Apple Shifts Supply Chain Away From Foxconn to Pegatron

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• EVA DOU

TAIPEI—For years, nearly all of the world's iPhones and iPads rolled off the assembly lines of a single company: Foxconn.

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Pegatron began making iPad Mini tablets, left, last year. Foxconn continues to assemble the larger iPads, right, as seen here in a store in China.

It was a famous partnership between two outsize personalities— Steve Jobs, Apple Inc.'s intense and mercurial co-founder, and Terry Gou, the Taiwanese manufacturer's equally demanding chairman.

But under current Chief Executive Tim Cook, Apple is dividing its weight more equally with a relatively unknown supplier, giving the technology giant a greater supply-chain balance.

Pegatron Corp., named after the flying horse Pegasus, will be the primary assembler of a low-cost iPhone expected to be offered later this year. Foxconn's smaller rival across town became a minor producer of iPhones in 2011 and began making iPad Mini tablet computers last year.

Pegatron's rise means an end to the monopoly that Foxconn Technology Group —the trade name for Hon Hai Precision Industry Co., the world's largest electronics contract manufacturer—has held over the production of Apple's mobile products.

People familiar with the matter point to strategic reasons for the shift: risk diversification after Foxconn's manufacturing glitches last year with the iPhone 5 that resulted in scratches on the metal casings, and Apple's decision to expand its product lines amid growing competition from Samsung Electronics Co. and others.

Pegatron also has been willing to accept thinner profits as it courts Apple's business, analysts said. The company declined to comment about its pricing.

Apple declined to comment.

Foxconn's cost advantages from scale have waned as it works to improve factory conditions after a spate of high-profile worker suicides and accidents in recent years. Although Pegatron briefly caught the public eye in 2011 due to a factory explosion that injured dozens of workers, the smaller company has largely escaped the laserlike spotlight that has forced Foxconn to increase wages and make changes to its labor practices.

Foxconn, in its growing heft as the world's largest electronics contract company, was also getting more difficult for Apple to control, with incidents such as changing component sourcing without notifying Apple, people familiar with the matter said. At the same time, Foxconn became frustrated with the growing complexity of Apple products, such as the iPhone 5, which is difficult to make in the volumes Apple needed.

Executive changes at Apple have also made a difference. Mr. Jobs had been easier at forgiving his favorite manufacturing partner, according to several people familiar with the relationship. Now, instead of relying on the uniquely close partnership between "two leaders with a hero complex"—as one of the people said—Mr. Cook is putting a greater premium on risk diversification, they said. Still, Mr. Cook and Mr. Gou have a strong relationship and have known each other even before Mr. Cook joined Apple in 1998, one of the people said.

But with its growing importance as an Apple supplier, Pegatron will likely also face growing scrutiny. The company declined to comment on whether it has made any changes to its labor practices after the 2011 factory explosion.

As with other contract manufacturers, Pegatron's success is based largely on secrecy and tact as it juggles production of competing products from companies such as Apple, Microsoft Corp., Hewlett-Packard Co. as well as Dell Inc.

At its sleek headquarters on the outskirts of Taipei, engineers serving different clients eat lunch together in the same cafeteria and gather after hours in the gym, but they rarely know the details of each others' work. Sensitive projects are cordoned off by keycard access, or even face recognition software.

While Pegatron migh seem to be a newcomer on the surface, the Taipei-based company's Apple ties run deep, with its earlier incarnation packaging Apple computers by candlelight more than a decade ago.

Pegatron Senior Vice President Andy Tsai said that in 1999, the company he founded, Alpha-Top Technology Corp., landed the contract for Apple's first-generation iBooks. It wasn't the best first collaboration: a massive earthquake in Taiwan knocked out power and paralyzed production.

"At that time, there were a lot of Apple people in my factory, telling us to find a solution," said Mr. Tsai. "I bought a lot of power generators, and we even used candles on the packing line."

Alpha-Top managed to keep its Apple business, although orders tapered off after it was acquired by Asustek Computer Inc., which juggled its own competing brand and contract work. Asustek spun off its contract manufacturing business in 2010 into Pegatron under pressure from clients.

Pegatron's revenue in the first quarter—219.1 billion New Taiwan dollars (US$7.4 billion)—is dwarfed by Foxconn's NT$809.1 billion ($27.3 billion). The smaller company also has thinner operating margins: 0.8% compared with Foxconn's 1.7%.

Pegatron, which has about 100,000 employees in Taiwan and China, expects to increase its China workforce in the second half of the year by around 40%, Chief Financial Officer Charles Lin said. Analysts attribute the staffing increase largely to expected production of low-cost iPhones.

Pegatron began making iPad Minis last year, but some people familiar with the situation said low yield rates meant volume was lower than originally planned and Foxconn ended up taking on the bulk of the production.

"There's a learning curve for any new products, so our yield rates are increasing," said Mr. Lin, although he declined to comment on any Apple products.

More than half of Pegatron's revenue in its consumer-electronics and communications businesses this year will be from Apple, said KGI Securities analyst Angela Hsiang. She expects Pegatron to make the majority of iPad Minis sold this year, as well as the majority of the coming less-costly iPhone.

Foxconn spokesman Simon Hsing conceded the company is in the midst of a challenging period.

"We are transforming the business and expanding in areas like e-commerce, " Mr. Hsing said, without providing more specific details.

Write to Eva Dou at eva.dou@dowjones.com