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China needs Apple and Apple needs China., but the pair's marriage has grown complicated.

Could the honeymoon be over?  
 
I. Tim Cook Demands Answers From Top Chinese Official in Wed. Meeting
 
After years of riding on the back of cheap Chinese labor to the tune of massive global profits, things have gotten a bit interesting between China's central government and Apple, Inc. (AAPL).  
 
This week, amid pro-Democracy protests in Hong Kong and flying accusations of Apple's role in U.S. National Security Agency (NSA) spying, Apple's iCloud was subject to a sophisticated phishing attack.  Data from anti-censorship advocacy Greatfire suggested that the redirects to the attack page were done at the level of China's "Great Firewall".  And that offered strong evidence that the attack was the work of Chinese censors, looking to steal citizens’ passwords to boost their surveillance campaign.

China iPhone
The Chinese government in Beijing allegedly targeted Apple with cyberattacks this week. [Image Source: VR-Zone]

Apple was rather unhappy at this development.  It moved fairly quickly to perform its own redirects, which successfully routed the traffic around the credential-stealing sites.  And on Tuesday, Apple CEO Timothy Donald "Tim" Cook boarded his private jet and flew to Beijing for a Wednesday meeting with China's Vice Premiere Kai Ma.
 
The meeting was held at the Beijing government complex, Zhongnanhai.  And according to China's state media service Xinhua, the topics included the "protection of users' information" amid the attack, which Chinese state media blamed on phantom "hackers".  Xinhua also stated that the pair discussed "strengthening cooperation and in information and communication fields."

Apple China
Apple's CEO Tim Cook meets with Vice Premier Ma Kai, one of the four most powerful men in the executive branch of China's government. [Image Source: Xinhua]

Apple was silent as usual on the visit.  But the fact that Apple was able to secure a meeting with one of the top four officials in China's State Council, the executive branch of the Chinese government, highlights just how much influence Apple and its suppliers still hold in China.  The Chinese government to some extent has to listen to Apple's concerns.  And it has to at least try to avoid the appearance that its overtly sabotaging one of its top trade partner's products.
 
But it's hard to escape the feeling that the warm, mutually beneficial union that once existed between Apple and China is slipping away.  The trip may have highlighted Apple's lingering influence in China.  But it also underscored the increasingly complicated nature of Apple's relationship with China.
 
II. The Ties that Bound
 
For years Apple relied on Chinese suppliers modestly, but it wasn't really a major player in the Chinese economy.  Its products didn't sell to many and frankly, they were too expensive for most Chinese buyers.  That all changed around in 2004 when sales of Apple's iPod began to heat up and in 2007 when the iPhone was launched.
 
Unlike Google Inc. (GOOG), Apple took a page from Microsoft Corp. (MSFT) and was never one to rock the boat.  China censored its people?  So what.  There's nothing wrong with obeying local laws -- when in Rome, do as the Romans do, it argued.
 
The Chinese government viewed Apple as a good neighbor.  And it had little problem with the growing relationship between the Californian gadgetmaker and its manufacturing industry.  Apple seemed like precisely the kind of ally China needed.  China won Apple's trust.  And Apple won China's trust.
 
By 2012, Apple was responsible for over 1 million supplier jobs in China.  Chinese workers were responsible for assembling virtually all of the tens of millions of iPhones and iPads that were sold around the globe annually.  
 
Apple needed China.  China was a key factor in Apple's industry-leading profit margins.  No one knew that better than Tim Cook who served as head of Apple's global supply chain at the time of the iPhone launch.  But Tim Cook -- who had stepped in as Apple's new CEO by 2011 -- knew something else.  China needed Apple.
 
Aside from direct job growth created by its products, Apple's success was a lure to other American businesses.  What's good for the goose is good for the gander, as the saying goes, and what was good for Apple proved very good for China's manufacturing economy.
 
But the relationship was not without stress, even then.  Apple's tight grip on supplier costs squeezed a bit too hard at times and a wave of employee suicides in 2010 had forced the Chinese government to pay lip service at least to scrutinizing Apple and its local suppliers.

Apple labor
Apple has faced increased scrutiny over its use of cheap Chinese labor, but in China has larged smooth over tensions on the issue. [Image Source: AFP]

But the pair seemed to mend fences on the issue of labor conditions in the last several years.  And Apple found another way to entrench itself as a key pillar of the Chinese economy -- local sales.  As the Chinese smartphone market swelled to become the world's largest in unit sales, the iPhone became a coveted status symbol.  By the end of last year Apple's quarterly sales in China had soared to nearly $9B USD quarterly -- nearly half as much as it makes in the Americas, its top market.  Accessories for the iPhone are a $1.3B USD market of their own in China, according to recent reports.
 
III. Chinese OEMs Stand on Their Own
 
Things were looking up in Apple and China's relationship, or so it seemed.  But some saw that in 2013 serious cracks began to show in the pair's relationship.
 
One key factor was the meteoric rise of domestic manufacturers in China.  In Q2 2014 three of the world's five largest smartphone manufacturers were Chinese.
 
Two were older firms.  In third there was the Huawei Technology Comp., Ltd. (SHE:002502), a veteran telecom firm founded by a former PLA officer.  Huawei's diversification into the device business is clearly firing on all cylinders.  And in fourth place is the Lenovo Group, Ltd. (HKG:0992), a bold and ambitious PC market veteran who -- like Huawei -- had seen great success in diversification into the mobile market.
 
Xiaomi's appearance in fifth was the biggest surprise.
Xiaomi Mi4
The Xiaomi Mi4

Its founder, Lei Jun, is the 23rd richest man in China and is quite a colorful celebrity.  He has earned the title "the Steve Jobs of China" for his penchant to dress like his self-proclaimed American tech idol, Apple's late founder Steve Jobs.  He even has a keynote style that uncannily echoes Jobs'.

Xiaomi Mi4
Xiaomi CEO Lei Jun idolizes Steve Jobs and emulates his flare for dramatic presentations, but he's no fan of today's Apple. [Image Source: Reuters]

In interviews Mr. Jun has indicated he was hesitant to compete with his idol (Steve Jobs), but in his final years he became determined to inherit his legacy.  Mr. Jun is no fan of Tim Cook, who he feels is degrading the Apple legacy.  In honor of Jobs, Mr. Jun has looked to out Apple, Apple.  His company has produced Android smartphones that look uncannily like the iPhones from the Jobs era.  And sales in China indicate iPhone buyers prefer Xiaomi devices to the real iPhone's designs in the Tim Cook era.
 
And in addition to Huawei, Lenovo, and Xiaomi, there's scores more OEMs where that came from, including ZTE Corp. (SHE:000063), Oppo Electronics, and the Coolpad Group Ltd. (who owns the Yulong brand).
 
What does all this success from domestic OEMs mean?  It means that China is nearing the day when it's more dependent manufacturing-wise on its own domestic production than in orders from foreign firms like Apple.  As time passes, China needs the American business less and less.
 
IV. American Cyberattack Hypocrisy is Exposed, Generates Ill Will in China
 
A second key factor in the chilling relationship is a more ubiquitous one for American tech firms -- the fallout from the NSA spying scandal.  While the Chinese national government allegedly had a very sophisticated global spying program of its own, the U.S. federal government had long been portraying itself falsely as anti-censorship and more inept when it came to cyber-spying.
 
The revelation that the U.S. was not only better at spying on its own people than China was required a major global perspective shift. And the fact that the U.S. was to blame for as much cyberspying in ally states like Germany as China hit even closer to home.
 
China's own spying efforts allowed it little room to object to America's tactics on a more macroscopic scale.  But it did take special issue with America's tech community on a very specific point -- accusations that Chinese businesses were a "threat" to America.  
 
In 2012 U.S. Congress carried out a campaign of theatrical antagonism against Huawei and other OEMs, calling them a potential security risk and threatening to ban them from the U.S. market.  The White House ultimately concluded that Chinese firms weren't actively enabling spying on the U.S., but nonetheless the federal government in the U.S. has avoided Chinese telecommunications equipment since that rhetoric emerged.
 
When the NSA spying revelations came, the hypocrisy of that stance became apparent. Not only did the American federal government potentially have the capability to exploit U.S. hardware companies to spy on foreign states (and its own people), NSA slides suggested it was actively exploiting security holes in American companies.  In other words, the U.S. was doing exactly what it initially accused China of doing, but eventually concluded China was not actively doing.  
 
China reacted to this news in an understandably irate fashion.
 
But rather than take an apologetic bent with his irate trade ally, President Barrack Obama struck a much more belligerent and pointed tone with China.  His administration moved to charge five PLA officers of hacking U.S. companies and government sites.  The move was useless from a justice perspective as the officers charged were all in China.  But the gesture wasn't entirely empty as it sent a clear message to China: "Yes we spy on our people and on your people, but lest you forget, so do you."
 
China has not taken kindly to that perspective.  In recent months Chinese state newspapers have carried increasingly scathing editorials calling on increased scrutiny of American electronics companies, including Apple.  The importance of America's electronics industry to China's economy is such that there was only so much the state media could say.  But nonetheless it defiantly walked the tightrope between those who called for severe punishments against America and business leaders who demanded a far cooler tone and respect for the importance of trade from Apple and others.
 
This dichotomy was illustrated in the alleged blacklisting of Apple products from Chinese government acquisition lists.  After Reuters reported the news, Chinese officials sought to help Apple save face, claiming it was not banned but rather excluded due to a technicality.  A bit of paperwork had been missing, they claimed, so Apple would not be eligible.  But in no way was the move meant to punish Apple.
 
Or so they said.
 
From a big picture perspective these two factors -- the rising success of domestic OEMs in China and the hurt feelings over American spying -- have combined to create the general sentiment in China that American business is not only a potential threat security-wise, but also is less economically vital as it once was.  As a result China appears more emboldened to be the one making the demands, where as before U.S. OEMs like Apple had more leverage to dictate terms.
 
V. China and Apple Need Each Other for Now, But That Too Shall Pass
 
So that takes us to today.  China is in an icy place with Apple and Apple with China.  Their interactions remain polite and civil on the surface.  But beneath the ice a greater fire is burn, a fire that could have deep impacts on both China and America's most valuable gadget maker.
 
Today an estimated 1.5 million jobs are created in China by the so-called "iEconomy" according to Quartz's analysis of Apple's labor audits.  And if China drives Apple's business away, many other American and European firms will perceive this as a key barometer that it's time to pull the plug on Chinese manufacturing and find alternatives.
 
Thus the bottom line remains unchanged.  Apple still needs China.  And China still needs Apple. 
 
But as Apple's bitter falling out with its once biggest processor supplier, South Korea's Samsung Electronics Comp., Ltd. (KRX:005930)(KRX:005935) illustrates that necessity can only preserve the peace for so long.  While Apple and Samsung haven't managed to quite quit their turbulent relationship, the pair have greatly reduced business in recent years.
 
This may give a clue to the future of Apple -- both in manufacturing and in device sales -- in China.  While China is still an incredibly vital asset to Apple, there may well come a time when the costs of doing business with the world's most populous nation outweigh its benefits.

China
China and Apple may eventually see their relationship wane under the pressure of new stresses.
[Image Source: CNN]

And even if Apple chooses to stay, in the long run there will come a time when Chinese OEMs can stand on their own and China realizes its full engineering might.  That day is coming soon and when it happens, it will spell the dawn of a new era in the Apple-China relationship.  For the first time China may soon discover that it no longer needs Apple.

Sources: Xinhua, via Reuters





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