iPhones Produced in China Smuggled Right Back in

Ponca City, We Love You writes "Factories in China produce iPhones that are exported to the United States and Europe and then smuggled right back in helping explain why Apple says it sold about 3.7 million iPhones last year while only 2.3 million are actually registered in the United States and Europe. For Apple, the booming overseas market for iPhones is a sign of its marketing prowess but also a blow to Apple's business model, costing the company as much as $1 billion over the next three years, according to some analysts. Since negotiations between Apple and China Mobile, the world's biggest mobile-phone service operator with more than 350 million subscribers, broke down last month, the official release of the iPhone in China has been stalled producing a thriving gray market. Copycat models are another possible threat to Apple in China. Not long after the iPhone was released, research and development teams in China were taking it apart, trying to copy or steal the design and software for use in iPhone knockoffs, or iClones and some people who have used the clones say they are sophisticated and have many functions that mimic the iPhone. "A lot of people here want to get an iPhone," says Shanghai lawyer Conlyn Chan."

You just can't repress anything these days

People in China are going to satisfy their demand for iphones one way or another. Not to bother with the ethics of the situation, but much like any other type of piracy, this is just a market at work. We truly live in a global economy now. Regional releases and other such nonsense just don't make sense any more. If you release a product with global demand, make sure you can supply it globally or it will be pirated, smuggled, etc. If Apple cares at all about the Chinese market, then they need to ink a deal fast, because someone will supply iphones in their stead if they don't get something done.

Don't build in China

If you do not want people to copy your product then do not have them made in China.

Recently I've found some iPod Nano knockoffs. These devices look good. They copy the Nano right
down to the nice plastic case that if it in on the shelf. The only difference is that these
devices do not have the feature where you can move your finger across the dial and they do not
have Apple's software. They are easy to use and cost less than $50 for a 4GB model. I've not
bought one yet. I have a 20GB iPod and it still works for me. When it breaks I'm buying a clone!

Re:Don't build in China

Doesn't really matter where you build it, people can get something and reverse engineer it no matter what. It's really more of an issue of market forces meeting demand where there is no legal supply.

Re:Don't build in China

Perhaps, but you don't hear people whining about cheap westrn-European knockoffs, or mid-western-American knockoffs much.

Re:Don't build in China

Perhaps, but you don't hear people whining about cheap westrn-European knockoffs, or mid-western-American knockoffs much.

Mainly because not much in those regions is cheap, and trademark & copyright laws are enforced against commercial entities that would try to make those knockoffs. China, Taiwan and such may have laws but the enforcement is quite lax.

funny math

costing the company as much as $1 billion over the next three years

"Costing"? This sounds like funny math to me (pioneered by record labels and Hollywood). Since Apple doesn't sell the iPhone at a loss, any sale (even without contract) is a net profit. They are not losing money from all the people who are buying it without getting a contract. Sure, they might have expected higher sales... but they have not lost anything.

Basically this "funny math" is saying: "We get $X from phone sale, plus $Y from the carrier deal. We expect to sell 1M phones, which means (X+Y)*1M $. We noticed that we actually sold 2M phones! Yay! But then we noticed that only half of those phones actually signed up for plans."

So they now claim that they have lost Y*1M $ because people didn't sign up.... umm... no. You made an additional X*1M $. That is not a loss. That is a profit.

"Costing" indeed.

Before you bash Apple

If you notice, we haven't heard ANYTHING from Apple. Apple looks like they are preventing this, because why would AT&T give them a cut if everyone else can carry the iPhone with unlocked iPhones. Apple seems to enjoy the extra sales and profits, but doesn't want to jeopardize the AT&T gravy train.

The funny math comes from business reporters/analysts that have been trained by this given the Record Labels/Movie Studios, as you pointed out. Also, it does matter to business analysts, because they are trying to project Apple profits. If you priced all iPhone sales as the deferred revenue model, you would be overstating future sales/profits. You need to know how many are "lost" to back them out of projections.

The loss is also probably more an accounting/spreadsheet thing.

If your estimate is $300 in profit from iPhone over 3 years, your line is probably:

If you estimate 1m/year

Year 1: $100m, Year 2: $200m, Year 3: $300m, Year 4: $300m, (and $300m in perpetuity)

Now, if you need to adjust that in future years, your choices are, recalculate and estimate new sales vs. unlocked sales. Or, put in a line under there: Loss from unregistered phones. The latter is easier, and looks more like an income statement's bad debt expense.

Bad debt expense is booked as an expense and a loss. However, for a company with virtual sales (software), obviously it's not really an expense. Producing the item cost you zero marginal costs, so if you don't get paid, you're no worse off than if you didn't make the sale. However, accounting treatment requires you to book the sales and then book the estimated losses from bad debts as a percentage, rather than incurring as you go.

For a small business, you might just not spend the cash until the credit card/check payment clears, but bigger businesses need to worry about GAAP compliance, and it's really important that revenue/costs are booked in the period that they occur, not when the cash clears.

Re:funny math

Apparently, there aren't so many phones that do more and do it better. For example, no other mobile phone browser seems to hold a candle to mobile Safari.

Isn't that theft?

Someone needs to explain how distribution channels can legally divert these phones away.

Apple is the only producer of these phones (well, through OEM partners), wich presumably moves the phones to some Apple warehouses and they, in turn, are moved off to Apple stores and authorised resellers (AT&T, Orange, T-Mobile and O2 if I'm not mistaking).

So, where do all the grey market phones come from? And how can Apple account for them if they've never been in their warehouses?

Mine was bought in an Apple store so I'm not even worried about it but I wonder about those I see in downtown Montreal cell phone outlets (at a premium price). Should those be considered stolen devices?

Re:Isn't that theft?

From what I heard in another report people are purchasing the phone from legal sources but not doing the activation. Since activation is a seperate step it is easy to bypass. They then apply the various hacks and use them on thier networks.
So they are devices legally purchased, so they get counted as sales.
That is why they are considered grey market, they are a legal product being used in an area where the manufacturer does not provide support or authorize thier sale.

Re:Isn't that theft?

I've been working with and in China for 10 years now, this is how it works...

Company A from America contracts with Company C in China to build product I.

Company A orders 100,000 I's every month.

Company C builds 120,000 I's every month.

Company C ships 100,000 I's to company A.

Company C sells the other 20,000 I's domestically at a higher profit.

Happens all the time. That's how most IP/knockoffs in China come about. Same product line, same product, they just build a few extra (at their cost, their customers know what the BOM is, and can quickly figure out overcharges) and sell them locally for more profit.

The key to keeping IP "protected" in China is to partner with a strong Chinese manufacturer and give them financial incentives to police the market for you. It's what I do with my IP; I have two "blessed" factories in China authorized to build with it, and they get to maintain that "blessed" status as long as:

1. The products they build meet quality standards
2. The products they build meet typical BOM and profit margin costs
3. They monitor and police the Chinese market for me to watch for knock-offs

The carrot? They get a virtual "lock in" of clients. They get to charge a few percent more profit because my IP carries a premium.

The stick? They would lose the lock in, and either lose their "blessed" status or end up having two, three, or a dozen more factories so blessed and then lose their premium profit.

The key to China is pretty simple - make it worth their while to do the policing for you. It's all about the RMB, folks...

Re:Isn't that theft?

Based upon the number of iPhones available for sale in Shanghai, Nanjing, and Beijing I'm pretty sure there's a lot of extra production going on...

Restricting a component is a good approach, as long as you can guarantee restriction of that component. You know the back-channels of China, though! A cousin of the senior engineer happens to work at that component vendor and over dinner at the New Year's celebration a deal is struck...

Personally, I've found it better to control on deliveries to the destination market (usually the US and the EU), and incentivise the Chinese factory strong enough that they make the same amount of money AND don't have the headaches of extra production to just play ball from day one.

BTW, for those others reading this little piece of lint (that is what a small, sub-thread is, right?) the problem is bad in China, but about 5X worse in India, based upon my experiences (consumer electronics products).

failed projections and "costs"

For Apple, the booming overseas market for iPhones is a sign of its marketing prowess but also a blow to Apple's business model, costing the company as much as $1 billion over the next three years, according to some analysts.

Gah, I hate that terminology. Making a business model around a certain fee structure, and then failing to get people to play along with your business model, is not a cost. It's just like those piracy reports where they say they LOST a billion dollars because people who were never going to buy the product ended up not buying the product. Apple may fail to meet projections. Apple may wish more people would fork money over to their exclusive business partners. Apple may have had their heart set on a shiney new building or parking lot or bonus for Steve, but not being able to meet those expectations isn't a loss or a cost. It's a failure.

Re:failed projections and "costs"

I live in north america. The only stopping most people of doing anything is the fear of getting caught. If there isn't a fear of getting caught, things automatically become "right", or even MORE than right, because they are "sticking it to the man".

The only question I have for you is the following: You said you lived in an underdeveloped country. Is it illegal in your country to pirate US-made stuff? I Don't live in the US myself, so I sure as hell don't follow US laws. I follow my country's laws (which however, support copyrights), and thats it. If tomorrow the law says that copyright is null and void, I'll only buy videogames (because I'm a collector), but movies will all get pirated, and software will be free (and as a software developer, I'll change job!).

Personally though, when I was young, my family could barely afford food (if that). If we couldn't afford something, we didn't buy it. Simple as that. Didn't go and get a bootleg. Sure, it meant I spent most of my life with no computer, no videogame, no nothing, but Im still alive.

(I'd make exception to that on softwares and tools that would help someone get OUT of poverty. Entertainment is one thing.... education and such, I feel is a RIGHT, not a priviledge, like games are.). Besides, if pirating tools and software get you rich, then you'll have money to buy them later :)

Having worked with apple since the late 80s

Apple always known about the gray market, Apple always supported the gray market, Apple always whined about the gray market. The truth is they always wanted and needed all the incremental revenue they could get. On the front end I remember them going out to the gray resellers and collecting serial numbers swearing they will get to the bottom of their source. On the back end they continued to pump millions of MDF dollars into known gray resellers to subsidise their low margins and to encourage them to keep up the volume. With the dollar being low and economy sucking eggs at home they are happy to offload as many units overseas with or without subscriptions. This gets rid of inventories that they will eventually have to price-protect at disti or super-retailer levels, and frees up purchasers to buy the new better/bigger products. The Spice Must Flow.

Another piece of purposedly planted misinformation

There's never been any negotiations between Apple and China Mobile. Needless to say, they have never broken down, since there was nothing to break down.

Both lies were nothing more than another drops in the long stream of manipulative misinformation about Apple concocted by stock market criminals. Steve Jobs clearly debunked these rumors, but apparently, after waiting for a short while, the criminals are trying to milk this cow again.

Re:Remember

Can't say I'm all that surprised about the phones being used in China or the copycats. I guess with one of the world's largest markets, there's going to be a healthy "grey" market too.

Re:Remember

Having been in Shanghai last autumn I'm wondering why people are surprised right now. I've seen more iPhones on the street there than in Germany. The electronics markets are full of them.

Re:Remember

Can't say I'm all that surprised about the phones being used in China or the copycats. I guess with one of the world's largest markets, there's going to be a healthy "grey" market too.

Sure, and with China's well documented tendencies towards theft of intellectual property, no one should be surprised.

What we should be doing here in the US, though, is everything we can to discourage use of Chinese products. There's no need to give China all our wealth and in the process create a powerful competitor. Problem is, we're already there...now it's time for damage control. The one good thing about a weak dollar policy is it will help.

Good thing we have a big crop of American scientists and engineers to compete into the future! Oh, wait...

Re:Remember

Sure, and with China's well documented tendencies towards theft of intellectual property, no one should be surprised.

Going with the Slashdot meme here, it's not theft because they haven't taken it away from you - you *still* have your IP.

But then I guess that it's only when $BIGFACELESSCORPORATION is complaining about you downloading their products in violation of US copyright law that such semantics come into play.

When another country is getting competitive against the US they *must* be *stealing* your ideas!

Re:Remember

China has, in the past, reverse engineered entire automobilies, built them cheaply, then sold those as OEM. This is a huge problem because we all know most knock-offs don't have the same quality standard as the origional. But at the same time they make true OEM auto makers jump through hoops in order to just get their server parts into the country (I've been dealing with this for the past two years).

China's trade practices are unfair and their government encourages deceit. It is IP theft.

And I don't even work for a US based company... so it's not US vs China.. it's China vs the Industrialized world.

Re:Remember

The Chinese make cheap goods:
1) People like to buy cheap goods

There, fixed that for you.

Capitalism/The Market is to blame. People want to buy commodity goods (virtually everything these days) as cheaply as possible.

you are joking right?

An economic embargo to force China to play nice in the ways that western governments deem nice will work

Your whole post is simple minded but this takes the cake. You think a country with a population of over 1 billion people that is joining the ranks of developed nations can be forced by an embargo to change their ways? You do realize just how many American dollars they own right?

In your ideal view of the world the only things we get from China is the cheap crap we don't need, and if we could just stop being addicted to cheap crap things would go right back to being pleasantville. Keep thinking that while sitting on a chair made out of chinese parts, wearing clothes made by chinese companies, typing on a computer manufactured in china. Do you really want the job of making these things? Wouldn't you much rather get an education and sit around and post on slashdot all day?

It looks like there will be more and more China bashing coming up, and it makes sense. It is easier to see the world as black and white, us vs. them. It is easy to disregard how complex a 1 billion person social system must be that has underwent revolution after revolution in the last hundred years. It is easy to proclaim that American's are the only ones that can properly carry out capitalism, when the Chinese have only been at it for 20 years.

and trust me, I don't like Clinton or her ol' boys network, but you don't know anything about business if you think cutting off one of the largest growing markets is a good idea.

Re:you are joking right? I second that not all is

cheap crap coming out of China.

Even Japan and Korea have been forced to manufacture in China, and Chinese companies DO realize that they have to improve or else...:

Japanese management style in China? Production practices in ...
http://www.blackwell-synergy.com/doi/abs/10.1111/1468-005X.00058 [blackwell-synergy.com]

Location decisions of Japanese new manufacturing plants in China ...
http://ideas.repec.org/a/spr/anresc/v40y2006i2p369-387.html [repec.org]

Even way back in 2002:

Samsung, LG Relocating Plants to China| Korea.net News
http://www.kois.go.kr/news/news/newsView.asp?serial_no=20020505006&part=104&SearchDay=2002.05.06 [kois.go.kr]

I find it hypocritical that US and wester nations (but the US, particularly) will spew volumes of criticism against China when just recently we have facing us a 143 million pounds beef recall. We endured selenium and other chemicals and metals in our water supply, with government not being aggressive enough on some offenders.

Granted, it is totally unacceptable for any company to produce goods containing lead, arsenic, other toxins, or flaking/dangerous matter.

Re:Remember

Yes, because if it was built in California, them shady Chinese wouldn't be able to get their grubby little paws on it.

Great logic.