Apple – Foxconn Parting Ways

In a tale as old as corporate relationships themselves, Apple Inc. AAPL has told longtime manufacturing partner, Foxtronn that it wants to “start seeing other suppliers.”

The Wall Street Journal reported that Pegatron Corp., named after the famed flying horse of Greek mythology, Pegasus, would assemble the low-cost iPhone that is expected out later this year.

Pegatron has been assembling a small number of iPhones since 2011 and last year began producing iPad Mini tablets for Apple.

The main reason for Apple’s supply chain diversification seems to be supply chain diversification. Sources told The Wall Street Journal that risk diversification is also a major factor, especially after Apple experienced problems last year when Foxconn manufacturing glitches produced scratches on iPhone 5 cases.

It doesn’t hurt that Pegatron, in trying to win Apple’s favor, has apparently shown a willingness to accept a smaller profit margin. Neither company would comment on pricing, according to the newspaper.

At any rate, Foxconn is at a pricing disadvantage. The company has had to spend money increasing wages and improving working conditions after a series of high-profile worker suicides.

In expanding its supply chain partner base, Apple may also be attempting to counteract growing independence on the part of Foxconn. One source pointed to an incident in which Foxconn changed components in Apple products without notifying Apple.

Pegatron is well-known for its ability to compartmentalize and maintain secrecy while assembling products for various companies such as Microsoft Corp. MSFT, Hewlett-Packard Co. HPQ Dell Inc. DELL, and Apple – all at the same time.

Operating margins are also a factor in Apple’s decision. Pegatron has a razor-thin margin of 0.8 percent. Foxconn’s is 1.7 percent, more than twice the size of Pegatron’s.

As for future supply chain expansion plans, Apple isn’t talking. Bloomberg, however, quoted Vincent Chen, an analyst at Yuanta Financial Holdings Co., who said, “Apple is a very risk-averse company, so they don’t want to be putting all their orders with one supplier.” Chen added, “Apple may introduce other assemblers beyond Hon Hai and Pegatron into its supply chain for upcoming products.”

Pegatron, with about 100,000 employees in Taiwan and China will increase its workforce by 40 percent in the second half of the year, according to Pegatron CFO, Charles Lin. Analysts say the staffing increase is primarily aimed at handling production of the new, low-cost iPhone.

At the time of this writing, Jim Probasco had no position in any mentioned securities.