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MAY 5, 2004
By Alex Salkever It's Time for an iPod IPO Apple would profit nicely from spinning out its digital music biz now -- before the market gets commoditized, which it will be for sure Happy Birthday, iTunes Music Store. On Apr. 28, Apple celebrated the first anniversary of its online music venture with Steve Jobs's gleeful announcement that his team had sold 70 million digital songs, exceeding Apple's (AAPL ) "wildest expectations." Jobs also introduced a handful of cool but relatively limited improvements to the iTMS, including the ability to view playlists from 1,000 radio stations around the country and to print CD jewel-case inserts. The biggest enhancement lets users share a song downloaded from iTMS on five different computers running iTunes. The new iPod mini is selling so fast that Apple has trouble keeping up with demand. According to Jobs, it holds a 40% market share in digital-music players and a 70% share of the paid music-download market. At the current rate, Apple can expect to sell 140 million songs via iTunes in the coming year, an average of about 2.7 million per week. All of this makes Apple a force to be reckoned with in the music business. In fact, its musical offerings have almost single-handedly driven Apple's stock within striking distance of $30 (it was trading around $26 as of May 4). ON THE VERGE. Still, if the iPod were a stock, I'd dump my shares. It's hard to imagine Apple maintaining its dominant position in digital music. Jobs had actually predicted 100 million in iTMS song sales in the first year, and he missed by a wide mark. Apple managed to turn in only a 10% quarter-over-quarter increase in iPod sales last quarter, implying the market is slowing. And several top executives dumped millions of their own Apple shares in late April, the first major sale by insiders in years (see BW Online, 4/29/04, "Uh Oh -- Insiders Are Selling at Apple"). For Apple, the best move right now is to spin out iPod and pocket the cash, because Wall Street's current euphoria marks the market's peak. Although Apple would be loath to admit it, digital music players are on the verge of commoditization. Shopping online, you can find a solid 40-gigabyte player from Creative (CREAF ) for $200 less than the 40-GB iPod. Creative also has its own 4-GB hard-drive-based music player on the market for 10% to 20% less than the iPod mini. And the Rio Nitrus, which has 1.5 GB of space, is also competing directly with the iPod mini but is $70 cheaper. OBVIOUS GAP. When you add it all up, the iPod's future dominance looks less and less sure -- and Apple's own apparent assumption of this continued dominance appears more arrogant. On the high end of the iPod line, Apple is close to pricing itself out of the market. On the lower end, rivals have moved in quickly to compete. It was only in January that Jobs announced the mini and explained that it was aimed at luring sales away from the costly flash-memory players. But he wasn't the only one who noticed that high-end flash players looked pricey compared to what could be done with small hard-drive players. Solid state flash memory has no moving parts but it's more expensive compared to hard drives, which store data on rotating magnetic disks. The newest are a tiny 1-inch in diameter. Rio, Creative, and others saw the same price-performance gap that Jobs noted, and their products followed hard on the heels of the mini. Such is life in the consumer-electronics market. PACKAGE DEAL. Sure, Apple still has a big edge: Its digital-music software is by far the best. And people love to manage their own songs in iTunes software and listen to them on their iPods. The total package is what seals the deal, not just the iPod alone, especially as players from other companies continue to improve with each generation. Ultimately, though, someone will build a piece of software that matches iTunes. When that happens, the iPod will end up in head-to-head price competition. So while the iTMS is a nice sidelight, it's a comparative blip. In the retail world, $140 million in song sales with slender profits would make Apple a midsize national or regional music seller, at best. And, yes, commoditization will happen. I can't think of a single product or company that has been able to maintain a truly dominant market share in any single consumer-electronics category for any length of time. The only exception might be gaming consoles, where Sony (SNE ) has ruled. But that's a weird market because the consoles are sold at a loss, something that Apple has never done and isn't interested in doing now. DITCH THE MAC BIAS. So what to do? Take the money and run. If Apple were to spin out a minority stake of its iPod business, it could rake in big bucks in an initial public offering. With the iPod on track to become a $1 billion business in the next year or so, Apple could expect to pull in at least that amount by selling a 40% stake. Then, Jobs could let someone else run the daily operations and the music side of things, including iTMS. This would be great because Apple more than ever needs to focus not just on the Mac platform but on Microsoft's (MSFT ) Windows, too. It has done well so far in building iTunes software and iPod devices for Windows. But if it really wants to become a major consumer-device company, it will need to ditch its Mac bias entirely. If Apple had rolled out the iPod and iTunes for Windows and Mac users at the same time, its dominance of the digital-music player market might have been far more complete and achieved far more quickly. Of course, I'm not holding my breath. Apple and Jobs have always served their core market of Mac diehards first. That's great for the Mac, but it limits their ability to attack the broader market. Competing in the broader market is what Apple clearly intends to do with the iPod and digital music in general. But reaping a couple billion dollars in the process would certainly help Apple return to what should be its focus: figuring out how to move beyond Macs to make killer consumer products that are relevant in a Windows-based world.  Salkever is Technology editor for BusinessWeek Online. Follow his Byte of the Apple column, only on BW Online Edited by B. Kite
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