Few companies epitomise the era of globalisation better than Hon Hai, the world’s largest contract electronics manufacturer. Known as Foxconn Technology Group, its formula for success includes: massive plants in China run with an abundant supply of low-cost labour, proximity to clusters of suppliers and a reliance on free trade and a seemingly insatiable global appetite for mass market devices.
Over the past 15 years, Foxconn has grabbed a significant share of the orders to make personal computers and smartphones for brands such as Apple, Dell and Huawei. Along with rival manufacturers from Taiwan such as Quanta Computer, Pegatron and Wistron, it has led a constant race to make the manufacturing process cheaper, faster and more efficient.
This Tuesday will be a historic day for Foxconn, when it will host an investor conference for the first time ever. On the agenda at the event in the Taipei suburb of Tucheng, which translates as Dirt City, is the looming existential challenges for a company which is both the world’s largest assembler of Apple iPhones and China’s biggest private sector employer.
The immediate order of business is to explain how the company will be run after Terry Gou, the tycoon who founded it 45 years ago, steps down as chairman to enter politics and run for the Taiwanese presidency.
But the even bigger issue will be how Foxconn plans to navigate two separate threats from politics and from artificial intelligence which have the potential to wreck the business model of the handful of Taiwanese electronic manufacturing services companies that dominate the consumer technology supply chain.
The company is caught in the middle of the escalating trade war between the US and China — the one-time champion of globalisation now suffering as more hawkish members of the Trump administration seek ways to “decouple” the two countries’ technology sectors. But it is also trying to come to terms with the impact of AI, which is leading to a shift in the market away from the mass production that fuelled its growth towards more niche, higher-margin items.
Reflecting worries over these challenges, Hon Hai’s share price has dwindled by 51 per cent over the past two years to T$71 on Friday. Last week, Mr Gou warned of a “tsunami” in the global economy triggered by the trade war.
With the US government raising tariffs to 25 per cent on $200bn of Chinese goods and blacklisting telecoms equipment maker Huawei last month, Taiwan contract manufacturing executives have been scrambling to shift at least some production out of China.
That is an endeavour fraught with difficulties. “It is nearly impossible to replicate the ecosystem we have in China quickly,” says Jean-Frederic Kuentz, a senior partner at McKinsey, the consultancy. “The first problem is that there is not enough manpower. The second is the network of suppliers — panel makers, molding companies, component makers. It is a big, big headache.”
The changes brought to the market by AI are at least as disruptive for the industry. Last year, global shipments of smartphones — a product that accounts for more than half of Foxconn’s revenue — dropped 4.5 per cent to 1.39bn units, and this year will see a 3.1 per cent decrease, according to analyst, a technology research firm.
Experts believe that even if growth returns next year, underpinned by the adoption of 5G, the boom days for smartphones are over. “For many functions that are on your smartphone today, you will soon no longer need it,” says Yu Kai, co-founder of AISpeech, a Chinese voice recognition start-up that Foxconn has invested in. “Some of them will be taken over by smart speakers, others by alternative home appliances, yet more by applications in your car. We may even see the day where the concept of a device becomes obsolete altogether as you interact via voice or image recognition with your environment.”
Some of the new AI-powered market segments, such as smart speakers, are growing fast. Applications in the automobile industry, medical services and robotics also offer growing returns. But analysts say these segments are too small and technologically too demanding to allow Taiwanese firms to quickly replace revenue and profits from their current range of IT products.
“At the moment, you have mass market products with more than 2bn units. Some of the new products will be in the tens of thousands of units. Only wearable are going to be in the hundreds of millions,” says Manish Nigam, head of Asian technology research at Credit Suisse. “There is no single new mass market product out there, so there will be consolidation among the contract manufacturers.”
Analysts say a focus on scale — the very strategy that boosted Foxconn and its Taiwanese peers in the last few tech cycles featuring the laptop, the tablet and the smartphone — is now making it harder for them to adjust.
“As HP, IBM, Dell, Apple came knocking on their door with huge volumes of things to be made, the Taiwanese never really diversified into the other things with low volume but much higher margins and also much higher technology threshold,” says another technology analyst. “They really completely collectively missed this. So now it’s a lot more complicated because in those niches where there is growth, it is not the EMS industry incumbents that benefit.”
Some experts believe that some of the contract manufacturing companies in the region that lost much of their IT business to Foxconn a decade ago could end up being the biggest beneficiaries of the new market segments. They name, for instance, Singapore-based Flextronics and Venture, both of which have sizable businesses making electronics hardware for the medical sector.
Liu Rufeng, a vice-president at AISpeech who works with manufacturers to develop hardware solutions for its voice recognition applications, says traditional EMS firms are mostly absent from these new areas.
“The hardware manufacturers that make smart speakers are often companies that were already making traditional speakers, such as TCL and Guanjie,” he says. “It is mainly Chinese companies, not the big Taiwanese EMS firms. In white goods, it’s the traditional white goods makers.”
As for in-car electronics, a market segment with higher technical barriers to entry but also much higher profit margins, Mr Liu says Chinese electronics contract manufacturers including Huayang and Botai were taking the lead.
Many of the big Taiwanese contract manufacturing firms are struggling to address these challenges — at a time when the US-China friction is likely to put additional strain on profit margins and is forcing some to rethink the way they organise their operations.
Pegatron, Foxconn’s closest rival, has relocated some production from China to Indonesia. The company is building a plant in Vietnam and eyeing production in India. Executives caution that such a footprint spread out over thousands of kilometres and across borders will significantly change the cost structure of production.
Tung Tzu-hsien, Pegatron chairman and chief executive, says no other country could offer as attractive an investment environment as China was able to in the past, with a massive workforce that gave companies headcounts in the hundreds of thousands, consistent policies that were backed by several generations of officials and a wide range of nearby component makers.
“That will not appear anywhere else again,” he says. “Where will we move next? I don’t know. Or will it no longer be fashionable to keep moving, and automation and robots will radically change the face of manufacturing?”
Wistron, the third-largest assembler of Apple’s iPhone, saw the contribution from its smartphone business drop to 15 per cent of revenues in the fourth quarter of 2018, less than half of what it had been a year earlier. Simon Lin, company chairman, said in March that he expected smartphone revenues to stabilise at this lower level, but at the same time the company is building a smartphone plant in India. Pressed by investors why Wistron would not phase out its smartphone business altogether if it was a drag on profits, Mr Lin said the company would be extremely cautious with any further capital investment.
“They are like a deer in the headlights,” says a Wistron investor.
The same cannot be said of Foxconn. Mr Gou has been continuously reinventing his business empire over the years. Having started out making plastic parts for television sets, he not only diversified into game consoles, PCs, laptops and smartphones, but also expanded upstream into manufacturing higher-margin components. Foxconn also made forays into automobile electronics more than a decade ago.
Mr Gou started to seriously work on automation several years ago. Shocked by a string of suicides among young migrant workers in the company’s vast factory towns in China, he pledged in 2011 to install as many as 1m robots in Foxconn plants within a few years.
Although the company is still far short of that target — analysts estimate the number of robots in Foxconn plants in China is less than 20,000 — Mr Gou’s automation push is part of a much bigger plan. Through Foxconn Industrial Internet, an affiliate that listed in Shanghai last year, the group is attempting to meld robotics, data analytics and the internet of things in a way that would allow revolutionary efficiency gains in its own factories and that it could also sell to others.
Foxconn calls those production lines “lights-off factories” — a term that means that it no longer needs to rely on humans to worry about problems such as tools wearing out or accidents on the line. One of the production lines where this concept is most advanced, in Foxconn’s big plant in Shenzhen, has been included in a World Economic Forum list of “lighthouse” factories highlighting future trends in manufacturing.
But industry experts say that so far Mr Gou’s beacon is little more than an experiment. “Most of FII’s revenue is still traditional, labour-intensive assembly,” says one analyst. A former Foxconn executive wants to use the new technologies to reduce inventory to zero. But he adds that progress was very slow because customers would need to share sensitive data on demand from customers — which they are all reluctant to do.
The initiative also has a flip-side: FII has been listed as a leading company under Made in China 2025, the Chinese government’s plan to turbo-boost an indigenous technology industry. In that context, the Chinese government fast-tracked FII’s Shanghai IPO last year.
“We believe that Terry Gou had to promise the Chinese leaders certain things in exchange, including to help push their domestic tech industry,” says a Taiwanese banker.
Such perceptions are not helpful against the backdrop of the escalating technology and trade fight between Beijing and Washington. Foxconn is already more directly in the line of fire than most because no one else has made a bigger bet on China. About 90 per cent of the group’s over 1m employees are in China. The company is China’s largest exporter, accounting for 4.2 per cent of the country’s total exports last year.
Mr Gou appears acutely aware of the risks. In recent speeches, he oscillated between suggesting that Taiwan’s technology industry mediate between China and the US and urging the country to organise its companies to “go to America and rebuild the supply chain”.
Those were just campaign speeches. Foxconn’s investors are likely to demand that Mr Gou’s successors take a clearer stance.
