BlackBerry deal bolsters Foxconn's attempts to turn into smartphone designer

Foxconn’s BlackBerry deal marks the Taiwanese firm’s biggest step up the value chain - a chance to not just assemble smartphones, but help design them, too.

The agreement to design and market phones starting in Indonesia, the world’s fourth-most populous country but an under-penetrated market, is a boon to a mega-manufacturer trying to grow its margins while making a play for a bigger slice of the global mobile devices market. Best known for putting together iPhones, Foxconn honed its skills by meeting Apple’s exacting standards and supply chain rigour. It boasts a workforce of more than 1 million and the scale to negotiate cheaper component prices than BlackBerry could obtain on its own.

Bolstering Foxconn’s makeover

BlackBerry announced that Foxconn will help design the hardware for its future low-end devices as part of a 5-year deal, furthering the template for manufacturing specialists to scale the value chain. BlackBerry itself will remain focused on software technology. The Canadian firm wants to produce many of the new phones in Indonesia - the first new model is codenamed Jakarta - where Foxconn has been navigating bureaucracy for over a year to set up a manufacturing plant in Southeast Asia’s biggest economy.

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Foxconn - the trading name of Hon Hai Precision Industry - expects an agreement with local authorities in February, and plans to set up joint ventures with local private firms to tap the potentially vast Southeastern Asian market. While it waits to set up production facilities in Indonesia, Foxconn will make BlackBerry phones at its Chinese factories. Indonesian government officials have said Hon Hai wants to gradually invest as much as $10 billion over 5 years with local partner Erajaya Swasembada , and Indonesia will offer the Taiwanese firm a tax package aimed at kickstarting the plan.

“BlackBerry wanted to develop new products in Indonesia, while we’re also tapping the local market there. They saw our ambition, so we started talking,” said Foxconn spokesman Simon Hsing. “The partnership gives us mutual benefits to explore existing and new emerging markets together.” The first Foxconn-built BlackBerry - a low-cost 3G model based on BlackBerry 10 software and targeting Indonesia - could be rolled out by April.

“A strategic partnership with BlackBerry is a recognition of Foxconn’s capability and new business model as an IIDM (Innovative Integrated Design Manufacturer) as our chairman Terry Gou calls it,” said Foxconn’s Hsing. “We’re no longer just a contract maker; we provide total solutions - from design, manufacturing, component supply to logistic management.”

Hon Hai has become the world’s largest electronics manufacturer after years of helping Apple and other tech giants put together their gadgets. That experience means it brings a number of advantages to the table. As Apple’s largest supplier, Foxconn has undergone years of manufacturing to the Cupertino company’s high standards. Its unmatched scale should allow it to buy components more cheaply, BlackBerry says. And Gou has made no secret of his ambitions to usher Foxconn into the increasingly crowded smartphone space, boosting margins as a result.

Foxconn has also extended its business this year to provide devices and applications that build on Mozilla’s Firefox operating system. But in recent years, the rapid rise of rivals like Pegatron Corp and increasingly tough demands from clients as competition intensifies may have put pressure on margins. Worker-rights advocates and major customers like Apple are also demanding Foxconn and other contract manufacturers improve wages and working conditions following a series of high-profile suicides and reports about untenable labour conditions at Chinese factories.

“Margins under this partnership with BlackBerry will definitely be higher,” said Arthur Liao, a Taipei-based analyst at Fubon Securities. “The most profitable bit will come from component sales and after-service, which includes inventory management and component repairs,” he said, adding that margins from after-service are usually above 15 percent, three times those on pure manufacturing.

FIH Mobile Ltd, Hon Hai’s handset making arm for non-Apple brands, will be the unit that collaborates with BlackBerry. The Hong Kong-listed company returned to a small profit in January-June after losing US$226 million in the same year-earlier period as orders fell from clients such as Nokia Oyj . Current FIH clients include Sony Corp and HTC Corp. According to Fubon’s Liao, FIH made around 50 million phones this year while Wistron Corp, BlackBerry’s contract maker, shipped around 20 million BlackBerries.

Shares in FIH, which on Monday forecast a net profit for the full year, have gained 9.4 percent to a 2-week high since the BlackBerry deal was announced. BlackBerry’s decision to produce the devices in Indonesia and Mexico is a pay-off for Foxconn’s huge investment in those two markets. Foxconn has shifted part of its expanding production facilities to Mexico since 2009 as this is close to its major customer, Apple. It’s unclear how far the BlackBerry brand travels beyond less-lucrative emerging markets.

Starting at the low-end means taking on Xiaomi and other emerging brands that excel at cut-rate smartphones, a potentially margin-eroding and debilitating battle. The rise of Chinese gadget makers has already dented Apple’s and Samsung’s market share in China and other developing countries, and Xiaomi has said it will now focus on Southeast Asia - precisely where Foxconn and BlackBerry mean to kick off their partnership.

To be sure, that’s where the BlackBerry brand remains strong. While it has fallen out of favour in Western markets, it still has a cachet and name recognition in Asia, particularly in Indonesia and other promising markets like India. It has other things going for it, too.

Foxconn will be helping in the design and manufacturing of the new phone, but taking on the inventory risk. Foxconn’s scale means it should be able to bring down the cost of the phone as it has the muscle to source components at lower prices. “I’ve got a really good bill of materials right now because of Foxconn - you know their volumes. I can’t buy components at prices anywhere close to the ones they buy at,” BlackBerry CEO John Chen told reporters. “This is a testing ground for both us and Foxconn. They are testing us and we are testing them.”

Reuters