Thursday, February 23, 2012

Learning Economics From An iPad

Far too often, books about and teachers of economics attempt to give us theoretical answers to questions on the subject as illustrations of their knowledge and wisdom.  Whether from the Austrian school or the Keynesian one, these answers begin with the assumption that their theory is correct and that certain answers will be the result, on the basis of their theoretical assumptions.

I don't know about you, but I'm a skeptic by nature and training.  I tend to reject out of hand solutions that are correct only 'in theory'.  They tend to have the same accuracy level as a coin flip, and since they don't or can't show the work used to reach them ... they are sometimes even less credible.  So I decided to see what happened if you worked an economics problem in the real world, using the facts that we know and some assumptions taken from other areas of capitalism to bolster the credibility of our calculations.

I decided to use the i Pad as the basis for this little experiment, not because I have one, but because of the recent furor over the pay rates of the workers of the Foxconn factory in China that makes them. I also chose it because there seems to be a bit of a stink (pun intended) about the conditions of this plant and why these devices are not being assembled in this country by a company that seems to be doing very well while based here.

In the spirit of full disclosure, I must admit I'm not a fan of Apple; and that my only concession to it is my I tunes account, begun when it was the only legal music download alternative.  I have a natural abhorrence for Apple products, cool as they are, because the company's proprietary application restrictions prevents anyone from playing their game on their home field.

Let's begin with some 'facts' to enter into our equation (and remember, I'm trying to keep this simple):

- The current i Pad 2 carries a price tag of anywhere from $499 to $829 (depending on the specs of the unit), so for the sake of argument and in the hopes of making calculations simple, let's set the price of the device at a median of $650. 
- The wage earned by the average worker, at least according to the ABC report on Foxconn, is $1.78 per hour.
- The Minimum wage in the United States is $7.25.
- The Minimum wage in the State of California, where Apple's Cupertino headquarters is located is $8.25.
- China's environmental restrictions for manufacturing are close enough to being non-existent so that they need not be considered; those in California are the toughest in the nation.

Bear with me and follow closely as I attempt to exhibit my supremely inferior maths skills, in combination with some knowledge that I picked up as the Director of Operations for an equipment manufacturing plant down in Georgia.

There are two types of cost in any given product.  There is a simple cost, which includes the cost of the materials alone; then there are 'burdened costs', which take into account the cost of overhead (including labor, building, regulatory compliance, etc.) and fully burdened costs (which take into account the costs of Administration, sales, marketing, and profit).  In order to make a profit and stay in business, a company must sell its product for at or for more than this fully burdened cost, which would include manufacturing costs plus administrative costs.  (This must have been the part of capitalism or a business plan that many of the 'green energy companies failed to understand.)

Now if we start off with the assumption that the unburdened cost of materials is about half of the final sell price (a pretty good assumption based on my past experience), we start with a base cost of $325.

$325 x 1.4 (40% for mfg overhead) = $455
$455 x 1.4 (40% for Admin overhead) = $637, pretty close to our original $650 number, which shows that most likely my assumptions on cost and burdening factors still hold true; and likewise showing a modest additional profit of $13 to be shared between plowing money back into the company and dividends for stockholders if I were strictly correct.

But that's all based on wage costs at Foxconn in China....

Now if we move our manufacturing facility back to the good old USA and build near the Corporate headquarters, our costs are going to go up.  Why our labor rates alone will see an increase of 460%, and the building, property, regulatory costs and taxes (CA is a high tax and regulation state after all) are likely to go up correspondingly.  But again for the sake of argument, let's use the wage rate as what is probably a pretty accurate bellwether of such cost increases.

$325 x 6.44 = $2,093 (our original 1.4 markup multiplied by 4.6 times to cover the increase in salary alone that go from $1.78 to $8.25 per hour, as well as the increased real estate and regulatory costs of operating in CA), and now we have our burdened cost.
$2,093 x 1.4 = $2,930.20 for our fully burdened cost. (We'll give ourselves a break and assume that our Admin costs are and always will be a US cost.) 

Now remember that in this example, I just used a minimum wage comparison in CA.  It seems highly unlikely that such a manufacturing operation would be allowed to operate with workers at minimum wage.  Far more likely in fact is that it would be a union assembly plant.  Now again, just to keep me from taking off my shoes and socks to perform the calculations, let's say that union scale is 10 times the $1.78 per hour in China, or $17.80 per hour (certainly not an unreasonable union wage, especially on the West Coast).

(Building, taxes and regulations and real estate won't increase, but with wages going up and staying up, I'll be nice and use the 1000% increase in labor previously mentioned to equal a total 8.5 times increase of the 1.4 burdened costs for a total cost factor of 12 )
$325 x 12 = $3,900 is now the calculations for our burdened cost.
$3,900 x 1.4 = $5,460 (again using the fixed Admin burden) gives us the fully burdened cost of an i Pad 2.

What is the likelihood that the i Pad would be as popular, or even a marketable product, at a price approaching these levels?  How likely would Apple be to even bring such a product to market, let alone to be 'knocked off' by other manufacturers, if this were the case?

Come to think of it, what do you think would be the cost of those fancy tennis shoes, those designer jeans, or hundreds of other products manufactured in factories around the world if similar math were applied to them.  Now while you are digesting that, ask yourself what kind of wages you would have to earn in order to be able to afford such products in your daily life.  Then ask what earning such wages would in turn do to the original calculations used for moving such manufacturing processes back into the US. (But don't do the calculations more than once, since the answer is a runaway spiral of costs and price that never ends.)

Now lest you think that my efforts here are purely selfish and uncaring (remembering that I am an unreconstructed Capitalist), what would losing all of these jobs do to the lives of employees in China?  Having perhaps taken away the jobs of these workers around the world for all of these products, how would they be expected to feed their families?  If we left these jobs in place but raised the salaries of the workers and working conditions of the factories in China to our levels, what would that do to the cost of the items just calculated? 
(Oh you don't care about these foreign workers as long as these jobs can be brought back to this country?  Who's being selfish now?)

See ... It's amazing the economics that you can learn on an i Pad, even if you don't own or use one.  

So endeth the lesson ....


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