Up the Value Chain: iPhone Manufacturer Foxconn Is Banking On Finance For Future Growth

Contract manufacturing is a brutal business: low margins, intense competition, uncertain loyalty from customers. Becoming the best at this set of tasks helped fuel the Chinese economy's growth. But now that they have learned the elements of success - including where the greatest profits lie - Foxconn and other Chinese companies are intent on moving up the value chain from the 'brawn to the brain economy.'

This strategy is aligned with China's broader goals as a global competitor. Foxconn and others are using their knowledge of manufacturing and of the country's supplier network to become lenders and investors in order to secure a future free of dependence on western companies. Competing enterprises - from electronics to finance - have every reason to be concerned as the knowledge Chinese companies gleaned is turned to others' advantage. JL

Eva Dou and Gillian Wong report in the Wall Street Journal:

Foxconn Technology Group doesn’t want just to make iPhones. It also wants to be the banker for the world’s electronics supply chain. Contract manufacturing is a brutally low-margin business, with assembly fees making up less than 1% of the sticker price of an iPhone. Apple’s largest contract manufacturer joins Baidu, Alibaba, Tencent as it quietly ventures into lending
Foxconn Technology Group doesn’t want just to make iPhones. It also wants to be the banker for the world’s electronics supply chain.
Apple Inc. AAPL 0.44 % ’s largest contract electronics manufacturer has quietly set up half a dozen financial-services companies in China over the past year that have begun providing loans and other financing to electronics component suppliers.
Foxconn, formally known as Hon Hai Precision Industry Co. 2317 -0.58 % , aims to begin repackaging the loans into financial products within a couple of years and sell them directly to investors, said Jack Lee, managing director of the business unit, Foxconn Financial Service Platform, which has offices in Beijing and Shanghai.
“This is where we have a niche advantage,” Mr. Lee said in an interview with The Wall Street Journal. “We know the suppliers’ business statuses better than anyone because we are their customer.”
The move to help with financing is part of the Taiwanese company’s efforts to become more than just a contract manufacturer of gadgets for Apple.
Electronics contract manufacturing is a brutally low-margin business, with assembly fees making up less than 1% of the sticker price of an iPhone, which costs more than $800 in China, according to analysts. Foxconn derives about half its revenue from Apple, but the company is trying to expand into more higher-margin businesses including component manufacturing, e-commerce, robotics and financial services.
Foxconn joins an array of technology companies that think they can do better than China’s state-owned financial institutions in serving local businesses and consumers.
Chinese Internet giants have raced to offer users online financial services such as money-market funds, consumer credit and small loans in an effort to attract more users. The Internet companies say the data they collect from hundreds of millions of mobile devices—including location, the use of local services, and e-commerce transactions—can help measure the creditworthiness of borrowers.
E-commerce giant Alibaba Group Holding Ltd. BABA 2.67 % , through its financial affiliate, and social-networking and games company Tencent Holdings Ltd. TCEHY 2.27 % have ventured into financial services and online banking already. But their online-only banks have been somewhat stymied by regulations that forbid users from opening bank accounts remotely. This means the banks are limited in their ability to collect deposits and conduct other banking services.
Internet search company Baidu Inc. BIDU -0.53 % intends to forge an alliance with China Citic Bank Corp. to create a direct bank that would offer loans and investment products online, according to a person familiar with the talks. The companies have yet to submit an application to China’s banking regulator for a license that would be required to establish such a bank, the person said.
For Foxconn, which is based in Taiwan and runs most of its manufacturing operations in China, targeting the electronics-supplier niche rather than the broader consumer market chased by Internet companies makes more sense. That is because as the world’s largest electronics contract manufacturer and China’s top exporter, it is linked to most parts of the global gadget supply chain.

Mr. Lee said Foxconn’s financial-services unit has done more than one billion yuan ($157 million) in transactions since it began around a year ago, and has about half a billion yuan in outstanding financing. The company has provided financing to more than 100 component suppliers so far, he said.
The unit’s loans are funded entirely by Foxconn right now, but Mr. Lee said he hopes to bring other strategic investors on board in the next few years, with an initial public offering of stock within five years. Foxconn has obtained business licenses from Chinese local governments to provide loans, factoring, financial guarantees and equipment leasing. Factoring is a method of financing in which a business sells its accounts receivable—or money owed it by its clients—to a third party called a “factor,” for cash up front.
“We are starting out with financing our own suppliers, but our goal is to expand to other parts of the supply chain,” Mr. Lee said.
While the unit is currently funded by Foxconn’s direct investment and refinancing by the company’s bankers, Mr. Lee said he hopes that within a couple of years the unit will be able to sell financial products directly to consumers.
Foxconn is also setting up a 300 million yuan private-equity fund to invest in Chinese startups, Mr. Lee said.
Tzyy Loon Ng, an S&P Capital IQ analyst, said Foxconn is expanding in areas such as supply-chain financing to reduce its risk of being overly reliant on Apple.
“They need to prepare for the day if sales from Apple slow,” he said. “It is better for them to prepare early.”