Apr 3 2014, 8:44am CDT | by Forbes
There’s talk that Apple might be about to purchase a unit of Renesas, a unit that designs and manufactures the chips that drive the displays of smartphones. This gives us an insight into the economics of what Apple is going with that vast cash mountain it has to hand. In the technical jargon it is looking to “vertically integrate” but there’s a twist being applied to this old strategy.
Here’s the actual report:
Renesas SP Driver, the largest maker of chips used to control mobile device screens, supplies all three of the companies that make displays for the iPhone, industry sources say: Sharp, Japan Display Inc and South Korea’s LG Display Co Ltd.
“There’s no doubt that, for Apple, the question of who buys Renesas SP is a matter of grave significance,” said one Japanese display industry source, who asked not to be identified due to the sensitivity of the matter.
Control over the supply chain has become increasingly crucial among smartphone makers.
It’s true that security of supply is a possible motivation for such a deal. But it’s also true that no one is going to buy a company that supplies Apple and then refuse to supply Apple. For the Apple supply contract is part of what provides value to the company being purchased. And again, no other smartphone maker would purchase it just to deny Apple those chips. All the supply lines across the industry depend much too heavily on each of the other players for one part or another of the build set that becomes the finished phone.
However, there’s more to this than just Apple’s possible desire to secure the supply chain. Apple does, as we know, have a vast cash pile. It remains outside the US simply because to bring it into the US would trigger a large corporate income tax bill (perhaps as much as $35 billion if all of it were brought in). So, that cash pile isn’t going to be used to pay dividends or to conduct stock buybacks: that tax bill pretty much precludes that. So what is Apple going to do?
They’ve certainly got enough cash to purchase pretty much anyone they want to. They could, for example, buy GM if that interested them: but that wouldn’t be very sensible, given that there’s no obvious logic behind the two companies joining forces. Apple could buy a record company or two and thus make iTunes the exclusive source of certain “must have” music. Ditto film production and Apple TV and so on. But that’s not the way that they seem to be thinking about their opportunities. These are examples of horizontal integration.
Rather, Apple seems to be using that cash to do a form of vertical integration. The classical version of this is that you keep buying the producers of your inputs. If you use a lot of steel then you buy a steel plant. If you buy a lot of chips then you buy a chip fabrication plant. And Apple could certainly do this. However, the Apple management seems to me to be being cleverer than this. For example, there’s no doubt that Apple could afford to purchase a silicon fab plant, or build one of their own. But they also know that the skill set within Apple isn’t particularly suited to running a fab. Design and marketing Apple does very well indeed, running manufacturing plants not so much (all those assembly plants are run by Foxconn and Pegatron etc for example). So Apple has, for example invested in the design of its own A7 chips (the A6 and earlier were designed for them by Samsung) but still contracts out the actual manufacturing to independent fabs like Samsung and soon to join the list TMSC.
Similarly, when Apple wanted to get more involved in sapphire they didn’t go and build their own factory. Rather, they teamed up with a company that has the requisite skills and then used their cash pile to finance the building of a new factory. Apple gets the first $500 million or so of material off the production line, the sapphire company gets the $500 million now to build the factory.
The mooted deal with Renesas fits in with this sort of strategy. Apple secures its supply, yes. It also gets tighter integration of its own design efforts with those producing the chips that drive the displays, to the presumable future benefit of the technology. And Apple also deploys some small part of that cash pile to gain this. It is vertical integration but not total and whole such. They’re not, for example, buying the screen manufacturers themselves. Leave that to people who observably have greater skills at that task than Apple does.
All in all it seems like a sensible plan for using that cash balance. No marching off into areas where Apple has no particular skills, nothing extra to add. And using their financial might (as with the sapphire) to improve the production of the raw materials that the company uses. And here, with the chip purchase, securing and being able to more closely integrate with a supplier of a small but vital part of the overall technological experience. Seems a reasonable and well thought out strategy.
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