Apple's Chinafication with Patrick McGee

Thanks, Orin. Thrilled to be here.

Oh, that's a great question. Well, I mean, I think its fate is completely bound with China's, and obviously we'll get into this—we've got lots of time. But I mean, the degree to which all roads lead through China, and then most roads are in China for the supply chain, is actually understated. Like even when people are saying 90% of production is in China, I think that's actually understating things. And the idea that they can do some quick move to India, which has convinced lots of lay people, but experts know that this is nonsense. I mean, China just means everything, because if I was talking about this in 2010, well, maybe I wouldn't have the same view. I mean, the statistics would be similar in how much was in China, but you'd say, 'Okay, but what really makes this company thrive is the DNA of Steve Jobs and the designs of Jony Ive.' And this is a time, if it's 2010, that we're reinventing the phone every year, and so like industrial design, product design, that's really driving the company. But this is a company that's been led by an operations chief since 2011, Tim Cook. What's operations? Well, that's everything that's in China. Ive has left the company. The iPhone, your listeners may have noticed, does not get reinvented every year to the same degree. It gets a better battery life, the cameras improve, but it's not like it's a triangle next year. You know, we sort of have reached saturation of what the iPhone can do, and then it's just improvements on the margins. So, you know, through that lens, the importance of operations, and therefore the importance of China, is more and more paramount.

Maybe. Depends if you count the Apple Watch and the AirPods, and you might not because they're iPhone-adjacent, right? They're not really products on their own to the same degree that an iPad or an iPhone is. On the other hand, they sell them in such large numbers that I think I'm correct in saying Apple makes more money from AirPods than it ever did from the iPod. Interesting, right? And considering what a cultural phenomenon the iPod was, that's a little bit mind-blowing. So, I wouldn't discount how popular and lucrative both the Apple Watch and the AirPods are. The Vision Pro, on the other hand, is a bit of a disaster. I gave the Vision Pro an immensely positive review when I did my first demonstration of it. Maybe just for the audience, the Vision Pro is their attempt at a headset. It cost $3,500. What it is capable of is phenomenal. What it actually does, if you buy the thing—as frankly I did—is pretty weak. I mean, they just haven't developed any content for it. I mean, not to go off on some tangent, but technologically they could set you courtside at the Warriors playoff games, you know, my home team, and you could watch through the Vision Pro and it would genuinely feel like you quantum leapt into the body of someone that's there. That's phenomenal. But for the life of me, I don't know why they haven't actually done that. Like, you can't do that yet, but you might be able to in a few years. So, maybe there's some hope there. But the Vision Pro obviously is not a success so far.

I mean, Apple will turn 50 next April, and the first 25 years is really the era in which they do manufacture their own computers, right? So, I mean, the basic gist of Apple is it's founded by two guys named Steve in a garage in 1976. Globalization of electronics, especially of computers, really doesn't exist at that stage. The way I put it is that if you've got a garage-sized computer from IBM, that is not going to make any economical sense to make it somewhere in Asia and then ship them over en masse. Obviously that's not going to make any sense. So Moore's law really drives what's possible with the evolution of the supply chain and the development of the supply chain. So, you know, I really give a lot of credit to the IBM PC in 1981, because I have this anecdote where Steve Jobs dissects a PC, right? Apple's sort of the—maybe not the ruling company, but they're the most innovative company in the early '80s building computers. And this is before they've come out with the Macintosh and the graphical user interface, but they're still a very creative company. Steve Jobs is a young millionaire, etc., very confident, and IBM is the world's biggest tech company and basically has been for decades. And they decide to get into the PC business. So Steve Jobs opens up the PC, tries to look at what it's configured, how it's configured, and realizes there's nothing there. There's certainly nothing that we can't do.

And he's right, except that he misses the picture that IBM has just launched a war on a battle that Apple wasn't prepared for. Apple thought IBM might come out with something that they couldn't match, that it was just so technologically layers above Apple that they would struggle to compete. And instead they banded a computer together based on existing parts. And the reason I'm driving home this point is because those existing parts can be made anywhere. So the IBM PC ends up being this huge catalyst for outsourcing and for electronics component manufacturing—not all over the world, because you don't really have them coming out of South Africa or something, but for East Asia in particular. The Japanese, the Koreans, the Taiwanese—they all get involved in building components and especially circuit boards, and once they start doing that they sort of take it the next step further and they begin assembling computers, designing computers, and then competing with their Western counterparts. So IBM really is the catalyst for globalization. And then I compare it to the 2007 iPhone, which is really the catalyst for chinification, because Apple is not working with components that you could find in other phones. It's basically doing proprietary processes. And once you're at the volume of doing this in a hundred million a year, 200 million a year, and you're running just-in-time manufacturing at really high quality levels, it is going to make zero sense to have a supply chain based on different time zones and different islands and bodies of water between them and hoping everything arrives at the exact time. So they need to consolidate into one country. And China just has the combination of cost—and they don't really have skill, we'll come back to that—but the combination of cost, abundant, even desperate, quite frankly, labor, and a government that'll just tailor-make policies and allow, you know, without environmental regulation, buildings to just be put up in such a time frame that were you doing the same project in Texas, you know, you wouldn't have the environmental bylaws passed by the time the building was actually up and running in China.

So, I mean, to be fair, the US originally was where this stuff was being built, but it's because IBM and then of course the PC clones, who all just replicate what IBM has done, that's what gives rise to the idea that this stuff can be built anywhere. Because when Compaq, Gateway, HP, Dell are all doing what IBM is doing, what's fascinating about that and why it plays such a role for globalization is they're all doing the same thing, right? If in 1989 you had a Dell, I had an HP, and our neighbor had a Gateway, it wouldn't matter. We would all be running Windows, we're all running on Intel chips, and none of the companies were putting an iota of thought into the design. I mean, they would literally all be beige. They would look about the same, and the components would be made by the same companies or at least similar companies. In fact, they might have even been made in the same factory in the same way and just badged differently. So it's the Taiwanese, for instance, that really take advantage of their lower cost to basically compete on the same components that were originally being built in America. And because computers begin to be so popular, you can do this at big scale. Components aren't like mainframe computers, right? You can ship them across the ocean in 30 days. And so someone like Terry Gou, who founds Foxconn, literally travels 30 different states in America in the early 1980s basically saying, 'Give me a chance.' And so not only is he operating on razor-thin margins, but he's using a labor base that of course is, you know, probably one-fifth, if not one-tenth, if not one-twentieth the labor cost that America has. So Asia just begins to win more and more orders, even if the brand name is associated with an American company and indeed the profit associated with an American company. I mean, there's a reason why it's fantastic to outsource and offshore your operations, because if you're Dell, if you're HP, the idea of paying fixed costs at a time when you don't need the computers being built is a bad idea. If someone says, 'I will offer you manufacturing as a service and you will only pay for what you need when you need it,' and by a company doing that and having all sorts of clients, they can shuffle their own workers around in a way that's far more economical than one single company ever could.

So, let me back up a little bit, just because I think you're sort of nailing the question on the head with 'what about if Foxconn was in Texas?' And the sort of progenitor to Foxconn is actually a company called Spacecraft Incorporated, known as SCI. They're founded after the Soviets launch Sputnik, and they begin making satellites, and they have a role in the, what's it called, the Saturn V rocket that goes to the moon. And as the sort of military-industrial complex builds, they begin taking orders to do the whole production. So in other words, SCI begins as a supplier of components and satellites and things like that, but eventually they turn to becoming what I think of as the first electronics contract manufacturer, where they're not playing any role in the design, but they will take someone's blueprint and they will build it for you. IBM essentially catches wind of this. In particular, they have this advanced way of doing circuit boards. I mean, at a time when literally Steve Jobs's pregnant sister was putting circuit boards together by hand, SCI comes around with a pioneering automated method to do it, and IBM takes advantage of this, and IBM begins to outsource not just the circuit board but the whole computer to SCI. So this is the closest thing you're going to find to Foxconn in Texas, which is, well, SCI is the world's largest contract manufacturer at the turn of the millennium. I think they have 30,000 people at the time in like 16 countries or something. And so it's actually like the PC boom is really run by a bunch of companies that few people have ever heard of: Solectron, Celestica, Jabil. And these are the winners. The companies you haven't heard of are all the companies that led to the mergers of these companies. And they are like an M&A banker's dream in the '90s because there's just all kinds of mergers and acquisitions because all they're fighting for is how do we do this more efficiently and at lower cost?

And there's something I want to say around 1992, it's called the Compaq shock, and it's when Compaq dramatically reduces the price of their computers. And of course if you're an American consumer you love this. I mean, it's something like 20 or 30% less than what everyone else is doing. And the reason they had accomplished it is they had gone into Asia at a time when the others hadn't really done it. And so that's basically what happened. So you have the supply chain competition among these assembly giants, and they've got disparate operations, and when they're competing with each other, it's they that move over to Asia. And worth knowing, Apple isn't doing this. Apple's not really working with contract manufacturers in the '80s and '90s. I'll give an asterisk that's explained in the book—that's a whole chapter. But for the most part, they are not. And that's what leads them to near bankruptcy in 1996. They're being outcompeted, right? And Apple's reputation was it was more bespoke but also a lot more expensive for, at the end of the day, roughly the same.

Yeah. So when Apple finally—I mean, you know what the standard thing for a product is that we say about Apple, right? I'm saying a cliche here: Apple didn't invent the MP3 player, it didn't invent the smartphone, but when it did it, it was just better than everybody else. Right? That in a nutshell is what happens for the supply chain. In other words, Apple doesn't lead the idea of going to Asia. It certainly doesn't lead the idea of going to China. It is late to both of these trends, but when it does it, it does it better than anybody else. So the likes of Dell, when they go to China in the early 2000s, it's because they see margin and they see cost savings that they can pass on to their consumers. So they just see, you know, high volumes and a workforce that can put things together cheaply. Apple looks at China differently, and they realize instead of making sort of a beige box computer, we can design something that's insane and that we wouldn't actually be able to build ourselves, but if you have armies of workers being paid 50 cents an hour just performing the most minute tasks, they will be able to put together whatever it is the Jony Ive studio comes up with. And so that's sort of how the translucent iMac and then the iMac G4, which is sort of this thing that looks like a sunflower—that's how China sort of comes into being, because I tell this seven-year narrative where Apple's experimenting on three continents with contract manufacturers here, there, everywhere, and it's really failing. But the company that's sort of playing a role on the side is Foxconn, and they're building in the Czech Republic, California, and in China. And the more that you're comparing what each of those facilities is capable of, the more the Chinese narrative is just making better business sense. And I should say, like, moral sense is the wrong way to put it, but an amoral sense in a way. Like in the Czech Republic, the problem is that the media covers the working conditions; the workers protest about the idea of building dormitories where they're going to be housed, right? So, like, China just wins out for a bunch of reasons that you could call unethical or what have you. But you begin to have a mass of consolidation into China.

And so, I think that fits in pretty well with the standard narrative. I don't think people are aware of just how much experimentation there was. I mean, you noticed, wow, your book takes a long time to get into China, right? I mean, there's this whole section called The Long March to China, and in a sense, I'm trying to handhold the reader that, yep, we're going to get there, it's going to take a while. Then the other thing, and this is probably the most novel part of the narrative, is I'm explaining the role of the manufacturing design engineer. These are the people living in California who take what Jony Ive has done, and it's their role to go to suppliers across Asia, you know, locate them, find them, and then train the hell out of them, because they're not capable of what Jony Ive has conceived of. They can't make it. They don't have the skill sets. But the engineers in California either do, or they will, you know, die trying kind of thing. But they do so by finding these suppliers, seeing what is possible, and then they train, audit, supervise, co-create all these processes. So it's not just they're coming up with new parts; they're coming out with like the machine that builds the machine, right? The production line, and then it gets thrown over the fence to the operations team, who then replicates every inch of that line and scales and scales and scales. So my point is there's this huge missing narrative that my book fills the hole for, of how Apple doesn't just find competence in China, it builds that competence in China. So I'm not just saying they're stuck—I'm saying they're stuck in China, but they're stuck on capabilities that they created there. I don't think anybody has really dug deep into that topic before. It's pretty novel.

Can I—I would put one pushback, which is that I don't know that the value add is there. In other words, you actually don't tend to have Chinese companies that are making enormous profit from this. But this is—the reason why I'm highlighting this is because this is another facet that people miss, because they say, well...

The profit's being made by Nvidia and Apple. So what's the problem? This is the golden age where we're doing all the software and the design, and the Chinese companies basically do it on the cheap. The reason they do it on the cheap is because their goal is not to distribute to shareholders. Their goal is to become so advanced in these things that every other country becomes de-industrialized and they're the only shop in town to do it. The best example, if we just leave the smartphone aside, is solar panels, right? Invented in 1954 by America. We had 80-90% market share by the 1980s. Today we have 3% market share. And the Chinese companies aren't the big Fortune 500 titans that you could name, but they sure have taken over that market. And maybe they're not making margin, but they're making volume. And we could get to a stage where we have no idea how to build this anymore. We're certainly not doing the innovation to make them better and better, and the Chinese can do all of it. So that's just a multi-decade example where we've completely lost capacity to do something that we invented and we've just sort of gifted it to the Chinese. And that's actually the story I'm trying to tell. I'm just doing it through the sex appeal of Apple designs, but you could sort of copy and paste this narrative to varying degrees to all sorts of sectors.

Yes. Smartphone on wheels. Increasingly that, and increasingly it's in fact these smartphone makers making it. And it's not a coincidence. One of the things I really try to point out is that Apple deliberately pays its suppliers very little. And you'd think, well, why do the suppliers put up with it? They put up with it because Apple is training the hell out of them. So basically, instead of thinking they're getting low margin, they're thinking, oh, we're actually getting a free Ivy League tuition in how to build stuff. So there have been real champions made in China, Chinese companies basically made under the tutelage of Apple engineers. You could even say under the tutelage of America's best engineers because B students aren't going to Apple. Apple can hire the best. They can take them away from SpaceX and Tesla and Dell and Motorola, and they can get them out of Stanford and Caltech. I can't tell you how many people on their first day at Apple show up and say, where, what do I do? They say, here's your flight to China, good luck out there. They're just taking the skills and then they're transferring them to China. And I should say it's not just a story of American ingenuity going over to China, because Apple has these subject matter experts whose specific role is to scour the world, go to Japan, go to Switzerland, how are Rolexes made? How are little tiny knobs on watches made, and can we use that technology for the iPhone? So they are taking the best stuff coming out of the countries with the most automation, signing little private deals with these companies, and then scaling it in China. Now, obviously in retrospect, there is a massive technology transfer here because the suppliers learn how to do this. Well, what do they do with it? The most obvious thing to do is that you go to the companies in China that are most like Apple, Huawei, OPPO, Vivo, Xiaomi, and you supply them the same stuff. Now, maybe you do it at a year's lag, but you'll notice that Chinese phones are really good at multi-touch. They're all rectangles with glass on them. There's a reason why BlackBerry isn't able to keep up, but Xiaomi is. So my sort of killer line for the book is that the iPhone didn't kill Nokia. Chinese competitors to the iPhone killed Nokia. And the reason the competitors were so good was that Apple trained all of their suppliers. So I call this the Apple squeeze. We're not going to pay you much, but we're going to train the hell out of you. Territory gets it in 1999. A bunch of Chinese manufacturers get it in 2016. And what you've seen is the increasing real estate within the iPhone shift from multinationals making in China to Chinese companies making in China. And I think there's been an extraordinary epic transfer of knowledge from America and from around the world to the Chinese.