier of the iPad2, which remains in short supply in markets around the world, is to capitalize on profits to be made on components, rather than the narrow margin it earns to assemble the devices.

"Hon Hai has not forgotten its PC mindset of the past of: ‘Buy our components and we'll assemble them for free,'" observes RBS Asia's Wang. As a result, Hon Hai is quietly fostering component capabilities currently monopolized by German and Japanese suppliers.

In forging his Hon Hai empire – which encompasses such customers as Dell, HP, Cisco, Sony, Nokia and Motorola – Gou has never worried that Apple will cause the empire to stall out. In fact, he believes the opposite, going all out to meet Apple's quality and production plans, whether relocating production facilities to inland China or investing in Brazil.

If Apple is fighting a new kind of business war, then who has the ability to lead the Apple army into the fray? The answer should be obvious.

(Additional reporting by Ching-Hsuan Huang and Elaine Huang)

Translated from the Chinese by Luke Sabatier

Keywords:

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