Apple iPhone: Sweet Ring Tone for Hon Hai

The Taiwanese electronics giant—which already makes the iPod Nano—will get a huge revenue boost if the iPhone connects with consumers

by Bruce Einhorn

Terry Gou, chairman of Hon Hai Precision Industry, has notched another win. His company is the world's biggest electronics manufacturer with clients including Apple (AAPL), Hewlett Packard (HPQ), and Nokia (NOK). The latest coup for the billionaire Gou (one of the richest men in Asia) is that Hon Hai will assemble Apple's new wireless handset called the iPhone, a product launch that could energize the consumer electronics industry later this year.

Apple Chief Executive Officer Steve Jobs unveiled the long-awaited handheld unit—which combines a wireless phone, a music and video player, and a mobile Internet browsing device—at the annual Macworld show on Jan. 9. Apple will start selling the gadgets mid-year and is aiming to sell 10 million iPhones in 2008. If it's a hit, Hon Hai will enjoy a mini-windfall of new business (see BusinessWeek.com, 1/10/07, "The Future of Apple").

Hon Hai, which also makes the iPod Nano for Apple, isn't the only Taiwanese company to have hitched a ride on Jobs' bandwagon (see BusinessWeek.com, 1/8/07, "Apple's Chinese Supply Lines"). Others, such as video iPod assembler Inventec Appliances, depend on Apple orders for important chunks of their revenue.

Hon Hai's Labor Controversy

Hon Hai, which operates under the trade name of Foxconn, was the No. 2 company on BusinessWeek's IT 100 rankings last year and has a far more diverse set of customers. Still, it gets about 5% of its sales from production of iPods (see BusinessWeek.com, 7/3/06, "The Info Tech 100").

Hon Hai may seem unstoppable now, but only six months ago it was caught up in a controversy that threatened its relationship with Apple. Following reports in the Western and Chinese press about alleged labor abuse at Foxconn factories in China, Apple went into damage-control mode, promptly announcing that it would send a team to China to investigate the allegations. Around the same time, Hon Hai launched a lawsuit against two Chinese reporters who had written critically about the company's labor practices. That prompted a furious response from bloggers in China.

The controversy subsided, however, thanks in part to the results of Apple's investigation, which found some abuses of overtime but otherwise was favorable to Hon Hai. Following the outcry in China surrounding the company's ham-handed effort to stifle criticism from the media, Hon Hai dropped its lawsuit against the two reporters.

There's Safety in the Backseat

Fortunately for Apple and Hon Hai the fallout has been minimal. Certainly there hasn't been any outpouring of opposition to the companies of the type Nike (NKE) faced following reports about conditions at its Asian factories. That's in part because Hon Hai has always taken a backseat in its relationship with customers such as Apple, preferring to stay out of the spotlight.

It's also a testimony to the popularity—and market dominance—of the iPod itself. While other companies such as Microsoft (MSFT) and Creative Technology (CREAF) offer similar products, none has the same iconic stature of iPod. Apple "has sold a phenomenal number" of the gadgets, says Jonathan Arber, research analyst in London with research and consulting firm Ovum. As for the labor controversy, "you have to question how much that filters down to consumers," he adds. "Consumer desire for iPods doesn't seem to have abated."

That's encouraging to investors. Hon Hai's Taiwan-listed stock price is up more than 55% in the past year, far outpacing the 24% rise in the Taiwan index. The stock is now trading close to its 52-week high. The company, which wants to boost revenue by 30% per year for the next five years, is now looking for new places to expand.

New Factories in Vietnam

For instance, Hon Hai is looking at building $1 billion worth of factories in Vietnam. And the company is likely to be the main beneficiary as customers increase the amount they outsource from Taiwanese-based manufacturers. For instance, last month the Economic Daily News, a well-regarded Taiwanese business newspaper, reported that Hewlett Packard's outsourcing to Taiwanese companies might amount to $30 billion by next year, up from $20 billion in 2006.

The addition of the iPhone means that Hon Hai now has another way to benefit from Apple's success, assuming that consumers take to the iPhone. An earlier attempt at merging the iPod with the cell phone, a collaboration between Apple and Motorola (MOT), didn't catch on.

Kevin Wang, an analyst in Shanghai with iSuppli, warns that Foxconn factories in China won't be putting out millions and millions of iPhones right away. "I don't think Foxconn will have great benefit in the short term," says Wang. "But in the future, if people who love the iPod buy the iPhone, then shipments will grow very quickly, and Foxconn will benefit from that."

Einhorn is Asia regional editor in BusinessWeek's Hong Kong bureau.