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Apple's Future: Profits Vs. Market Share Is it really that Simple? There are two basic global tendencies in the world of manufacturing. The first is to try and run your widget factories and outlets in such a way as to maximize your profits. This is the classic American model that seeks profit margins from a low of 15% to whatever the market will bear. The second model, pioneered by the Japanese in the 1960s, is more market share conscious. Profits and dividends are secondary. The goal is to capture market share by undercutting your competitor's prices. Japanese corporations often tolerate profit margins as low as 5%, far lower than any American board of directors could allow to continue without fear of being replaced by the shareholders. Lester Thurow, in his book "Head to Head", called this empire building. Of course, the above is an obscene over simplification. However, the crux of the market share vs. profit margin quandary is currently what must be the central theme of debate among Apple's top management while planning strategically for the future. Unlike widgets, CPUs and operating systems are unusually dependent on mind share, an elusive by-product of market share. Developers won't code and peripheral makers won't port to platforms below a certain critical mass necessary for efficiencies of scale. Moreover, market share in the IT world has formed a positive feedback loop for the dominant players locking out smaller competitors. Apple's entire problem can be summed up in terms of market share or, its lack thereof. Apple has made its comeback from the brink. The iMac is entering the end-game of its product lifecycle. We can expect Apple's management to be making some rather momentous decisions about how to continue its operations from here. How they decide to manage margins vs. the market in the upcoming year will determine the whole fate of Apple. The opportunity for some sort of surprising innovation is at least as great as the chance of a major blunder. Throw in the Internet as a wild card (invalidating historical analogies) and Apple's future is unknowable but promising. Apple has the highest profit margin of any computer manufacturer. Revenues, in spite of the last year of rapid growth, are still down from the peak in ‘95 because Apple's market share is about half of what it was then. The increased profitability of Apple's product line can't make up for the decline in market size. In fact, Apple's healthy gross profit, much of it obtained through cutbacks, tends to obscure the central fact that it's only by growing the Mac user and developer community that Apple can hope to be a long term success story. That's why the announcement last week of OS X wasn't nearly as important as the way in which Apple intends to market it. Everyone knows OS X is going to happen. A welcomed surprise came when the planned price of OSX was lowered from a $1,000 to $500 ($299 for educators) with an unlimited client license. Achieving a certain level of ubiquity for OS X is more important than turning a profit. $1000 for server software, like a dollar per port Firewire license, would probably have destined the whole project to the long list of contenders that failed to attain that critical end user mass. Last month, Apple lowered its imprudently high price per port on the Firewire to eliminate the chance for a competing standard to evolve. The same strategic planners seem to have won a major price cut for OS X in their search for market share. A further happy surprise came with the announcement that OS X would have an open source. It would seem that Apple has learned some hard lessons from its long history of bungling the marketing aspects of their insanely great products. Open source will ensure that a worldwide community of developers can cheaply and easily write code for OS X. Winning over the development community is necessary if the OS X is ever going to gain the support needed to exist in the server market space along side Linux, Solaris, Unix and NT. The $500 price tag makes OS X cheaper than NT 4.0. Steve Jobs said, "We're going to apply that Apple magic to create a server people can set up in 15 minutes". If so, then OS X would be the cheapest server OS out there, if you factor in the sysop's wages! 1.6% of the servers running the Internet today are Macs, according to http://www.macwebsite.com/. They go on to say, "WebSTAR, the most popular Macintosh web server package, is listed as the driving force behind over 50,000 web sites, more than such well known Unix or Windows NT packages such as IBM's Lotus-Domino server and the servers published by Netscape Communications!" OS X Server will augment Apple's position in the rapidly growing server market that is characterized by high profit margins, well-informed end users and a demand for new technical innovations. Although a rather different sales environment from the consumer oriented market of the iMac, the server sales of the future may grow susceptible to some of the same strategies used to make the iMac appealing. Getting a network set up is becoming the main thrust of IT budgets at small businesses and schools everywhere. The high cost of employing experts to maintain these networks could be avoided with OS X. If the word gets out that this is so, there is a massive market as yet untapped by Apple. It should be noted that servers are just less than 1% of the units shipped by Apple in the last quarter, so OS X isn't going to impact cash flow for years. However, it would be a mistake to underestimate the possible future importance of a user friendly server operating system. The very concept is currently an oxymoron. The Fifth Best Investment on Wall Street Apple was rated number 5 in the first Barron's 500 company rankings. The numero uno slot went to AOL with Dell claiming second, third to Best Buy. http://interactive.wsj.com/articles/BarronsCoverMain.htm Best Buy! I would have thought that Best Buy would be suffering the same inofficious fate as Circuit City or CompUSA: a slow death by sales erosion to the Internet spurred on by miserable sales staff and service. But no. Best Buy's stock is up 80% this year. Barron's says sales are strong for Best Buy because of the surge of cheap digital consumer electronics like cameras and DVD players. And Best Buy's future is looking positively stunning. Barron's talks about HDTV as if it were the Second Coming, "We are heading into what will be the biggest-ever product in the history of consumer electronics. When investors finally sit up and take note, you'll start to see panic buying of stocks that stand to benefit, primarily, Best Buy." Hmmm. Perhaps a little bit of hyperbola there. I don't think I'll be spending 4,000 bucks on a new HDTV for at least a couple of years. By then, the bandwidth of the Internet might have relegated the TV to the status a second-class medium like radio. As for Apple, Barron's acknowledges that the company has made a stunning comeback. Whether Apple is going to be able to continue it's lucky streak that started with the iMac and, hopefully, will be continued with the consumer portable is still unclear. That seems to be the prevailing opinion among investors. However, just the fact that Apple won 5th place in Barron's ranking is amazing and even confusing. It implodes all my cherished paranoid conspiracy theories about the media and Wall Street. Just for the record, following my own advice I've been accumulating AAPL as we skip along the bottom these last few weeks and I remain bullish waiting for the quarterly numbers to set off a stream of short covering. Your comments are welcomed. |