A Juggernaut In Electronics

Taiwanese contract manufacturer Hon Hai has blown past rivals. Has it grown too big?

Even as electronics manufacturers have stumbled in recent years, one company--Taiwan's Hon Hai Precision Industry Co.--has blown past the competition to become the top player in the industry, churning out all manner of products for name-brand gadget makers. For evidence of the Taiwanese giant's strength, look no further than Flextronics International Ltd.'s $3.6 billion takeover of Solectron Corp., announced on June 4. Hon Hai "is the key reason Flextronics and Solectron merged," says Byron Wu, China research manager for electronics market watcher iSuppli Corp.

While rivals have suffered from shaky earnings, overcapacity, and languishing stock prices, Hon Hai has continued to surge ahead. Even though Hon Hai is now No. 1, it's growing faster than the other major players, making marquee products such as Apple's iPod and forthcoming iPhone, Sony's (SNE ) PlayStation 3, Nintendo's (NTDOY ) Wii, Hewlett-Packard printers and PCs, and thousands of other gizmos. Hon Hai's sales jumped 44% last year, to $40 billion, which is more than the combined revenues of its three nearest rivals, Flextronics, Solectron, and Jabil Circuit. Profits for Hon Hai climbed 47%, to $1.8 billion, for the year. And its stock? Up 52% in the past 12 months.

From its Taiwanese base, Hon Hai has expanded rapidly in China in recent years. At one mammoth complex in the southern province of Guangdong, Hon Hai and its Hong Kong-listed subsidiary, Foxconn International Holdings Ltd., employ 200,000 workers and have their own police force, soccer stadium, and chicken farm.

But Hon Hai's real advantage isn't just low-cost Chinese labor. After all, most of its rivals have plants on the mainland, and Hon Hai itself employs a total of 360,000 people in scores of factories worldwide, from Malaysia to Mexico. Hon Hai's edge is that it makes about one-third of its own components--everything from circuit boards and connectors to the casings for iPods. The comparable figure for major competitors is less than 10%, Macquarie Securities Ltd. estimates. That helps boost Hon Hai's earnings, since it can better keep costs in check and cut more profitable deals with customers.

Now the company is honing its expertise in new areas. Since it started making LCD panels in 2004, subsidiary Innolux Display has grown into one of the world's leading producers of the screens, and last year Hon Hai bought Taiwanese camera manufacturer Premier Image Technology Corp. and is making a push in that market. In March, Hon Hai announced it was getting into the notebook PC business by acquiring a minority stake in Simplo Technology Co., a Taiwanese producer of batteries for laptops, for $43 million. "We just try to enhance and strengthen our role in the whole supply chain," says Hon Hai spokesman Edmund Ding. And the company believes the outsourcing market is far from tapped out. "We still see some opportunities," Ding says.


There's a downside to Hon Hai's success. Electronics makers are reluctant to grow overly dependent on a single manufacturer. "They are worried that Hon Hai is getting too big," says Daniel Chang, an analyst with Macquarie Securities in Taipei. And the company has drawn scrutiny from foreign labor rights groups, culminating in news reports last year that workers making iPods toiled in sweatshop-like conditions (see BusinessWeek.com, 6/2/07, "Overseas Sweatshops Are a U.S. Responsibility"). An investigation by Apple Inc. found relatively minor infractions, but Hon Hai further sullied its image by suing two Chinese journalists who had written critically about working conditions. Hon Hai dropped the suit in the face of a storm of criticism from Chinese bloggers and newspapers.

A bigger worry may be Hon Hai's future once founder Terry Gou retires. The 56-year-old chairman has said he'll step back from day-to-day operations next year to focus on broader strategic issues. But given the renewed push from rivals both at home and abroad, there's little chance Gou will really take a backseat. Says John Antone, general manager of Asia-Pacific for Intel Corp. (INTC ), which supplies chips for Hon Hai's computer motherboards: "He's going to stay involved."

By Bruce Einhorn, with Peter Burrows in San Mateo, Calif.

— With assistance by Peter Burrows

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