Xi Jinping had plenty of reason to be upset with Apple. Global revenues at the tech giant had soared from $6 billion in 2003 to $157 billion in 2012, and though Apple’s success had much to do with product conception and design, its ability to build and distribute its hardware couldn’t be accomplished without operations in China. In addition, Chinese consumers had been Apple’s biggest source of growth during the prior three years. As Xi took power, he emphasized a policy of “in China, for China,” and it didn’t look like Apple was sharing the wealth.
Apple’s net margins had jumped from 1.1 percent in 2003 to 26.7 percent in 2012; profits, in the same period, expanded at a meteoric rate from $69 million to $41.7 billion. Yet the company’s chief assembler, Foxconn, appeared to be getting a raw deal. Foxconn had been a more profitable company than Apple in the early 2000s.
But as iPod and then iPhone volumes took flight, Apple’s margins soared while Foxconn’s collapsed by two-thirds. And far from being some outlier, Foxconn was among the chief beneficiaries—indeed, one of the chief enablers—of Apple’s growth. Plenty of other suppliers would work for Apple on several generations of a product and become overly dependent on the tech giant for revenue, only to find that its technology wasn’t needed in the next generation of hardware, lose Apple as a client, and go bankrupt. “If it’s even slightly convenient for them, they’ll knife you,” says the top executive of an American supplier that suffered such a fate.
Worse, Apple had become so successful that negative stories involving the company attracted global attention portraying China in a poor light. Beginning in 2010, the wave of suicides at Foxconn had put Chinese working conditions in the international headlines for months. When, in September 2012, some 2,000 Foxconn staff in the city of Taiyuan rioted, the assembler responded by sending in 5,000 police. Mayhem like this wasn’t at all atypical in China; what was rare was the international media coverage. Journalists devoted outsized attention to the uprising because the factory played a role in supplying iPhones. From Beijing’s perspective, Apple’s attempts to evaluate its supply chain challenges and set the problem straight didn’t necessarily help.
After Apple commissioned an independent evaluation, it acknowledged that 60 percent the 229 suppliers audited had failed to comply with 60-hour maximum workweeks; about half worked improperly with hazardous chemicals; and more than 100 facilities failed to pay proper overtime. When Cupertino published the report, the context was an American company playing the role of white knight, cleaning up the supply chain. The unspoken subtext suggested that, if left unsupervised, Chinese factories would exploit workers and endanger their lives —an embarrassing message for an ostensibly socialist country.
Then there was Apple’s signature line: “Designed by Apple in California. Assembled in China.” For some, the statement diminished the importance of China’s contributions. The country had developed extensive world-class industrial clusters on a previously unknown scale. Thousands of skilled engineers using sophisticated machinery had played a critical role in making Apple products functional and beautiful. Assembly wasn’t at all the crux of the partnership. The signature line looked outdated, seemingly structured to keep China in its place.
For any hard-liners, these suspicions were brazenly confirmed by Apple’s organizational structure. The ideal template for a Western company, from Beijing’s perspective, was a joint venture—a partnership with a local company in which the multinational gets access to a billion customers but the local partner learns the ins and outs of operating the business so it can eventually flourish on its own. In the 1990s, such “technology transfer” was critical for China to avoid forever being a haven for low-skilled cheap labor. They could play that junior-partner role for a while, to lure in capital and provide jobs, but the goal was for Chinese firms to eventually compete on their own. For Western companies, such arrangements could be very lucrative.
Volkswagen was the first major carmaker to sign such a deal in 1984, and within a few years the JV was the largest carmaker in the country. As China’s new-car market outpaced America’s, VW’s leading position helped it overtake GM as the world’s largest carmaker.
But the arrangements could also be dangerous. Numerous companies avoided entering China in the 1990s due to the risks and uncertainties of IP protection. Once China entered the WTO in 2001, however, explicitly conditioning market access on tech transfer was illegal in most sectors. As President Clinton had put it:
“We don’t have to transfer technology or do joint manufacturing in China anymore.” But the practice didn’t really end; instead, the pressure turned informal. The Chinese market was so large that foreign companies would sometimes “voluntarily” enter such agreements. A textbook example occurred in the early 2000s when China planned the largest high-speed rail network in the world. The potential orders to foreign companies were enormous, creating a Prisoner’s Dilemma among Siemens, Bombardier, and Kawasaki.
In the end, all three agreed to transfer technology to state-backed companies in exchange for market access. By 2010, policy had shifted to favor local industry; the foreign companies struggled to compete in China, and the local companies began exporting their technology abroad. As one Japanese executive involved put it: “[The Japanese and Europeans] were afraid this situation would happen in the future, but they thought it would take more time. The Chinese catch-up speed was so fast; they could not have imagined they would be competing [with the Chinese] for contracts in the US.”
For many foreign companies the go-to structure became the wholly owned foreign enterprise, which ostensibly allowed companies to protect their intellectual property and license their tech to Chinese factories. But Apple’s oldest business in the country-the third-party channel sales unit, which distributes Apple products to authorized partners—was neither a joint venture nor a wholly owned foreign enterprise. Instead, Apple had classified the business unit as a trading company, a designation that was practically offensive. The term was associated with the Dutch and English East India Companies, colonial-era businesses involved in China’s “century of humiliation.”
Back then, Western powers annexed Hong Kong and Macau and forced China to import opium, a premodern equivalent of fentanyl that had a disastrous effect on the population. Trading companies were linked with exploitation, plunder, and unequal treaties. It didn’t help that Apple had created zero R&D centers in the country, while the likes of HP, Microsoft, and Motorola had established theirs a decade earlier. Nor did Apple have formal partnerships with local companies, while Samsung alone had more than thirty-five.
The Party Leads Everything
On the morning of the original CCTV episode on March 15, 2013, some ten hours before the first attack on Apple aired, Apple Store employees in Shanghai were confronted by a cohort of media, including CNN and local outlets seeking comment from the tech giant. The journalists had been prebriefed about the coming Consumer Day episode by Mofcom, China’s Ministry of Commerce, which manages media relations in the country by preapproving government messaging and coordinating missives across departments. Store managers felt blindsided by allegations that Apple had mistreated Chinese customers, yet they couldn’t respond without first informing Cupertino.
It was late in California and senior executives couldn’t be reached, resulting in awkward silence for hours as news crews waited impatiently. When an emergency conference call with half a dozen senior leaders came together, Tim Cook coolly rejected the allegations that Apple treated Chinese customers poorly. He took the bold stance that he ran the world’s largest company and didn’t need to apologize for anything.
Over the following three weeks, as the media attacks widened, Cupertino learned that treating Chinese government officials like vendors in their supply chain wasn’t going to fly. Only then did Cook pen an apology letter, in Mandarin, for Apple’s China website. (According to one person, the Apple CEO also flew to Beijing for a secret meeting with China’s top officials. “The Chinese would never accept a written apology,” this person says. “You have to lose face in front of them, and bow.”)
To secure Apple’s China business, Cook amended its warranty policy in the country, pledging that eligible customers with broken phones would be given new units. The enhanced policy was like a godsend to the yellow cows. It turbocharged their illicit scheme to such an extent that Apple Stores in China soon had a separate line just for iPhone returns. When their turn came, some migrant workers would unpack entire backpacks filled with iPhones, returning each for a brand-new unit.
The updated warranty policy had given the yellow cows a new source of iPhone supply: existing models. They began stealing them from consumers, in China and abroad, and then deployed special tools to amend the fifteen digit IMEI number—which in those days was printed on the back of the iPhone and again on the SIM tray inside.
In some cases, the yellow cows would obtain a top-tier iPhone, take it apart and separately sell pricey components like the memory chip, replace them with inexpensive lookalike parts, and then return the tampered unit for a brand-new model. The yellow cows became so adept at this that even a well-trained Genius Bar worker couldn’t detect which phones had been tampered with.
Successfully clamping down on these practices would take several years and involve a series of stunning discoveries. Apple began holding onto returned units for thirty days, using that time to figure out which had been compromised. Their systems allowed them to type in the IMEI number, and if the number was legit, then the system would indicate they were holding the correct unit; but sometimes the data would indicate the IMEI was an activated phone still in use on the other side of the world.
That confirmed they were holding a manipulated unit, allowing them to deem it ineligible for return. As the scam went on, Apple learned to place the units under a special X-ray-like microscope, providing a near-atomic view that outclassed the resellers’ ability to fool them. It would take Apple more than five years to deter the bad actors, by serializing every major component within the iPhone, pairing the display, battery, and camera to the logic board.
The move caused blowback from right- to-repair activists, as it inadvertently made it more difficult and costly for legitimate third parties across the world to help customers with broken iPhones. But the blowback was considered a small price to pay for ending the devious trade-in scheme Apple was facing in China.
Back in 2013, the magnitude of the problem facing Apple wasn’t at all understood—not by Apple, and certainly not by Western media. Indeed, the consensus narrative to emerge was that Apple had gained the upper hand against the Chinese government. Beijing’s attack on the company had “largely backfired,” The Atlantic wrote, as “hundreds of thousands of Weibo users- students, intellectuals, white-collar workers and celebrities-voiced their support for the American technological behemoth.”
In Forbes, Gordon G. Chang mocked Beijing for an obvious goof when a celebrity actor with millions of followers took a hard stance against Apple using his Weibo account, but ended his screed with the words “…Post around 8:20.” Whoops! The actor had included part of the instructions. Who wrote the instructions wasn’t entirely clear, but in a country where a motto is “the party leads everything,” Chinese netizens had an educated guess. “Users began posting acerbic comments with the #PostAround8:20 hashtag,” Chang wrote. “Weibo censors later deleted tens of thousands of postings with that hashtag.”
But whatever the failures of the digital blitzkrieg were, Cupertino was made to understand that it was China that had the leverage, not Apple. While Beijing was unlikely to take hard action against Apple’s manufacturing operations, given that its economy depended on attracting Western companies to build things in the country, it seemed completely willing to attack Apple’s retail presence and digital offerings.
For hard-liners, the iPhone was often a symbol of the younger generation’s materialism, individualism, and fascination with the West-all trends they were happy to crush. As one editorial in the Global Times opined: it was “shameful” for the Chinese to go gaga for the newest iPhones at inflated prices.
“For now,” the editorial said, “if you see someone with an iPhone 6, cast your eyes on them contemptuously.”
This excerpt from Patrick McGee’s ‘Apple in China: The Capture of the World’s Greatest Company’ has been published with permission from Simon & Schuster.