Here Is Why a U.S. iPhone Factory May Be on the Near-Term Horizon

Apple's (AAPL) production of the iPhone in China could be detrimental to its long-term growth.

President-Elect Donald Trump's rhetoric during the campaign of establishing a 45% tariff on Chinese goods imported into the U.S. could become policy starting in January. Bankers and lawyers are already advising Chinese clients to cease any programs until his stance on cross-border deals for U.S. targets gets clarified.

On Friday, Japanese newspaper The Nikkei reported that Apple has approached two iPhone manufacturers, Foxconn Technology and Pegatron, to investigate moving iPhone production to the U.S.

Let's take a close look to see if it is viable and what the implications for Apple and its supply chain would be.

Although the iPhone is manufactured by the Chinese, the major chips come from non-Chinese suppliers such as Broadcom, Intel, NXP, Qualcomm, Samsung Electronics, Skyworks Solutions, Texas Instruments and TSMC. 

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Many of these companies are building or have built semiconductor fabrication plants in China to reduce manufacturing cost through perceived cheap labor and their proximity to end-product contract manufacturers,. This could, in fact, be a detriment to these companies.

For example, Intel's Dalian fabrication plant has been outfitted to produce 3D NAND chips. Much of the output will go into smartphones.

Obviously, they won't go into a Samsung Electronics smartphone because that company makes its own 3D NAND chips, but they could go into other manufacturers' phones as well as the iPhone.

At issue is whether Intel's 3D NAND chips, made in China and imported into the U.S. for use in iPhones could be subject to the 45% tariff. Clearly the policymakers have much to consider.

One alternative to get around a possible 45% tariff for iPhone manufacturers is that production in China could halt and Apple could move assembly to other low-cost places such as India, Mexico or Southeast Asia.

But keep in mind that the Trump administration isn't anti-China but against products made by U.S. manufacturers in China. The 45% tariff could readily be placed on these other countries.

Clearly, the U.S. is the most viable manufacturing solution because it brings jobs and revenue (taxes) back to the U.S.

President Barack Obama made a mistake eight years ago when he tried to bring solar jobs back to the U.S. because he overlooked the fact that as Chinese manufacturers drove U.S. manufacturers out of business through low-priced solar panels, they came back and bought the empty solar plants. Although U.S. citizens now had jobs, money went back to China.

Manufacturing cost would be the most obvious and important factor to Apple. Clearly, the reason that most electronic gadgets are manufactured in China is because of low labor costs, but that is no longer true.

A study by The Boston Consulting Group shows that when the most important economic factors are considered, such as currency exchange rates, energy expenses, productivity growth and total labor costs, China is virtually even with the U.S.

China and other low-manufacturing-cost countries have experienced significant increases in relative manufacturing costs since 2004 because of a combination of dramatic increases in energy costs, lagging productivity growth, sharp wage increases and unfavorable currency swings, according to the study.

In a different study, China's labor costs are shown to be just 4% cheaper than those in the U.S. when productivity is factored in, according to Oxford Economics.

And while productivity doubled in China between 2003 and 2016, the U.S. remains as much as 90% more productive.

Market research firm IHS Markit's teardown of the iPhone 7 shows a bill of materials of $219.80 and an additional $5 in labor costs to total manufacturing cost of $224.80 for the phone. The phone retails for $649.

A different study pegs the labor cost at $12.50.

A study released released on Aug. 24 by China Labor Watch, showed that labor conditions at Pegatron, one of Apple's major iPhone factories based outside Shanghai, had worsened over the past year as wages were cut to $1.60 from $1.85 per hour. Meanwhile, the factory implemented excessive overtime hours that spanned up to 90 additional hours per month.

Pegatron is a leading assembler of iPhones, and this study is a black eye for Apple that could be rectified with production in the U.S.

Let's look at some of the factors that would affect iPhone cost if production were to move to the U.S. 

"If Apple could find enough workers in one place to assemble massive amounts of iPhones in the U.S. the cost per iPhone would likely increase by about $30 or $40 [a new iPhone starts at $649 in the U.S.], and only a small part of that would be due to labor," Jason Dedrick, a professor at the School of Information Studies at Syracuse University, told The Wall Street Journal.

A complicating factor is the logistics of getting components from Apple's supply chain, which are located in 28 different countries. These include, the battery, camera, display and integrated circuits, as well as the multitude of housings, screws, etc.

If components were made in the U.S., there would be an additional cost of $90, according to Dedrick.

Adding in the extra $40 in assembly and $90 in components comes to $130, which is less than half the $292 markup from a 45% tariff on a $649 phone

Some components such as the antenna, glass and various semiconductors are already made in the U.S., so that cost could fall on these items because shipping costs could be lowered.

Foxconn Technology, one of Apples two main assemblers, has already demonstrated a solution that could be applicable in the U.S.: robots. Since September 2014, Foxconn Technology has reportedly replaced 60,000 factory workers with robots.

Of course, that would severely impact job creation in the U.S. But considering that the move to the U.S. would create infrastructure jobs in construction, service and transportation, making the move would still be a good alternative.

There are zero jobs in the U.S. related to making the iPhone.

Last year, the strongest growth in the number of operational units recorded was registered in the electronics industry, which boasted a rise of 18%, according to the latest forecast from the International Federation of Robotics.

The strongest growth drivers for the robotics industry are found in China, and in 2019, some 40% of the worldwide market volume of industrial robots are expected to be sold there alone. 

A boom in robot sales for iPhone assembly will be profitable for U.S. robot manufacturers.

Apple is merely exploring the possibility of the move. But the company has been treading on thin ice for a while amid the anemic economic growth of the Obama administration.

That could change dramatically under a Trump administration.

"Apple sought the Holy Grail of tax avoidance," said Sen. Carl Levin (D-Mich.), chairman of the Senate Subcommittee on Investigations after a Senate inquiry. "It has created offshore entities holding tens of billions of dollars while claiming to be tax resident nowhere."

The company is locked in a battle with the European Union over back taxes to the tune of $14.5 billion.

Trump's plan to lower the corporate tax rate to 15% may meet Apple Chief Executive Tim Cook's hope for U.S. tax reform, perhaps even leading to a reversal of the company's tax inversion. And it may get Trump off Cook's back, as the president-elect criticized Apple multiple times during his campaign over the company declining to unlock San Bernardino shooter Syed Farook's iPhone when asked to do so by the government.

A "Made in America" moniker on an iPhone would be positive for the company in light of a potential 45% tariff on imports from China, specifically because costs would be less than the tariff.

More importantly, the 45% tariff would apply to nearly all smartphones from competitors made in China.

Apple, without the tariff, would benefit from a lower cost structure compared with Samsung Electronics, and the fast-rising Chinese smartphone companies could be penalized if they tried entering the U.S. market. Apple would gain market share and revenue from the move.

The increased price would hurt sales, but since the bill of materials for the iPhone is $225 and we add another $130 for Made in America costs, that still leaves a substantial profit on a $649 phone.

But let's not forget the cost and logistics of shipping millions of iPhones from China around the world. Chinese companies benefit from transportation, and myriad companies benefit from ancillary products as simple as the printers of the instructions to the makers of the box.

The transfer of revenue to U.S. companies would benefit Americans, and this is what Trump talked about during his campaign.

His rhetoric was just that, rhetoric. Details will need to be ironed out by the Trump administration and by Congress. 

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.

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