A STRATEGIC ANALYSIS OF APPLE CORPORATION

A project study submitted in the partial fulfillment of the requirements for the subject “Organizational Event Analysis for Experiential Learning” Submitted By Huzefa A. N. Deepti Dinesh Gaurav Vinay Harmanjeet Singh

Under the guidance of PROF. DEBAJYOTI MAJUMDAR

THE INDIAN INSTITUTE OF PLANNING AND MANAGEMENT HYDERABAD

CERTIFICATE
This is to certify that this is a project report on “A STRATEGIC ANALYSIS OF APPLE CORPORATION” submitted by Mr. Huzefa, Ms. A. N. Deepti, Mr. Dinesh Gaurav, Mr. Vinay and Mr. Harmanjeet Singh (PGP/SS/2007-09) as a part of the curriculum for the first trimester. The work has been undertaken and completed under the guidance of Prof. Debajyoti Majumdar and is satisfactory. Prof: Date:

Page 2 of 54

ACKNOWLEDGEMENT

It gives us great pleasure in presenting our project work on “A STRATEGIC ANALYSIS OF APPLE CORPORATION”. We, the students of PGP/SS/2007-09, IIPM-HYDERABAD successfully completed our project and would like to thank Prof. Debajyoti Majumdar for his timely encouragement, guidance and support. We, as co-workers are also grateful to each other for the team work without which this study could not have been completed successfully.

Page 3 of 54

PREFACE

The primary objective of this report is to provide the readers the insight into the success of apple industry. We hope that the report has made the text interesting and lucid. In writing this report, we have benefited immensely by referring to many publications and articles. We express our gratitude to all such authors and publishers. Any suggestions to improve this report in contents or in style are always welcome and will be appreciated and acknowledged.

Page 4 of 54

DECLARATION
We hereby declare that all the information that has been collected, analyzed and documented for the project is authentic possession of us. We would like to categorically mention that the work here has neither been purchased nor acquired by any other unfair means. However, for the purpose of the project, information already compiled in many sources has been utilized. (Huzefa) (Deepti)

(Dinesh)

(Vinay)

(Harmanjeet)

Page 5 of 54

CONTENTS
EXECUTIVE SUMMARY………………………………………………………………………. 7 HISTORY OF APPLE………………………………………………………................................ 8 MISSION AND VISION……………………………………………………………………….. .15 THE PC INDUSTRY……………………………………………………………………………..16 THE ONLINE MUSIC INDUSTRY…………………………………………………..................17 THE FUTURE OF APPLE……………………………………………………………………… 17 PERSONAL COMPUTERS- A SHIFT IN STRATERGY……………………………. 17 APPLE IN THE LIVING ROOM……………………………………………………… 19 STRATEGIC ALLIANCES……………………………………………………………..20 EXTERNAL ANALYSIS……………………………………………………………....................21 TECHNOLOGICAL ENVIRONMENT……………………………………....................21 PERSONAL AWARENESS-STYLE AT A PREMIUM……………………... 21 INTEROPERABILITY……………………………………………………….22 TECHNOLOGY AND THE DIGITAL LIFESTYLE………………………..23 REGULATORY ENVIRONMENT……………………………………………………24 INDUSTRY ANALYSIS USING PORTER’S FIVE FORCES MODEL………………………25 WHICH EXTERNAL THREATS ARE MORE SIGNIFICANT……………..............26 ADDITIONAL EXTERNAL THREATS……………………………………………………….28 SECUTITY…………………………………………………………………………….28 VERTICAL INTEGRATION OF COMPETITORS…………………………………..29 VALUE CHAIN ANALYSIS…………………………………………………………………...30 TECHNOLOGY AND PRODUCT DESIGN…………………………………………30 PRODUCTION………………………………………………………………………..31 SALES AND MARKETING………………………………………………………….31 CUSTOMER SERVICE…………………………………………………………… ..31 LEGAL SERVICES…………………………………………………………………...32 SWOT ANALYSIS……………………………………………………………………………..33 STRENGTHS………………………………………………………………………….33 WEAKNESSES………………………………………………………………………..34 OPPORTUNITIES………………………………………………………………..……34 THREATS…………………………………………………………………….………36 FINANCIAL ANALYSIS…………………………………………………………….………..36 2ND QUARTER 2006…………………………………………………………………36 HISTORICAL PERFORMANCE……………………………………………………36 STOCK PRICE PERFORMANCE…………………………………………………..37 PROFITABILITY MEASURES…………………………………....………………..38 LIQUIDITY AND LEVERAGE MEASURES………………………………………38 PRODUCT UNIT SALES……………………………………………………………39 OPERATING SEGMENTS………………………………………………………….39 MARKET VALUE ANALYSIS………………………………………………………………40 PROFORMA INCOME STATEMENT……………………………………………...41 PROJECTED FREE CASHFLOW&EQUITY VALUATION………………………42 STRATEGY……………………………………………………………………………………43 PRODUCT DIFFERENTIATION…………………………………………………....43 STRATEGIC ALLIANCES………………………………………………………….47 RECOMMENDATIONS………………………………………………………………………50 CONCLUSION………………………………………………………………………………..51 INDEX…………………………………………………………………………………………52 BIBLIOGRAPHY……………………………………………………………………………..53

Page 6 of 54

EXECUTIVE SUMMARY
Apple Computer’s 30-year history is full of highs and lows, which is what we would expect in a highly innovative company. They evolved throughout the years into an organization that is very much a representation of its leader, Steven Jobs. Apple made several hugely successful product introductions over the years. They have also completely fallen on their face on several occasions. They struggled mightily while Jobs was not a part of the organization. Apple reached a point where many thought they would not survive. When asked in late 1997 what Jobs should do as head of Apple, Dell Inc.'s (DELL) then-CEO Michael S. Dell said at an investor conference: "I'd shut it down and give the money back to the shareholders.” (Burrows, Grover, and Green) Well, times changed. Less than 10 years later, BusinessWeek ranked Apple as the top performer in its 2006 BusinessWeek 50. Apple attributes their recent success to robust sales of iPod music players (32 million in 2005). They are optimistic about the economies of scope with media giants, such as Disney and Pixar. (BusinessWeek) Apple rarely introduces a new type of product. Thus, instead of being the pioneer, they are an expert “second mover” by refining existing products. Portable music players and

notebook computers are examples. Apple increases the appeal of these products by making them stylish and more functional. They now appear poised to make significant strides in the home computer market and to creating a total digital lifestyle whereby the home is a multimedia hub.

Page 7 of 54

HISTORY OF APPLE
Steve Jobs and Steve Wozniak founded Apple on April 1, 1976. The two Steves, Jobs and Woz (as he is commonly referred to – see woz.org), have personalities that persist throughout Apple’s products, even today. Jobs was the consummate salesperson and visionary while Woz was the inquisitive technical genius. Woz developed his own homemade computer and Jobs saw its commercial potential. After selling 50 Apple I computer kits to Paul Terrell’s Byte Shop in Mountain View, CA, Jobs and Woz sought financing to sell their improved version, the Apple II. (Linzmayer, 7-9) They found their financier in Mike Markkula, who in turn hired Michael Scott to be CEO. The company introduced the Apple II on April 17, 1977, at the same time Commodore released their PET computer. Once the Apple II came with Visicalc, the progenitor of the modern spreadsheet program, sales increased dramatically. In 1979, Apple initiated three

projects in order to stay ahead of the competition: 1) the Apple III – their business oriented machine, 2) the Lisa – the planned successor to the Apple III, and 3) Macintosh. (Linzmayer, 145) In 1980, the company released the Apple III to the public and was a commercial flop. It was too expensive and had several design flaws that made for less-than-stellar quality. One design flaw was a lack of cooling fans, which allowed chips to overheat. In late 1980, Apple went public, making the two Steves and Markkula wealthy – to the tune of nine figures. By 1981, the Apple III was not selling well and Scott infamously fired 40 people on Feb 25 (“Black Wednesday”). Scott’s direct management style conflicted with the culture Jobs and Markkula preferred, and Scott resigned in July. Markkula stepped into his position as CEO. (Linzmayer, 15-6)

Page 8 of 54

In August 1981, IBM released their PC. Unimpressed and unafraid, Apple welcomed IBM to the PC market with a slightly smug full-page ad in the Wall Street Journal. It would not be long before IBM’s PC dominated the market.

The Xerox Alto was the inspiration for Apple’s Lisa. Apple employees were able to examine the Alto in exchange for allowing Xerox to invest in Apple before Apple’s initial public offering (IPO). Apple released the Lisa in January 1983 and was notable for being the first computer sold to the public that utilized a Graphic User Interface (GUI). Unfortunately, the Lisa was not compatible with existing computers, and therefore came bundled “with everything and a list price to match.” (Linzmayer, 77) At $9,995 (over $21,000 in 2005 dollars), the Lisa missed its target market by a wide margin.

Page 9 of 54

Jobs attempted to control the Lisa project. Scott, unimpressed with the performance of Jobs on the Apple III project, had Jobs head up the dog-and-pony show for the pending IPO. Jobs, looking for a project to lead, inserted himself into the Macintosh development team. Using his considerable influence, Jobs was able to procure the resources to produce a computer that was faster than Lisa, used a GUI, had a mouse, and sold for ¼th of Lisa’s price. Apple introduced the Macintosh with great fanfare during the 1984 Super Bowl. The Orwellian-themed

commercial (directed by Ridley Scott, of ‘Alien’ fame) portrayed IBM as Big Brother and embodied Macintosh and Apple as freedom-seeking individuals breaking away from this oppressive regime. The commercial was largely successful and sales for the Mac started strong. However, Mac sales later faded. (Linzmayer, 76-93, 109-14)

John Sculley left PepsiCo to join Apple in April 1983. He was famous for engineering the “Pepsi Challenge”, in which blinded testers tasted both Coke and Pepsi to unveil the ‘truth’ of the taste of Pepsi. In response to lagging Mac sales, Sculley contrived the ‘Test Drive a Macintosh’ campaign. In this promotion, prospective users could take home a Macintosh with only a refundable deposit on their credit card. While lauded by the public and the advertising

Page 10 of 54

industry, this campaign was a burden on dealers and significantly impeded the availability of Macs to serious buyers. In 1985, Apple tried to have lightening strike twice with their In what was becoming Apple’s typical

‘Lemmings’ commercial during the Super Bowl.

patronizing fashion, this commercial insulted current PC users by portraying them as witless lemmings, unthinkingly doing harm to themselves. Although Jobs attempted to overthrow Sculley, the board backed Sculley. Jobs left Apple to form NeXT computer. (Linzmayer, 143-5, 153-8, 207) After Jobs left in 1985, sales of the Mac “exploded when Apple’s LaserWriter met Aldus PageMaker.” (Linzmayer, 159) Apple dominated the desktop publishing market for years to come. Under Sculley, Apple grew from $600 million in annual sales to $8 billion in annual sales by 1993. Apple introduced Mac Portables in 1989 and the first PowerBooks in 1991. By 1992, PC competition ate into Apple’s margins and earnings were falling. Sculley was under pressure to have Apple produce another breakout product. He focused his energy on the Newton – Apple’s introduction of the Personal Digital Assistant (PDA). Despite Sculley generating

substantial demand for Newton, it did not live up to the hype due to it being severely underdeveloped. Sculley resigned in 1993 and Michael Spindler replaced him. (Linzmayer, 158, 161, 183-96)

Page 11 of 54

Spindler spent most of his time and energies on regaining profitability, with the end goal of finding a buyer for Apple. Over the next several years, Spindler shopped Apple to Sun Microsystems, Eastman Kodak, AT&T, and IBM. Meanwhile, Apple was unable to meet the growing demand for its products due to supplier problems and faulty demand predictions. To add insult to injury, Microsoft released Windows 95 with great fanfare in 1995. After significant quarterly losses in 1996, the board replaced Spindler with Dr. Gil Amelio, CEO of National Semiconductor. (Linzmayer, 233-40) Dr. Amelio tried to bring Apple back to basics, simplifying the product lines and restructuring the company. One of Apple’s most pressing issues at the time was releasing their next generation operating system (code named “Copland”) to compete with Windows 95. Amelio and his technology officers found that Copland was so behind schedule that they looked outside the company to purchase a new OS. Ultimately, and somewhat ironically, they decided to purchase NeXT computer from Jobs. Naturally, Apple welcomed Jobs back into the fold. The board became increasingly impatient with Amelio due to sales not rebounding quickly enough. Apple bought out Amelio’s contract after just 1 ½ years on the job. (Linzmayer, 240) Jobs eventually claimed the CEO position. Then, he cleaned house by revamping the board of directors and even replacing Mike Markkula (who had been with the company since the beginning). Jobs simultaneously put an end to the fledgling clone licensing agreements (which created a few Mac clones) and entered into cross-licensing agreements with Microsoft. On May 6, 1998, Apple introduced the new iMac, a product so secret that most Apple employees had never heard of it. (Linzmayer, 289-95) The new iMac was a runaway success with its translucent case, all-in-one architecture, and ease of use. It brought Apple to a new market of users – those who had never owned a computer before. Jobs further simplified the product lines into four

Page 12 of 54

quadrants along two axes: Desktop and Portable on one, Professional and Consumer on the other. Apple completed the matrix with the introduction of the consumer-based iBook in 1999.

The year 2001 was an important year for consumers of Apple products. Apple opened their first 25 retail stores (totaling 163 stores in 4 countries as of May 2006). In September 2001, Apple introduced the new iMac featuring a screen on a swivel.

The new iPods (portable music players) were a tremendous success. Apple sold so many that Apple’s dependence on Mac sales was significantly less. This was no small feat considering that the 2001 iMac became Apple’s best-selling product “by a long shot”. (Linzmayer, 301)

Page 13 of 54

Apple offered iTunes (a free application) to help their consumers organize music on iPods and Macs.

In 2003, Apple expanded iTunes by 1) opening the iTunes music store to allow Mac users to purchase music online and 2) expanding iTunes to Windows users. Sales of iPods skyrocketed and currently provide the bulk of product sales to Apple. (Apple) In 2005, Apple announced that it would start using Intel-based chips to run Macintosh computers. In April 2006, Apple announced Boot Camp, which allows users of Intel-based Macs to boot either Mac or Windows OS. This functionality allows users who may need both OSs to own just one machine to run both, albeit not simultaneously.

Page 14 of 54

VISION STATEMENT
"Man is the creator of change in this world. As such he should be above systems and structures, and not subordinate to them."

Explanation of vision
Apple lives this vision through the technologies it develops for consumers and corporations. It strives to make its customers masters of the products they have bought. Apple doesn't simply make a statement. It lives it by ensuring that its employees understand the vision and strive to reach it. It has put systems in place to enable smooth customer interaction. It has put objectives in place to continuously move forward; implemented strategies to fulfil these objectives; and ensured that the right marketing, financial and operational structures are in place to apply the strategies.

MISSION STATEMENT
"Apple is committed to bringing the best personal computing experience to students, educators, creative professionals and consumers around the world through its innovative hardware, software and internet offerings."

Page 15 of 54

The PC Industry
We can glean Insight into the history and composition of the PC Industry from its eponymous title. In the late 1970s, as Wozniak and Jobs were starting Apple computer, personal computers were an emerging product. The following chart (Reimer) gives an overall view of the major market players since the mid-1970s.

PC Share of Market
100% 90% 80% 70% Share of Market 60% 50% 40% 30% 20% 10% 0%
ar 76 96 19 98 20 00 20 02 80 82 84 90 78 86 88 92 Ye 19 19 19 19 19 19 19 19 19 19 19 94

IBM SOM Apple II SOM Mac SOM Amiga SOM C64 SOM TRS 80 SOM

By 1983, the market share of the Apple II fell to 8% while the PC had 26%. Market share of Macintosh peaked at slightly more than 10% in the early 1990s and has since tapered to between 2-3%. The IBM PC and its clones became the standard due to the success of the open nature of the PC. This allows product developers to offer vastly more products for the platform. Some argue that not licensing the Mac OS was a mistake. Bill Gates and Microsoft were encouraging Apple to license their OS in the early 1980s, because they were developing software for Apple and had much riding on the success of the company. When Apple did not license, Microsoft began developing their operating system, Windows. (Linzmayer, 169-75, 245-9)
Page 16 of 54

The Online Music Industry
While Apple clearly dominates the online music industry, the battle for domination is not over. Although digital music sales are growing rapidly, the Recording Industry Association of America (RIAA) states that digital sales account for only 4% of all music sales. (Borland) Analysts at Forrester (Bartiromo) and Gartner (Bruno) validate this. Apple’s sales are between 66% and 75% of downloads and 80% of music players. (Bruno) Apple is part to a suit alleging monopolistic practices concerning their market share dominance of players and downloads. (Grundner) The other players in the download market are (the revised) Napster, Yahoo Music, Rhapsody, and illegitimate file-sharing services. Portable music players competing with the iPod include those made by Creative, Samsung, iRiver, and Sony. A major point of contention between these services and player manufacturers is the control of a variety of incompatible Digital Rights Management (DRM) schemes.

The Future of Apple Personal Computers – A Shift in Strategy
Apple has historically taken a far different path than the traditional Windows and Intel combination. Microsoft provides the Windows operating system to separate downstream

hardware producers such as Dell. Apple vertically integrated both the operating system software and hardware completely under Apple. A consumer running Microsoft Windows can choose from a myriad of systems based on the Intel processor, while a consumer running Apple’s OS X must purchase Apple hardware.

Page 17 of 54

Apple is adjusting this strategy by migrating their microprocessors from IBM and Motorola PowerPC to Intel. Analysts believe that the Intel-based Macintosh may be able to run Microsoft Windows applications by the end of 2006. (Burrows) In addition to switching processors, Apple positioned their computers as an immediate option for the traditional Microsoft Windows user. With Apple Boot Camp, users may now use Mac OS X or Windows on an Apple computer. (Sutherland) Figure 1: Apple Boot Camp – Allowing Mac OS X or Windows

By allowing users to run Windows on an Intel Mac, Apple reduced the switching costs for traditional PC users. Apple may steal away customers that are willing to pay a premium for a system that runs both Windows and Mac OS X. Figure 2: IBM PowerPC Processor, Intel Processor Core Duo / Pentium M

Page 18 of 54

Apple continues to retain a strategic option to license its technology to clone makers such as Dell. Past attempts at licensing Apple technology (to IBM, Gateway, and others) failed on accord of Apple’s rigid demands. Many technology leaders (such as a 1985 letter by Bill Gates to Apple CEO John Sculley) criticized Apple for keeping a closed architecture. Apple cofounder Steve Wozniak criticizes this strategy, “We had the most beautiful operating system, but to get it you had to buy our hardware at twice the price. That was a mistake.” (Linzmayer, 245-57) Whether Apple would be willing to pursue this reversal of vertical integration is unclear. Although such a move would cannibalize a portion of Apple’s own hardware sales, it would also provide royalty-based revenue that could approach $1 billion annually. (Burrows) Jobs

traditionally sided against licensing Apple technology. He referred to Mac clone producers as “leeches” and he personally killed Power Computing (a Mac clone producer) by terminating their license in 1997. (Linzmayer, 255)

Apple in the Living Room
Apple’s iPod and iTunes are a powerful combination that fosters a network style of increasing returns. (Barney, 124) By selling iPods, Apple increases the consumer demand for music from iTunes. By placing more musical choices on iTunes (including less popular songs that appeal to niche audiences), there is more demand for iPods. Apple had 70% of the legal music download market in early 2005. (Yoffie) Apple is shooting for the digital living room of the future. For example, Apple just released a “boom box” portable version of the iPod. This iPod (the iPod Hi-Fi) comes with a remote control. Instead of forming a strategic alliance, Apple engineered the iPod Hi-Fi and designed it with high-fidelity features. (Burrows) Apple is clearly trying to develop a stronger core competency in the entertainment area.

Page 19 of 54

Figure 3: The Apple Hi-Fi

Apple may also release an Apple-branded cell phone and iPod combination device by the end of 2006. (Burrows) This product would again position Apple as a “second mover”

responding to Palm’s Treo and Verizon’s VCAST technology.

Strategic Alliances and Entertainment
Jobs had the early strategic vision to complement computing with movie entertainment. After founding NeXT, he personally acquired a majority interest in the young movie company Pixar in February 1986. (Linzmayer, 219) Jobs went on to invest ¼ of his personal wealth into Pixar. In 1995, Pixar solidified its position within animated movies with the debut of Toy Story. Grossing $358 million worldwide, it became the 3rd-largest grossing animated movie in history. (Linzmayer, 222) After this success, Jobs took Pixar public and negotiated far better terms with Disney. Later successes included Toy Story 2, Monsters Inc., and Finding Nemo. Ironically, Jobs stated in the November 23, 1998 BusinessWeek, “I Think Pixar has the opportunity to be the next Disney – not replace Disney – but be the next Disney.” (Linzmayer, 222-4) The alliance between Pixar and Disney has tremendous potential for economies of scope. As CEO of Apple and Disney’s largest shareholder, Jobs is the strategic link between Disney,

Page 20 of 54

Apple, and Pixar. Opportunities include combining the animated movie expertise of Disney and Pixar, as well as sharing the content of Disney’s ABC or ESPN networks over Apple’s digital offerings. (Burrows, Grover, and Green) A current example of the fusion between Disney, Jobs, Apple, and technology is video on the iPod. Disney’s Desperate Housewives was one of the first television programs available for purchase and download to the newer video-enabled iPod. There are concerns about whether these synergies will come to fruition. There are fears that the personality and style of Jobs may conflict with Disney, and that Disney CEO Iger could be “Amelioed” -- driven out of office by Jobs in a manner similar to how Jobs drove Amelio out of the CEO post at Apple. (Burrows, Grover, and Green)

EXTERNAL ANALYSIS Technological Environment Brand Awareness – Style at a Premium
Apple’s products are trendy and stylish. After Jobs returned in 1997, Apple retained designer Jonathan Ive to differentiate their computers from the typical beige box. Ive’s design of the iMac included clear colorful cases that distinguished Apple computers. (Linzmayer, 295-6) Apple’s iPod (with the trademark white ear buds and simple track wheel) commands a 15%-20% premium over other MP3 players. (Yoffie) Apple and Pixar limit the number of computer products and movies that they sell. Product differentiation with focused quality and style also extend to the Jobs Pixar – “Pixar's executives focus on making sure there are no ‘B teams,’ that every movie gets the best efforts of Pixar's brainy staff of animators, storytellers, and technologists.” (Burrows, Grover, and Green)

Page 21 of 54

Figure 4: The Stylish Design of the iMac and Mac Mini

Apple positions its Macintosh computers as higher quality and higher price. HP, Dell, and other PC manufacturers are pricing many systems under the $1,000 threshold. “Apple is struggling to meet demand for its new MacBook Pro laptop despite a $1,900 price tag that is nearly twice that of garden-variety rivals.” (Burrows) Apple has only recently entered the low-end (below $500) consumer market with the Mac Mini. Although the Mac Mini is a base model with few features, it comes encased in a very small and distinctive package. Apple portrays this computer as “Small is Beautiful”. (Apple) Likewise, the iPod Shuffle was Apple’s first entry into the lower-end ($100 range) of flashmemory-based portable music players.

Interoperability
Although Apple competes directly with Microsoft for operating systems, the release of iTunes for Windows in 2002 was a key strategic move. This decision expanded the potential customer base to nearly all personal computer owners, even though Apple only has 2%-3% of all personal computer sales. (Yoffie) Conversely, Apple depends on Microsoft for a version of Microsoft Office. As the most widely used office suite of applications, Macintosh users rely on Office to correspond with companies that standardized on Windows. This is from a strategic alliance between Apple and Microsoft after Jobs returned in 1997. (Linzmayer, 290)

Page 22 of 54

Apple’s iTunes service has a technological hook (asset specificity) to Apple’s iPod. Although versions of iTunes exist for both Apple and Microsoft operating systems, the iTune’s AAC file format prevents other portable music players (such as iRiver or Samsung) from playing purchased songs. (Yoffie)

Technology and the Digital Lifestyle
Apple not only dominates the music player market, its iLife suite provides consumers with easy-to-use software for music and video composition. With “podcast” a household word, Apple’s Garage Band application makes the recording of podcasts and music very easy. (Boddie) Figure 5: The GarageBand Music and Podcast Application

Page 23 of 54

Regulatory Environment
While introducing new technologies, there is a persistent threat of legal action by competitors. For example, Apple sued Microsoft in 1988 (settled in 1997 for an undisclosed amount) for perceived similarities between Microsoft Windows and Macintosh audiovisual works. (Linzmayer, 172-4) Microsoft has generally been the focus for government antitrust charges (such as U.S. v. Microsoft) (US DOJ, 2006). Both federal and state governments assert that Microsoft’s

dominance blocked fair competition within the software industry. This is an advantage for Apple, because its operating systems are a viable substitute for Windows. Furthermore,

Microsoft’s continued support for Office for Macintosh reduces the perceived level of market monopoly and abuse. (Linzmayer, 290-1) Manufacturers will continue to trespass on Apple’s intellectual property. For example, the company tex9 released an open source music program called xtunes that was very similar to iTunes. In 2002, Apple took legal action against tex9, who then altered the program and renamed it sumi (pronounced, “sue me”). (Linzmayer, 300) Legal threats can surface from somewhat unusual sources. Apple Corps Ltd. is the London-based company that owns the rights to the music of the Beatles. Paul McCartney and Ringo Starr recently sued Apple over the use of the Apple logo in iTunes, claiming that it violated Apple’s agreement not to produce music under an apple-based logo. (Associated Press) Research and development is a key component to Apple’s sustained competitive advantage. Apple is currently taking legal action against several popular technical web sites for releasing proprietary product research. Sites such as appleinsider.com have allegedly posted verbatim content from documents protected by employee non-disclosure agreements.

Page 24 of 54

(McCullagh) Release of critical insider information could give Apple’s competitors a jump in producing rival products.

Industry Analysis Using Porter’s Five Forces Model
Apple operates in two primary industries: • • Computing - Hardware and Software Delivery of Entertainment and Media Apple has always been under intense competition within the computer, software, and entertainment industries. “Looking to 2005...Every time that Apple had jumped into the lead in a product category during the past two decades, it had had difficulty in sustaining its leadership position.” (Yoffie) We use Porter’s Five Forces Model to understand why Apple’s industries are so competitive. Figure 6: Porter’s Five Forces Model

Threat of New Entrants

Bargaining power of Suppliers

Level of Threat in an Industry

Bargaining power of Buyers

Threat of Substitutes

Page 25 of 54

Figure 7: Summary of Industry Threats (Computer Equipment and Entertainment Distribution)
Type and Severity of Threat Entry – High Threat Organization Verizon Amazon Google The “Next Google” Microsoft Linux Napster, Rhapsody Dell, HP, Lenovo iRiver, Samsung, Creative DreamWorks YouTube.com XM, Sirius XBox, PS2 Various Music CDs, DVDAudio and SuperAudio CD Broadcast, Cable, Satellite, NetFlix, TiVo, Theatres Motorola, IBM, Intel, Samsung Microsoft The Big Five - BMG, EMI, Sony, Universal, and Warner Disney, ABC, NBC, CBS, Fox, Pixar, Sony Consumers and Illegal peer-to-peer file sharing Distributors Examples Streaming audio and video with V CAST. On demand online services to purchase music (similar to iTunes). They make everything. New entrants with disruptive technology. Windows Operating System, Windows Media Player for playing music and video. Competition to Mac OS X Operating System. Online music sources – alternatives to iTunes Music Store. Alternate sources for computer hardware. Small, stylish MP3 Players. Animated movies. Online video. Satellite Radio for music. Entertainment Media, Media and Music. Internet Streaming Radio and Podcasts. Alternative means to acquire music. Alternative sources for video. Suppliers of Processors and computer memory. Strategic Alliance / Supplier of Office for Mac. Sources of music. Will they raise prices and break the dollar per song model? Some in the record industry resent Apple’s distribution model. “Apple reaps billions from selling its hit music player, but there are sparse profits from the songs being sold over the Net.” (Burrows, Grover, and Green) Suppliers of Television and Movies. Will they sign exclusive contracts with other online services? Note that this threat is reduced for Disney / Pixar. Consumers share music using peer-to-peer networks without paying for music. Apple retailers may pressure for lower prices or better terms. For example, the release of the Apple Store in 2001 “infuriated longtime independent Apple retailers that didn’t appreciate Cupertino cannibalizing their sales.” (Linzmayer, 300) Consumers or businesses may reduce spending on personal computers or non-essential (potentially high elasticity of demand) music players if they fear economic downturns. Consumers and businesses may continue to use previous-model iPods and

Rivalry – High Threat

Substitutes – Moderate Threat

Suppliers – High Threat

Buyers Moderate Threat

Consumer Attitudes and Behaviors Consumer Refresh

Page 26 of 54

Cycles

Macs rather than upgrade to current iPods, iMacs, or OS

Page 27 of 54

The total industry threat for the industry space that Apple occupies (computer equipment and distribution of entertainment) is a high threat industry. Apple must continue to pursue product differentiation (i.e. the style and ease-of-use of an iPod) and economies of scope (i.e. offering ABC television shows on iTunes) to maintain their sustained competitive advantage in this industry.

Which External Threats are Most Significant

Computer Hardware and Software: Open Source software such as the Linux Operating System and Open Office applications threaten both Apple and Microsoft. The low (often, free) cost of the software may allow it to overtake Apple and Microsoft, especially in developing markets such as China.

Music Products: Major online retailers such as Amazon are considering entry into the online music market. With a wide internet presence and a household name, Amazon could present a formidable challenge to Apple. If the major record labels (Universal, Sony BMG, EMI, and Warner) negotiate better terms with new competitors to iTunes, Apple may be unable to provide some of the music content that they currently offer. The major music labels dislike Apple’s dollar per song pricing. They would prefer to earn higher profits with “variable pricing”. (Wingfield) With variable pricing, the most

popular songs would be greater than $1, and less popular songs would be less than $1. Although the labels recently renewed their contracts with Apple, there may be provisions that allow future changes in the pricing model. (Wingfield and Smith)

Suppliers: The recent shift to Intel processors could present a significant threat to Apple. With only two companies (Intel and AMD) producing Intel-compatible processors, there is a strong potential for tacit collusion and oligopoly power between these suppliers. Apple purchasing must now directly compete with HP, Lenovo, and Dell. If shortages or
Page 28 of 54

exclusive agreements materialize, Apple could face problems with obtaining raw materials. Apple should consider additional sources such as Advanced Micro Devices (AMD). Figure 8: CPU Market Share

Additional External Threats Security
Apple software, like all large software products, has security vulnerabilities that hackers may exploit. A significant exploitation in the future could damage many businesses and

households using Apple computers. This would affect future customer purchasing decisions. Apple enjoys a competitive advantage, because their OS X is mature and stable due to its basis on BSD Unix. In fact, “computer security folks back at FBI HQ use Macs running OS X”. (Granneman)

Page 29 of 54

However, the increased use of Apple computers is prompting hackers to target the platform. In February 2006, there was documentation of the first known Apple OS X worm. By using iChat instant messaging, it spreads to other users and deletes files from their Mac computers. (Sophos) If Mac OS X becomes as wide of a target as Windows, Apple’s perceived differentiation as the more secure platform may disappear.

Vertical Integration of Competitors
Sony is an example of a competitor with a unique position against Apple. Sony Music supplies Apple with many of the songs for iTunes. Sony also creates a version of the Walkman portable music player that is a direct competitor to the iPod. (Hall) Sony is attempting to vertically integrate forward directly to the music buyer. Sony integrated their music system (Mora) into the Sony Walkman. Sony is exclusively distributing certain songs on Mora. (Hall) Mora currently targets Japanese consumers. If Sony can gain additional momentum (such as collaborating with other record labels), their service could present a formidable challenge to iTunes in additional markets. Figure 9: The Sony 20GB Walkman and Mora (only available in Japanese)

Page 30 of 54

Value Chain Analysis
To determine where Apple developed distinctive capabilities, Porter’s generic value chain model provides a systematic framework for identifying Apple’s utilization of resources. Primary activities for Apple include Technology and Product Design, Production, Sales and Marketing, Customer Service, and Legal Services.

Technology and Product Design
This component represents the true core (no pun intended) of Apple’s capability. From being the first platform to run an electronic spreadsheet (VisiCalc on the Apple II Plus) to the first to establish a “digital lifestyle” hub (the Macintosh product lines), Apple’s history is rich with cutting-edge technology development. (Linzmayer) Apple drives to be the best, no simply the first. The Apple operating system is universally regarded as more stable and reliable than Windows, while the desktop publishing software bundles (iMovie, iPhoto, iTunes, etc.) are the most comprehensive available to end users. Ives best summarizes the entrepreneurial culture

Page 31 of 54

within Apple by saying that “it’s very easy to be different, but very difficult to be better.” (Linzmayer, 301)

Production
Because Apple had long refused to license its operating system to external entities, the bundled packages of Apple-developed hardware and software became the cornerstone of Apple’s production process. Apple achieved unparalleled performance via 64-bit architecture, integrated distinctive styling with the multi-colored translucent iMac cases, and redefined intuitive operation with the iPod. While every product introduction has not been a success (Lisa, Newton, etc.), Apple treats component production as a natural extension of the design process.

Sales and Marketing
We could simply title this section “Steve Jobs”. Since his return as CEO in 1997, Jobs personally unveils all new product introductions, reviews corresponding marketing campaigns, and approves new product development guidelines. In a departure from their turbulent history, Jobs “entered into patent cross-licensing and technology agreements with Microsoft.” (Linzmayer, 290) After years of unimpressive market share growth and cannibalization of a loyal consumer base, the door to the expansive PC market was now more accessible to Apple than ever before. Apple continued to command a market premium for producing a “better mousetrap” throughout its history.

Customer Service
How has Apple retained substantial cash reserves during the explosive growth and dominance of PCs worldwide? Apple created a virtual love affair with their customer base by delivering technically superior products (iPods vs. other MP3 players, Macs vs. PCs, etc.), and

Page 32 of 54

aggressively pursuing hardware and software updates. Apple integrated their primary activities so well that it is transparent to the consumer where one activity begins and the other ends. A perfect example of this is Apple’s willingness to develop software to run Windows XP on its new Intel-based iMac and then post it online free to iMac users. (Wingfield) In such an environment, customer service merely becomes the realization of receiving a little more than expected. Although Apple employs many resources and capabilities to support their primary activities (human resources, supply procurement, etc.), the most strategically relevant would be Legal Services.

Legal Services
In a market climate of constant change and innovation, it is inevitable that the drive to expand product and service offerings will subject Apple to patent and copyright infringement claims. The dispute over the Apple logo on its iTunes Music Store, for example, continues despite a previously reached settlement with Beatles’ Apple Corps Ltd. in 1991. (Dow Jones Newswires) While such litigation as Microsoft’s Windows infringement on Mac OS patents has been highly publicized, use of legal guidance to drive acquisition versus internal development strategies for such products as GarageBand and iMusic have proven highly valuable. (Linzmayer, 172-4, 250) Intellectual property is sacred to Apple. There was a recent attempt to uncover the identities of internal “sources who leaked confidential information about an unreleased product to online media outlets in 2004.” (Wong)

SWOT Analysis

Page 33 of 54

Although participation in such activities may add value, they may not be a source of competitive advantage. Ultimately, the value, rarity, inimitability, and/or organization (VRIO) of an activity or resource determine its sustainability as a source of competitive advantage. Within this context, we can identify a firm’s strengths, weaknesses, opportunities, and threats (SWOT).

Strengths

Technical savvy – Product lines are easy to use and stable. Recent integration with Microsoft products lines and Intel processors demonstrate ability and willingness to adapt to a diverse customer base. (Mossberg) Such innovation, however, would not be

sustainable without a learning environment tolerant of mistakes. While the pure technical expertise alone is not a valuable or rare resource, it becomes very costly to imitate when it exists within the socially complex, entrepreneurial culture of Apple.

Financial vitality – Cash reserves remained robust and stable despite stagnant market share growth in the computer hardware and software arenas. Apple exploited this by resisting market pressures to reduce costs, tightly integrating product packages, and forming strategic alliances (i.e. securing the backing of all major music distributors in the support of iTunes).

Brand loyalty – The only way that Apple could maintain the financial vitality described above is via a fanatical, almost cult-like, affair with its customer base. Such brand loyalty is extremely costly and time-consuming to imitate.

Steve Jobs – As discussed earlier, Jobs proved to be a vital component to Apple’s success. During his absence (1985-1996), Apple experienced the most turbulent (financial and innovative) timeline in its history. Immediately upon his return, he replaced most of the Board of Directors, pruned and focused the new product ideas, and delivered seven

Page 34 of 54

consecutive quarters of positive earnings to shareholders. (Linzmayer, 289-99) As such, Jobs is certainly a valuable, rare, and hard to imitate resource that Apple fully exploits.

Weaknesses

Market share – Apple has historically been strongest in the US geographical and educational vertical markets. With the educational market facing tightening budget

constraints and the US approaching a PC saturation point, Apple may need to burn cash more quickly and succumb to market cost pressures on its products without a strategic innovation, integration, or divesture.

Steve Jobs – For virtually the same reasons Jobs is a strength, he is simultaneously a weakness. The aggressive drive to bring innovative visions to life was noticeably absent and painfully felt (especially by shareholders) during his departure. The apparent

absence of succession planning coupled with a lust for the limelight positioned Jobs as Apple’s single consciousness in the eyes of consumers and shareholders.

Opportunities

Consumer electronics – With the startling success of the iPod and iTunes, Apple entered the consumer electronics market. By expanding the iTunes concept to downloadable mobile phone features and movies (podcasts), the door is now open to develop new and potentially profitable strategic alliances with peripheral component manufacturers (speaker, home stereo, etc.) and media transmission giants (Disney, TBS, Verizon, etc.).

PC hardware and software market growth – With cross-licensing of operating system platforms in place, Apple entered the high-volume business environment traditionally dominated by Windows-based PCs. The introduction of Intel-based processors prompted

Page 35 of 54

businesses to replace PCs with iMacs. They did this to gain a level of stability and reliability in their business applications that PCs failed to provide. An example is Japan’s Aozora Bank Ltd., who is replacing 2,300 PCs with iMacs. (Wingfield) Apple must establish themselves as a credible player in business desktop applications to overcome the “desktop publishing” stereotype.

Threats

Legal risks – In a market that literally changes at the speed of thought, patent and copyright infringement risks remain high. As long as operating systems and support software packages continue to converge and remain relatively easy to imitate, present and future lawsuits are inevitable. unresolved. The Apple records claim against iTunes remains

Competition – This threat occurs primarily on two fronts: PC hardware/software and consumer electronics. For the same reasons discussed in the opportunities section, the threat of imitability (cloning, pirating, etc.) increases. As relative newcomers to the consumer electronics arena, will Apple retain a competitive advantage as they diversify their offerings (speakers, home entertainment systems, etc.)?

Financial Analysis 2nd Quarter 2006
Apple’s financial performance continued to strengthen over the last several quarters. In the most recent earnings announcement, Apple reported significant growth in net revenues driven

Page 36 of 54

by the strong performance of its iPod product line. Net sales for the 2nd quarter grew to $4.36 billion, which is a 34% increase over 2nd quarter 2005 results. Net income increased by 41% to $410 million. (Apple Reports) The iPod product line continues to drive the financial performance of the company. In the 2nd quarter alone, Apple sold 8.5 million iPods, representing a 61% increase over the 5.3 million units sold in the 2nd quarter of the prior year. Mac sales showed slight growth of only 4%. (Apple Reports) Apple’s year-to-date revenues total just over $10 billion and earnings total just under $1 billion. For the 3rd quarter, CFO Peter Oppenheimer stated, “…we expect revenue of about $4.2 to $4.4 billion” which will push total sales above last term’s annual numbers. (Apple Reports)

Historical Performance
Although sales remained stagnant during 1998-2002, sales more than doubled since (see graph below). This dramatic shift in performance is primarily due to the increase in sales from the iPod product line.

Apple Revenue Growth
16000 14000

Net Sales

12000 10000 8000 6000 4000

(Apple Computer, 2005) 2000
0 1998 1999 2000 2001 2002 2003 2004 2005

Stock Price Performance

Page 37 of 54

Another interesting way to consider the financial performance is to evaluate how Apple’s stock price performed against the market and against its main competitors. As we see from the chart above, Apple’s performance has been inconsistent over the last 20 years compared to the S&P 500. It also has not performed at the same level as its main competitors, Dell and

Microsoft. However, performance improved since 2003.

Profitability Measures
Apple substantially improved in its key measures of profitability in the last few fiscal years. In terms of return on assets, return on equity and profit margin, Apple strengthened financially and now has similar ratios to that of its competitors and the overall computer hardware industry (see table below).

2003 Return Assets Return Equity on on 1.01% 1.63%

2004 3.43% 5.44%

2005 11.56% 17.88%

Microsoft '05 19.75% 28.56%

Dell '05 15.42% 67.31%

Industry '05 11.98% 36.61%

S&P 500 8.13% 19.61%

Page 38 of 54

Profit Margin P/E Ratio

1.11%

3.33%

9.58% 33.89

31.57% 22.63

6.39% 18.51

6.36% 26.32

13.75% 22.09

In reviewing Apple’s 1st and 2nd quarter 2006 earnings releases, gross margins dropped slightly. Apple attributes this decline primarily to price pressures, especially in the iPod product line. (1st Quarter 10Q) This will continue to affect performance over time. However, Apple’s ability to maintain the momentum it built in the marketplace will control the speed with which erosion will occur.

Liquidity and Leverage Measures
Apple historically held very little long-term debt. The table below compares Apple’s liquidity measures to their competitors, their industry, and the general market. During the period of strong financial performance, Apple accumulated cash. This strengthens Apple’s position should they choose to access the capital markets.
2003 Current Ratio Quick Ratio 2.5 2.47 2004 2.6 2.59 2005 3 2.9 Microsoft '05 2.88 2.85 Dell '05 1.11 1.08 Industry '05 1.81 1.45 S&P 500 1.82 1.31

Product Unit Sales
In the last several years, there have been dramatic changes to Apple’s product sales by category. Apple breaks its unit sales into four primary categories: desktops, notebooks, iPods, and peripherals. The graph below shows the product mix for Apple in 2002. Note the

domination by desktops and notebooks and the small contribution by iPods. (Apple Computer)

2002 Product Sales
Desktops Notebooks iPod
Page 39 of 54 Peripherals

2005 Product Sales
Desktops Notebooks iPod Peripherals

When you compare the same graph for 2005, you see dramatic differences in the product mix for Apple. The iPod sales now account for 32.5% compared to 2.5% for 2002. The combined sales of computers (desktop/notebook) lost share, dropping from 79% to 45% of sales. This drop merely represents a shift in Apple’s product mix, not their global computer market share (which remains stable in the 2-3% range). Meanwhile, sales of peripherals (including wireless connectivity and networking solutions), remained stable. (Hoover’s)

Operating Segments
Apple breaks its sales into five “operating segments”. The chart below shows the sales by segment for each year 2002-2005. On a percentage basis, only the retail segment appears to be outperforming the others. (Apple Computer, Hoover’s)

Sales by Region Segment
16000 14000

Total Sales

12000 10000 8000 6000 4000 2000 0

Other Retail Japan Europe America's

Net sales in the retail segment grew to $2.35 billion in 2005. In the 1st quarter 2006, sales
2002 2003 2004 2005

growth continued in the retail segment to $1.1 billion (a 91% increase over the same period last Year

Page 40 of 54

year). This increase was due to growth in the number of stores (from 101 to 135) and to a 41% same-store sales growth. (1st Quarter 10Q) Although the retail segment was the only segment to realize growth as a percentage of total sales, all of the segments had solid growth. In the Americas, sales increased 65% and continued to represent approximately 47% of total worldwide sales. Sales in Japan and Europe grew by 92% and 47%, respectively. (1st Quarter 10Q)

Market Value Analysis
We used Discounted Cash Flow (DCF) analysis to assess the appropriate equity value of Apple. To complete this analysis, we developed a pro-forma income statement and extracted free cash flow. We then discounted these cash flows using a calculated Weighted Average Cost of Capital (WACC). Apple’s WACC equaled their cost of equity since they carry no long-term debt. We used the Capital Asset Pricing Model (CAPM) to calculate the cost of equity. CAPM consists of a risk-free rate, a market risk premium, and a company Beta. The yield on the 10-year Treasury is the standard for a risk-free rate. To determine the market risk premium, we used the average return that an investor would require for an investment with average risk. (Higgins) We used data available online to determine Apple’s Beta, projected to be 1.46. (Google, 4/21/06) The below chart summarizes Apple’s cost of equity.
Cost of Equity/WACC Risk Free Rate Market Risk Premium Beta Adjusted Apple Risk Premium Cost of Equity/WACC Note 10 Yr Treasury (Analysis) From Google Value 5.12 4 1.46 5.84 10.96

Page 41 of 54

Pro-Forma Income Statement
We made several key assumptions in compiling a pro-forma income statement. First, to complete the estimate for the 2006 data, we merely annualized the earnings for the first two quarters. We then projected a declining rate of growth in sales for the next four fiscal terms of 30%, 20%, 15%, and 10%, respectively. We do not believe that the growth in iPods is

sustainable for the long-term. We also used the percent-of-sales method to calculate cost of goods sold, research & development, SG&A, and interest. We applied the 2005 tax rate for all future periods. As the table below shows, the mid-term earnings growth is positive.
2005 13931 9888 534 1859 1650 165 480 1335 1.57 848,612 Annualized 2006 20216 14353 809 2628 2426 239 705 1960 2.31 848,612 2007P 26280.8 18659 1051 3417 3154 311 916 2548 3.00 848,612 2008P 31536.96 22391 1261 4100 3784 374 1100 3058 3.60 848,612 2009P 36267.50 25750 1451 4715 4352 430 1265 3517 4.14 848,612 2010P 39894.25 28325 1596 5186 4787 473 1391 3869 4.56 848,612

Net Sales Cost Of Sales R&D S,G,A Operating Income Interest Income Taxes Net Income EPS Shares Out (000's)

Projected Free Cash Flow and Equity Valuation
We assume that Apple will continue without long-term debt. We also assume that there will be no significant changes in capital expenditures and net working capital. Thus, free cash flow will equal net income plus depreciation. Given WACC, we are able to discount cash flows back using half-year PV factors (we are through the first half of 2006). We calculated our terminal value using a perpetual annual growth rate of 7%, which is slightly above the industry growth rate of 5.6%. (Datamonitor)

Page 42 of 54

Free Cash Flows Net Income Depreciation Free Cash Flows WACC PV Factor Terminal Value PV FCF Sum of PV of CF PV of Terminal Value FMV of Invested Capital Less Existing Cash Balance Intrinsic Value of Equity

2006 A 1960.00 239.00 2199.00 10.96 0.9505 1862.98 11270.90 68619.42 79890.32 8261 71629.32

2007P 2548.00 310.70 2858.70 10.96 0.8565 2182.36

2008P 3058.00 372.89 3430.89 10.96 0.7715 2359.25

2009P 3517.00 428.86 3945.86 10.96 0.695 2444.32

2010P 3869.00 471.78 4340.78 10.96 0.626 2421.99

Terminal

0.626 109615.6 68619.42

Given intrinsic equity value, we estimate the per share stock price. Given their particular market condition, Apple appears undervalued (see table below).

Equity Value Total Shares (000's) Value (000's) Value/Share Current Price (5/5/06)

848612 71629000 $84 $71.89

Strategy
We can describe Apple’s strategy in terms of product differentiation and strategic alliances. In each of these strategies, we examine what Apple did historically and then discuss alternatives for Apple’s future.

Product Differentiation
Apple prides itself on its innovation. When reviewing the history of Apple, it is evident that this attitude permeated the company during its peaks of success. For instance, Apple pioneered the PDA market by introducing the Newton in 1993. (Linzmayer, 203) Later, Apple introduced the easy-to-use iMac in 1998, and updates following 1998. (Linzmayer, 294-6) It released a highly stable operating system in 1999, and updates following 1999. (Linzmayer, 297) Apple had one of its critical points in history in 1999 when it introduced the iBook. This completed their “product matrix”, a simplified product mix strategy formulated by Jobs. This

Page 43 of 54

move allowed Apple to have a desktop and a portable computer in both the professional and the consumer segments. The matrix is as follows (Linzmayer, 297): Professional Segment Desktop G3 Portable PowerBook Consumer Segment iMac iBook

In 2001, Apple hit another important historical point by launching iTunes. This marked the beginning of Apple’s new strategy of making the Mac the hub for the “digital lifestyle”. (Linzmayer, 299) Apple then opened its own stores, in spite of protests by independent Apple retailers voicing cannibalization concerns. (Linzmayer, 300) Then Apple introduced the iPod, central to the “digital lifestyle” strategy. Philip W. Schiller, VP of Worldwide Product Marketing for Apple, stated, “iPod is going to change the way people listen to music.” (Linzmayer, 300) He was right. Apple continued their innovative streak with advancements in flat-panel LCDs for desktops in 2002 and improved notebooks in 2003. (Linzmayer, 301-2) In 2003, Apple released the iLife package, containing improved versions of iDVD, iMovie, iPhoto, and iTunes. (Linzmayer, 302) In reference to Apple’s recent advancements, Jobs said, “We are going to do for digital creation what Microsoft did for the office suite productivity.” (Linzmayer, 302) That is indeed a bold statement. Time will tell whether that happens. Apple continued its digital lifestyle strategy by launching iTunes Music Store online in 2003, obtaining cooperation from “The Big 5” Music companies—BMG, EMI, Sony Entertainment, Universal, Warner. This allowed iTunes Music Store online to offer over 200,000 songs at introduction. (Linzmayer, 302) In 2003, Apple released the world’s fastest PC (Mac G5), which had dual 2.0GHz PowerPC G5 processors.

Page 44 of 54

Product differentiation is a viable strategy, especially if the company exploits the conceptual distinctions for product differentiation. Those that are relevant to Apple are product features, product mix, links with other firms, and reputation. (Barney, 266-71) Apple established a reputation as an innovator by offering an array of easy-to-use products that cover a broad range of segments. However, its links with other firms have been limited, as we will discuss in the next section on strategic alliances. There is economic value in product differentiation, especially in the case of monopolistic competition. The primary economic value of product differentiation comes from reducing

environmental threats. The cost of product differentiation acts as a barrier to entry, thus reducing the threat of new entrants. Not only does a company have to bear the cost of standard business, it also must bear the costs associated with overcoming the differentiation inherent in the incumbent. Since companies pursue niche markets, there is a reduced threat of rivalry among industry competitors. A company’s differentiated product will appear more attractive relative to substitutes, thus reducing the threat of substitutes. If suppliers increase their prices, a company with a differentiated product can pass that cost to its customers, thus reducing the threat of suppliers. Since a company with a differentiated product competes as a quasi-monopoly in its market segment, there is a reduced threat of buyers. With all of Porter’s Five Forces lower, a company may see economic value from a product differentiation strategy. (Barney, 277-81) A company attempts to make its strategy a sustained competitive advantage. For this to occur, a product differentiation strategy that is economically valuable must also be rare, difficult to imitate, and the company must have the organization to exploit this. If there are fewer firms differentiating than the number required for perfect competition dynamics, the strategy is rare. If

Page 45 of 54

there is no direct, easy duplication and there are no easy substitutes, the strategy is difficult to imitate. (Barney, 281-7) There are four primary organizing dilemmas when considering product differentiation as a strategy. They are as depicted below.
Organizing Dilemmas Inter-Functional Collaboration Too Much (Lockstep) Slows Innovation Connection to the Past Too Much (History as Constraint) Stifles Innovation Commitment to Market Vision Too Much (Foresight) No Innovation Can Take Place Institutional Control Too Much (Bureaucracy) Lack of Flexibility in Uncertain Market Source: Barney, 290 Too Little (No Collaboration) No learning makes implementation difficult Too Little (No History) Lack of Direction in Innovation Too Little (No Sight) Fail to Exploit Historical Advantage Too Little (Chaos) Lack of Direction in Innovation

To resolve these dilemmas, there must be an appropriate organization structure. A U-Form organization resolves the inter-functional collaboration dilemma if there are product development and product management teams. Combining the old with the new resolves the connection to the past dilemma. Having a policy of experimentation and a tolerance for failure resolves the commitment to market vision dilemma. Managerial freedom within broad decisionmaking guidelines will resolve the institutional control dilemma. (Barney, 294) Five leadership roles will facilitate the innovation process: Institutional Leader, Critic, Entrepreneur, Sponsor, and Mentor. The institutional leader creates the organizational

infrastructure necessary for innovation. This role also resolves disputes, particularly among the other leaders. The critic challenges investments, goals, and progress. The entrepreneur manages

Page 46 of 54

the innovative unit(s). The sponsor procures, advocates, and champions. The mentor coaches, counsels, and advises. (Barney, 295) Apple had issues within its organization. In 1997, when Apple was seeking a CEO acceptable to Jobs, Jean-Louis Gassée (then-CEO of Be, ex-Products President at Apple) commented, “Right now the job is so difficult, it would require a bisexual, blond Japanese who is 25 years old and has 15 years’ experience!” Charles Haggerty, then-CEO of Western Digital, said, “Apple is a company that still has opportunity written all over it. But you’d need to recruit God to get it done.” Michael Murphy, then-editor of California Technology Stock Letter, stated, “Apple desperately needs a great day-to-day manager, visionary, leader and politician. The only person who’s qualified to run this company was crucified 2,000 years ago.” (Linzmayer, 289) Since Jobs took over as CEO in 1997, Apple seems to have resolved the innovation dilemmas, evidenced by their numerous innovations. To continue a product differentiation strategy, Apple must continue its appropriate management of innovation dilemmas and maintain the five leadership roles that facilitate the innovation process.

Strategic Alliances
Apple has a history of shunning strategic alliances. On June 25, 1985, Bill Gates sent a memo to John Sculley (then-CEO of Apple) and Jean-Louis Gassée (then-Products President). Gates recommended that Apple license Macintosh technology to 3-5 significant manufacturers, listing companies and contacts such as AT&T, DEC, Texas Instruments, Hewlett-Packard, Xerox, and Motorola. (Linzmayer, 245-8) After not receiving a response, Gates wrote another memo on July 29, naming three other companies and stating, “I want to help in any way I can with the licensing. Please give me a call.” (Linzmayer, 249)

Page 47 of 54

In 1987, Sculley refused to sign licensing contracts with Apollo Computer. He felt that up-and-coming rival Sun Microsystems would overtake Apollo Computer, which did happen. (Linzmayer, 249-50) Then, Sculley and Michael Spindler (COO) partnered Apple with IBM and Motorola on the PowerPC chip. Sculley and Spindler were hoping IBM would buy Apple and put them in charge of the PC business. (Linzmayer, 250) That never came to fruition, because Apple (with Spindler as the CEO) seemed contradictory and was extraordinarily difficult in business dealings. (Linzmayer, 251-2) Apple turned the corner in 1993. Spindler begrudgingly licensed the Mac to Power Computing in 1993 and to Radius (who made Mac monitors) in 1995. However, Spindler nixed Gateway in 1995 due to cannibalization fears. (Linzmayer, 252-3) Gil Amelio, an avid supporter of licensing, took over as CEO in 1996. Under Amelio, Apple licensed to Motorola and IBM. (Linzmayer, 253-4) In 1996, Apple announced the $427 million purchase of NeXT Software, marking the return of Steve Jobs. (Linzmayer, 216) Amelio suddenly resigned in 1997, and the stage was set for Jobs to resume power. Jobs despised licensing, calling cloners “leeches”. He pulled the plug, essentially killing its largest licensee (Power Computing). Apple subsequently acquired Power Computing’s

customer database, Mac OS license, and key employees for $100 million of Apple stock and $10 million to cover debt and closing costs. The business was worth $400 million. (Linzmayer, 2557) A massive reversal occurred in 1997 and 1998. In 1997, Jobs overhauled the board of directors and then entered Apple into patent cross-licensing and technology agreements with Microsoft. (Linzmayer, 289-90) In 1998, Jobs stated that Apple’s strategy is to “focus all of our software development resources on extending the Macintosh operating system. To realize our

Page 48 of 54

ambitious plans we must focus all of our efforts in one direction.” (Linzmayer, 293) This statement was in the wake of Apple divesting significant software holdings (Claris/FileMaker and Newton). There is economic value in strategic alliances. (Barney, 370-84) In the case of Apple, there was the opportunity to manage risk and share costs (Barney, 373-4), facilitate tacit collusion (Barney, 374-5), and manage uncertainty (Barney, 378-9). It would have been

applicable to the industries in which Apple operated. Tacit collusion is a valid source of economic value in network industries (Barney, 380), which the computer industry is. Managing uncertainty, managing risk, and sharing costs are sources of economic value in any industry (Barney, 380). Although Apple eventually realized the economic value of strategic alliances, it should have occurred earlier. The following are some comments about Apple’s no-licensing policy. (Linzmayer, 245-9) “If Apple had licensed the Mac OS when it first came out, Windows wouldn’t exist today.”—Jon van Bronkhorst, Robertson Stephens analyst, San Francisco Chronicle, August 8, 1994 “The computer was never the problem. The company’s strategy was. Apple saw itself as a hardware company; in order to protect our hardware profits, we didn’t license our operating system. We had the most beautiful operating system, but to get it you had to buy our hardware at twice the price. That was a mistake. What we should have done was calculate an appropriate price to license the operating system. We were also naïve to think that the best technology would prevail. It often doesn’t.”—Steve Wozniak, Apple cofounder

Page 49 of 54

“If we had licensed earlier, we would be the Microsoft of today.”—Ian W. Diery, Apple Executive VP, Newsweek, August 29, 1994 “I am aware that I am known as the Great Satan on licensing…I was never for or against licensing. I just did not see how it would make sense. But my approach was stupid. We were just fat cats living off a business that had no competition.”—Jean-Louis Gassée, Be CEO and ex-CEO of Apple, admitting he made a strategic mistake A strategic alliance can be a sustained competitive advantage if it is rare, difficult to imitate, and the company has an organization to exploit it. If the number of competing firms implementing a similar strategic alliance is relatively few, the strategy is rare. If there are socially complex relations among partners and there is no direct duplication, the strategy is difficult to imitate. (Barney, 384-9) When organizing for strategic alliances, a firm must consider whether the alliance is nonequity or equity. A non-equity alliance should have explicit contracts and legal sanctions. (Barney, 390) An equity alliance should have contracts describing the equity investment. (Barney, 392-5) There are some substitutes for an equity alliance, such as internal development and acquisitions. However, the difficulties with these drive the formation of strategic alliances. It is vital to remember, “Commitment, coordination, and trust are all important determinants of alliance success.” (Barney, 395)

Page 50 of 54

RECOMMENDATIONS

FOR COMPANY: Lowering the cost of products and maintaining the same quality standards Can form joint – ventures Knowledge Management More number of retail stores for easy access Continuous innovation to expand

FOR OTHERS: Do not compromise on price for quality Choose the products based on individual needs Be unique and different

Page 51 of 54

CONCLUSION
We feel that Apple must focus on several key aspects to continue to grow and succeed. They must continue a stable commitment to licensing, push for economies of scope between media and computers, and become a learning organization. Apple apparently made a commitment to licensing. Although it should continue, Apple may want to consider other forms of strategic alliances. An equity strategic alliance may offer Apple the opportunity to obtain additional competencies. An effective way for a company like Apple to accomplish this would be in the form of a joint venture. Apple should continue pushing the new line of media-centric products. Meanwhile, Apple should not lose focus on its computers. Macintosh computers were 39% of Apple’s sales in 2005. (Burrows) This very innovative company exploits its second-mover position. In the future, they will need to continue innovating to expand the boundaries of both media and computers. One persistent element of both competitive advantage and risk is Steve Jobs. He is both synonymous with Apple’s success and has a large equity interest in Apple and Disney. If he were to divest his leadership position, the reaction of both the market and consumers would be uncertain. Given his position within the organization as well as the history of the company when he was gone, Apple must find a way to learn as an organization. This will allow the company to withstand a departure by Jobs. Based on the actions of the organization, we feel that the mid-term performance of Apple will be strong. This period allows Apple time to overcome their challenges if they move swiftly. For this reason, we feel that they will continue to succeed and will continue to outperform their peers.

Page 52 of 54

INDEX
HISTORY OF APPLE……………………………………….8 EXTERNAL ANALYSIS…………………………………..21 PORTER’S FIVE FORCES MODEL………………………25 VALUE CHAIN ANALYSIS………………………………30 SWOT ANALYSIS…………………………………………33 FINANCIAL ANALYSIS………………………………….36 MARKET VALUE ANALYSIS…………………………...40 STRATERGIES…………………………………………....43

Page 53 of 54

BIBLOGRAPHY
www.appleinc.com www.google.com http://trad.org http://www.divisiontwo.com/articles http://www.cnet.com

Page 54 of 54

Sign up to vote on this title
UsefulNot useful