There was an interesting think piece on the Nikkei news service this past holiday weekend comparing and contrasting Apple’s path to success with Japan’s LCD giant, Sharp Electronics. The key distinction between the two companies according to Nikkei columnist Koichi Nishioka is a horizontal vs. vertical integrated production method. Sharp with its multi-billion dollar capital investment in LCD fab production creates an actual production city that turns sand into LCD-TVs. Apple, shuns and shudders at the very thought of manufacturing, contributing only the creative thought design and ultimate blueprint for products made a world away. But the analysis goes deeper to reveal some interesting truths about the basic assumptions we make on the evils of outsourcing, trade balance and value creation.

Steve Sechrist
Senior Analyst and Editor
Projection Monthly

To this point, Nishioka turned to a recent UC Irvine study looking at the entire value chain in a 30Gb Gen5 iPod that challenges the notion of a growing trade deflect due to outsourcing. The report, "Who Captures Value in a Global Innovation System?" demonstrates that of the $299 retail price, it’s the innovator, creator and marketer (Apple) along with the US-based distributors and retailers that gain the lion’s share of the profits ($155) that are kept within the nation’s borders.

While it is no revelation to find outsourced goods return more value back to US firms than paid in foreign production costs (no profit, no product), the level of profit and extent these costs are spread over a wide area, and not just concentrated on the point of origin (China) is revealing.

In fact the study, authored by Greg Linden and others at UCI’s Personal Computing Industry Center (PCIC), shows some startling facts. Even though the device is exported from China at $144, when value added elsewhere is subtracted, China’s "surplus" on this product is reduced to just $4. The study attributes this, in part to "supply chain disaggregation" and suggests that export figures in general and trade surplus numbers in particular do not tell the entire story. As the authors put it, "trade statistics can mislead as much as inform. For every $300 iPod sold in the US, the politically volatile US trade deficit with China increases by about $150 (the factory cost). Yet, the value added to the product through assembly in China is probably a few dollars at most." They also conclude this is "fairly representative" for the industry.

On the profit side, Apple claims a whopping $80 gross margin from the $244 wholesale price and another $75 more is collected by retailers and distributors when the product is sold by Apple in one if its retail channels (presumably Apple collects this part too if sold thru an Apple store). By contrast, of the $144 cost of the product, $33 in gross margin is generated from the top seven inputs. In the words of the authors: "The dominance of Apple’s gross margin suggests that in this particular iPod model, the US captures most of the value.

Apple long ago asked itself the question "what is the company’s core competency?" Asked another way, "where does the company add value?" It correctly surmised that unlike Sharp, it is not in manufacturing or assembly, so it remade itself into entertainment and distribution company in the process.

Although the paths to success are very different between the two companies, both have enjoyed an unusual degree of success in highly competitive fields. Perhaps the common thread between the two is applied creative thought, the "stuff" that creates value add. One is directed at manufacturing expertise and the other at product development, marketing and distribution. - Food for thought anyway.

Reply to the author