Tuesday 31 January 2012

How the US lost out on iPhone work

Not long ago, Apple boasted that its products were made in America. Today, few are. Why? It is not just because workers overseas are cheaper,

WASHINGTON: When Mr Barack Obama joined Silicon Valley's top luminaries for dinner in February last year, each guest was asked to come with a question for the President.

But as Mr Steve Jobs of Apple spoke, President Obama interrupted with an inquiry of his own: What would it take to make iPhones in the United States?

Almost all of the 70 million iPhones, 30 million iPads and 59 million other products Apple sold last year were manufactured overseas.

Why can't that work come home, Mr Obama asked.

Mr Jobs's reply was unambiguous. 'Those jobs aren't coming back,' he said, according to another dinner guest.

The President's question touched upon a central conviction at Apple. It is not just that workers are cheaper abroad. Rather, Apple's executives believe the vast scale of overseas factories as well as the flexibility, diligence and industrial skills of foreign workers have so outpaced their American counterparts' that 'Made in the US' is no longer a viable option for most Apple products.

Apple has become one of the best-known, most admired and most imitated companies on earth, in part through an unrelenting mastery of global operations. Last year, it earned more than US$400,000 (S$503,000) in profit per employee, more than Goldman Sachs, ExxonMobil or Google.

However, what has vexed Mr Obama as well as economists and policymakers is that Apple - and many of its high-technology peers - is not nearly as avid in creating American jobs as other famous companies were in their heyday.

Apple employs 43,000 people in the US and 20,000 overseas, a small fraction of the over 400,000 American workers at General Motors in the 1950s, or the hundreds of thousands at General Electric in the 1980s. Many more people work for Apple's contractors: An additional 700,000 people engineer, build and assemble iPads, iPhones and Apple's other products. But almost none of them work in the US. Instead, they work for foreign companies in Asia, Europe and elsewhere, at factories that almost all electronics designers rely upon to build their wares.

'Apple's an example of why it's so hard to create middle-class jobs in the US now,' said economist Jared Bernstein, who until last year was an economic adviser to the White House.

'If it's the pinnacle of capitalism, we should be worried.'

Apple executives say that going overseas, at this point, is their only option. One former executive described how the company relied upon a Chinese factory to revamp iPhone manufacturing just weeks before the device was due on shelves. Apple had redesigned the iPhone's screen at the last minute, forcing an assembly line overhaul. New screens began arriving at the plant near midnight.

A foreman immediately roused 8,000 workers inside the company's dormitories, according to the executive. Each employee was given a biscuit and a cup of tea, guided to a workstation and within half an hour started a 12-hour shift fitting glass screens into bevelled frames. Within 96 hours, the plant was producing more than 10,000 iPhones a day.

'The speed and flexibility are breathtaking,' the executive said. 'There's no American plant that can match that.'

Similar stories could be told about almost any electronics company - and outsourcing has also become common in hundreds of industries, including accounting, legal services, banking, auto manufacturing and pharmaceuticals.

But while Apple is far from alone, it offers a window into why the success of some prominent companies has not translated into large numbers of domestic jobs. What's more, the company's decisions pose broader questions about what corporate America owes Americans as the global and national economies are increasingly intertwined.

'Companies once felt an obligation to support American workers, even when it wasn't the best financial choice,' said Dr Betsey Stevenson, the chief economist at the Labour Department until last September. 'That's disappeared. Profits and efficiency have trumped generosity.'

Companies and other economists say that notion is naive. Though Americans are among the most educated workers in the world, the nation has stopped training enough people in the mid-level skills that factories need, executives say.

To thrive, companies argue that they need to move work where it can generate enough profits to keep paying for innovation. Doing otherwise risks losing even more American jobs over time, as evidenced by the legions of once-proud domestic manufacturers - including General Motors and others - that have shrunk as nimble competitors have emerged.

Apple, which has a reputation for secrecy, declined to comment.

This article is based on interviews with more than three dozen current and former Apple employees and contractors - many of whom requested anonymity to protect their jobs - as well as economists, manufacturing experts, international trade specialists, technology analysts, academic researchers, employees at Apple's suppliers, competitors and corporate partners, and government officials.

Privately, Apple executives say the world is now such a changed place that it is a mistake to measure a company's contribution simply by tallying its employees - though they note that Apple employs more workers in the US than ever before.

They say Apple's success has benefited the economy by empowering entrepreneurs and creating jobs at companies like cellular providers and businesses shipping Apple products. And, ultimately, they say curing unemployment is not their job.

'We sell iPhones in over a hundred countries,' a current Apple executive said. 'We don't have an obligation to solve America's problems. Our only obligation is making the best product possible.'

For over two years, the company had been working on a project - code-named Purple 2 - that presented the same questions at every turn: How do you completely reimagine the cellphone? And how do you design it at the highest quality - with an unscratchable screen, for instance - while also ensuring that millions can be manufactured quickly and inexpensively enough to earn a significant profit?

The answers, almost every time, were found outside the US. Though components differ between versions, all iPhones contain hundreds of parts, an estimated 90 per cent of which are manufactured abroad. Advanced semiconductors have come from Germany and Taiwan, memory from South Korea and Japan, display panels and circuitry from South Korea and Taiwan, chipsets from Europe and rare metals from Africa and Asia. And all of it is put together in China.

In its early days, Apple usually did not look beyond its own backyard for manufacturing solutions. A few years after Apple began building the Macintosh in 1983, for instance, Mr Jobs bragged that it was 'a machine that is made in America'. In 1990, while Mr Jobs was running NeXT, which was eventually bought by Apple, the executive told a reporter that 'I'm as proud of the factory as I am of the computer'. As late as 2002, top Apple executives occasionally drove two hours north-east of their headquarters to visit the company's iMac plant in Elk Grove, California.

But by 2004, Apple had largely turned to foreign manufacturing. Guiding that decision was Apple's operations expert, Mr Timothy Cook, who replaced Mr Jobs as chief executive last August, six weeks before Mr Jobs' death. Most other American electronics companies had already gone abroad, and Apple, which at the time was struggling, felt it had to grasp every advantage.

In part, Asia was attractive because the semi-skilled workers there were cheaper. But that was not driving Apple. For technology companies, the cost of labour is minimal compared with the expense of buying parts and managing supply chains that bring together components and services from hundreds of companies.

For Mr Cook, the focus on Asia 'came down to two things', said a former high-ranking Apple executive. Factories in Asia 'can scale up and down faster' and 'Asian supply chains have surpassed what's in the US'. The result is that 'we can't compete at this point', the executive said.

The impact of such advantages became obvious as soon as Mr Jobs demanded glass screens in 2007.

Jobs wanted a non-scratch glass screen, he got one... super-fast

IN 2007, a little more than a month before the iPhone was scheduled to appear in stores, Apple chief Steve Jobs beckoned a handful of lieutenants into an office. For weeks, he had been carrying a prototype of the device in his pocket.

Mr Jobs angrily held up his iPhone, angling it so everyone could see the dozens of tiny scratches marring its plastic screen, according to someone who attended the meeting. He then pulled his keys from his jeans.

People will carry this phone in their pocket, he said. People also carry their keys in their pocket. 'I won't sell a product that gets scratched,' he said tensely. The only solution was using unscratchable glass instead.

'I want a glass screen, and I want it perfect in six weeks.'

After one executive left that meeting, he booked a flight to Shenzhen, China. If Mr Jobs wanted perfect, there was nowhere else to go.

For years, cellphone makers had avoided using glass because it required a degree of precision in cutting and grinding that was extremely hard to achieve. Apple had already selected an American company, Corning, to manufacture large panes of strengthened glass.

However, figuring out how to cut those panes into millions of iPhone screens required finding an empty cutting plant, hundreds of pieces of glass to use in experiments and an army of mid-level engineers. It would cost a fortune simply to prepare.

Then, a bid for the work arrived from a Chinese factory.

When an Apple team visited the plant, the owners were already constructing a new wing. 'This is in case you give us the contract,' the manager said, according to a former Apple executive.

The Chinese government had agreed to underwrite costs for numerous industries, and those subsidies had trickled down to the glass-cutting factory. It had a warehouse filled with glass samples available to Apple, free of charge. The owners made engineers available at almost no cost. They had built on-site dormitories so employees would be available 24 hours a day.

The Chinese plant got the job.

'The entire supply chain is in China now,' said another former high-ranking Apple executive. 'You need a thousand rubber gaskets? That's the factory next door. You need a million screws? That factory is a block away. You need that screw made a little bit different? It will take three hours.'

An eight-hour drive from that glass factory is a complex, known informally as Foxconn City, where the iPhone is assembled today. To Apple executives, Foxconn City was further evidence that China could deliver workers who could outpace their American counterparts in speed and diligence.

Why? Because nothing like Foxconn City exists in the United States.

The facility has 230,000 employees, many working six days a week and often spending up to 12 hours a day there. At least one in four workers lives in company barracks, and many earn less than US$17 (S$21) each a day.

When one Apple executive arrived during a change of shifts, his car was stuck in a river of employees streaming past. 'The scale is unimaginable,' he said.

Foxconn employs nearly 300 guards to direct foot traffic so workers are not crushed in doorway bottlenecks. The facility's central kitchen cooks an average of about three tonnes of pork and 12 tonnes of rice a day. While the factories are spotless, the air inside nearby teahouses is hazy with the smoke and stench of cigarettes.

Foxconn Technology has dozens of facilities in Asia, Eastern Europe, Mexico and Brazil. It assembles an estimated 40 per cent of the world's consumer electronics for customers such as Amazon, Dell, Hewlett-Packard, Motorola, Nintendo, Nokia, Samsung and Sony.

'They could hire 3,000 people overnight,' said Ms Jennifer Rigoni, who was Apple's worldwide supply demand manager until 2010, but declined to discuss specifics of her work. 'What US plant can find 3,000 people overnight and convince them to live in dorms?'

In mid-2007, after a month of experimentation, Apple's engineers finally perfected a way to cut strengthened glass so it could be used in the iPhone's screen.

The first truckloads of cut glass arrived at Foxconn City in the dead of night, according to the former Apple executive. Managers woke thousands of workers, who crawled into their uniforms - white and black shirts for men, red for women - and quickly lined up to assemble the phones by hand.

Within three months, Apple had sold a million iPhones. Since then, Foxconn has assembled more than 200 million more.

Foxconn, in statements, declined to speak about specific clients. 'Any worker recruited by our firm is covered by a clear contract outlining terms and conditions and by Chinese government law that protects their rights,' it wrote. It said it 'takes our responsibility to our employees very seriously, and we work hard to give our more than one million employees a safe and positive environment'.

The company disputed some details of the former Apple executive's account.

It wrote that a midnight shift, such as the one described, was impossible 'because we have strict regulations regarding the working hours of our employees based on their designated shifts, and every employee has computerised time cards that would bar them from working at any facility at a time outside their approved shift'. It said all shifts begin at either 7am or 7pm, and employees receive at least 12 hours' notice of any schedule changes.

Foxconn employees, in interviews, have challenged those assertions.

What an American engineer can't do
What would it take to build an iPhone in America? No less than transforming the national and global economies,

Apart from sheer speed and flexibility, another critical factor that led Apple to manufacture in China was that it provided engineers at a scale that the United States could not match.

Apple's executives had estimated that about 8,700 industrial engineers were needed to oversee and guide the 200,000 assembly-line workers eventually involved in manufacturing iPhones. The company's analysts had forecast that it would take as long as nine months to find that many qualified engineers in the US.

In China, it took 15 days.

Companies like Apple 'say the challenge in setting up US plants is finding a technical workforce', said Professor Martin Schmidt, an associate provost at the Massachusetts Institute of Technology.

In particular, companies say they need engineers with more than a high school education but not necessarily a bachelor's degree. Americans at that skill level are hard to find, executives contend.

'There are good jobs, but the country doesn't have enough to feed the demand,' Prof Schmidt said.

Some aspects of the iPhone are uniquely American.

Its software, for instance, and its innovative marketing campaigns were largely created in the US. Apple recently built a US$500 million (S$630 million) data centre in North Carolina. Crucial semiconductors inside the iPhone 4 and 4S are manufactured in an Austin, Texas, factory by Samsung of South Korea.

But even those facilities are not enormous sources of jobs. Apple's North Carolina centre, for instance, has only 100 full-time employees. The Samsung plant has an estimated 2,400 workers.

'If you scale up from selling one million phones to 30 million phones, you don't really need more programmers,' said Mr Jean-Louis Gassee, who oversaw product development and marketing for Apple until he left in 1990. 'All these new companies - Facebook, Google, Twitter - benefit from this. They grow, but they don't really need to hire much.'

It is hard to estimate how much more it would cost to build iPhones in the US. But various academics and manufacturing analysts estimate that because labour is such a small part of technology manufacturing, paying American wages would add up to US$65 to the expense of each iPhone. Since Apple's profits are often hundreds of dollars a phone, building domestically, in theory, would still give the company a healthy reward.

But such calculations are, in many respects, meaningless because building the iPhone in the US would demand much more than hiring Americans - it would require transforming the national and global economies. Apple executives believe there are simply not enough American workers with the skills that the company needs or factories with sufficient speed and flexibility. Other companies that work with Apple, like Corning, also said they must go abroad.

Manufacturing glass for the iPhone revived a Corning factory in Kentucky, and today, much of the glass in the phone is still made there. After the iPhone became a success, Corning received a flood of orders from other companies hoping to imitate Apple's designs. Its strengthened glass sales have grown to more than US$700 million a year and it has hired or continued employing about 1,000 Americans to support the emerging market.

But as that market has expanded, the bulk of Corning's strengthened glass manufacturing has occurred at plants in Japan and Taiwan.

'Our customers are in Taiwan, Korea, Japan and China,' said Mr James Flaws, Corning's vice-chairman and chief financial officer.

'We could make the glass here and then ship it by boat, but that takes 35 days. Or, we could ship it by air, but that's 10 times as expensive. So we build our glass factories next door to assembly factories, and those are overseas.'

Corning was founded in the US 161 years ago and its headquarters are still in upstate New York. Theoretically, the company could manufacture all its glass domestically. But it would 'require a total overhaul in how the industry is structured', Mr Flaws said.

'The consumer electronics business has become an Asian business. As an American, I worry about that, but there's nothing I can do to stop it. Asia has become what the US was for the last 40 years.'

Modernisation has always caused some kinds of jobs to change or disappear. As the American economy transitioned from agriculture to manufacturing and then to other industries, farmers became steelworkers and then salesmen and middle managers. These shifts have carried many economic benefits, and, in general, with each progression, even unskilled workers received better wages and greater chances at upward mobility.

But in the last two decades, something more fundamental has changed, economists said. Mid-wage jobs started disappearing. Particularly among Americans without college degrees, today's new jobs are disproportionately in service occupations - at restaurants or call centres, or as hospital attendants or temporary workers - that offer fewer opportunities for reaching the middle class.

But as Apple's overseas operations and sales have expanded, its top employees have thrived. In the last fiscal year, the company's revenue topped US$108 billion, a sum larger than the combined state budgets of Michigan, New Jersey and Massachusetts. Since 2005, when Apple's stock split, share prices have risen from US$45 to more than US$427.

Some of that wealth has gone to shareholders. Apple is among the most widely held stocks, and the rising share price has benefited millions of individual investors, 401(k)s (a US retirement savings plan) and pension plans. The bounty has also enriched the company's workers. In the last fiscal year, besides their salaries, Apple's employees and directors received stock worth US$2 billion and exercised or vested stock and options worth an added US$1.4 billion.

But the biggest rewards have often gone to Apple's top employees. Chief executive Tim Cook last year received stock grants - which vest over a 10-year period - that, at today's share price, would be worth US$427 million, and his salary was raised to US$1.4 million. In 2010, his compensation package was valued at US$59 million, according to Apple's security filings.

A person close to Apple argued that the compensation received by the company's employees is fair, in part because it has brought so much value to the nation and the world. As the company has grown, it has expanded its domestic workforce, including manufacturing jobs. Last year, Apple's American workforce grew by 8,000.

While other companies have sent call centres abroad, Apple has kept its centres in the US. One source estimated that the sales of Apple's products have caused other companies to hire tens of thousands of Americans. FedEx and United Parcel Service, for instance, both said they have created American jobs because of the volume of Apple's shipments, though neither would provide specific figures without permission from the company, which declined to provide details.

'We shouldn't be criticised for using Chinese workers,' a current Apple executive said. 'The US has stopped producing people with the skills we need.'

What is more, Apple sources said the company has created plenty of good American jobs in its retail stores and among entrepreneurs selling iPhone and iPad applications.

Towards the end of US President Barack Obama's dinner last year with late Apple founder Steve Jobs and other Silicon Valley executives, the two men spoke again.

'I'm not worried about the country's long-term future,' Mr Jobs told Mr Obama, according to one observer.

'This country is insanely great. What I'm worried about is that we don't talk enough about solutions.'

At dinner, for instance, the executives had suggested that the government should reform visa programmes to help companies hire foreign engineers. Some had urged the President to give companies a 'tax holiday' so they could bring back overseas profits which, they argued, would be used to create work. Mr Jobs even suggested it might be possible, some day, to locate some of Apple's skilled manufacturing in the US if the government helped to train more American engineers.

Economists debated the usefulness of those and other efforts and noted that a struggling economy is sometimes transformed by unexpected developments. The last time analysts wrung their hands about prolonged American unemployment, for instance, in the early 1980s, the Internet hardly existed. Few at the time would have guessed that a degree in graphic design was rapidly becoming a smart bet, while studying telephone repair was a dead end.

But what remains unknown is whether the US will be able to leverage tomorrow's innovations into millions of jobs.

In the last decade, technological leaps in solar and wind energy, semiconductor fabrication and display technologies have created thousands of jobs. But while many of those industries started in the US, much of the employment has occurred abroad. Companies have closed major facilities in the US to reopen in China. By way of explanation, executives said they are competing with Apple for shareholders. If they cannot rival the company's growth and profit margins, they will not survive.

'New middle-class jobs will eventually emerge,' said Harvard economist Lawrence Katz. 'But will someone in his 40s have the skills for them? Or will he be bypassed for a new graduate and never find his way back into the middle class?'

The pace of innovation, said executives from a variety of industries, has been quickened by businessmen like Mr Jobs. General Motors went as long as half a decade between major automobile redesigns. Apple, by comparison, has released five iPhones in four years, doubling the speed and memory of the devices while dropping the price that some consumers pay.

Before Mr Obama and Mr Jobs said goodbye, the Apple executive pulled an iPhone from his pocket to show off a new application - a driving game - with incredibly detailed graphics. The device reflected the soft glow of the lights in the room. The other executives, whose combined worth exceeded US$69 billion, jostled for a position to glance over his shoulder. The game, everyone agreed, was wonderful.

There was not even a tiny scratch on the screen.

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