The iPhone 5's Dirty Little Secret

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Reports from two Chinese worker-advocacy organizations point to a darker side of the new iPhone 5 release. Less than a month ago, it seemed that Apple's (NAS: AAPL) manufacturing partner had finally cleaned up its act, but new labor issues threaten to further tarnish the company's image. Is Apple's reputation sliding down a slippery slope it can't recover from?

The deets
A New York Times article published on Monday highlights further labor infractions by Apple's Chinese manufacturer, Foxconn International Holdings. Foxconn is Apple's largest supplier, but its 1.2 million-person workforce also builds devices for companies such as Cisco (NAS: CSCO) , Hewlett-Packard (NYS: HPQ) , Intel (NAS: INTC) , and Nokia (NYS: NOK) .

After several journalists first revealed gross misconduct at Foxconn's facilities earlier this year, Apple hired the Fair Labor Association to launch a full-scale investigation into its manufacturing practices. An August update not only reported that Foxconn had completed all necessary tasks on time, but also that the company was actually ahead of schedule on reforming its worker conditions.

Then this happened: China Labor Watch and Students and Scholars Against Corporate Misbehavior both revealed that Foxconn is using unpaid "interns" as labor on their assembly lines. Foxconn employs around 32,000 students, almost 3% of its entire workforce. Students receive a monthly $80 stipend, while Foxconn pays the rest of their would-be salary to the student's school.

Too much, too soon?
Although Apple and the Fair Labor Association might have been shocked to hear this news, Foxconn's labor shortage should have come as no surprise. With new regulations limiting worker overtime, Foxconn has had to dramatically increase its worker base in the past six months.

Unfortunately, Foxconn seems to have filled this need with hundreds of students pulled from school to assemble Apple products, including its new iPhone 5. China Labor Watch estimates that as much as 10% of iPhone assembly lines could currently be staffed by students to meet high short-term demand for Apple's newest device.

Foolish bottom line
Labor costs account for just 5% of an iPhone's total cost. If we assume that half of that occurs in China, Foxconn's labor amounts to around $10 of an iPhone's final price tag. Not insignificant, to be sure, but Apple's brand and reputation allow it to price its products at a 25% to 50% premium over competitors. You do the math: Apple shouldn't be risking $25 to $50 to save $10.

Even though Foxconn was calling the shots, Apple ultimately failed us on this one. The company needs to play hardball and not let mistakes like this go unnoticed. It's playing a dangerous game, and although I love Apple today, I'd really like to still love Apple tomorrow.

Despite all the bad publicity Apple's received, its transparency and accountability give me reason to believe that this company will continue to excel in the manufacturing sector. To understand the full context of Apple's business, the Fool has prepared a special report outlining his criteria for Apple's ultimate success or failure. It's chock-full of excellent analysis and comes with a full year of free updates, so be sure to pick up your copy today.

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Fool contributorJustin Loiseauowns shares of Apple and two really old iPods. You can follow him on Twitter,@TMFJLo, and on Motley Fool CAPS,@TMFJLo.The Motley Fool owns shares of Cisco Systems, Intel, and Apple.Motley Fool newsletter serviceshave recommended buying shares of Intel and Apple and creating a bull call spread position in Apple. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days. The Motley Fool has adisclosure policy.

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