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Apple’s cutting-edge manufacturers are getting sliced up even more than expected

Even when there’s a new iPhone on the way, these are not easy times for contract manufacturers like Foxconn and Pegatron, the Taiwanese companies that have built massive businesses assembling Apple’s gadgets on razor-thin profit margins.

Pegatron’s second-quarter net income fell 28% to $NT1.39 billion ($46.6 million) from a year earlier, well short of expectations. Declining business from clients such as Toshiba and Microsoft, which is writing down the value of unsold Surface tablets made by Pegatron, more than offset the gains from making Apple’s iPad.

Apple is Pegatron’s biggest client, accounting for 27% of revenue according to Bloomberg, and that percentage is only expected to climb as the PC business declines. According to multiple reports, Pegatron is also assembling the low-cost iPhone that will be unveiled on Sept. 10. Analysts warned that Pegatron is at risk of becoming over-reliant on Apple, especially with rival Foxconn’s predicament—a contract manufacturer that has hitched its wagon to a ruthless, formerly invincible client—as a cautionary tale.

Foxconn, also known as Hon Hai, reported over the weekend that consolidated July revenue fell 1.65% year-over-year to $NT300 million ($10 million), and sales for the first seven months of the year were off 8.75%. Even as it loses some business to Pegatron, Foxconn is expected to boost shipments of Apple products as the US company introduces new smartphones and tablets later in the year. Foxconn is trying to limit its exposure to the whims of Apple by developing its own gadgets like a Firefox-powered tablet.

In addition to being captive to Apple’s product release cycle and CEO Tim Cook’s proven ability to squeeze any possible inefficiency out of his company’s supply chain, the contract manufacturers are facing persistent criticism from labor advocates and environmental regulators. China’s Ministry of Environmental Protection has accused Foxconn and UniMicron Technology of releasing toxic wastewater into rivers in eastern China, and the nonprofit group China Labor Watch has accused Pegatron of creating oppressive working conditions that violate Chinese law and Apple’s labor standards.

This is what the cutting edge of global manufacturing looks like: Just because you enabled a sea change in the way that electronic gadgets were made doesn’t mean you will be well-positioned for the next wave. Assembling devices for Apple has always been a cyclical, low-margin business, albeit one that was highly desirable when the Steve Jobs-led firm could do no wrong, and its revolutionary products were sure-fire hits. Now that the rest of the world is catching up to Apple on tablets and Google’s Android platform has surpassed the iPhone, there are dangerous new uncertainties for business models with barely any room for error.

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