How China built 'iPhone City' for Apple's partner

A vast, boxy customs centre acts as a busy island of commerce deep in central China. Government officers race around wooden pallets piled high with boxes — counting, weighing, scanning and approving shipments. Unmarked trucks stretch for more than a mile awaiting the next load headed for Beijing, New York, London and other destinations.

The state-of-the-art facility was built several years ago to serve a single global exporter: Apple, now the world’s most valuable company and one of China’s largest retailers.

The well-choreographed customs routine is part of a hidden bounty of perks, tax breaks and subsidies in China that supports the world’s biggest iPhone factory, according to confidential government records reviewed by The New York Times, as well as more than 100 interviews with factory workers, logistics handlers, truck drivers, tax specialists and current and former Apple executives. The package of sweeteners and incentives, worth billions of dollars, is central to the production of the iPhone, Apple’s best-selling and most profitable product.

It all centres on Zhengzhou, a city of 6 million people in an impoverished region of China. Running at full tilt, the factory here, owned and operated by Apple’s manufacturing partner Foxconn, can produce 5,00,000 iPhones a day. Locals now refer to Zhengzhou as “iPhone City.” The local government has proved instrumental, doling out more than $1.5 billion to Foxconn.

It helps cover continuing energy and transportation costs for the operation. It recruits workers for the assembly line. It pays bonuses to the factory for meeting export targets. All of it in support of iPhone production. “We needed something that could really develop this part of the country,” said Li Ziqiang, a Zhengzhou official. “There’s an old saying in China: ‘If you build the nest, the birds will come.’ And now, they’re coming.”

The US officials have long decried China’s support of its state-owned companies, calling the subsidies and other aid an unfair competitive advantage in a global marketplace. But the Zhengzhou operation shows the extent of China’s effort to entice overseas multinationals to set up production in the country.

Local and provincial officials have courted manufacturers with incentive packages that make it easier and cheaper to do business. Beijing, for decades, has encouraged such efforts at the national level, by developing special economic zones that offer tax breaks to multinationals and exempt them from costly and cumbersome rules.

In this way, China is not unlike other countries, including the US, where states and cities vie for companies. To compete in the era of globalisation, multinationals, which face pressure from shareholders and customers, must seek the best opportunities, increasingly by relying on a highly interconnected supply chain spread across the world. In China, the competition for companies is secretive and rarely exposed to public scrutiny or debate — and it is often focused on manufacturing partners, rather than multinationals themselves.

While Apple came later than many technology companies, it now generates nearly a quarter of its revenues from sales in China and has some of the fattest profit margins in the business. As such, the Zhengzhou operation provides an especially illustrative look at China’s importance to US technology companies — and specifically iPhone production and, more recently, Apple’s consumer sales. A 32-gigabyte iPhone 7 costs an estimated $400 to produce. It retails for roughly $649 in the US, with Apple taking a piece of the difference as profit. The result: Apple manages to earn 90% of the profits in smartphone industry worldwide, even though it accounts for only 12% of sales, according to Strategy Analytics, a research firm.

It is difficult to tally the total value of government benefits for the Zhengzhou operation or to determine the exact effect on the profits of Foxconn or Apple. The subsidies aren’t disclosed by the Chinese government or Foxconn. They aren’t available in public records. And Apple says it was not a party to Foxconn’s negotiations. As China’s largest private employer, Foxconn, a Taiwanese company, has enormous leverage in the negotiations for those incentives. The company’s size and scale is connected to Apple. Foxconn is Apple’s largest supplier. Apple is Foxconn’s largest customer.

The two companies are intertwined in Zhengzhou. When the factory opened, Apple was Foxconn’s only customer here. Even now, the US technology company accounts for almost all of the production at the Zhengzhou plant, where about half of the world’s iPhones are made. Apple is also the main exporter using the customs facility here. A growing backlash against globalisation puts Apple and other big multinationals directly in the sightlines of two increasingly combative giants: the US and China.

President-elect Donald Trump has vowed to bring down the full force of the government on US companies that move jobs overseas, threatening punitive tariffs on the goods they sell back at home. Apple has been a frequent target of Trump.

China, under the leadership of President Xi Jinping, is growing less tolerant and more suspicious of Western influence, particularly US technology companies and the huge influence they have over Chinese consumers. A state-owned publication called Apple one of the “guardian warriors” that have “seamlessly penetrated” China and may pose a threat to national security.

National security review
Regulators shut down Apple’s iTunes Movies and iBooks Store last spring. The Chinese authorities fined the technology giant for failure to fully pay its taxes. And Apple went through a national security review in China for the iPhone 6, delaying its release in the country.

Apple is now engaged in the corporate version of shuttle diplomacy. In December, the company’s chief executive, Timothy Cook, along with other Silicon Valley executives, met with Trump in New York, part of an effort to build bridges with the incoming administration. China and the US are playing a high-stakes game. The iPhone is a collection of intricate parts that are made around the world and assembled in China, spurring employment in many countries; Apple says it supports 2 million jobs in the United States.

As China and the US both brandish a new form of economic nationalism, they risk disrupting the system, without necessarily achieving their goals. And multinationals and their manufacturing partners would face serious financial trade-offs. As the Zhengzhou operation shows, China not only provides a large pool of labour; it also offers incentives that would be difficult to replicate in the United States or anywhere else. The benefits in Zhengzhou flow through the production process for the iPhone, from the factory floor to the retail store.

Foxconn receives a bonus when it meets targets for exports. Those subsidies, according to the government records, totalled $56 million in the first two years of production, when the factory was exclusively dedicated to the iPhone. The Zhengzhou government eliminated corporate taxes and value-added taxes that Foxconn pays for the first five years of production; they are half the usual rate for the next five.

The customs operation is also in a so-called bonded zone, an area that China essentially considers foreign soil, subject to different import and export rules. This setup allows Apple to sell iPhones more easily to Chinese consumers.
International New York Times