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Apple
Apple's Business Model and Strategy

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By RodgerRafter
February 13, 2002

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I believe that Apple management's primary goal is for the company to make as much money as possible by the January 17, 2011. Apple's top managers each received 1,000,000 shares worth of options that expire on that date. Apple has a well-constructed business strategy to steadily increase sales. If Apple executes on their business model, as I believe they can, those top managers may eventually become billionaires.

Here are some of the elements of Apple's business strategy as I see it:

1. Build a Better Machine

For now, Apple has a big handicap vs. the other box makers because of the market share issues. People who already own Windows machines or have experience working with them have a natural incentive to buy a Windows box over a Mac. Apple has to overcome this by building a better machine, both for specific markets where they are established like publishing and education and for the highly competitive consumer market. Apple pours millions into R&D to maintain their "ease-of-use" advantage," and keep their technology on the cutting edge.

On the Windows side, it's usually a race to the bottom to see who can build the box that appears to be the best deal, with the cheapest components and the most gigs, and megs. Since customer loyalty doesn't account for much in the Wintel commodity market, the quality of the machines is not as big an issue.

Apple has tremendous customer loyalty as a result of producing better quality machines, and the installed base has been growing over the past 3 years. This will lead to a bigger share of the upgrade market down the road.

2. "The Whole Widget"

Apple produces both the hardware and software and, as a result, has control over the whole machine. They save a large amount of time in getting out new products and have far fewer compatibility problems as a result.

3. Common Unified Architecture

Apple's products all have the same basic architecture, so development costs are streamlined and products can be brought to market more quickly. I talked to Jon Rubenstein (VP Hardware) about this after the 2000 shareholders meeting. He was gushing with pride at how quickly Apple could get new products tested and into production as a result of the common architecture.

4. Specific Product Offerings

Apple's product offerings are specifically focused at certain groups. Thus, Apple can produce one machine that is the best possible machine for education and another that is the best possible machine for graphic artists, and market them appropriately.

5. Seasonal Sales

Apple tries to keep production levels on a relatively constant and stable level. This is more efficient because it keeps production capacity going at an optimal level.

While most PC makers seek big holiday sales and fat profits during the last quarter of the year, Apple tends to just sell old machines for bigger than usual profits. Some new product offerings and speed bumps are delayed until after Christmas, so that production and sales can be smoothed out over time. Other new product releases are staggered throughout the year so to provide new surges in sales whenever needed.

6. Free Software

Back around 96-97, when Apple was scraping bottom, my crackpot solution for the platform was for Apple to buy up as much software as possible and make it all free for Apple users. To a much smaller degree, that's what they've been doing lately. Apple bought much of the software that they are now giving away free in iDVD & iMovie.

A computer can't do anything without software. As a result, software drives the value of the machine. The iSuite gains maximum utility for the Mac community because it is all free and is distributed to as many users as possible.

My lifestyle dictates I don't use iTunes much, and I certainly wouldn't pay much for it, but I do enjoy it from time to time. Because Apple made iTunes free, my Mac is a little more valuable to me.

7. Acquisitions

By acquiring new companies, Apple increases the strength and breadth of their offerings, and the value of the Mac relative to a Wintel box. As the recession deepens, more struggling tech companies will become eager to sell out to Apple at more attractive prices.

Sometimes Apple uses cash for acquisitions, but they'd much rather use stock. There is no limit to the amount of stock they can print up, but cash is much more precious.

8. Big Profit Margins

Apple has by far the highest gross profit margins among box makers, but this can be a bit deceiving. The company has huge R&D costs associated with software development that the other box makers avoid. These costs don't factor into cost of sales, but they do increase the value of the Mac and the amount Apple can charge for the machine. The result is much higher gross margins.

9. Bigger Profit Margins on the High End

Apple has a dominant position within the publishing and graphic arts industry and can charge a premium on the high end products sold to these markets. Time is money for these users, and it's worth it for them to pay more for faster, beefier machines because they get more productivity out of them. It's much easier to buy a fully loaded box from Apple than it is to add in a lot of 3rd party upgrades, so Apple tends to overcharge for BTO memory and drive capacity.

10. Smaller Margins in Competitive Markets

Because the gross margin is so high on individual units, Apple can cut prices dramatically to compete in certain targeted markets. For example, if Apple is competing directly with Dell to sell to a given school district, Apple can cut prices as much as 25% and still sell at a profit. Dell would be taking a big loss if they cut prices this much.

Apple's standard education prices on hardware are about 10% below the basic retail price. For software, education prices are about 50% lower. This has to do with Education being an important and competitive market much more than it has to do with Apple's altruistic intentions.

Apple can tinker as much as they want with prices when they want to go after a specific market or customer. A big sale with only 2% profit margins can be a good deal if it brings a new customer into the Mac fold. If no sale is made, then no profit is realized at all.

11. "Incremental Growth" in Market Share

When analysts trot out the market share issue during conference calls, Fred always responds by saying that Apple looks at market share within specific markets. This is a better use of the market share idea that is useful to Apple's execs and should be useful to us as investors.

Within a given market, Apple's market share goes a long way toward determining the value of a Mac relative to the value of a PC. Apple has great market share in education, and as a result, almost all software targeted at the education market is available on the Mac. Apple's market share on Wall Street trading desks stinks, so there isn't much incentive for developers to port trading software to the Mac. Market share, to a large degree, determines the availability of software, which then effects the relative value of a computer to a potential customer.

Apple looks at the market share of individual markets to decide where to direct its marketing muscle and how to tailor its hardware and software. The company has a strategy of "incremental growth," using leverage in one area to gradually push into new areas. Education and publishing have long been the core of Apple's market. From there, Apple had some overlap with, and inroads into, the consumer market and video production market. Apple has directed most of their recent growth strategy at wooing a bigger portion of these markets. As this strategy proves successful, Apple will have more leverage on the Small Office/Home Office markets because more Macs will be found in these places and more software developers will cater to Macs in these markets. SOHO advances should eventually give Apple more leverage on the corporate market.

Analysts often ask about when Apple will make a push for the huge corporate office. It doesn't make sense for Apple to focus their energies here, yet. In a few years, however, Apple should be better positioned to fight for this market.

Right now, Apple has around 5% of the worldwide PC market, but it's not outrageous to imagine a day when they have 50% or 75% or even 90%. Given the momentum generated over the past 4 years, and a well constructed, well executed business plan, I wouldn't bet against Apple gaining 50% market share by January 17, 2011.

Rodg.

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