[S5E5] Apple in China with Patrick McGee

That was considerably shorter than what you did for Pat Gelsinger, but I guess he has a more illustrious career than me, so I'll forgive you.

So I'll try not to go too far back, but as an undergrad I studied religion, which is famously interesting but gives you no job offers upon conclusion or graduation. So in a sense, you know, my only skill set was maybe thinking critically, reading, and writing, and so journalism, I guess, just became a sort of default, you know, something I could fall into. And just as I did that, around 2006 the financial crisis began to grow, and so we, I think, mostly associate it with Lehman Brothers in 2008, but I sort of, you know, got an early inkling. So by the time everyone was catching up to it in 2008, I'd already been a sort of financial reporter for a solid 18 months or so. So I sort of went from absolute zero to understanding credit markets and bonds and such. That basically led later to a job covering the bond markets for the Wall Street Journal. And then the Financial Times hired me to cover Asian markets out of Hong Kong. And so if you do that Steve Jobsian thing where you connect the dots looking backwards, I sort of think the origins of the book were covering Asian — well, you know, covering the rise of China. I mean, as I was in Hong Kong during Xi Jinping's first term when you began to have sort of like a clamoring in the streets, you know, for either independence or democracy or whatever — the various things — I'm saying whatever because there were various things that people in Hong Kong, not acting as a monolith, were asking for. Then I covered the Volkswagen scandal living out of Germany and very much supply chains and sort of walking in and out of factories all the time and beginning to understand Germany's dependence on China. So the economy was really booming, but they were sort of giving up all their technological know-how to China, and that became pretty interesting. And then I became the Apple reporter. So you couple those things together, right? Basically like China, supply chains, and Apple. I think that only in retrospect, of course, but that's sort of the origins of the book.

Yeah, I'm sure lots of people know the history, or at least they think they know, but the sort of missing topography is that they're a manufacturing company, right? I mean, these are two Steves in a garage. You know, some people usually an Apple history begins with the Apple II. You know, we forget that it's called the Apple II because there's an Apple I. Well, what's the Apple I? It's a circuit board. That's all it is. It's a fully assembled circuit board. That was the genius of Steve Wozniak. He could design a circuit board. And so they make stuff themselves. It's sort of the DNA of the company. It's in the ethos of the company. And Steve Jobs is this, you know, maniacally obsessive figure in good ways and bad. And you want to control your destiny through manufacturing. It's worth knowing that there is no electronic supply chain in the late 1970s. Not for personal computers. I mean, the product has basically just been invented. And so it's not just like an ethos, like there's not even a choice about the matter. Things begin to change in the 1980s when the PC has been cloned and you have someone like Michael Dell, you know, birthing Dell out of his dormitory. And so he's not in a factory. He's sort of managing the logistics of things. And so that goes on really for a decade. And of course, Steve Jobs gets kicked out of the company and he's sort of in his 12-year exile, founding NeXT, where he's still building it himself. And, you know, his favorite — one thing he says about the NeXT computer is, 'My favorite thing about it is that it was not built in Osaka.' So that's obviously Japan, not China, but he really cared about building things. By the time Windows 95 comes out, the PC world has absolutely taken over Apple. And it's really interesting how Apple has lost, right? They haven't lost for the things that Steve Jobs wanted to define computers by. They haven't lost because Windows or anything Microsoft was doing was superior to Apple. But the PC boom has won because if you control 95% of the market and you're getting more and more stuff built in Asia and you got interchangeable parts and the computer aesthetics and stuff aren't really a consideration, well, you can just price things at a cheap rate and sort of every household in America is wanting to have a PC and it just becomes the de facto standard, which means that developers don't prioritize the Mac and so forth. And so the company is basically just irrelevant by the early 1996. And my book begins with this sort of stunning anecdote where, you know, they're days away from being able to pay their 14,000 people on the payroll and they have to sell a Sacramento, Colorado facility that, you know, most people who probably think they do know the Apple history don't even know this thing. And yet to me it's a seminal moment because it's what sparks the first time Apple has a global outsourcing strategy. So it's total desperation. They do not have the money to continue building their own computers. They need to move to a third-party operation. And there's more to the story here. And if you've read the book, you'll know that I then go back in time to tell that certain peripheral products, the Newton, for instance, the printer, those were outsourced. And so Apple's not starting from scratch, but it's the first time that, you know, PCs — or sorry, I should say desktop computers for Apple are going to be made by somebody else instead of Apple.

So when Steve Jobs comes back, there's this fascinating anecdote where he goes to meet Jony Ive for the first time intending to fire the guy because he looks at all of Apple's products and he says, 'Well, they're all — I clearly don't have a great design team.' And Jony Ive doesn't think the meeting is going to go well either. So he shows up with a resignation letter in his pocket. And of course, instead they have a total melding of the minds. And, you know, there's this obscure product. It's sort of related to the Newton, but it's called the E — oh gosh, I'm getting it wrong. eMate. It's this little...

eMate 300. Thank you. Yeah. Sorry. So, it's — I quote someone saying it looked like a tight green butt in spandex, and it runs the Newton operating system, but it's a laptop essentially for the education market, but it's like a grayscale screen and so forth. And it's made of translucent plastic like before the iMac, right? That they're actually shipping this thing. And Steve Jobs loved it. And I know that because I've got some notes that no one's been able to use before, but I was able to obtain them for the book where he really likes this thing. And so he goes to meet Jony, and of course the ID team, industrial design team, has been doing all sorts of really cool experiments. I mean, you can actually find some of this stuff now. They had, you know, Macs that instead of beige box Macs, they were translucent plastic, like completely see-through with all the wires and stuff. And so I guess just Steve Jobs just gets totally enamored by this stuff. And the famous quote that he says, according to Ian Parker of The New Yorker, is, 'Fuck, you guys haven't been very effective, have you?' And that sounds like he's dissing them, but actually what he's saying is, 'You're obviously brilliant designers, but you don't know your own worth or you don't know how to communicate that.' And so in the late 1990s, I mean, just remember Apple's in crisis and these designers trying to do this cool stuff, they're just getting nowhere because to the engineering-led teams, design is just an irritant. And Steve Jobs just totally flips that on its head and says, 'We're not going to beat the IBM PCs of this world by having competitive prices. That's just not going to work for us. So we need to build things, which means we need to design things in a totally different way that sort of redefines the aesthetics and why you want to own a computer.' You know, he doesn't want it sort of in the basement in some cloistered-off corner. He wants it near your kitchen. And so it needs to look more like a cool coffee machine or something, right? A piece of art that you might have and be, you know, have friends are going to comment on it or whatever. So this is sort of the origins of what becomes the Bondi Blue iMac. The problem is, of course, they can't build it. I mean, however impressive Apple engineers are, they are not CRT experts, cathode ray tubes. And so they use their analog CRT supplier, which is LG in Korea, to basically design this — or not design, but build this computer that they design. And one of the first chapters about this is called 'Unmanufacturable' because the thing that Jony Ive and team come up with, like, the engineers cannot make it. And Apple spends months trying to figure out, like, is our product design team just like, can they just not do this, or is there something wrong with the design itself? So it's this really interesting chapter, and of course it's just never been told because we've never cared to look at how do you actually build the things that come out of the mind of Jony Ive. You know, there's just — I mean, I don't know, you just go Google this around or whatever. Go find me a great chapter or an essay somewhere or a magazine on how the iPod was actually built and who made it and what were the problems on the production line. I don't know why, but journalists just haven't bothered to ask these questions for 25 years. So the origin of the whole book was just that realization and then saying, let's tell that story. And of course by doing so you introduce all sorts of geopolitical dilemmas and tension because Apple's success has come at this massive cost of sort of getting lured into China and then being stuck there. So sorry, I'm probably giving too much away there.

I have no more definitive answer, but I have a couple. So one, just going back to my own personal history there. The fact that I lived in Hong Kong and then was studying supply chains and writing about how to build cars, where that is kind of more of the story, I guess that just made me ask some of the right questions. I mean, you know, if you're covering Silicon Valley and Apple's one of the companies you follow, none of the other companies fit the bill. I mean, Google's not really making anything that would cause you to sort of be in a Google factory somewhere. The same thing is, broadly speaking, true of Meta or Amazon. Even Nvidia — I mean, Nvidia doesn't fabricate their own chips or anything. So I think there's just a sense that if you're a California-based reporter, you're not really in and out of factories the way you are that if you were based in Germany, if you were based in Shenzhen, let's say. The other thing, of course, is that it's not going to be reported in China because they just don't have a free media. So you just don't have some flourishing Chinese paper where reporters are in and out of factories talking to Foxconn people all day long. So there's that. The other answer is just that Apple is ridiculously good at controlling the narrative. Whether it's conscious or unconscious, the whole Apple landscape in the media basically gets concerned about what the new iPhone is going to look like. I mean, if you want to see like the most tweeted stuff right now on Apple, you know, it's just going to be about like whether the new iPhone is called the Air and is really thin. I mean, I just don't give a — I mean, it's just not part of what I care about at all. And so I just think we're so obsessed with design questions, even though the design guy, Jony Ive, left in 2019. And there's literally — it's a vacant position. I mean, Apple is iconic when it comes to design. Literally hasn't had a chief design officer since 2019. And then the other design guy, Jony Ive — I mean, sorry, Steve Jobs died in 2011. Like, this is an operations-led company and we still treat it — because Steve Jobs is so damn good, we still treat it like it's a Steve Jobs-run company and it isn't. And so there's just sort of a wake-up call in covering like the underbelly of this company that, you know, Apple probably furious with me because I'm not covering all the things they don't want you to talk about, right? How the sausage is made.

Well, thank you. My editor had advice that should have been pretty basic to an author, but it was actually really valuable to me, and it was: think in scenes. So every chapter essentially should begin where, you know, a film director should be able to be like, 'Yep, I understand who the characters are, what the scene would be, etc.' And that's really why like there's a chapter early in Taiwan where, you know, it begins in a karaoke bar where this Apple engineer is recognizing that there's something strange about some of these characters. And what he's recognizing is that in their sharp suits and interesting, you know, manner of speaking and sort of a sort of arrogance to some degree, he's recognizing that these are gangsters and that there's a problem in the Apple supply chain, which is that they're paying Quanta, their contract manufacturer, but Quanta is not actually paying the suppliers, the sub-suppliers that it's supposed to be paying. And so Apple has just spent the last couple days beating up on all these engineers, trying to get them to perfect their processes, and then is slowly realizing that these suppliers haven't even been paid because all the money's been tied up in these triad-like organizations in Taiwan. And that just allows you to tell this brief history of Taiwan where like there's these gangsters that go back there. I don't know what the Taiwanese name is, but they're like the Yakuza in Japan, which are more well-known. And, you know, when Taiwan goes after all these gangsters to really like sort of take care of organized crime, some of them just run for office and then you have sort of the gangsters involved in the politics and so the lines between sort of legal and illegal in Taiwan become really blurry. And so Apple, it's just sort of like this moment where it's like, how does this American corporation navigate these kind of things? But it's one of the early reasons why Apple has to take control of the supply chains because they can't just leave it willy-nilly to what turns out being like a bunch of nefarious actors and nefarious activity. So anyway, so just like the smoke-filled room where people are singing karaoke songs is just like the great way to open that chapter, and I just tried to do that over and over. So I'm glad that you picked up on that.

Oh, that's a big question. How do they get started? I'm not sure I know the founding dates of Quanta and Inventec and so forth. I mean, to some extent it goes back to the birth of the IBM PC where the big decision that IBM makes — I mean, you have to remember, I quote Steve Ballmer saying that at the time IBM was the sun, the moon, the stars of the PC industry. If you could name one technology company in the early '80s, it was IBM. I mean, they were just absolutely massive. And so when they move into building a PC because they're the main — they're the leader in mainframe, I mean, they're literally America's most valuable company for decades until the '80s. And so when they move into PCs, everyone expects that they're going to build something with, let's say, some features that are going to be too difficult for everybody else to match, or maybe they're just going to do something that is, you know, not very good because they're such a bureaucratic organization. And IBM kind of stuns everybody by basically building this like 12-person team, puts them in Boca Raton, Florida, and they decide to essentially outsource everything. And they allowed IBM divisions to bid, you know, on certain contracts for supplying things, but those IBM subdivisions aren't put in any sort of elevated position. So what that means is that this computer, the IBM PC in 1981, is basically bandaged together of existing parts and they're interchangeable and they're standardized. And so try to think of like Thomas Friedman talking about the world being flat, right? This is like the paradigmatic example of that where once the IBM is cloned by the likes of Compaq and then later Dell and HP and all these companies, they're not differentiating against each other by design. They're all using Intel chips. They're all wanting Windows. It's all about logistics, distribution, and manufacturing. It's not about anything else. So there's no sexy computer in the 1990s until the iMac comes around. And so what that means is that Asia and places that have abundant labor, some sophistication in their assembly lines, and, you know, currencies that are undervalued and stuff, they all have this advantage in supplying parts. And so in the late 1980s you get these Taiwanese companies that begin making motherboards for the computer industry. And once they sort of know how to do one thing, they sort of look at what that part connects to, right, in the innards of a computer. And then they start making that part and then they expand, expand, expand until eventually they can do the whole kit and caboodle, if you will. You know, brand it with an HP logo or whatever and send it back to America. So that's sort of the, you know, whiplash-speed origin story of the Taiwanese getting involved. And then there's some distinctions between Foxconn and the others. But essentially part of the story there is that the Taiwanese don't necessarily know how to do this stuff. And so it's American engineers that are going over to teach them. And so Apple's early outsourcing efforts before the comeback of Steve Jobs is making the Newton in Japan with Sharp and then making the Newton second generation in Taiwan, and the laptops in the early 1990s are made out of Japan. So essentially this sounds like an obscure episode in Apple history, but for me it's foundational because what it means is these Apple engineers from Cupertino are flying to and from Japan all the time. And what they're recognizing is that, like, holy — the Japanese are brilliant at engineering. And so it just becomes more and more obvious that they should shift certain production to Japan. And by the late 1990s, everything is moving. And Japan just ends up being sort of too expensive, so Taiwan becomes the place. Taiwan becomes too expensive, so China becomes the place. And to fast forward today, China is becoming too expensive, so India might be the place.

Yeah, yeah, yeah. No, that's interesting. I just hadn't drawn the connection. I think you're right about that. I think what has happened is that the iPod becomes wildly successful. I mean, people don't remember, but the iPod is the first time that Apple really like gains a certain cultural preeminence. However sexy the candy-colored iMac is that we talked about, that was never more than 4% market share, 5% market share. I mean, I quote a Fortune article in 2001 that says Apple risks being as inconsequential as Liechtenstein. When I said that to a family member, they said, 'What's Liechtenstein?' Which makes my point for me, right? And the iPod is just in a totally different league. I mean, one thing that I didn't really realize is that it's a failure for the first two years after coming out in 2001, but by 2003, once you make it available for the Windows network, it goes gangbusters. And within a few years, I mean, it's 80% of the MP3 market. I mean, that's a slip calling it the iPod market. There really was nothing else. I mean, iPod was the MP3 player of choice the entire 2000s. It becomes just an absolute icon, let's say, of globalization or computing or whatever. I mean, there were stories in China of people wearing the white headphones that you get with the iPod, even if they didn't have an iPod, because it could be in your pocket. So you just wanted the illusion of looking like you had an iPod. I mean, that was the status symbol that it was. And I quote somebody in the book who worked on the iPod project and they just had such contempt for the Mac team because the iteration of iPods in the heyday was incredible. I mean, you had the iPod, I don't know, third or fourth generation, and then the iPod mini within a year. The iPod mini gets replaced by another iPod mini, I think, like within seven or eight months, and then the iPod Nano comes out. The iPod Nano is like 20% the size of the original iPod. I mean, it's incredibly innovative. And so Steve Jobs just basically looks at the iPod team, looks at the Mac team, and says the iPhone is basically going to be like a seventh-generation iPod rather than a first-generation phone, right? Okay. And so he doesn't want it to be like a Mac but for the pocket. He wants it to be an iPod that happens to be able to take phone calls. So that would be my sort of analogy. So the iPod and iPhone team kind of do get like siphoned off from the rest of the company, but it's because he doesn't like the way that Macs are produced. He thinks they're stodgy and slow, and he wants that sort of like iPod relentlessness to be infused across the entire iPhone team. And he eventually got his dream with the iPod Touch, if you remember that one, that was not very useful. It had the glass screen. But I had a lot of friends who had that.

That's funny. I like that you're making these connections that I haven't quite made, but like I think you're right in both cases. Yeah. I mean, I would argue that when people are talking about the diversification, like the supposed diversification from China, like actually the rise of services is more of a balance sheet diversification than anything they've done in India. And it's because services have been the fastest-growing division at Apple for I think a solid six or seven years. It's also been very important for the narrative. I mean, if you actually look at sort of what a breakdown of the services revenue is, it's actually more like the fact that Google pays them $20 billion a year and that's pure profit more so than it is Ted Lasso. But they will talk about Ted Lasso every earnings call, right? Or Severance or whatever. I mean, that is probably a money-losing division within services. But by having it so public, as it were, they're able to talk about all these Hollywood stars and stuff instead of saying, 'And Google paid us $20 billion this year.' So services is brilliant in multiple respects, but one of them is just a PR campaign that it enables.

Yeah. No, I'm thankful for the question because when I speak, you know, and sound bites go around on X or, you know, Blue Sky or whatever, the sort of most frustrating thing that I hear is, 'Oh, like his book just says Apple did everything and China did nothing.' And it's like I'm trying to say the opposite, right? Like my point is that China is so helpful to China — to Apple, sorry — that if they try to go do this in India, like it's almost like obviously going to be a failure. Like China offers so many things that you can't find in other countries. And so I'm trying to give them all kinds of credit. And so yeah, so Terry Gou is the most important of the contract manufacturing CEOs. And it gets a little bit wonky, so you probably don't want to hear the full answer, but essentially everybody else among the Taiwanese contract manufacturers are trying to move up the value chain and take control of design. So they call themselves ODMs, original design manufacturers. And so if you're a Western PC maker, you're already offloading all of your manufacturing to somebody. So that sort of takes it off balance sheet and that creates all sorts of efficiencies. It is even better if they say, 'By the way, we will also design the computer for you, so you don't even have to do the research and development.' And it literally gets to the point where like catalogs are being compiled in Taiwan where you as a Western PC executive just sort of pick a design pre-existing out of a catalog and then they just make it for you and badge it. Can you just remember or just think about how antithetical to the entire Apple ethos or to Jony Ive this is? Like, offensive, right? They don't want to do that at all. And so Foxconn is unique in a sense in not going that direction at all. They instead prioritize moving heaven and earth to respond to the designs of Apple. And so this makes them a perfect partner because Apple doesn't want any part in this 'you design it for us' mentality. And Foxconn wants to prioritize a strategy where they vertically integrate. So they don't want to do low-value assembly either. But if they vertically integrate and take care of things, you know, well beyond the final assembly, the plastic injection molding, the metal stamping and all sorts of things, even deriving the raw materials, what that means for them politically matters a lot in China because the more you vertically integrate, the more people you need, and the more people you need, the more dormitories and entertainment venues and grocery stores, etc., Terry Gou is going to build. And so by doing that, he's establishing connections with the provincial officials, the city officials in China. And if you have a bit of understanding of how Chinese politics works, you know that Chinese communism is not like Soviet communism and that it's really top-down. It's federalism on steroids. The local cadres are in competition with other local cadres in different parts of the country. And so they're desperate to derive new growth in their areas. That's how they're judged. That's how you move up the ranks of the Communist Party. And so Foxconn ends up having these great political calculations to be able to get more factories, more people, etc., in exchange for getting growth. And the way they get growth is by partnering with Apple. So sorry, I went on too long about that. I promise it's more interesting in the book to anyone listening, but there are tangible reasons why Foxconn is a better partner for Apple than any of the other rivals.

Yeah. This really stunned me.

I mean, I thought I was maybe looking in the wrong currency or something because Foxconn in the first four years of the 21st century made more money in absolute dollars than Apple did. And they also made more profit margins. So yeah, I believe in 2000, I'm going by memory here, but I believe Foxconn's net margins were 10.4%. And by the end of the decade, they've fallen to around 2%. So there's almost like an iron law: the more closely you work with Apple, the less you make in margins. Now they are making up for it in volume, but more than that, they're making up for it in learning. So this is like the key to understanding Terry Gou. I don't know why he knows this. I don't know if it's a mystical sense. I don't know if Apple tells him, but he understands better than anybody else. But even though Apple isn't a big company, they are a unique company. And to fulfill their demands means that Apple will train the hell out of your entire workforce. And then you can then go use those skills to fulfill the demands of a Dell or an HP or a Sony or anyone else. And so the value of working with Apple is not the profits. It's the tuition-free training. What one engineer told me is the Ivy League equivalent of hardware engineering.