27 May 2010 | Richard Brass

Tyrannical, secretive - and a huge success. Richard Brass investigates how Apple devised the ultimate supply chain

In each of the past two years, AMR Research has named Apple’s supply chain the best in the world. Its operation, the supply chain consultancy says, marks “an epic shift away from the 20th-century production-efficiency mentality to a new era of value based on ideas, design and content.”

And the financial results are remarkable. Quarterly revenues of $13.5 billion (£9.1 billion). Net quarterly profit of $3.1 billion (£2 billion), with earnings per share twice what they were at the same time last year. Sales of a key product more than double those of a year before, with a gross margin of over 40 per cent. A war chest of $40 billion (£27 billion) in cash and securities.

That’s without taking into account Apple’s latest blockbuster, the iPad, which launches in the UK this week. Even in these cash-strapped times, consumers in the US, where it went on sale last month, camped outside stores overnight to get their hands on it at $499 (£336) apiece. It shifted half a million units in the first fortnight.

Appeal to the market

From its early days as a pesky maverick annoying the big players in its industry, through turmoil, near-collapse, key departures and returns, Apple has emerged as one of the most successful money-making machines of all time. Even in a dire economic climate its ground-breaking products are lapped up by ever-enthusiastic consumers in numbers that drive other companies into frenzies of self-examination in the search for ways to emulate such formidable success.

In the first three months of this year alone, Apple shifted more than eight million iPhones, a product that, although released three years ago, still has no real competitors. It also sold almost three million Macs and nearly eight million iPods, a device that has been largely superseded by more recent Apple innovations but is still in high demand. It’s a safe bet the iPad, too, will fly off shelves in other countries as soon as it arrives, whatever disasters may befall international markets and the global economy in the meantime.

So what’s the secret? In a ferociously competitive industry famous for copycat tactics, and an economic environment which is delicate at best, how is Apple producing such impressive growth, selling ever-growing volumes of premium-priced products, keeping healthy margins and building a cash pile that would be the envy of any business?

The usual answer is to do with design and marketing. The smooth lines of Apple products, their clean, elegant functionality and simple, shiny must-haveness are a big part of their success.

Similarly, its marketing operation could teach any business a few things about massaging demand. Apple builds excitement about a product by closely guarding information and letting just a few appetising tidbits slip into the public domain. Then it presents a highly choreographed launch that brings salivating technology journalists from all over the world, desperate for a glimpse of the latest masterpiece.

None of that would work without a strong supply chain operation behind it. And in this less glamorous area, Apple is regarded by some as just as leading-edge as it is in the front-end disciplines of making nice things and getting people to want them. The company is famously secretive – and that includes speaking to SM about its supply chain operations. So here we talk to analysts and former employees to find out how Apple does it, and how it has overcome obstacles.

Supply chain excellence

Apple, according to AMR, demonstrates “an intoxicating mix of brilliant industrial design, transcendent software interfaces and consumable goods that are purely digital. The mechanical and financial benefits of this approach include extremely high inventory turns, minimal material or capacity limitations to growth, and excellent margins.”

Intoxicating and transcendent – not words you see in most research reports. But it wasn’t always that way. Even AMR notes that historically, Apple had a poor reputation for supply chain performance – but the arrival of the iPhone in 2007 changed all that.

“With the introduction of the iPhone, Apple could have stumbled at meeting demand or failed on quality. It did neither. Behind-the-scenes moves such as tying up essential components well in advance and upgrading basic information systems have enabled Apple to handle the demands of its rabid fan base without having to fall back on their forgiveness for mistakes.”

A number of analysts make the point that Apple’s supply chain is in key respects different from those of most companies, in that it comprises physical and digital components in a way unseen before, with the company’s revenue and growth coming increasingly from the digital side. The changing nature of this two-sided supply system has led some to suggest that Apple’s supply chain is a new type of beast entirely.

That’s not without its problems. When Apple rolled out the 3G version of the iPhone in 2008, there was no shortage of the new handsets themselves in the company’s outlets. A sure sign the physical supply chain processes of manufacturing, inventory and logistics were working well. The digital side, however, proved more difficult, and the company initially struggled under the snowstorm of activation demands through the iTunes store triggered by the new phones.

That, says Kevin O’Marah, chief strategist at AMR, highlighted the problems of a company straddling these two very different kinds of supply chain. “The pioneering position they have taken in the digital supply chain is showing how tough it is to compete in this new realm,” he says.

Apple’s difficulties with that launch also highlight the strains placed on the supply chain by the company’s marketing approach of building demand while restraining supply, and then releasing the goods in one big blazing launch.

“For years, industry pundits have lavished praise on Apple as an industry supply-chain leader that takes advantage of design and manufacturing expertise on a truly global basis,” says supply chain commentator Jason Busch, founder and MD of Azul Partners, and blogger on Spend Matters.

“When it comes to such an innovative product, the possibility of potential issues rises exponentially early on in large-scale production runs, especially as suppliers at all levels begin to coordinate activities more closely. The challenge lies when product innovation outpaces the ability of suppliers to ramp up quickly enough in the early stages of a new-product supply chain.”

The company’s ability to bring together two sides of the supply chain (digital and physical) efficiently and at increasingly low cost is a central plank to Apple’s rise to global dominance. So how has it overcome difficulties to be recognised as the best?

Perfecting outsourcing

Perhaps the key innovation Apple has made on its procurement side is that it has almost entirely outsourced its supply chain. Nigel Johnson, who worked at Apple for seven years before helping to found consulting firm Reclipse, believes outsourcing is the key to Apple’s supply-side success.

“It’s probably one of the best supply chain models in the world,” he says. “It has done a very good job of perfecting outsourcing, of simplifying it and the way that it’s managed. It qualifies a supplier and builds with them globally, so somebody else does all the physical work and then it goes direct to the customer. But, whoever does it, the masterplan is always Apple’s.

“Using iPhoto [to order prints] is a good example. You press a button on a Mac or an iPhone or an iPad, and it goes off to an outsourcer somewhere, and Apple doesn’t touch it, and then it goes to a customer that Apple hasn’t touched.

“That means it’s pretty good at understanding the whole end-to-end chain, and I don’t think that kind of understanding has been developed yet among many companies. It also gives it a lot of sway over its supply chain.”

Dave Howell, another former Apple insider and now CEO of software developer Avatron, working largely on creating apps for Apple, believes this ability to outsource everything from innovation to risk is at the heart of the company’s success.

“Apple has mastered the art of identifying negative metrics and moving them off its books,” he says.

“It optimises its physical supply chain by requiring suppliers to carry adequate inventory and taking the associated pipelines off its own books. It does the same thing with software development for iPhone and iPad, where third-party developers take all the financial risk of developing apps. Apple still has a 30 per cent margin on iPhone apps, but has near-zero development cost.

“Also, in the iPad world at least, Apple owns its entire vertical pipeline, including chip design, industrial design, box assembly, operating system, applications, hardware distribution, software distribution, and soon advertising. In the Windows world these parts would be split up between companies such as Intel, Dell, Microsoft, Adobe, PC distributors, internet software sites and AdMob. There’s no way such a disparate system could ever be optimised for anything.

“Apple’s trick is that it not only owns all of those inputs, but controls them tyrannically and makes external companies carry the inventory.”

Tyrannical it may be, but Howell believes this supply model opens opportunities to suppliers, at least on the software development side, that they would never have in a more traditional arrangement, while also creating an innovation machine for Apple.

“They create an opportunity that’s real, and they allow some people to succeed beyond their dreams,” he says.

“They’ve created a mechanism for people to write apps without any marketing team, without even management or project management, to create apps with only engineering and graphic design. Now it’s possible, probably for the first time, to do it on your own in your bedroom.

“So they’ve got all these people taking the kind of chance that a start-up takes, that it’s hard for Apple to take any more. If you come up with an idea within Apple you have to run it through chains of management and veils of secrecy that manage to shut down most innovative thinking at an individual level. And now they have that working for them, without them having to even invest in it. It’s beautiful.”

Leading figures

The face of Apple’s success is unquestionably that of Steve Jobs, master marketer and co-founder.

He left and then returned Messiah-like in troubled times to guide the company to glory, and emerges from time to time, dressed in enigmatic black, to amaze halls full of starry-eyed journalists with the latest piece of sleek whizzbangery. But behind the success of the company’s mysterious outsourced supply chain is another, far less public figure.

Tim Cook appeared as if from nowhere at the helm of Apple last year when Jobs took time off for medical treatment, an event that triggered a small seizure among Apple shareholders. Cook soon restored investors’ nerves, improving the COO’s position as a prospective heir to the top job when Jobs finally goes.

But, according to Apple-watchers, far more important than Cook’s role in stepping into Jobs’s shoes has been his work on the supply chain.

“He turned a company that was on the brink of bankruptcy into one that is generating a huge amount of free cash,” says Charlie Wolf, an analyst at investment banking group Needham & Co.

Having earned his spurs as a procurement professional, Cook was hired from Compaq in 1998 to deal with the problems in Apple’s supply chain, at the time heavy

with inventory and contributing to an annual loss of more than $1 billion. Cook’s solution was to close down factories and warehouses and initiate the outsourcing process that has created the supply organisation that now earns so much praise.

Describing inventory as “fundamentally evil”, Cook set about instilling a logistical discipline that has given Apple a market-leading inventory management system, territory formerly dominated by Dell.

He also used Apple’s healthy balance sheet to lock in suppliers. When Apple introduced the iPod Nano in 2005, it pre-paid suppliers of flash memory such as Samsung and Hynix and effectively cornered the market for flash memory for years, leaving competitors empty-handed.

Cook’s success in reshaping Apple’s supply chain makes him a prime example of how procurement can be the ideal preparation for a position on the top floor.

While Cook’s outsourced supply chain may work well for app developers in their bedrooms, for bigger entities, and those on the physical rather than the digital side, supplying to Apple undoubtedly brings a particular set of problems.

Sworn to secrecy

Confidentiality is a key one. Secrecy all along the supply chain is an integral part of making Apple’s tightly controlled marketing approach successful, understandable in an industry that is so heavily dependent on intellectual property (IP), and in which competitors take the first opportunity to rip apart each other’s products to study them and begin turning out something similar.

For suppliers, however, the required degree of secrecy can create unusual pressures. Apple has been criticised by some suppliers – anonymously, of course – for bringing them in at the absolute last minute, which can create all kinds of problems, and for insisting on the most rigorous security and confidentiality measures they’ve ever experienced. But it must be a price worth paying, anonymous complainers included, to be part of the Apple supply empire.

The pressure apparently felt by suppliers in the Far East to ensure none of Apple’s secrets find their way to competitors have been highlighted recently, with allegations of particularly tough treatment of employees in at least one facility.

However, when it comes to monitoring ethical issues among its suppliers, many analysts believe Apple is leading the way in the industry. The company has a detailed supplier code of conduct and regularly conducts audits of suppliers’ facilities to check that the code is not being breached, auditing 102 factories last year.

The effectiveness of audits has been questioned by some but they appear to go further than most of the industry.

Supply chain commentator Bob Ferrari, MD of the Ferrari Group, a supply chain consulting firm, argues secrecy is a crucial element of its success and so should be respected by any supplier that wants to play a part in Apple’s runaway success.

“Apple has always had a culture of secrecy, more specifically protecting its intellectual and product capital. It is a company driven by product innovation, which has worked very well in terms of explosive business growth in sales and profitability. Apple goes to extraordinary lengths to protect its IP.”

If that’s difficult for suppliers, the argument runs, then they should look for business elsewhere.

“It is no wonder that Apple remains secretive in telling the world about its supply chain business process and IT capabilities,” says Ferrari. “The results speak for themselves.”

* Richard Brass is a freelance journalist