Patrick McGee on How China Captured Apple | Prof G Conversations

Once you are teaching a supplier how to do advanced electronics in any number of degrees, they're not necessarily going to stay with building smartphones. But once you have those skills, what else do you do with them? You do the most obvious adjacent tasks in electronics. The same skill sets will help build you drones. The same skill sets will help you build military weaponry. I mean, chips are the foundation of the modern world, and Apple helps these companies with chips.

San Francisco. I just got back from sort of, you know, a two-week book tour in New York and London, but this is where I live, San Francisco. So let's dive right into it.

So just before I give you the numbers, I should just very briefly say that, you know, the pushback I'm getting is the line that Apple built China. The book doesn't sort of so stringently say that. It says it was the biggest contributor to the high-tech electronics industry, which has been described by scholars like Barry Naughton as Xi Jinping's most important thing. So obviously I'm not claiming that they built everything. It's just that their efforts in China really are that of a nation-building effort.

Okay, the numbers are phenomenal. And it's worth knowing what the numbers mean as well. So since 2008, Apple has trained 28 million people in the supply chain. Apple would push back and say that that's not all in China, but they also won't tell you which percentage is in China because they know that it's very, very high. Maybe it's 27 million, maybe it's 26 million. The numbers are astonishing. It's a bigger labor force than all of California. In 2015, Apple is sort of on the back foot with Beijing and provincial officials. They're trying to demonstrate how influential they are to the country, largely as an effort not to have to do joint ventures, which is what Beijing has wanted from Western companies for decades. So they do their own supply chain study and realize they're sitting on real political capital. What they realize is that they're investing $55 billion a year, and they basically go to Zhongnanhai, Tim Cook and two top deputies, that's the Citadel of Chinese Communist Power in Beijing, Forbidden City, and they pledge that they will spend that amount for the next five years, totaling $275 billion. This is mostly training costs and wages, in addition to really sophisticated machinery that they put on other people's production lines. So if the 28 million workers line sounds like dramatically high or too high, Tim Cook's own estimate for how many workers they have in any given year is 3 million, and the churn in Apple's supply chain is ridiculous. And the other interesting thing to know about this is Apple does not work like other companies where they're just hoping that component makers innovate on their own initiative, you know, come up with lighter materials, more durable materials. Apple is sending people by the plane load to engineer those materials, invent those materials, do the production processes behind the parts. And so they take dramatic control of their supply chain on a level and scale that I don't think any other company in the world matches at all.

So when Xi Jinping comes into power in 2013, he doesn't understand what Apple's contributions to the country are. And we know this because within 36 hours of him being appointed president, CCTV, sort of state-sponsored CNN of China, attacks Apple. And there's many reasons to think of Apple as an exploitative power in the country. For instance, their margins go from something like 1.1% in 2003 to above 25% by 2012. And yet from Beijing's perspective, this massive success is all on the back of China, right? In two respects. One, they know better than anybody that Apple wouldn't have another place to ship the quality and quantity of products that they're shipping at that point. And two, it's the Chinese market, the Chinese buyers that are accounting for a dramatic share of Apple products, right? And there's this dramatic narrative in the book where Apple really does not think China is going to be a market in 2008. They build their first retail store there purely because of the Beijing Olympics. And then, without really even trying in a certain sense, the iPhone becomes this spectacular success story in 2010, and it continues forward to such a degree that hardliners in Beijing are upset with Apple because it sort of represents the materialism, the individualism of Western culture, and that's not really something they're in favor of. So the relationship with Xi and Cook begins on a really rocky patch because Apple represents so many things that Xi Jinping doesn't like, and Apple begins this effort, a two- or three-year effort really, to appoint or hire this group of people that call themselves the gang of eight.

Doug Guthrie. Yeah, I know Doug well.

So Doug Guthrie is the guy that's leading China University, sorry, Apple University within China. And so they come up with this narrative that flips the narrative on its head, saying we're not exploiting China. We are actually contributing in a great way by having our engineers work in hundreds of factories, hand in glove training them, auditing them, supervising them, and installing machinery on a totally epic scale. And this is where some of the numbers are just astounding, that really changes the relationship. So Tim Cook basically goes with this message to Zhongnanhai, the Citadel of Communist Power, and tells the Chinese leadership about this. And aside from content, let's say, having to ban VPNs, having to ban WhatsApp and the New York Times, Apple really hasn't had any problems in China since then. That was the winning formula to get over Xi Jinping. This is my language, not Apple's, of course, but Apple realizes it's the biggest supporter of Made in China 2025, which is Beijing's directive in 2015 for the country to become self-sufficient in robotics, in automation, in high-end electronics. And so Apple ends up being this massive supporter of that and gives rise to Huawei, OPPO, Xiaomi, etc., because when Apple is training hundreds of their suppliers, they basically say go forth and multiply to them so that they're not so dependent on Apple, and so they basically give birth to the Chinese smartphone market, and those numbers too are pretty astounding. So that, in a nutshell, I would say, is the Cook-Xi relationship. The Cook-Trump relationship is really quite different because when Tim Cook is telling the Beijing government how much they're investing, it's real substance. There's ways that they're calculating the figures and one could question them on accounting basis or whatever, but the reality is that Apple is doing 90% of their production in China. So when they say we're investing this much, we're training this number of people, these are accurate figures. When Apple is conducting the same lobbying effort with Washington, the numbers are pretty fanciful. So if your listeners don't really agree with me or think it's a number that's too high when I say they're investing $55 billion a year, just remember that in February, Apple said that it's going to put in $500 billion investment and spend into America over the next four years. So just sort of suspend your disbelief here for a second. I'm saying they're investing this crazy amount in a country where there's 90% of their production, and Apple's own figure that they're trying to convince everybody of is even higher in a country where 0% of their production takes place. So something is amiss here, and it's not me being bad with the figures. It's that Apple is making a lobbying effort that's based on sleight of hand and sort of magician trick, misleading information. So what I'm saying there is that Cook's relationship with the Trump administration is based on a lack of substance and a sort of political window dressing because they know what a threat Donald Trump is. Xi Jinping is not as big a threat as Donald Trump is. And you could just sort of see that in a commonsensical way, which is that broadly speaking, Xi Jinping and Tim Cook have their interests aligned. If they can both have Apple producing in China, that works wonders for both of them. That does not work wonders for Donald Trump. He does not want production to be in China. And so the push to make iPhones in the US, which is fanciful for all reasons we can get into, is really what puts Tim Cook in buying tier.

I would just push back on that number because that itself is a fanciful figure. The problem isn't that they'd be more expensive. The problem is that they couldn't be built. We have no idea how much an iPhone would cost if it were built in America. It's more that we just completely lack the capability. The line I like to use is an iPhone has a thousand components in it, being produced with the logistics, the production, the just-in-time manufacturing for those phones up to a million a day. So that means a billion parts a day. And good luck finding an American corporation that can do one of those components at a million a day, let alone hundreds of factories that can do all of it. We're just 15, 20 years behind. And that's even assuming that we would have the sort of Nietzschean will to power that China has for its manufacturing sector. I keep getting asked the question, but it's sort of a useless exercise. There are at least 15 to 20 reasons why iPhone manufacturing en masse is never going to happen in America. It really just is a fantasy.

Not like the thing that people don't get is just the volumes that are involved. So Tim Cook is under such political pressure that I could see some final assembly taking place in America just because it makes such a great press release, but it's never going to be in consequential numbers. It's certainly not going to be cost competitive. And frankly, if you think of who would have to work in these factories, it's totally antithetical to the MAGA crowd. In other words, it's the people fleeing Honduras that would be ripe for these factories. Those are the sort of people that could work a 12-hour day and have the sort of desperation because you're trying to find the equivalent of, what does America have in terms of labor support that would be equivalent to people working 14-hour days in the hot fields in western China that go find a life in Shenzhen instead? And it's not going to be American-born people. It's going to be the people that are trying to get over the Trumpian wall, if you will, to get into the country. So there's a contradiction in terms even if you really wanted to fulfill the scenario.

So let me give you the answer I've gotten from a very senior person who used to work at Apple, and then I'll sort of give you my answer. His answer, and I'm sorry I can't name this person, but he's someone that you would know, he said, what else would you have us do? Like, if we knew in 2008 that Xi Jinping was the next leader and was going to take China in an authoritarian direction, okay, that's harsh, but there's still no place to build at the quality, scale, etc. that we needed to build at. So short of just saying don't make the iPhone in such numbers, this person just said there was really no alternative. I like the Mexico question. So if we go back 30 years, one thing that people don't quite understand about NAFTA is it's quite successful between its signing in 1993 and 2001. And in America we have this parochial view and we talk about the China shock, right? The impact of China entering the WTO on American jobs and so forth. But the China shock is even bigger in Mexico, because Mexico is more of a competitor in terms of actually being a mass producer of things than China was, or sorry, than America was. So Mexico gets hit harder by this than America. But when you are building something in Mexico, politically this is a taboo thing. Politically, if you can shame a factory rather because they're going from Ohio to Mexico, it's a politically winning strategy. But if that factory goes to China instead of Mexico, it's actually far worse because the intermediary trade, think of something like the automotive industry, cross borders between Mexico and US is quite substantial. So when you have a product quote unquote made in Mexico, it's often 20 to 25% made with American support in terms of the intermediate goods, the content that's actually in that product. Once it's in China, there's basically no intermediary trade, right? It goes down from like 20 to 25% to 5%. So I'm really in support of what we used to call NAFTA because when jobs go to Mexico, you're actually leveraging the sort of low-wage competitiveness of an allied nation that's on our border. And you would do so in such a way that there's still trade with something like the aerospace sector centered around San Diego for higher value-add. When it goes to China, it all goes. So I think there's a substantial difference there, and therefore I'm a big advocate of friend-shoring or nearshoring. But reshoring isn't going to happen for a company the size of Apple.

What everyone knows about Apple is industrial design. That's Jony Ive creating the look, feel, and substance of a product. But Apple operates in a pyramid structure. And as the pyramid goes wider, the more and more employees you have. I mean, it's been described as an upside-down funnel rather than a pyramid. So at the very top, two dozen people maximum, is Jony Ive's team coming up with a translucent iMac, coming up with multi-touch glass for the phone, that sort of thing. They sort of throw it over the fence to product design or PD. These are geniuses of a different sort who have to respond to Jony Ive's god-like demands and make sure that all the components and everything fit into the very thing that he has dictated, right? And so that's its own problem. What we don't know is sort of the next level of the pyramid. This is manufacturing design or MD. These are the people who then make sure that that prototype can actually be built at scale. And so in order to do that, they go to Asia, primarily China today but historically Asia, to work hand in glove with dozens and later hundreds of factories to actually build the capabilities that are there. So in a sense, a key contention of my book, and it's really demonstrated rather than really argued, is that China doesn't have the tech competence in the early 2000s to respond to what Jony Ive's studio is coming out with. That's not a knock against China. Nobody had that. Nobody had the tech confidence to respond to what they were doing. And so Apple had to go build it there. And because volumes of the iPod go from a few million to dozens of millions, and then you get the iPhone where you go from 5 million in 2007 to a quarter billion by 2015, the numbers are just staggering. And Apple is maniacally obsessed about quality in a way that really no other company is. So you've got that combination of insane world-beating quantity with insane world-beating quality. And in order to actually execute the plans coming out of Steve Jobs and Jony Ive's minds, you need someone like Tim Cook to operationally scale it. Right? So my line about this is Jony Ive and Steve Jobs are what make Apple products unique. Tim Cook is what makes Apple products ubiquitous. And this manufacturing design element of the pyramid is a part of operations, which is, in the product cycle, the fourth element of the pyramid. So then someone like Tim Cook and his team take what MD has created in Asia and they get other factories involved to build resiliency and to push down costs and drive competition between suppliers. So they have this huge, huge impact. Okay, now here's where this goes. Once you are teaching a supplier how to do advanced electronics in any number of degrees, they're not necessarily going to stay with building smartphones. I mean, first of all, that is what they do in the first stage. And so you see this huge localized smartphone ecosystem build up, not just for Western companies but for Chinese companies. So Huawei, Xiaomi, Oppo, Vivo now have 55% global market share. I mean, really the only companies in the world doing smartphones are Samsung from Korea, iPhone from America, and a bunch of Chinese companies. Pixel and everyone else are so small that they get categorized as other. But once you have those skills, what else do you do with them? Well, you do the most obvious adjacent tasks in electronics, right? The same skill sets will help build you drones. The same skill sets will help you build military weaponry. Chips are the foundation of the modern world, and Apple helps these companies with chips. And to the degree that Congress has had to basically intervene, Marco Rubio a few years ago threatened them with fire and fury essentially if they continued working with a company called YMTC, which was making memory, and Apple wanted those chips to be in its own smartphones for China. So to simplify, once you understand how intolerant of defects Apple culture is, and that they are not working with suppliers who are already competent and they are not going after price, they are going after quality, and they are sending people by the literal plane load to four different industrial clusters in China to do all of this, you'll begin to understand how they have such an impact on the country, and then they're not really in control of what the country does with those skill sets afterwards. And so of course China has funneled it into other things that they're interested in, which is electric vehicles, drones, and military weaponry.