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JANUARY 18, 2002 SPECIAL REPORT: THE FUTURE OF APPLE Finally, a Chance for Apple to Flourish Steve Jobs certainly has the needed pieces. The key question: Will its hot products and a major retail effort boost market share? AAPL ). At a time when the rest of the PC industry remains mired in a deep slump, Apple enjoys a strong order backlog for its newly introduced iMac models, which incorporate an innovative free-floating flat-panel display into a design more resembling a desk lamp than a desktop computer. The company has another hit on its hands with the nifty iPod, the portable digital-music player that sold 125,000 units in the last two months of 2001 despite its relatively stiff price of $399. It also has the new iPhoto, a photo-editing product that makes it much easier to organize and view pictures taken by any digital camera. For digital camcorder buffs and digital-music freaks, Apple's iMovie software and iTunes MP3 organizer and CD-burning software complete a troika of applications that are in demand. Add them up and they form the basis for Apple's claim that it has built a hub for those who embrace the digital lifestyle, one that's better - or at least easier to use -- than the products sold by any other computer company. NEARLY FULL ARSENAL. The good news doesn't stop there. Apple's long and torturous development of a replacement for the creaky Macintosh operating system -- the software that controls the basic functions of a computer -- appears to be largely finished with the latest version of Mac OS X. Based on the widely used Unix program, OSX has wowed developers with its stability, graphics capability, and flexibility. With its product arsenal nearly full, Apple is aiming for renewed market prominence by turning to the audience that has always appreciated it most -- the masses. Since May, 2001, it has opened 27 Apple Computer retail stores in high-traffic malls across the country, an attempt to sell more effectively than at the warehouse-size electronics stores (through which it still distributes), where Macs must compete for shelf space with a slew of other major brands. Jobs says 40% of all buyers at his stores are new customers. During the company's quarterly conference call on Jan. 16, Apple CFO Fred Anderson speculated that the majority of these buyers are abandoning Windows machines for the cuddlier Mac. Meanwhile, Jobs scored a marketing coup when Time magazine ran a cover story on the new iMac. All of which can add up: Apple now boasts operating margins of about 30% -- triple or quadruple the average for the temporarily downtrodden PC biz. Plus it has $4 billion in the bank, and Apple expects to see significant revenue growth on the back of the iMac introduction. TO THE NEXT LEVEL? This rosy picture has just one flaw: Despite Apple's considerable achievements -- and the hype -- its market share remains stalled at a decidedly modest 5% of the U.S. household computer market, according to International Data Corp. Worldwide, its share is closer to 3%, though Apple claims that number would be higher if its international education market were included. The company has clearly won millions of new users with its hot iMac products since the line was launched in late 1998, but that constitutes a fraction of the growing legion of PC buyers. Yes, Jobs has more than stanched the bleeding. He has turned Apple into a lean and mean, highly profitable niche computer company. But can he take his baby to the next level -- and generate enough top-line growth to keep investors happy and make Apple more than the T-bird of PCs? Jobs thinks his versatile new lineup will appeal so much to the average consumer that Apple can at last get beyond its niche role as the computer for schools and graphic designers. This year's results will tell whether he's right. Apple's chief certainly has laid extensive groundwork for this effort. Over the past five years, he has done a textbook job of bringing Apple back to health, while capitalizing on its reputation as a computer company that relies on catchy product design more than the staid clock speed of its microprocessor. NICE NICHES. It's true that Apple has had little choice but to focus on its core markets: consumers, education, and creative professionals. They're about the only ones remaining from the days of a decade or so ago, when it last had a double-digit market share. Still, those markets don't look so bad, considering the vicious price wars that have erupted in the Wintel universe. The economic downturn has affected corporate demand for PCs far more dramatically than consumer demand, as evidenced by the strong Christmas sales of PCs boxes equipped with Microsoft's (MSFT ) newly launched XP operating system. Cheryl Vedoe, Apple's vice-president for education products, says laptops are the fastest-growing product in the education market, where she puts Apple's iBook market share at upwards of 25%. Jobs is clearly pursuing portions of the PC business that not only suit Apple but are some of the healthiest parts of a rapidly maturing business. The original iMac set the stage for Apple's new offensive. The company sold 6 million of them -- and learned how to fully exploit a new-product launch. "They have a very different business model than other PC vendors," explains Megan Graham-Hackett, a computer hardware analyst at Standard & Poor's (like BusinessWeek Online, a unit of The McGraw-Hill Companies). "Their earnings prospects are really tied to the next product introduction. So everything they introduce has to sell very well into their installed base of users. Then they have a blowout quarter." CHALLENGING SONY. So, if Apple is to move up in the pack, the trick is to sustain early momentum. It succeeded at doing so with the original iMac, but the company also has had some big misses, as with the Newton handheld computer and the G4 Cube, a cube-shaped computer aimed at power users that flopped because of its limited expansion capabilities and high price. By expanding into the peripheral devices market with the iPod, Apple could be stepping onto thin ice by challenging electronics maker Sony, among others. The Japanese company's sleek Vaio line of desktops and laptops has already become Apple's archrival in the boutique computer market. And when it comes to consumer electronics, "I would submit that it's a race without a finish line," says Charles Johnson, director of global product design at appliance maker Whirlpool. "The good news is, it's a demonstrable advantage in the minds of consumers if you can consistently do it. The bad news is, it's not easy to do." The company's performance in the computer business, however, seems to indicate that Apple at least has a shot at playing the brutal consumer-electronics game. Under production chief Tim Cook, the company has continued to cut costs and take advantage of falling prices on the commodity components Apple uses in its machines. That has steadily closed the once-yawning price gap between Macs and Wintel machines. SUCH A DEAL! In the $1,800 version of its new iMac, Apple's inclusion of a DVD-burning drive and a flat-panel display has eliminated the price gap almost completely, since the two devices typically cost close to $600 as add-ons to a Wintel machine. "Here's a breakthrough design, incredible value, and it runs Office, and it's a Unix machine. That's great for our buyers. You can't get a better deal anywhere else," gushes Phil Schiller, Apple's vice-president for worldwide product marketing. OS X is also prompting software developers to write or adapt more programs for the Mac. The platform traditionally has suffered from a weak lineup of computer games, but game giant Activision has built a version of its Tony Hawk's Pro Skater 2 for OS X. To combat ingrained perceptions that Apple lacks software, the company is selling 300 titles in its stores. Apple still has numerous obstacles to surmount. For starters, it's long overdue for an upgrade of its PowerMac line of computers for the so-called professional audience -- the graphic designers and artists who make up about 30% of Apple's customer base. While these machines are souped up for performance, the gap between the PowerMacs and the latest crop of iMacs has shrunk enough to make them a questionable buy for many customers. NIFTY APP. As a result, Needham & Co. analyst Charles Wolf, a veteran Apple watcher, figures Jobs within the next six months will roll out new models with chips that finally break the 1-gigahertz speed barrier. The new machines will also need to feature key graphics software such as Photoshop from Adobe (ADBE ) and Quark Xpress, neither of which have been released for OS X. Until Apple updates its tools for professional users, that market may well stagnate, hurting the company's bottom line. A far bigger hurdle will be turning Jobs's digital-lifestyle-hub strategy into meaningful growth. While iPhoto is a nifty application, it isn't the first piece of the digital hub. Both iMovie and iTunes were out long before iPhoto. Exact numbers remain scarce, but neither seems to have driven enough sales to the Mac platform to produce a sustained sales increase. That said, a spike could still be on the way with the rise of broadband and wider consumer acceptance of technologies that process images, an area where Apple excels. "I think the digital hub is a very important part of the pie," says Needham's Wolf. "They have really optimized the Mac to take feeds from digital devices. And the applications are designed better than anything on the Microsoft platform." THE STORE STORY. The strategy's linchpin, according to Wolf, is Apple's ability to publicize its products through its own stores -- and via agreements with CompUSA and other big retailers to allow Apple to build stores within stores to better sell Mac gear. Located in tony locales such as New York's SoHo shopping and gallery district and Northern Virginia's Tysons Corner, the Apple stores aim for maximum visual impact through flashy displays built around core Mac functions, such as film editing or digital music. "The stores are a crucial element in this equation because they're the only place where non-Mac users can see the Macintosh and the programs that run on it," says Wolf. Thus far, they appear to be paying off. They're selling a lot of "beyond-the-box" items, such as software and services that carry higher margins. The stores are averaging an annual sales rate of a very respectable $10 million each, and they're attracting new users in high-enough numbers that Apple feels they're worth the investment. If Apple opens 73 more stores and sells 100 computers per week in each of them to first-time buyers, which Wolf projects will happen within the next few years, Apple could up its market share in the U.S. personal computer sector to nearly 7%, Wolf believes. That number could rise if sales at the Apple stores hold up over time. LOST COOL. Still, retail is a tricky business and keeping a company hip is a tightrope walk. Witness the plight of once-legendary retailer Gap, which drowned stores in leather about a year too late to cash in on the boom in leather sales -- and flipped the company from cool to clueless in a single year. Can Jobs keep his coolness quotient high enough long enough to make his plan work? He has already spent five years putting the pieces together. It might be several more before the fruits of his labor -- a higher market share for Apple -- will emerge. In the meantime, the company looks rock solid for the first time in years -- and at least set to make a run at a more lucrative future.  By Alex Salkever, technology editor of BusinessWeek Online Get BusinessWeek directly on your desktop with our RSS feeds.  Add BusinessWeek news to your Web site with our headline feed. Click to buy an e-print or reprint of a BusinessWeek or BusinessWeek Online story or video. To subscribe online to BusinessWeek magazine, please click here. Learn more, go to the BusinessWeekOnline home page  | | JANUARY |
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