China locks down world's largest iPhone factory, Apple's share prices fall 3.7%

With little warning, China locked down the world's largest iPhone factory on Wednesday, declaring the zone around the Zhengzhou Foxconn Technology Group complex off-limits to combat a local Covid-19 outbreak. It's the last thing Apple Inc. needed.

The abrupt move is expected to further disrupt a factory already grappling with an outcry over an on-site coronavirus outbreak, worker exodus and enforced quarantine. Local authorities said Wednesday that they'll sterilize Foxconn's campus and the surrounding areas in the next three days and send N95 masks to workers, another sign of the government's tightening grip.

It served up a stark reminder of the dangers for Apple of relying on a vast production machine centered on China in a time of unpredictable lockdowns and uncertain trade relations. The company's shares fell 3.7% on Wednesday, dragged down in part by the latest comments from Federal Reserve Chairman Jerome Powell.

"The Zhengzhou plant plays a monumental role in increasing capacity ahead of the holiday season," said Nicole Peng, an analyst with Canalys. "Some of the orders generated in holiday promotional campaigns may not be able to be immediately delivered. Product delivery in certain channels could also be delayed."

For now, Foxconn's plant will keep operating within a "closed loop," or a self-contained bubble that limits contact with the outside world, the company said in a statement Wednesday. That will keep some production going. But Foxconn didn't address questions about how it will ship goods in and out of the compound during the area's lockdown.

Xi Jinping's Covid Zero policy, which relies on swift lockdowns to stamp out the disease wherever it pops up, has shown little regard for the economy and thrown swaths of the global supply chain in disarray. It's curtailed output for big names, from Tesla Inc. to Toyota Motor Corp., often with little advance warning. But Apple is by far the largest business to adopt China as its factory floor.

Zhengzhou is the site of Apple's most critical production, churning out four in five of its latest-generation handsets and the vast majority of iPhone 14 Pro units, according to Counterpoint senior analyst Ivan Lam. The Cupertino, California-based company relies on its smartphone for roughly half its revenue, and the lockdown comes in the middle of its peak production season in the buildup to holiday season shopping.

Apple's iPhone production ramps up to tens of millions of handsets per month at its peak -- hundreds of thousands a day -- every one of which needs a plethora of components, from chips and displays to casings.

A big reason why Apple's suppliers haven't yet shifted more of its iPhone production out of China is the accompanying component supply chain, which largely makes parts in China, according to Counterpoint's Lam. Even India, which is the only other country with a plant qualified to produce iPhone 14 Pro units, mostly gets its components shipped in from China and just does final assembly and packaging.

Much now depends on the length of the lockdown, which is intended to last for a week until Nov. 9, but officials elsewhere in China have extended such actions for weeks, sometimes months, at a time.

The government notice emerged after Zhengzhou reported Covid-19 cases jumped to 359 for Tuesday, up more than threefold from a day before. New case numbers for Nov. 2 dropped to 167, though it's too early to tell if curbs might get rolled back. Officials there have in recent days progressively imposed a web of smaller lockdowns and restrictions on areas as small as an apartment block.

Chinese officials have allowed so-called green lanes for important enterprises during past lockdowns, but the sheer scale of Apple's logistical needs might give some pause. Foxconn also urgently needs workers to replace those who've left, and it's hard to hold a recruitment drive when crowds are forbidden.

While Foxconn should have enough materials stockpiled to keep production humming for weeks, questions remain about whether it will be able to ship any finished products out. The language of Zhengzhou's lockdown notice is unequivocal in forbidding all activities and vehicle movements other than those for essential purposes like distribution of medical supplies. Foxconn's inventory will eventually need replenishing, in any case.

As China's largest private-sector employer and a key tax contributor in Zhengzhou, Foxconn will likely win concessions from local officials -- but those will need to be significant. China's top chipmaker, Semiconductor Manufacturing International Corp., worked with local authorities to transport much-needed materials into its Shanghai plant when the financial hub was in total lockdown early this year.

Foxconn has sought to mitigate the potential disruption by raising wages and arranging for backup from its other Chinese plants should assembly lines stall in Zhengzhou. Apple can handle 100% of orders for iPhone 14 and older models via other sites within China, but only has a handful of much smaller locations qualified to handle the iPhone Pro. Its main alternative is a smaller plant in Guangdong province, Lam said. Some of Foxconn's factories in other parts of China haven't been running at full capacity due to reasons including Covid disruptions, Peng said.