Apple's Bold Swim Downstream


Apple Computer CEO Steven P. Jobs always has gobs of new products to unveil to the Mac faithful at the Macworld trade show each January, and this year he showed up with a more startling bag of tricks than usual. The company that has become synonymous with high-end style in computers and music players unveiled not one but two new products aimed at Joe Mainstream.

Taking clear aim at the low end of its two core markets, Jobs first announced the Mac mini, an impossibly small $499 PC that is Apple's (AAPL) first entry into the sub-$700 market that now accounts for almost 70% of all home PC sales. Then he brought out the iPod shuffle, which is smaller than a pack of Wrigley's gum and starts at just $99 -- a far cry from the $249 the Cupertino (Calif.) company now gets for its cheapest music player, the iPod mini. "I think we're going to bring in a lot of new customers to Apple," said Jobs in a post-keynote interview, his iPod shuffle draped on its lanyard around his neck.

RIDING HIGH. The packed house of Macolytes loved it -- and most analysts are applauding as well. Still, the new strategy is not without risk. Chief among the fears: that by moving into crowded entry-level sectors, Apple could cannibalize its higher-priced products, putting at risk the strong profits it needs to finance innovation.

Jobs's shift comes even as many analysts were expecting the company to gain PC market share in 2005 for the first time in years -- without having to stray from its more lucrative high-end niche. "Some people will ask: Should they have left well enough alone?" says First Albany Capital analyst Joel Wagonfeld.

Clearly, Jobs & Co. believe the time is right to broaden out: Thanks to the phenomenal popularity of the iPod, the company is riding high. On Jan. 12, Apple announced that its fiscal first-quarter net earnings quadrupled, to $295 million, over the previous year, on revenues up 74%, to $3.49 billion. Sales of the red-hot iPod alone hit 4.5 million units, a 500% increase. Apple also sold 26% more computers than it did during the same period a year ago. Those numbers sent Apple's shares soaring in after-hours trading.

OS LURE. Crucially, many of the folks who bought the music player last quarter are Windows users. With iPod mania running full tilt, Jobs figures there's an opening to grab PC market share by drawing in users who want Apple's famous style and ease-of-use.

Until now, Apple products have been too expensive for most PC users, but Jobs is betting that the $499 mini could make Apple a viable contender at the core of the market. To simplify things even further, Apple made sure PC users can plug their existing display, keyboard, and mouse into the unit. "This is the most affordable Mac ever," Jobs told the crowd. "People who are thinking of switching will have no more excuses."

Low cost isn't the only lure. Jobs is also betting that once PC users finally get a chance to use Apple's highly regarded operating system and software suites, there'll be no turning back. The deluge of viruses and spyware targeted at Windows has reached such a pitch, Jobs figures, that people will be ready to embrace Apple's relatively safe OS.

FRAGMENTED MARKET. Apple intends to press its software advantage hard: While Jobs devoted a few minutes of his two-hour speech at Macworld to the Mac mini, he spent most of the speech extolling the Mac OS and the latest iteration of Apple's iLife software suite, which makes it easier than ever for users to manage photos, music, and video.

Jobs may have hit upon a winning strategy. Just ask Michael Wood. Having already fallen hard for his wife's iPod and intrigued by a $499 Macintosh computer, the Shelby (N.C.) auto salesman is now considering a Mac. Citigroup Smith Barney analyst Richard Gardner expects the mini could double Apple's market share in PCs, to 4%. That may not sound like much, but it would translate into an extra $4 billion in revenues for Apple.

What about the iPod shuffle? Having dominated the hard-drive segment of the digital music-player market, Apple is ready to take a run at cheaper players that use flash memory. Now that market is fragmented among dozens of players that charge roughly $150 for devices that hold 120 songs.

EXPANDING EMPIRE. What Jobs has done is deliberately undercut the competition. The base model of the new shuffle costs $99 and holds 120-plus songs. To get to that low price, however, he has designed a bare-bones player that may not appeal to everyone. Unlike many other flash players, Apple's gadget boasts no screen -- meaning users can't see or control what they're playing.

Apple is betting that there are plenty of low-budget buyers out there who will find the shuffle enough gadget for their needs. It also hopes they'll be tempted to move up into a pricier iPod, especially if they get hooked buying music from the company's iTunes Music Store, which currently plays solely on Apple products.

Even Dan Torres, vice-president for marketing at music player rival Rio, expects the shuffle to expand Apple's empire. "This is going to be another piece of the pie for them," he says. "It will attract new customers -- and be the third or fourth iPod for many [existing customers]."

KEEP IT SIMPLE. But couldn't the cheaper products prompt some customers to shun the higher-priced ones? For example, the hordes of people who bought iPods as gifts this year may be content to get that favorite niece a less pricey shuffle next year. Apple has done what it can to prevent that from happening by segmenting its lineup. With its far greater storage and better controls, the original iPod is a very different gadget from the shuffle. Likewise, Jobs, who shrugs off fears of cannibalization, has made sure the new mini lacks the power and many features found in the iMac and the company's higher-priced computers.

Still, Apple will have to tread carefully as its enters the low end of the PC market if it is to avoid succumbing to the profitless prosperity that has dogged so many others. After all, only Dell makes consistent profits these days in this business, and it's a very efficient manufacturer.

To beat the odds, Apple will keep its costs low so it can maintain its profit margins and thereby have the resources to keep innovating. That's one reason, analysts say, that the company has opted to keep its new products simple, with fewer or less expensive components. The iPod shuffle lacks a hard drive, enabling Apple to benefit from tanking prices for flash memory. The Mac mini has a slower chip and less storage than Apple's pricier machines. And leaving out the display, keyboard, and mouse cuts costs even further.

"TOO FEW OR TOO MANY". The upshot: Smith Barney's Gardner says Apple should churn out 15% gross margins for the mini, about what it gets for the iMac G5. And because Apple has already paid for the Mac operating system and its retail stores, says Gardner, nearly half of every gross profit dollar the mini generates will drop to the bottom line.

At the end of the day, most analysts agree Jobs has played his cards shrewdly. If cannibalization gets too severe or margins erode, Apple could back away from the low end. Indeed, the company seems to be proceeding somewhat tentatively. For an outfit that typically hypes its new hardware to the heavens, Jobs is notably low-key when it comes to the Mac mini. Nor is he predicting an overnight market share grab.

"We have our ideas about how many we can sell, but it'll be either too few or too many," he says. "I'll know in a month or so." Either way, it's not likely to end the good times in Cupertino. By Peter Burrows in San Francisco, with Andrew Park in Charlotte, N.C.


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