Robotics Series – 6 – Terminators of the world factory?

Photo Fangru YANG / Executive Editor of Modern Weekly Business Page, Taiwan high-tech industry observer / October 23rd, 2014

You may not know Hon Hai, but it is to produce 70% of all iPhones 6. It also operates the largest factories on Earth. Terry Gou, founder and chairman, based his success on cheap labor costs as well as audacious merging strategies. Will the rise of automated factories mean the end of this success story, and more broadly the end of China as the world factory? As a matter of fact, Mr. Gou is fond of robots, and he won't be the last to launch an automated factory. But he may need Chinese arms for a while. Here is why.

This article is the sixth of a series which will be completed within one month.

The second week of June saw Terry Gou, the founder of the OEM empire Hon Hai Group (also known as Foxconn), confirm the order number of iPhone6 with Apple CEO Tim Cook. There is no doubt that the order is the most important one for Hon Hai in 2014.

Tong Zixian, the president of the Pegatron Group, which is not far from Hon Hai’s headquarters in Taipei, also received a confirmation from Apple: 30% of iPhone 6 orders will be commissioned to his company, making it the largest proportion of smart phone orders from Apple that the company has ever received.

According to people familiar with the matter, 68 million sets of iPhone 6 have been ordered for Phase I, which is twice the number of iPhone 5 orders during the same phase. The big order also exemplifies the optimism of Tim Cook, who believes a wave of “device upgrade” is soon to arrive. Hon Hai is estimated to have earned 30 billion dollars in revenue after it took up 70% of the iPhone 6 orders. This brings the company fairly close to the 38.7 billion dollars that Lenovo made in 2013, which composes good evidence that iPhone 6 will be a big hit after its debut in September.

To cope with an order worth 30 billion dollars, Hon Hai wasted no time to kick off its recruitment plan which aims to hire 100,000 people from mainland China in the second half of June. These new workers are expected to work for factories located in Zhengzhou, Henan province and other regions. Millions of Chinese laborers and component suppliers are dedicated to bringing this new phone that has attracted so much attention to the market.

Apple conducted R&D of Macintosh G5 in Japan, yet the manufacturing was taken over by Hon Hai, which soon found it had no access to the core technologies of the model. Terry Gou recounted that the company only had very limited time to produce in bulk after receiving the order. The original prototype had a beautiful design, with the part to grasp formed as a sharp right angle that needed the test of a hand hold for safety. Terry Gou stepped up and offered his hand for the experiment. His hand was hurt as expected, and prompted the employees, who were shocked by Gou’s terrible bleeding, to redesign the machine for better safety.

Having his hands on every aspect is the creed that makes this 64-year-old high-tech tycoon the leader of 1.5 million workers across the world. He successfully built the largest factory in human history with the help of this philosophy. Last year Hon Hai registered revenue worth 819.3 billion RMB and ranked 32nd among the Fortune Top 500 enterprises in 2014, making it the top of all corporations from Mainland China, Hong Kong and Taiwan.

Not long ago, Terry Gou and Masayoshi Son, the founder of Softbank from Japan, unveiled Pepper the robot in Tokyo. Masayoshi Son defined it as the first ever humanoid robot in human history. Sold at the price of 198,000 yen, Pepper is able to read emotions from its human users through sensors, voice detection and cloud computing technologies. For instance, Pepper will have a different mood when its owner seems happy. This characteristic makes Pepper highly marketable in Japan, a country plagued by the serious issue of an aging population.

Hon Hai will surely manufacture Pepper upon the arrival of orders. The company was also the producer of the animatronic pet dinosaur toy Pleo only 5-6 years ago. All evidence shows that Hon Hai is leading the business of contract manufacturing. Hon Hai has a very good chance to produce Transformers if they are ready for sale.

No wonder if Hon Hai is to produce Pepper and its Transformers friends. Terry Gou, who once said, “Human needs to breathe. Machines don’t,” has been thinking of robots for some time now.

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Terry Gou’s robot dream
The buzz around iPhone 6 might have overshadowed Gou’s robot dream. In 2010, he started talking about launching an automated factory, envisioning the full replacement of human labor by automation. In 2011, he publicly claimed that Hon Hai would be developing 1 million robots for assembling phones in its factories.

Other news told a different story. From 2010 Q3 to 2011 Q4, Hon Hai recruited an additional 300,000 workers in China. In the following years, the company kept expanding its employment size. Mega factories in Indonesia and Brazil are also in the pipeline.

These two opposite trends raise a question. If Gou’s robot dream is to become reality, then what’s the reason for the company following with such a grandiose recruitment plan? Or to make things frank, if all factories are eligible to be automated, why does Apple entrust Hon Hai for manufacturing instead of building its own factory?

As a matter of fact, in recent years Tim Cook moved back several assembly lines that produce Apple laptops back to Fremont, California, echoing with the trickle-back vision set forth by president Obama. For this gigantic factory with top-notch technology, Apple has to hire American workers to support employment goals raised by the president. But robots, actually, will do most of the work.

Still, robots can’t do everything and labor costs still make a difference. Especially when you make smartphones. 90% of the assembly of a smart phone can only be done by human labor. It is impossible for a robot to put together 500-600 parts in a tiny space only 9-10 cm in length.

Furthermore, over 500 operators are required for the assembly of an iPhone 6 from the very beginning to the end – ten times the labor needed for making a laptop or a Macbook.

Automobile factories deploy large robotic arms for the assembly of large auto parts, such as car doors. Even factories churning out instant noodles, biscuits or ceramic bricks are equipped with robotic arms. Amazon utilizes one thousand sets of Kiva robots working busily in their warehouses. But still, it is hard for robots to take over the entire assembly line of phones, tablets and laptops.

Robotic arms are now used in dealing with a variety of parts of a smartphone to replace human arms on a large scale. This works especially great when it comes to parts that are sized by micrometer or nanometer like a camera lens. With a high operation precision, robotic arms can be trusted, for example, when dealing with certain types of single key parts, such as CPU slot or case polishing. Still, only a small number of robot-assembled small and complicated products like smartphones can reach a fine standard.

As of now, Hon Hai has invested NT$300 million for its unmanned factory at its headquarters in Tucheng District. The automated assembly line operated by robotic arms can plant 3000 wires on a circuit board as large as 2-3 square centimeters with perfect precision. 7000 CPU slots can be produced by mechanic arms every single day. A CPU, either from Intel or AMD, needs to be accompanied by a CPU slot at its side so the motherboard can receive electric signals. If we say a CPU is the heart of a computer, a CPU slot can be understood as the valve of the heart. Hon Hai enjoys a market share as high as 75% of the CPU slot, which gives it a dominant say on the steady supply of such product.

This unmanned factory is a pilot project run by Foxnum Technology Co., Ltd, a subsidiary of Hon Hai. After scooping up the most outstanding talents from Industrial Technology Research Institute of Taiwan, the company was able to form the best team in this industry.

Gou’s visit to a Japanese watch factory inspired him to a great deal. The factory was highly automated, while still able to produce timepieces with extraordinary delicacy. He then proposed to cut the size of the factory by half so as to be more convenient for relocation. He even found lighting was not a necessity. The dark factory physically helped with the idea of energy-saving and emission-cutting.

But the Japanese story is not the Chinese one. Labor costs surged in Japan during the past three decades, a trend that led Japanese to focus on automation. Chinese labor costs are still very low. And before an iPhone 6 is put in a box for sale, there must be an operator working day and night to assemble as many as 500-600 parts in all. For Hon Hai, whose major business is to deal with Apple products with a complex assembly process, Chinese workers’ bare arms are indispensable.

This is the very reason why Tong Zixian from the Pegatron Group never championed the use of robots. Barry Lam, the founder and chairman of Quanta Computer that produced Apple laptop, is also conservative on robots. Robots are simply not capable of handling all manufacturing processes of iPhone, iPad, iPod or Macbook Air as required by Hon Hai, Pegatron or Quanta.

Vertical merging
There is a close and dependent relationship between parts-producing and product-assembling. All along, Hon Hai ran against the trend by merging vertically from assembling, the top of the chain to the component production, the one lies at the bottom. Presumably, the company stood out from all competitors who developed from the bottom-up.

One of the secrets for Hon Hai to survive and thrive in the competition in recent years was a mode called Component Module Move (CMM) created by Terry Gou himself.

Hon Hai successfully implemented its plan for vertical merging under the CMM mode. Clients can enjoy the convenience of one-stop shopping and a wider coverage of services provided by Hon Hai. The company is versatile enough to offer any component or module, be it mechanics or electrical, upon the request of the client. It also caters to their needs for product assembly, system assembly or test.

The comprehensiveness of its services brought up multiple profit-winning opportunities for Hon Hai, as it is capable of working on components, module design and system assembly. It helps to boost overall sales of the company while benefiting the clients with a competitively low price.

A handful of well-known PC companies in the US decided to outsource the production of their barebones operations around the year 2000. Yet it is almost impossible to find an enterprise that commands the ability to manufacture and assemble everything from molds, computer cases or even hard drives. Hon Hai seized this opportunity for a new business model and ushered onto the stage of the barebones foundry industry.

The Vice President of Taiwan University Ming-Je Tang defined Hon Hai’s operation mode as an innovation. In the process of its continued vertical merging, Hon Hai is both the producer and the assembler of components. Take smartphones for instance. The tech company takes away 61% of the overall cost of the components for their production before they proceed to the assembly work.

World factory
Every year from 1980 until now, endless labor sources kept emerging in cities like Shenzhen. They could be hired at a low cost with high productivity and almost no complaints. It is these insignificant individuals that formed the base of the largest OEM in the world.

Taiwanese high-tech companies take pride in the “982 Theory”, meaning it only takes 2 days for them to finish 98% of the order they received. The Theory is only attainable in mainland China where a consistent production environment can be guaranteed. Relocating their production bases to countries like Vietnam, the Philippines, Thailand and Malaysia has an extremely low success rate after a few such attempts by the Taiwanese enterprises.

The steadiness granted by the environment enables OEMs to finish orders with high precision and great quantity. Hon Hai, with a million of its workers materializing big orders worth 1-2 billion RMB, is the perfect model.

Expansion in the mainland is always the key for Hon Hai’s target of globalization. Terry Gou started planning for a production base in mainland China in 1988. After 10 years when a variety of OEMs were springing up, Hon Hai had already earned its dominance in the industry.

Aside from Master Kong and Want Want, Hon Hai is the only tech company with a strong presence in mainland China that originates from Taiwan. Its factory in Longhua district in Shenzhen was developed from nothing in 1996 to an industrial complex with 420,000 workers.

The Shenzhen Special Economic Zone grew from scratch to one of the most economically developed regions in China thirty years after Reform and Opening-up. Provinces in the hinterland eyed to replicate the miracle and sent invitations to Terry Gou with VIP treatment. Scandals like suicidal jumps didn’t make his corporation suffer one bit.

When a lack of cheap labor spread across the coastal regions, Hon Hai was right in the middle of expansion. This prompted Gou to march into where most migrant workers come from: Henan province, with a population of over 100 million. In Zhengzhou, Hon Hai benefited remarkably from cheap labor, and more importantly, preferential land and tax policies provided by the local government.

Henan is the only inland province that hadn’t yet host to any large scale electronics manufacturing base, whereas it is the major source for migrant workers in manufacturing at Zhujiang Delta. Terry Gou believes that competition at Mainland China is much more fierce than that in Taiwan. His investment decisions are made on the basis of local governance of the region, which explains why all his businesses are profitable.

Apart from Henan, Terry Gou is also preparing for a new factory in Guizhou that will employ 50,000 people as an alternative. The change of landscape and capacity will reshape development patterns among provinces in China.

As the high-tech industry makes outsourcing its primary choice for manufacturing, Hon Hai is undoubtedly the biggest winner. Quality, price and pace are three priorities for the company – simple and straightforward. However, it is easier said than done for a company to produce cheaper products with great quality at a faster pace.

Hon Hai is indeed the giant of the manufacturing industry. But its long history and deeply rooted operation mode are also the biggest challenges for Hon Hai to transform. It is impossible for Terry Gou to tell Apple that Hon Hai will quit the foundry industry. This will leave all clients, shareholders, suppliers, employees and other stakeholders in the lurch. Thus Hon Hai needs and will need Chinese workers to take orders and make money. It is fair to say that robots and unmanned factories are not entirely fanciful. But China is safe to consolidate its “World Factory” position as no other country or region is able to catch up.

Note from the editors. The original version of this article was originally published in our Chinese edition, developed with Shanghai Jiao Tong University, SJTU ParisTech Review. This version has been edited for ParisTech Review.

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