Apple Can Use Its Huge Cash Balance To Fund Supply Chain Improvements

AAPL: Apple logo

Apple’s (NASDAQ:AAPL) famed supply chain has been one of the biggest drivers of profits at the Cupertino-based company. It therefore should come as no surprise that Apple has decided to split the costs of improving factory conditions at Foxconn with the latter. [1] In fact, we believe it to be a very effective way of putting the company’s huge stockpile of cash to good use. This will not only help Apple maintain a good relationship with its supplier but also strengthen its supply chain and enable it to negotiate favorable deals in the future. With margin contraction still a concern as competition from Samsung, HTC, Nokia (NYSE:NOK) intensifies and smartphones penetrate emerging markets, Apple should keep investing in its supply chain in order to support its future margins.

The decision comes on the back of an audit of Foxconn’s Chinese plants by the Fair Labor Association (FLA), which made several suggestions about improving the working conditions and hiking the wages of its employees. Foxconn has since pledged to put the recommendations to action and now has Apple’s support for the same.

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Supply chain investment

Apple’s decision to split the bill goes to prove its commitment towards its suppliers and comes at a time when Foxconn’s margins are under pressure from higher employee costs spurred by the audits. Foxconn parent company Hon Hai Precision Industry posted lower profits than usual in the first quarter of 2012 as the manufacturer’s gross margins slid from 7.25 percent in 2011 to 4 percent in 2012.

We believe Apple’s gesture can pay rich dividends later as it enables the company to negotiate favorable deals in the future. We also think that this might be part of a bigger strategy to strengthen its supply chain ecosystem. Foxconn recently signed a deal with Sharp that will give it 11% stake in the latter as well as 46.5% ownership in Sharp’s LCD plant in Sakai, Japan. We believe Apple has had a role in this deal as it helps it reduce its dependence on Samsung and ensures sufficient competition in its supply chain. (see Is Apple The Invisible Force Behind The Sharp-Foxconn Deal?)

Supports gross margins

Apple has a huge cash balance of almost $110 billion that it can choose to invest in its supply chain in order to bolster its margins. We see competition intensifying as Apple enters emerging markets with smartphones at the risk of getting commoditized. This can have a negative impact on Apple’s gross margins in the long-term. But Apple will be looking to leverage its growing economies of scale to negotiate better deals with the suppliers and support its margins. Such gestures on Apple’s part surely don’t hurt its chances at the negotiation table.

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  1. Apple, supplier Foxconn to share costs on improving factories, Reuters, May 10th []