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 THE STAT 26Percentage of wireless customers who use their cell phones to take picturesMore Vitals
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AUGUST 5, 2003
Where "Think Different" Is Taking Apple Rather than accept being a niche PC maker, Steve Jobs is transforming his baby into a high-end consumer-electronics and services company From the word go nearly two years ago, sales of Apple Computer's IPod MP3 player have been music to the PC maker's ears. Never has that been more true than on July 16, when Steve Jobs & Co. stunned analysts by announcing they had sold 304,000 players in the company's third quarter, nearly four times most analysts' expectations. The reason: Customer demand soared in May after Apple (AAPL ) launched its third-generation iPod, which stores 7,500 songs in a player that's lighter than two CDs -- and is compatible with Microsoft's (MSFT ) Windows operating system. Apple's flagship retail store in New York City's Soho section stayed open until 11 p.m. the day of the launch just to meet the demand. "It's a paradigm shift at the company," says Charles Wolf, an analyst at investment firm Needham & Co. and a longtime Apple watcher (who owns shares of Apple stock). "They are redefining what kind of company they are." Indeed, the release of iPod for Windows last August established the demarcation line in an extraordinary strategic change for Apple, a company that over the past two decades has steadfastly refused to loosen its control over the creation, manufacturing, or distribution of its products. BEYOND THE MAC. Years after Apple launched its advertising campaign admonishing customers to "Think Different," CEO Steve Jobs appears to be taking his own advice. Instead of resigning himself to the idea that Apple will never be more than a niche PC supplier, Jobs is slowly transforming it into a high-end consumer-electronics and services company à la Sony (SNE ) -- one that he hopes ultimately will be less dependent on sales of the Macintosh PC, which now account for about 80% of revenues. Apple's transformation has been gradual. It started in October of 1999, when the company introduced iMovie, a video-editing program for the Mac that brought professional-quality digital editing to the masses. iTunes software for playing and managing digital music files came next, in January of 2001. Then just 10 months later, Apple launched the first iPod. Though iPod got rave reviews, it soon became clear that most people weren't going to abandon their Windows PC just for the chance to use what arguably was the best MP3 player on the market. So in August of 2002, Apple introduced an iPod for Windows. By Christmas, it plans to launch more new Windows-compatible products, such as the wildly successful music-download service, the iTunes Music Store, originally just for Macs. "That represents a shift in strategy, whether they realized it at first or not," says Wolf. "The iPod was the first product that wasn't tethered to the Mac." Apple executives decline to comment on company's strategy. "CADILLAC OPERATION." Nonetheless, a look at Apple's balance sheet reveals why it's so anxious to broaden its audience beyond the Mac's niche audience. In its third quarter, which ended June 30, Apple earned $428 million in gross profit, a 27.7% margin on sales of $1.55 billion, but it spent $419 million on operating expenses, leaving it with an operating margin of just 0.6%. "Apple's gross margins are the envy of the industry," says IDC analyst Roger Kay. "But below the line, they give it all back. They pour money into R&D and [selling, general, and administrative expenses]. They have expensive retail locations and high-end advertising. It's a Cadillac operation." Wall Street hasn't punished the stock, however. Apple shares are trading at a 52-week high of about $21. But to rise further, Apple has to do one of two things: Increase revenues and profits -- or cut staff and development and marketing costs. Jobs has clearly stated that his aim is to do the former. When the Net bubble burst in 2000, he promised his staff that there would be no layoffs. Instead, he said, Apple would "innovate through the downturn." SKYROCKET POTENTIAL? The iPod was the first step. According to an analysis by Needham's Wolf, at the current wholesale price of $360, a Windows version of iPod should have been able to capture close to a 10% share of the 2002 MP3 market -- about 900,000 units, worth about $325 million in revenue. At a lower price point, sales could skyrocket. Wolf figures that at a wholesale price of $315, Apple would still earn more than 20% gross margins and sell 1.25 million players. That's $400 million in revenues. Couple that potential with market researcher IDC's prediction that the MP3 market will nearly triple over the next three years, and it's possible that by 2006 Apple could generate $600 million in annual sales on the iPod for Windows -- boosting its total revenues by about 10%. "The iPod is the first step. It should not be the last," says Wolf. Morphing into a consumer-electronics company also capitalizes on a hip brand -- the cult of cool -- that Apple has spent billions building. Take the iTunes Music Store, which launched with much hoopla in April. Apple was the first player in that business to persuade the five major music labels to sign onto a pure à la carte download service, where music aficionados could buy individual tracks for 99 cents and burn them to a CD or transfer them to an MP3 player. STREET CRED. Until iTunes, customers' only legal option had been the more complex subscription services hawked by the label-backed services, Pressplay and MusicNet (see BW Online, 4/30/03, "Steve Jobs, the Pied Piper of Online Music", and 4/22/03, "Web Music Gets Its Act Together"). On its first day, Apple sold a million downloads. By the end of July, it had sold about 7.5 million tracks. Media reports at the time credited Jobs's street credibility in Hollywood as key to getting the service off the ground. (Jobs personally called individual artists, including Eagles lead singer Don Henley, to persuade them to make their music available on the service.) But insiders say it was more Apple's popularity with elite style influencers that helped persuade gun-shy music execs to grant the licenses required to create a less restrictive service. Says one label exec: "Until Apple, it wasn't cool to buy digital music. This was about getting to that pivotal group of people -- the people who buy the cool sneakers and wear the right clothes -- and showing them that legally downloading music could be cooler than stealing it."
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