China Bites the Apple

Today we are in constant communication.

communication     constant communication

Feeding our communication needs is the perpetually innovating company, Apple (AAPL). You may have heard of it. In fact, I'd be willing to bet a fairly decent sum that you are reading this very sentence on an Apple product right now.


"We are living in the world of the cool factor. Why else would one stand in line (or sit in a tent) overnight, waiting to purchase their sixth version of an Apple iPhone with roots over a century ago by Alexander Graham Bell? Because the emotional response of owning the coolest new gadget overwhelms the rational thought of staying in bed." 

- The Sustainable Investor

And stand in line they did. This week, Apple released an astonishing sales figure: the company sold 74.5 million iPhones during its fiscal first quarter (Oct. 27 - Dec. 27), exceeding analysts' expectations by over 12 million.

Apple's total quarterly revenue was 74.6 billion, coupled with a record net profit of $18 billion ($3.06 per diluted share for my AAPL investors). A significant improvement from just one year ago, when AAPL reported quarterly revenue of $57.6 billion and net profits of $13.1 billion.While this news has been widely reported, the media has failed to mention the following: Apple's market share and success has risen in tandem with its commitment to corporate social responsibility. Particularly, labor practices.An Image-Conscious China:The Chinese consumer is renowned for constantly aspiring to own the trendiest new gadget. Apple's first quarter revenues in Greater China (Hong Kong, Mainland China, Taiwan) were calculated at $16.1 billion, a 70% increase from just one year prior. Moreover, China iPhone sales increased by 83%. This is no small feat. At 1.3 billion cell phones, China is the largest market in the world. Just one year ago, the iPhone was 6th on China's desirable smartphone list, trailing Huawei, Lenovo, Samsung, Xiaomi and Yulong.Apple has seriously heightened its focus on China over the last two years, partnering with behemoth mobile carrier China Mobile, introducing products with desirable attributes, such as larger screens, and continuously building new stores in the region. While these factors have undeniably contributed to Apple's bottom line, I can't help but wonder...Might the Chinese consumer be rewarding Apple with increased brand loyalty in response to the company's heightened efforts in corporate social responsibility?

"When we work on making our devices accessible by the blind, I don't consider the bloody ROI. [We do] a lot of things for reasons besides profit motive. We want to leave the world better than we found it. If you want me to do things only for ROI reasons, you should get out of the stock." - Tim Cook, CEO Apple

Albeit Apple is well on its way to building the greenest building in the world and its energy sources are about 95% renewable, the company has not always been the epitome of corporate social responsibility. In fact, Apple has drastically turned the tables over the past few years. Prior criticisms have included the company's harsh treatment of factory workers, excessive use of dirty energy to power data centers, failure to recycle, and the hazardous mining of precious resources.

Importantly, fingers have been steadfastly pointed at Apple's labor practices in China.

Over 90% of Apple's products are assembled in China. To be fair, most multinational corporations are leveraging similar contract manufacturers, but often with greater success comes heightened scrutiny. The luster of Apple products was tarnished in 2010 when 18 workers at Foxconn, Apple's largest subcontractor, committed suicide and again in 2012 when disgruntled employees leaked videos of harsh working conditions.

The New York Times wrote an in-depth series about working conditions at Apple’s partner sites and instigated a petition signed by thousands of consumers begging Apple to ameliorate the situation in China. In February 2012, the Fair Labor Association conducted an initial audit of Apple's China operations, in which it found, "excessive overtime and problems with overtime compensation; several health and safety risks; and crucial communication gaps that have led to a widespread sense of unsafe working conditions among workers."

Apple, recognizing the severity of the potential consequences, did not take these accusations lightly. At the beginning of 2014, gone was the "work until quotas are obtained" mantra. Labor requirements were reduced to 53 hours per week, seating areas were provided for workers who had previously been forced to stand for ten hours straight, and additional restrooms and lunch breaks incorporated.

We can applaud the leadership of both Steve Jobs and Tim Cook for drastically improving conditions. Apple has been extremely transparent and detailed regarding its efforts. (View here!) As proclaimed on the company's website: "We're working to eradicate unethical hiring and exploitation of workers - even when local laws permit such practices. We're continuing our efforts to end excessive work hours. And we're driving responsible sourcing of tin, tantalum, tungsten, and gold."

Opportunity On the Horizon

And Apple knows it, too. The company plans to establish 40 retail stores in China by the middle of 2016, sell old iPhone models at less expensive prices, and increase marketing promotion to the chinese consumer. Given that the chinese market is four times that of the U.S., there is massive potential for Apple in China.

It seems as though competitor Samsung has been in the hot seat regarding working conditions and has been losing market share. In July 2014, Samsung was criticized by the China Labor Watch for abuse of child labor laws - five children under 16 were found working for one of its suppliers, resurfacing the memory of a similar situation in 2012 when seven underage children were working for that same supplier. Not coincidentally, in 3Q 2014, Samsung lost its #1 China market share to Xiaomi.

On the flip side, Apple, who has been improving its corporate social responsibility image is gaining market share. Is this a direct 1:1 relationship? Of course not. But it seems reasonable to conclude that if a company's main consumption is from the country in which lousy working conditions are prevalent, quality of labor conditions might weigh into brand perception. As cell phone features among suppliers become less differentiated, image marketing becomes vital. Admittedly, Apple has a strong product and the desire for an iPhone likely outweighs the memories of poor working conditions among chinese consumers.

But what about companies with less impressive products? The implications of poor working conditions could be catastrophic to bottom line.