Global Emerging Markets (GEMs) : Sony

The End of Outsourcing?

Charles Krakoff — Mon, 03 Oct 2011 20:07:00 GMT

Foxconn International Holdings, the world’s largest contract manufacturer of electronic components, made notorious last year by a rash of employee suicides at its Chinese factories, recently published its half-yearly financial results, which showed that its annual labor costs per employee have risen by a third over the past year, to $2,900.

Foxconn, 71% owned by Hon Hai Precision Industry of Taipei, and which also assembles products for Sony, Dell, and Hewlett Packard, employs an estimated 400,000 people at its two factories in Shenzhen (Hon Hai, with 800,000 employees, is the 10^th-largest employer in the world). These people, most of them young, many of them women, work 11-hour shifts, seven days a week. According to the New York Times, Mr. Ma Xiangqiang, a 19-year-old Foxconn employee who jumped to his death from a Foxconn dormitory in January 2010, had worked 286 hours in the month prior to his suicide, including 112 hours of overtime, more than three times the legal limit. By all accounts, Foxconn is not a fun place to work, combining some of the worst features of military service, summer camp, and prison, but the problems facing Foxconn are far from unique.

Coastal China is in many ways a victim of its own success. China’s explosive industrial growth of the past 30 years, much of it concentrated in the Pearl River Delta in Guangdong Province, adjacent to Hong Kong, has lifted hundreds of millions of people out of abject poverty and introduced many of them to the temptations of consumerism. Rising living standards have been accompanied by increased awareness of the world and demands for more personal freedom. Workers no longer accept unremitting drudgery as an inevitable norm. Foxconn has responded in two ways: one, by increasing salaries, and the other, by setting up factories in Western China, where wages are lower and labor militancy so far nonexistent. China’s government has encouraged companies to set up factories in the interior, partly to reduce the strain on coastal cities’ infrastructure, but also to dissipate the kind of worker discontent that could quickly turn political. These are at most temporary expedients. Neither is a solution to the rising cost of doing business in China. Western China may offer lower wages, but the additional cost of moving components and assembled units thousands of miles within China may negate any labor cost savings. More fundamentally, Foxconn’s travails call into question the sustainability of China’s current export-dominated economic model.

It’s a fair bet that logistics – transporting the many components that go into an iPhone or an iPad and then getting the finished product to market – accounts for a much higher proportion of the final cost than the assembly work itself, which most analysts estimate at less than one per cent of the retail price. As the cost of Chinese assembly rises and the negative publicity associated with worker suicides and sweatshop working conditions intensifies, a company like Apple or HP might start to question whether assembling its products in China makes sense. With overtime and bonuses, a worker in a Chinese electronics factory can earn $500 a month. This is a lot less than the $3,000 or so a U.S. worker might get, but then Chinese manufacturing labor is far less productive. Shifting iPad assembly from China to the U.S. might raise unit costs by a few pennies, a small price to pay for greater control over their supply chains, while moving it to, say, Mexico, might even reduce the cost. No wonder the Financial Times said that “Hon Hai and its offshoots are looking like relics from another era.” No wonder, too, that Foxconn has reportedly been considering a $12 billion investment in Brazil, where import duties have raised the cost of an entry-level iPad 2 to nearly $1,000, as compared to around $400 in the U.S. The higher cost of Brazilian labor is insignificant compared to the savings in import duties, and a Brazilian-made iPad, just like a Brazilian-made Ford Fiesta, can also sell for a competitive price in the U.S. or Europe.

If China is no longer the cheapest place to manufacture or, as seems to be the case with Foxconn’s factories, its cost advantages are outweighed by other considerations, where does this leave Chinese manufacturing and the Chinese economic model? China continues to excel at making products like shoes and T-shirts, for which labor represents a much bigger share of the cost than for an iPad. But even in these product groups, a combination of lower labor costs and special trade preferences has caused a lot of production to shift to places like Vietnam, Bangladesh, Nicaragua, and Haiti. At some point, however, the world will run out of cheaper manufacturing locations. Once Vietnam and Haiti accede to the ranks of middle-income countries, where will the sweatshops move? Burundi? Somalia? It seems unlikely.

These developments prove only that present trends never continue indefinitely. The current fear of an unstoppable Chinese manufacturing juggernaut, which will end up like the victor in a game of Monopoly, owning all the money and all the property and manufacturing everything the rest of the world consumes, is no more valid than the old fear of an unstoppable Japan.

These developments also indicate that the doctrine of comparative advantage – the one economic theory that is neither obvious nor trivial – will reassert itself. Even if China had an absolute cost advantage in manufacturing of every imaginable product, which it clearly has not, it would still make sense for it to specialize in production of goods or services in which it is relatively more efficient. This mix of goods and services will change over time. China is likely to remain a formidable exporting power, but as its economy matures and its labor costs rise, its exports will shift from cheap, labor-intensive manufactures to goods and services containing higher added value, following a similar trajectory to that of Japan, Taiwan, and South Korea. More cars and flat panel displays and fewer T-shirts.

Does this mean an end to outsourcing? Not at all. But what is outsourced, and from where, will continue to change. Expect China, just now starting to export cars, to be building car factories in the United States 15 or 20 years from now. Expect Apple to shift assembly of its iPads from China back to the U.S. or perhaps to Mexico, where it can shorten its supply chain and better control quality. For now, your undershorts and T-shirts will continue to be made in Haiti or wherever else labor is cheapest and trade preferences greatest. For just about everything else, all bets are off.

Stop Trying to Give Me What I Don’t Even Know I Want

Charles Krakoff — Tue, 11 May 2010 21:57:00 GMT

One could argue that true genius in business is more about giving consumers things they don’t even know they want than about giving them what they want or say they want. I remember the first time I saw the Apple iPod. I went online immediately and ordered one, even though in those dark ages I had to purchase third-party software to make it run with my PC. I also remember when the Sony Walkman and the CD player and disk were both introduced, and although I was slower to get those, I marveled at the genius of the people who gave us such elegant solutions to problems most of us were only dimly aware we had.

If you were of a certain mind you might take these phenomena as proof of the excesses of a capitalist system that invents and then sells people all kinds of stuff they don’t need. Not a bit of it! The needs these products fill are not at all the same as the invented needs of an earlier generation of marketing geniuses (let’s call them Mad Men). Remember feminine hygiene deodorant spray? Ring around the collar? Or, as the ad for some long-forgotten brand of air freshener went, “I remember the night when the girls came over for bridge club. I was so embarrassed because of lingering odors, the houseatosis.”

That was an earlier era. Each one of the newer generation of technology-based products filled a constellation of needs, even if some of the negative side effects took time to become apparent. To most of us, CDs were a godsend. Portable, nearly indestructible, they took up a fraction of the space of regular albums and weighed far less, and reduced almost to nil the chance that someone having had a bit too much to drink would lurch against the turntable and scratch your precious and irreplaceable Coleman Hawkins record. But we later learned that the plastic “jewel box” in which CDs came were woefully awful compared to cardboard record sleeves, and that the sound quality of a digital CD couldn’t match that of a good vinyl record.

For me the iPod was as nearly perfect as technology gets. It did everything I wanted it to do and nothing I didn’t, and no one had even bothered to ask me. I travel over 150 days a year and I fell in love with the idea that I could bring my record collection with me wherever I went instead of having to content myself with a dozen or so CDs. Of course you can’t read the liner notes on an MP3, so you have to wonder – at least until you can get to a computer and Google it – who played piano on that particular Miles Davis recording. Some say the sound quality on an MP3, unless you save it as as a massive file, is even worse than that of CDs, though one virtue of advancing age is that it becomes harder to hear the difference. And who could have foreseen that our teenage children, never the most communicative of souls, wouldn’t even hear us telling them to go pick up their rooms because they forever have those little white listening pods stuck in their ears? But those inconveniences emerged only later.

The most recent crop of miraculous inventions, however, has underwhelmed me. The critics do have a point when they point to the inexorable logic of capitalism that you have to keep moving forward, forever inventing, manufacturing, and selling new products. This is hard to sustain. Sony, once the greatest innovator in consumer electronics, has become an also-ran. With last month’s release of the iPad, Apple may soon suffer the same fate, even if the current sales figures tell a different story.

Though the iPod remains the gold standard of portable music devices, there are plenty of others almost as good, and the fat profit margins Steve Jobs reaped on the first generations of the product have become substantially thinner. Ditto, I suspect, with the iPhone. So along comes the iPad, and in spite of the million units Apple has sold in less time than it takes me to walk to the mailbox, it strikes me as a sad orphan of a product. It’s either a big iTouch (the non-telephone version of the iPhone) or a small computer, too big to carry in your pocket but not big enough to write a term paper or a business plan. Instead of brilliantly figuring out where we want to go before we ourselves know, Apple this time seems to have invented a new kind of deodorant spray for parts of our bodies that should never be sprayed: a solution in search of a need. Right now, some sellers on e-bay are offering various versions of the iPad at a premium to Apple’s prices, for those who absolutely must have one tomorrow, but some are already offering them at steep discounts.

In what no one could possibly think a unrelated event, shortly after the iPad was released Microsoft announced that it had scrapped development of the Courier, a tablet-like computer that promised to offer everything the iPad does not, most notably the ability to translate handwritten notes into editable text. There have to be millions of consultants, students, scholars, cops, lawyers, reporters, and engineers for whom this would be a Holy Grail of sorts. Some industry experts have suggested that the engineering obstacles in making the Courier work were insurmountable, especially for a company like Microsoft not noted for its prowess designing, manufacturing, and marketing hardware. It could be as simple as fear of going head to head with Apple, a contest in which Microsoft has often come second. Remember the Zune, Microsoft’s answer to the iPod?

So will I buy an iPad now that my first choice will never make it to market? No. Someone once described Alexander Solzhenitsyn’s novel August 1914 as what War and Peace would be if it hadn’t been written by a genius. Genius Steve Jobs may be, but the iPad, however much money it makes for Apple shareholders, strikes me the same way. In this case genius failed to deliver the goods. So I am hoping that someone, almost certainly not a genius, will use a more prosaic set of tools to find out what people (okay, me) really want and give it to us.

Blood Cell Phones

Charles Krakoff — Wed, 07 Apr 2010 15:50:00 GMT

In 2003, motivated by the savagery of civil wars in Sierra Leone and Liberia, 75 countries joined a U.N.-sponsored global initiative to prevent trade in “conflict diamonds,” popularly referred to as “blood diamonds.” Conflict diamonds are gems mined in areas afflicted by armed conflict, the proceeds of which go to purchase arms and other materiel to prolong and intensify the conflict, which is usually all about control of those same diamond deposits. This initiative, called the Kimberley Process, instituted a system of certification under which governments of both source countries and purchasing countries would collaborate to prevent conflict diamonds from being sold internationally. The Kimberley Process was endorsed by major diamond producers, including world market leader De Beers, to avoid being tainted by the blood diamond label and, perhaps coincidentally, to reinforce their market dominance by banning trade in stones of uncertain provenance. But it was also a good-faith effort to put an end to the spread of vicious conflicts motivated and fueled by mineral resources.

Less well-known than the conflicts in West Africa is the civil war that continues to rage in parts of the Democratic Republic of Congo (DRC), known at various points in its history as Zaire, the Belgian Congo, and the Congo Free State, which in the late 19^th and early 20^th centuries was the private preserve of Leopold II, King of the Belgians. The current war, which dates back to the 1994 Rwandan genocide and the overthrow of dictator Mobutu Sese Seko in 1997 and has its roots in earlier political and ethnic squabbles, is reckoned to be the deadliest armed conflict since the Second World War, claiming over five million lives between 1998 and 2008.

Disclosure: I spent two of the happiest years of my life as a Peace Corps Volunteer in Zaire in the late 1970s, have visited the country numerous times since then, and retain a strong sentimental attachment to the place.

For well over 100 years – you can, arguably, go back at even further to the 17^th century Kongo Civil war in what were then Portuguese dominions, and are now parts of both Angola and DRC – foreign powers and greedy locals have exploited the country’s ethnic divisions to grab its boundless natural resource wealth for themselves. Joseph Conrad, in Heart of Darkness, called it “the vilest scramble for loot that ever disfigured the history of the human conscience,” and what he wrote in 1899 about the insane quest for rubber and ivory pretty much still applies to space-age metals dug out of riverbanks by conscript labor under the watchful eyes of local warlords and their enforcers. It’s easy enough for us in the rich countries to turn a blind eye to all this. Congo is far away, and the atrocities are perpetrated by one set of Africans against another, so what’s it got to do with us? Quite a lot, actually.

Neither the starving laborers nor the thugs pointing automatic weapons at them have much use for tantalum, a rare earth metal found in great abundance in Eastern Congo, nor for tungsten, also mined in the same area, but these turn out to be essential components of cell phones and various other high-tech devices. So if you just stood in line overnight to buy a new iPad, or if you suffer from addiction to video games or your Blackberry smart phone, you are complicit, however unwittingly, in this vile commerce. In a memorable turn of phrase, former British parliamentarian Oona King said,”Kids in Congo [are] being sent down mines to die so that kids in Europe and America [can] kill imaginary aliens in their living rooms.”

Members of the U.S. Congress, in a rare show of bipartisanship, have introduced legislation to try to curb the trade in conflict minerals from Congo. Representative James McDermott, Democrat of Washington state, in November 2009 sponsored H.R. 4128, the Conflict Minerals Trade Act, a bill that attracted 30 co-sponsors, including a sprinkling of Republicans. Meanwhile, arch-Republican Senator Sam Brownback of Kansas, together with co-sponsors Dick Durbin, a Democrat from Illinois, and Wisconsin Democrat Russ Feingold, has introduced a similar bill in the Senate. An impressive array of major corporations, including Dell and HP, and prominent NGOs, including Amnesty International and Human Rights Watch, have expressed strong support for the bill. The big question is whether it will work.

The track record of the Kimberley Process is not reassuring. A report by Global Watch, a British NGO, and one of the prime movers in the establishment of the Kimberley Process, warned that controls are inadequate in major diamond processing centers such as Surat in India and Antwerp, thus allowing substantial leakage of blood diamonds onto the international market. Human Rights Watch in June 2009 published a report alleging massive human rights violations in Zimbabwe’s Marange diamond fields. It accused the Zimbabwean Army of using force “to control access to the diamond fields, and to take over unlicensed diamond mining and trading,” all to the benefit of Robert Mugabe’s ruling ZANU-PF party. Fraudulent Kimberley Process certificates are reportedly in wide circulation throughout the world’s diamond supply chain.

Rep. McDermott’s bill seeks to avoid some of these risks by reducing the burden of compliance on governments of poor diamond producing countries, which often lack both the means and the will to stop the trade. It also takes a dimmer view of international cooperation in general, which seems to make sense, since the more parties involved the more cracks for things to fall through. Instead, it requires the U.S. State Department to pay greater attention to the minerals issue in its annual reports on human rights practices in DRC and neighboring countries. More important, it puts the burden of proof on “enterprises under U.S. jurisdiction” to exercise due diligence “to ensure that their purchases of minerals or metals are not originating from mines and trading routes that are used to finance armed groups in the Democratic Republic of the Congo.” The bill would also require the U.S. tariff code to identify items potentially containing conflict minerals and would require importers to certify that their imports of those items are conflict mineral free. Since every company that uses these minerals has a substantial operation in the U.S., the bill would place a significant part of the world trade in these substances under U.S. jurisdiction.

The law should be passed, if for symbolic reasons only. It could help attract the attention of U.S. consumers, who in turn would put their own pressure on importers and manufacturers to comply. Consumer pressure on companies like Nike and Wal-Mart have done more to curb unsafe and exploitative working conditions in shoe and garment factories in developing countries than any number of government regulations and trade restrictions could have done. If consumers start demanding that Apple and RIM do more to keep conflict minerals out of their iPhones and Blackberries it could prove far more potent than whatever sanctions the law may impose.

The immediate practical effect of the legislation is more doubtful. The minerals in question are completely fungible and easy to transport and hide. Not as easy as a pocketful of diamonds, but total world production of tantalum is less than 1,000 tons a year. Even at currently depressed tantalum prices of $35 a pound, a small truck full of coltan (tantalum-bearing ore), representing a small fortune to a trader or a warlord, can easily cross an international border for a few dollars in bribes.

That is exactly what happens. According to official trade statistics, Rwanda exports more tantalum than DRC, even though its reserves and the scale of its mining operations are a fraction of those of its huge neighbor. The bulk of Rwanda’s exports are reckoned to come from Congo, but with minimal processing in Rwanda and with every additional transformation and transaction the stuff becomes harder to trace to its source. The recession put a damper on demand, but the price could spike with introduction of any new technology that uses the stuff. The introduction of the Sony Playstation 2 in 2001 caused the price to go from less than $50 to $275 a pound almost overnight. Though Sony claims to have abandoned use of tantalum from Congo, some analysts have suggested that this is almost impossible, given Congo’s probable real share of world supply. Since Sony and Nokia and Samsung and other consumer electronics companies buy their minerals from intermediaries, they can’t be certain of their real provenance, and it can be equally hard for intermediaries like Cabot Corporation, the world’s largest processor of tantalum, to know for sure.

Cabot, for its part, states “We do not and will not mine any material containing Tantalum, including coltan, in the Democratic Republic of the Congo. We reject any new offer of ore if there is any possibility that the source is the DRC…We employ several controls to ensure that we do not purchase ore from the DRC, including the requirement of a government issued certificate of origin to ensure the ore we purchase is not sourced from the DRC.” It also claims it does not purchase tantalum from neighboring countries, including Rwanda, Burundi, Congo-Brazzaville, and Zambia.

There is no reason to doubt Cabot’s seriousness of purpose, but as international traffic in arms, people, drugs, gems, endangered species, laundered money, and stolen works of art demonstrates, a government-issued certificate often isn’t worth the paper it’s written on. That’s no reason to dismiss the proposed legislation, which should be passed. But the real solution lies elsewhere.

Alternative sources of tantalum and other high-value minerals can be found, even if Congo remains the mother lode. Australia, Venezuela, Colombia, Mozambique, Canada, and Brazil all have important tantalum deposits, though some of those countries have potential conflict issues of their own. Ceramic capacitors, though currently in short supply, have some important advantages over tantalum in appliances like laptop computers. But these are longer-term fixes. To make this year’s crop of electronic marvels the world will still depend on the Congolese coltan mines. And Congo is such an important source of other strategic minerals that wiping out the tantalum trade will not end armed conflicts and human rights abuses connected with other high-value minerals, including gold, copper, cobalt, and, yes, diamonds.

The only real answer, of course, is for Congo to have a reasonably strong, reasonably representative government that can control its borders, guarantee its people a modicum of freedom, and wipe out internal armed insurrection. That’s a tall order, and something never before seen in Congo’s history. The rest of the world could help by putting an end to its meddling, armed or otherwise, and imposing sanctions on any country that refuses to do so. This too is not easy with such riches at stake.

When I lived in Congo in the late seventies, people had grown fed up with Mobutu’s brutality and vainglory and were fond of saying that any change in the status quo would be an improvement. The subsequent thirty-plus years have proven them tragically wrong. Still, I recoil at the notion that the Mobutu regime is as good as it gets for the Congolese. The legislation now before the U.S. Congress represents just the tiniest step towards a better future for Congo, but it’s a step that must be taken. And if that means we don’t get a new cell phone this year or next it would be a small price very much worth paying.