AStrategicAnalysis

of

AppleCorporation

TimothyPivovarnik

JeffShaver

AdamSiler

RichardSterling

DaveStrubbe

EXECUTIVESUMMARY 3

HISTORYOFAPPLE 4

THEPCINDUSTRY 10

THEONLINEMUSICINDUSTRY 12

THEFUTUREOFAPPLE 12

PERSONALCOMPUTERSASHIFTINSTRATEGY 12

APPLEINTHELIVINGROOM 14

STRATEGICALLIANCESANDENTERTAINMENT 15

EXTERNALANALYSIS 17

TECHNOLOGICALENVIRONMENT 17

BrandAwarenessStyleataPremium 17

Interoperability 18

TechnologyandtheDigitalLifestyle 18
REGULATORYENVIRONMENT 20

INDUSTRYANALYSISUSINGPORTER'SFIVEFORCESMODEL 21

WHICHEXTERNALTHREATSAREMOSTSIGNIFICANT 23

ADDITIONALEXTERNALTHREATS 25

SECURITY 25

VERTICALINTEGRATIONOFCOMPETITORS 25

VALUECHAINANALYSIS 26

TECHNOLOGYANDPRODUCTDESIGN 27

PRODUCTION 27

SALESANDMARKETING 27

CUSTOMERSERVICE 28

LEGALSERVICES 28

SWOTANALYSIS 29

STRENGTHS 29

WEAKNESSES 30

OPPORTUNITIES 31

THREATS 31

FINANCIALANALYSIS 32

2NDQUARTER2006 32

HISTORICALPERFORMANCE 33

STOCKPRICEPERFORMANCE 34

PROFITABILITYMEASURES 35

LIQUIDITYANDLEVERAGEMEASURES 35

PRODUCTUNITSALES 36

OPERATINGSEGMENTS 36

MARKETVALUEANALYSIS 37
PROFORMAINCOMESTATEMENT 38

PROJECTEDFREECASHFLOWANDEQUITYVALUATION 39

STRATEGY 40

PRODUCTDIFFERENTIATION 40

STRATEGICALLIANCES 44

CONCLUSIONS 48

REFERENCES 49

ExecutiveSummary

AppleComputer's30yearhistoryisfullofhighsandlows,whichiswhatwewould
expectinahighlyinnovativecompany.Theyevolvedthroughouttheyearsintoan
organizationthatisverymucharepresentationofitsleader,StevenJobs.Applemade
severalhugelysuccessfulproductintroductionsovertheyears.Theyhavealso
completelyfallenontheirfaceonseveraloccasions.TheystruggledmightilywhileJobs
wasnotapartoftheorganization.Applereachedapointwheremanythoughttheywould
notsurvive.Whenaskedinlate1997whatJobsshoulddoasheadofApple,DellInc.'s
(DELL)thenCEOMichaelS.Dellsaidataninvestorconference:"I'dshutitdownand
givethemoneybacktotheshareholders."(Burrows,Grover,andGreen)

Well,timeschanged.Lessthan10yearslater,BusinessWeekrankedAppleasthetop
performerinits2006BusinessWeek50.Appleattributestheirrecentsuccesstorobust
salesofiPodmusicplayers(32millionin2005).Theyareoptimisticabouttheeconomies
ofscopewithmediagiants,suchasDisneyandPixar.(BusinessWeek)

Applerarelyintroducesanewtypeofproduct.Thus,insteadofbeingthepioneer,they
areanexpert"secondmover"byrefiningexistingproducts.Portablemusicplayersand
notebookcomputersareexamples.Appleincreasestheappealoftheseproductsby
makingthemstylishandmorefunctional.Theynowappearpoisedtomakesignificant
stridesinthehomecomputermarketandtocreatingatotaldigitallifestylewherebythe
homeisamultimediahub.

HistoryofApple
SteveJobsandSteveWozniakfoundedAppleonApril1,1976.ThetwoSteves,Jobsand
Woz(asheiscommonlyreferredtoseewoz.org),havepersonalitiesthatpersist
throughoutApple'sproducts,eventoday.Jobswastheconsummatesalespersonand
visionarywhileWozwastheinquisitivetechnicalgenius.Wozdevelopedhisown
homemadecomputerandJobssawitscommercialpotential.Afterselling50AppleI
computerkitstoPaulTerrell'sByteShopinMountainView,CA,JobsandWozsought
financingtoselltheirimprovedversion,theAppleII.(Linzmayer,79)

TheyfoundtheirfinancierinMikeMarkkula,whointurnhiredMichaelScotttobe
CEO.ThecompanyintroducedtheAppleIIonApril17,1977,atthesametime
CommodorereleasedtheirPETcomputer.OncetheAppleIIcamewithVisicalc,the
progenitorofthemodernspreadsheetprogram,salesincreaseddramatically.In1979,
Appleinitiatedthreeprojectsinordertostayaheadofthecompetition:1)theAppleIII
theirbusinessorientedmachine,2)theLisatheplannedsuccessortotheAppleIII,and
3)Macintosh.(Linzmayer,145)

In1980,thecompanyreleasedtheAppleIIItothepublicandwasacommercialflop.It
wastooexpensiveandhadseveraldesignflawsthatmadeforlessthanstellarquality.
Onedesignflawwasalackofcoolingfans,whichallowedchipstooverheat.Inlate
1980,Applewentpublic,makingthetwoStevesandMarkkulawealthytothetuneof
ninefigures.By1981,theAppleIIIwasnotsellingwellandScottinfamouslyfired40
peopleonFeb25("BlackWednesday").Scott'sdirectmanagementstyleconflictedwith
thecultureJobsandMarkkulapreferred,andScottresignedinJuly.Markkulastepped
intohispositionasCEO.(Linzmayer,156)

InAugust1981,IBMreleasedtheirPC.Unimpressedandunafraid,Applewelcomed
IBMtothePCmarketwithaslightlysmugfullpageadintheWallStreetJournal.It
wouldnotbelongbeforeIBM'sPCdominatedthemarket.

TheXeroxAltowastheinspirationforApple'sLisa.Appleemployeeswereableto
examinetheAltoinexchangeforallowingXeroxtoinvestinApplebeforeApple'sinitial
publicoffering(IPO).ApplereleasedtheLisainJanuary1983andwasnotableforbeing
thefirstcomputersoldtothepublicthatutilizedaGraphicUserInterface(GUI).
Unfortunately,theLisawasnotcompatiblewithexistingcomputers,andthereforecame
bundled"witheverythingandalistpricetomatch."(Linzmayer,77)At$9,995(over
$21,000in2005dollars),theLisamisseditstargetmarketbyawidemargin.

JobsattemptedtocontroltheLisaproject.Scott,unimpressedwiththeperformanceof
JobsontheAppleIIIproject,hadJobsheadupthedogandponyshowforthepending
IPO.Jobs,lookingforaprojecttolead,insertedhimselfintotheMacintoshdevelopment
team.Usinghisconsiderableinfluence,Jobswasabletoprocuretheresourcestoproduce
acomputerthatwasfasterthanLisa,usedaGUI,hadamouse,andsoldforthofLisa's
price.AppleintroducedtheMacintoshwithgreatfanfareduringthe1984SuperBowl.
TheOrwellianthemedcommercial(directedbyRidleyScott,ofAlien'fame)portrayed
IBMasBigBrotherandembodiedMacintoshandAppleasfreedomseekingindividuals
breakingawayfromthisoppressiveregime.Thecommercialwaslargelysuccessfuland
salesfortheMacstartedstrong.However,Macsaleslaterfaded.(Linzmayer,7693,109
14)

JohnSculleyleftPepsiCotojoinAppleinApril1983.Hewasfamousforengineeringthe
"PepsiChallenge",inwhichblindedtesterstastedbothCokeandPepsitounveilthe
truth'ofthetasteofPepsi.InresponsetolaggingMacsales,SculleycontrivedtheTest
DriveaMacintosh'campaign.Inthispromotion,prospectiveuserscouldtakehomea
Macintoshwithonlyarefundabledepositontheircreditcard.Whilelaudedbythepublic
andtheadvertisingindustry,thiscampaignwasaburdenondealersandsignificantly
impededtheavailabilityofMacstoseriousbuyers.In1985,Appletriedtohave
lighteningstriketwicewiththeirLemmings'commercialduringtheSuperBowl.Inwhat
wasbecomingApple'stypicalpatronizingfashion,thiscommercialinsultedcurrentPC
usersbyportrayingthemaswitlesslemmings,unthinkinglydoingharmtothemselves.
AlthoughJobsattemptedtooverthrowSculley,theboardbackedSculley.JobsleftApple
toformNeXTcomputer.(Linzmayer,1435,1538,207)

AfterJobsleftin1985,salesoftheMac"explodedwhenApple'sLaserWritermetAldus
PageMaker."(Linzmayer,159)Appledominatedthedesktoppublishingmarketforyears
tocome.UnderSculley,Applegrewfrom$600millioninannualsalesto$8billionin
annualsalesby1993.AppleintroducedMacPortablesin1989andthefirstPowerBooks
in1991.By1992,PCcompetitionateintoApple'smarginsandearningswerefalling.
SculleywasunderpressuretohaveAppleproduceanotherbreakoutproduct.Hefocused
hisenergyontheNewtonApple'sintroductionofthePersonalDigitalAssistant(PDA).
DespiteSculleygeneratingsubstantialdemandforNewton,itdidnotliveuptothehype
duetoitbeingseverelyunderdeveloped.Sculleyresignedin1993andMichaelSpindler
replacedhim.(Linzmayer,158,161,18396)

Spindlerspentmostofhistimeandenergiesonregainingprofitability,withtheendgoal
offindingabuyerforApple.Overthenextseveralyears,SpindlershoppedAppletoSun
Microsystems,EastmanKodak,AT&T,andIBM.Meanwhile,Applewasunabletomeet
thegrowingdemandforitsproductsduetosupplierproblemsandfaultydemand
predictions.Toaddinsulttoinjury,MicrosoftreleasedWindows95withgreatfanfarein
1995.Aftersignificantquarterlylossesin1996,theboardreplacedSpindlerwithDr.Gil
Amelio,CEOofNationalSemiconductor.(Linzmayer,23340)
Dr.AmeliotriedtobringApplebacktobasics,simplifyingtheproductlinesand
restructuringthecompany.OneofApple'smostpressingissuesatthetimewasreleasing
theirnextgenerationoperatingsystem(codenamed"Copland")tocompetewith
Windows95.AmelioandhistechnologyofficersfoundthatCoplandwassobehind
schedulethattheylookedoutsidethecompanytopurchaseanewOS.Ultimately,and
somewhatironically,theydecidedtopurchaseNeXTcomputerfromJobs.Naturally,
ApplewelcomedJobsbackintothefold.Theboardbecameincreasinglyimpatientwith
Amelioduetosalesnotreboundingquicklyenough.AppleboughtoutAmelio'scontract
afterjust1yearsonthejob.(Linzmayer,240)

JobseventuallyclaimedtheCEOposition.Then,hecleanedhousebyrevampingthe
boardofdirectorsandevenreplacingMikeMarkkula(whohadbeenwiththecompany
sincethebeginning).Jobssimultaneouslyputanendtothefledglingclonelicensing
agreements(whichcreatedafewMacclones)andenteredintocrosslicensing
agreementswithMicrosoft.OnMay6,1998,AppleintroducedthenewiMac,aproduct
sosecretthatmostAppleemployeeshadneverheardofit.(Linzmayer,28995)Thenew
iMacwasarunawaysuccesswithitstranslucentcase,allinonearchitecture,andeaseof
use.ItbroughtAppletoanewmarketofusersthosewhohadneverownedacomputer
before.Jobsfurthersimplifiedtheproductlinesintofourquadrantsalongtwoaxes:
DesktopandPortableonone,ProfessionalandConsumerontheother.Applecompleted
thematrixwiththeintroductionoftheconsumerbasediBookin1999.

Theyear2001wasanimportantyearforconsumersofAppleproducts.Appleopened
theirfirst25retailstores(totaling163storesin4countriesasofMay2006).In
September2001,AppleintroducedthenewiMacfeaturingascreenonaswivel.

ThenewiPods(portablemusicplayers)wereatremendoussuccess.Applesoldsomany
thatApple'sdependenceonMacsaleswassignificantlyless.Thiswasnosmallfeat
consideringthatthe2001iMacbecameApple'sbestsellingproduct"byalongshot".
(Linzmayer,301)AppleofferediTunes(afreeapplication)tohelptheirconsumers
organizemusiconiPodsandMacs.

In2003,AppleexpandediTunesby1)openingtheiTunesmusicstoretoallowMacusers
topurchasemusiconlineand2)expandingiTunestoWindowsusers.SalesofiPods
skyrocketedandcurrentlyprovidethebulkofproductsalestoApple.(Apple)
In2005,AppleannouncedthatitwouldstartusingIntelbasedchipstorunMacintosh
computers.InApril2006,AppleannouncedBootCamp,whichallowsusersofIntel
basedMacstobooteitherMacorWindowsOS.Thisfunctionalityallowsuserswhomay
needbothOSstoownjustonemachinetorunboth,albeitnotsimultaneously.

ThePCIndustry

WecangleanInsightintothehistoryandcompositionofthePCIndustryfromits
eponymoustitle.Inthelate1970s,asWozniakandJobswerestartingApplecomputer,
personalcomputerswereanemergingproduct.Thefollowingchart(Reimer)givesan
overallviewofthemajormarketplayerssincethemid1970s.

By1983,themarketshareoftheAppleIIfellto8%whilethePChad26%.Marketshare
ofMacintoshpeakedatslightlymorethan10%intheearly1990sandhassincetapered
tobetween23%.TheIBMPCanditsclonesbecamethestandardduetothesuccessof
theopennatureofthePC.Thisallowsproductdeveloperstooffervastlymoreproducts
fortheplatform.

SomearguethatnotlicensingtheMacOSwasamistake.BillGatesandMicrosoftwere
encouragingAppletolicensetheirOSintheearly1980s,becausetheyweredeveloping
softwareforAppleandhadmuchridingonthesuccessofthecompany.WhenAppledid
notlicense,Microsoftbegandevelopingtheiroperatingsystem,Windows.(Linzmayer,
16975,2459)

TheOnlineMusicIndustry

WhileAppleclearlydominatestheonlinemusicindustry,thebattlefordominationisnot
over.Althoughdigitalmusicsalesaregrowingrapidly,theRecordingIndustry
AssociationofAmerica(RIAA)statesthatdigitalsalesaccountforonly4%ofallmusic
sales.(Borland)AnalystsatForrester(Bartiromo)andGartner(Bruno)validatethis.
Apple'ssalesarebetween66%and75%ofdownloadsand80%ofmusicplayers.
(Bruno)Appleisparttoasuitallegingmonopolisticpracticesconcerningtheirmarket
sharedominanceofplayersanddownloads.(Grundner)

Theotherplayersinthedownloadmarketare(therevised)Napster,YahooMusic,
Rhapsody,andillegitimatefilesharingservices.Portablemusicplayerscompetingwith
theiPodincludethosemadebyCreative,Samsung,iRiver,andSony.Amajorpointof
contentionbetweentheseservicesandplayermanufacturersisthecontrolofavarietyof
incompatibleDigitalRightsManagement(DRM)schemes.

TheFutureofApple
PersonalComputersAShiftinStrategy

ApplehashistoricallytakenafardifferentpaththanthetraditionalWindowsandIntel
combination.MicrosoftprovidestheWindowsoperatingsystemtoseparatedownstream
hardwareproducerssuchasDell.Appleverticallyintegratedboththeoperatingsystem
softwareandhardwarecompletelyunderApple.AconsumerrunningMicrosoft
WindowscanchoosefromamyriadofsystemsbasedontheIntelprocessor,whilea
consumerrunningApple'sOSXmustpurchaseApplehardware.

AppleisadjustingthisstrategybymigratingtheirmicroprocessorsfromIBMand
MotorolaPowerPCtoIntel.AnalystsbelievethattheIntelbasedMacintoshmaybeable
torunMicrosoftWindowsapplicationsbytheendof2006.(Burrows)

Inadditiontoswitchingprocessors,Applepositionedtheircomputersasanimmediate
optionforthetraditionalMicrosoftWindowsuser.WithAppleBootCamp,usersmay
nowuseMacOSXorWindowsonanApplecomputer.(Sutherland)

Figure1:AppleBootCampAllowingMacOSXorWindows
(http://www.eweek.com/slideshow_viewer/0,1205,l=&s=27287&a=175119&po=18,00.as
p)

ByallowinguserstorunWindowsonanIntelMac,Applereducedtheswitchingcosts
fortraditionalPCusers.Applemaystealawaycustomersthatarewillingtopaya
premiumforasystemthatrunsbothWindowsandMacOSX.

Figure2:IBMPowerPCProcessor(http://itc.ua/img/ko/2003/50/proc5.jpg),Intel
ProcessorCoreDuo/PentiumM(http://blog.pcactual.com/blogpca/images/Intel
%20Pentium%20M.jpg)

Applecontinuestoretainastrategicoptiontolicenseitstechnologytoclonemakerssuch
asDell.PastattemptsatlicensingAppletechnology(toIBM,Gateway,andothers)failed
onaccordofApple'srigiddemands.Manytechnologyleaders(suchasa1985letterby
BillGatestoAppleCEOJohnSculley)criticizedAppleforkeepingaclosedarchitecture.
ApplecofounderSteveWozniakcriticizesthisstrategy,"Wehadthemostbeautiful
operatingsystem,buttogetityouhadtobuyourhardwareattwicetheprice.Thatwasa
mistake."(Linzmayer,24557)
WhetherApplewouldbewillingtopursuethisreversalofverticalintegrationisunclear.
AlthoughsuchamovewouldcannibalizeaportionofApple'sownhardwaresales,it
wouldalsoprovideroyaltybasedrevenuethatcouldapproach$1billionannually.
(Burrows)JobstraditionallysidedagainstlicensingAppletechnology.Hereferredto
Maccloneproducersas"leeches"andhepersonallykilledPowerComputing(aMac
cloneproducer)byterminatingtheirlicensein1997.(Linzmayer,255)

AppleintheLivingRoom

Apple'siPodandiTunesareapowerfulcombinationthatfostersanetworkstyleof
increasingreturns.(Barney,124)BysellingiPods,Appleincreasestheconsumerdemand
formusicfromiTunes.ByplacingmoremusicalchoicesoniTunes(includingless
popularsongsthatappealtonicheaudiences),thereismoredemandforiPods.Applehad
70%ofthelegalmusicdownloadmarketinearly2005.(Yoffie)

Appleisshootingforthedigitallivingroomofthefuture.Forexample,Applejust
releaseda"boombox"portableversionoftheiPod.ThisiPod(theiPodHiFi)comes
witharemotecontrol.Insteadofformingastrategicalliance,AppleengineeredtheiPod
HiFianddesigneditwithhighfidelityfeatures.(Burrows)Appleisclearlytryingto
developastrongercorecompetencyintheentertainmentarea.

Figure3:TheAppleHiFi.(http://www.apple.com/ipodhifi/)

ApplemayalsoreleaseanApplebrandedcellphoneandiPodcombinationdevicebythe
endof2006.(Burrows)ThisproductwouldagainpositionAppleasa"secondmover"
respondingtoPalm'sTreoandVerizon'sVCASTtechnology.

StrategicAlliancesandEntertainment

Jobshadtheearlystrategicvisiontocomplementcomputingwithmovieentertainment.
AfterfoundingNeXT,hepersonallyacquiredamajorityinterestintheyoungmovie
companyPixarinFebruary1986.(Linzmayer,219)Jobswentontoinvestofhis
personalwealthintoPixar.

In1995,PixarsolidifieditspositionwithinanimatedmovieswiththedebutofToyStory.
Grossing$358millionworldwide,itbecamethe3rdlargestgrossinganimatedmoviein
history.(Linzmayer,222)Afterthissuccess,JobstookPixarpublicandnegotiatedfar
bettertermswithDisney.LatersuccessesincludedToyStory2,MonstersInc.,and
FindingNemo.Ironically,JobsstatedintheNovember23,1998BusinessWeek,"IThink
PixarhastheopportunitytobethenextDisneynotreplaceDisneybutbethenext
Disney."(Linzmayer,2224)

ThealliancebetweenPixarandDisneyhastremendouspotentialforeconomiesofscope.
AsCEOofAppleandDisney'slargestshareholder,Jobsisthestrategiclinkbetween
Disney,Apple,andPixar.Opportunitiesincludecombiningtheanimatedmovieexpertise
ofDisneyandPixar,aswellassharingthecontentofDisney'sABCorESPNnetworks
overApple'sdigitalofferings.(Burrows,Grover,andGreen)

AcurrentexampleofthefusionbetweenDisney,Jobs,Apple,andtechnologyisvideoon
theiPod.Disney'sDesperateHousewiveswasoneofthefirsttelevisionprograms
availableforpurchaseanddownloadtothenewervideoenablediPod.
(http://www.apple.com/itunes/videos/)

Thereareconcernsaboutwhetherthesesynergieswillcometofruition.Therearefears
thatthepersonalityandstyleofJobsmayconflictwithDisney,andthatDisneyCEOIger
couldbe"Amelioed"drivenoutofofficebyJobsinamannersimilartohowJobs
droveAmeliooutoftheCEOpostatApple.(Burrows,Grover,andGreen)

ExternalAnalysis

TechnologicalEnvironment

BrandAwarenessStyleataPremium

Apple'sproductsaretrendyandstylish.AfterJobsreturnedin1997,Appleretained
designerJonathanIvetodifferentiatetheircomputersfromthetypicalbeigebox.Ive's
designoftheiMacincludedclearcolorfulcasesthatdistinguishedApplecomputers.
(Linzmayer,2956)Apple'siPod(withthetrademarkwhiteearbudsandsimpletrack
wheel)commandsa15%20%premiumoverotherMP3players.(Yoffie)

AppleandPixarlimitthenumberofcomputerproductsandmoviesthattheysell.
ProductdifferentiationwithfocusedqualityandstylealsoextendtotheJobsPixar
"Pixar'sexecutivesfocusonmakingsuretherearenoBteams,'thateverymoviegetsthe
besteffortsofPixar'sbrainystaffofanimators,storytellers,andtechnologists."(Burrows,
Grover,andGreen)

Figure4:TheStylishDesignoftheiMacandMacMini
(http://www.apple.com/pr/photos/iMac/imacphotos.html

http://trad.org/technique/apple/iMac.jpg/view

http://www.divisiontwo.com/articles/MacMini2.html)
ApplepositionsitsMacintoshcomputersashigherqualityandhigherprice.HP,Dell,and
otherPCmanufacturersarepricingmanysystemsunderthe$1,000threshold."Appleis
strugglingtomeetdemandforitsnewMacBookProlaptopdespitea$1,900pricetag
thatisnearlytwicethatofgardenvarietyrivals."(Burrows)

Applehasonlyrecentlyenteredthelowend(below$500)consumermarketwiththe
MacMini.AlthoughtheMacMiniisabasemodelwithfewfeatures,itcomesencasedin
averysmallanddistinctivepackage.Appleportraysthiscomputeras"Smallis
Beautiful".(Apple)Likewise,theiPodShufflewasApple'sfirstentryintothelowerend
($100range)offlashmemorybasedportablemusicplayers.

Interoperability

AlthoughApplecompetesdirectlywithMicrosoftforoperatingsystems,thereleaseof
iTunesforWindowsin2002wasakeystrategicmove.Thisdecisionexpandedthe
potentialcustomerbasetonearlyallpersonalcomputerowners,eventhoughAppleonly
has2%3%ofallpersonalcomputersales.(Yoffie)

Conversely,AppledependsonMicrosoftforaversionofMicrosoftOffice.Asthemost
widelyusedofficesuiteofapplications,MacintoshusersrelyonOfficetocorrespond
withcompaniesthatstandardizedonWindows.Thisisfromastrategicalliancebetween
AppleandMicrosoftafterJobsreturnedin1997.(Linzmayer,290)

Apple'siTunesservicehasatechnologicalhook(assetspecificity)toApple'siPod.
AlthoughversionsofiTunesexistforbothAppleandMicrosoftoperatingsystems,the
iTune'sAACfileformatpreventsotherportablemusicplayers(suchasiRiveror
Samsung)fromplayingpurchasedsongs.(Yoffie)

TechnologyandtheDigitalLifestyle

Applenotonlydominatesthemusicplayermarket,itsiLifesuiteprovidesconsumers
witheasytousesoftwareformusicandvideocomposition.With"podcast"ahousehold
word,Apple'sGarageBandapplicationmakestherecordingofpodcastsandmusicvery
easy.(Boddie)

Figure5:TheGarageBandMusicandPodcastApplication
(http://www.apple.com/ilife/garageband/)

RegulatoryEnvironment
Whileintroducingnewtechnologies,thereisapersistentthreatoflegalactionby
competitors.Forexample,ApplesuedMicrosoftin1988(settledin1997foran
undisclosedamount)forperceivedsimilaritiesbetweenMicrosoftWindowsand
Macintoshaudiovisualworks.(Linzmayer,1724)

Microsofthasgenerallybeenthefocusforgovernmentantitrustcharges(suchasU.S.v.
Microsoft)(USDOJ,2006).BothfederalandstategovernmentsassertthatMicrosoft's
dominanceblockedfaircompetitionwithinthesoftwareindustry.Thisisanadvantage
forApple,becauseitsoperatingsystemsareaviablesubstituteforWindows.
Furthermore,Microsoft'scontinuedsupportforOfficeforMacintoshreducesthe
perceivedlevelofmarketmonopolyandabuse.(Linzmayer,2901)

ManufacturerswillcontinuetotrespassonApple'sintellectualproperty.Forexample,the
companytex9releasedanopensourcemusicprogramcalledxtunesthatwasverysimilar
toiTunes.In2002,Appletooklegalactionagainsttex9,whothenalteredtheprogram
andrenameditsumi(pronounced,"sueme").(Linzmayer,300)

Legalthreatscansurfacefromsomewhatunusualsources.AppleCorpsLtd.isthe
LondonbasedcompanythatownstherightstothemusicoftheBeatles.PaulMcCartney
andRingoStarrrecentlysuedAppleovertheuseoftheApplelogoiniTunes,claiming
thatitviolatedApple'sagreementnottoproducemusicunderanapplebasedlogo.
(AssociatedPress)

ResearchanddevelopmentisakeycomponenttoApple'ssustainedcompetitive
advantage.Appleiscurrentlytakinglegalactionagainstseveralpopulartechnicalweb
sitesforreleasingproprietaryproductresearch.Sitessuchasappleinsider.comhave
allegedlypostedverbatimcontentfromdocumentsprotectedbyemployeenondisclosure
agreements.(McCullagh)ReleaseofcriticalinsiderinformationcouldgiveApple's
competitorsajumpinproducingrivalproducts.

IndustryAnalysisUsingPorter'sFiveForcesModel

Appleoperatesintwoprimaryindustries:

ComputingHardwareandSoftware

DeliveryofEntertainmentandMedia

Applehasalwaysbeenunderintensecompetitionwithinthecomputer,software,and
entertainmentindustries."Lookingto2005...EverytimethatApplehadjumpedintothe
leadinaproductcategoryduringthepasttwodecades,ithadhaddifficultyinsustaining
itsleadershipposition."(Yoffie)WeusePorter'sFiveForcesModeltounderstandwhy
Apple'sindustriesaresocompetitive.(Barney,7898)

Figure6:Porter'sFiveForcesModel(Barney,79)
Figure7:SummaryofIndustryThreats(ComputerEquipmentandEntertainment
Distribution)

TypeandSeverityofThreat Organization Examples

EntryHighThreat Verizon StreamingaudioandvideowithVCAST.

Amazon Ondemandonlineservicestopurchasemusic(similartoiTunes).

GoogleTheymakeeverything.

The"NextGoogle" Newentrantswithdisruptivetechnology.

RivalryHighThreat Microsoft WindowsOperatingSystem,WindowsMedia

Playerforplayingmusicandvideo.

Linux CompetitiontoMacOSXOperatingSystem.

Napster,Rhapsody OnlinemusicsourcesalternativestoiTunesMusicStore.

Dell,HP,Lenovo Alternatesourcesforcomputerhardware.

iRiver,Samsung,Creative Small,stylishMP3Players.

DreamWorks Animatedmovies.

YouTube.com Onlinevideo.

SubstitutesModerateThreat XM,Sirius SatelliteRadioformusic.

XBox,PS2 EntertainmentMedia,MediaandMusic.

Various InternetStreamingRadioandPodcasts.

MusicCDs,DVDAudioandSuperAudioCD Alternativemeanstoacquiremusic.

Broadcast,Cable,Satellite,NetFlix,TiVo,Theatres Alternativesourcesforvideo.

SuppliersHighThreat Motorola,IBM,Intel,Samsung Suppliersof

Processorsandcomputermemory.

Microsoft StrategicAlliance/SupplierofOfficeforMac.

TheBigFiveBMG,EMI,Sony,Universal,andWarner Sourcesofmusic.Willthey
raisepricesandbreakthedollarpersongmodel?Someintherecordindustryresent
Apple'sdistributionmodel."Applereapsbillionsfromsellingitshitmusicplayer,but
therearesparseprofitsfromthesongsbeingsoldovertheNet."(Burrows,Grover,and
Green)

Disney,ABC,NBC,CBS,Fox,Pixar,Sony SuppliersofTelevisionandMovies.Will
theysignexclusivecontractswithotheronlineservices?Notethatthisthreatisreduced
forDisney/Pixar.

BuyersModerateThreat ConsumersandIllegalpeertopeerfilesharing
Consumerssharemusicusingpeertopeernetworkswithoutpayingformusic.

Distributors Appleretailersmaypressureforlowerpricesorbetterterms.Forexample,
thereleaseoftheAppleStorein2001"infuriatedlongtimeindependentAppleretailers
thatdidn'tappreciateCupertinocannibalizingtheirsales."(Linzmayer,300)

ConsumerAttitudesandBehaviors Consumersorbusinessesmayreducespendingon
personalcomputersornonessential(potentiallyhighelasticityofdemand)musicplayers
iftheyfeareconomicdownturns.

ConsumerRefreshCycles Consumersandbusinessesmaycontinuetouseprevious
modeliPodsandMacsratherthanupgradetocurrentiPods,iMacs,orOS

ThetotalindustrythreatfortheindustryspacethatAppleoccupies(computerequipment
anddistributionofentertainment)isahighthreatindustry.Applemustcontinuetopursue
productdifferentiation(i.e.thestyleandeaseofuseofaniPod)andeconomiesofscope
(i.e.offeringABCtelevisionshowsoniTunes)tomaintaintheirsustainedcompetitive
advantageinthisindustry.

WhichExternalThreatsareMostSignificant

ComputerHardwareandSoftware:OpenSourcesoftwaresuchastheLinux
OperatingSystemandOpenOfficeapplicationsthreatenbothAppleandMicrosoft.The
low(often,free)costofthesoftwaremayallowittoovertakeAppleandMicrosoft,
especiallyindevelopingmarketssuchasChina.

MusicProducts:MajoronlineretailerssuchasAmazonareconsideringentryinto
theonlinemusicmarket.Withawideinternetpresenceandahouseholdname,Amazon
couldpresentaformidablechallengetoApple.Ifthemajorrecordlabels(Universal,
SonyBMG,EMI,andWarner)negotiatebettertermswithnewcompetitorstoiTunes,
Applemaybeunabletoprovidesomeofthemusiccontentthattheycurrentlyoffer.The
majormusiclabelsdislikeApple'sdollarpersongpricing.Theywouldprefertoearn
higherprofitswith"variablepricing".(Wingfield)Withvariablepricing,themost
popularsongswouldbegreaterthan$1,andlesspopularsongswouldbelessthan$1.
AlthoughthelabelsrecentlyrenewedtheircontractswithApple,theremaybeprovisions
thatallowfuturechangesinthepricingmodel.(WingfieldandSmith)
 Suppliers:TherecentshifttoIntelprocessorscouldpresentasignificantthreatto
Apple.Withonlytwocompanies(IntelandAMD)producingIntelcompatible
processors,thereisastrongpotentialfortacitcollusionandoligopolypowerbetween
thesesuppliers.ApplepurchasingmustnowdirectlycompetewithHP,Lenovo,andDell.
Ifshortagesorexclusiveagreementsmaterialize,Applecouldfaceproblemswith
obtainingrawmaterials.AppleshouldconsideradditionalsourcessuchasAdvanced
MicroDevices(AMD).

Figure8:CPUMarketShare(http://www.pcpitstop.com/research/cpumfr.asp)

AdditionalExternalThreats

Security

Applesoftware,likealllargesoftwareproducts,hassecurityvulnerabilitiesthathackers
mayexploit.Asignificantexploitationinthefuturecoulddamagemanybusinessesand
householdsusingApplecomputers.Thiswouldaffectfuturecustomerpurchasing
decisions.Appleenjoysacompetitiveadvantage,becausetheirOSXismatureandstable
duetoitsbasisonBSDUnix.Infact,"computersecurityfolksbackatFBIHQuseMacs
runningOSX".(Granneman)

However,theincreaseduseofApplecomputersispromptinghackerstotargetthe
platform.InFebruary2006,therewasdocumentationofthefirstknownAppleOSX
worm.ByusingiChatinstantmessaging,itspreadstootherusersanddeletesfilesfrom
theirMaccomputers.(Sophos)IfMacOSXbecomesaswideofatargetasWindows,
Apple'sperceiveddifferentiationasthemoresecureplatformmaydisappear.

VerticalIntegrationofCompetitors

SonyisanexampleofacompetitorwithauniquepositionagainstApple.SonyMusic
suppliesApplewithmanyofthesongsforiTunes.Sonyalsocreatesaversionofthe
WalkmanportablemusicplayerthatisadirectcompetitortotheiPod.(Hall)

Sonyisattemptingtoverticallyintegrateforwarddirectlytothemusicbuyer.Sony
integratedtheirmusicsystem(Mora)intotheSonyWalkman.Sonyisexclusively
distributingcertainsongsonMora.(Hall)MoracurrentlytargetsJapaneseconsumers.If
Sonycangainadditionalmomentum(suchascollaboratingwithotherrecordlabels),
theirservicecouldpresentaformidablechallengetoiTunesinadditionalmarkets.

Figure9:TheSony20GBWalkmanandMora(onlyavailableinJapanese)
Sources:http://www.cnet.com.au/mp3players/mp3players/0,39036128,40002062,00.htm

http://mora.jp/

ValueChainAnalysis

TodeterminewhereAppledevelopeddistinctivecapabilities,Porter'sgenericvaluechain
modelprovidesasystematicframeworkforidentifyingApple'sutilizationofresources.
PrimaryactivitiesforAppleincludeTechnologyandProductDesign,Production,Sales
andMarketing,CustomerService,andLegalServices.

TechnologyandProductDesign

Thiscomponentrepresentsthetruecore(nopunintended)ofApple'scapability.From
beingthefirstplatformtorunanelectronicspreadsheet(VisiCalcontheAppleIIPlus)to
thefirsttoestablisha"digitallifestyle"hub(theMacintoshproductlines),Apple'shistory
isrichwithcuttingedgetechnologydevelopment.(Linzmayer)Appledrivestobethe
best,nosimplythefirst.TheAppleoperatingsystemisuniversallyregardedasmore
stableandreliablethanWindows,whilethedesktoppublishingsoftwarebundles
(iMovie,iPhoto,iTunes,etc.)arethemostcomprehensiveavailabletoendusers.Ives
bestsummarizestheentrepreneurialculturewithinApplebysayingthat"it'sveryeasyto
bedifferent,butverydifficulttobebetter."(Linzmayer,301)

Production

BecauseApplehadlongrefusedtolicenseitsoperatingsystemtoexternalentities,the
bundledpackagesofAppledevelopedhardwareandsoftwarebecamethecornerstoneof
Apple'sproductionprocess.Appleachievedunparalleledperformancevia64bit
architecture,integrateddistinctivestylingwiththemulticoloredtranslucentiMaccases,
andredefinedintuitiveoperationwiththeiPod.Whileeveryproductintroductionhasnot
beenasuccess(Lisa,Newton,etc.),Appletreatscomponentproductionasanatural
extensionofthedesignprocess.

SalesandMarketing

Wecouldsimplytitlethissection"SteveJobs".SincehisreturnasCEOin1997,Jobs
personallyunveilsallnewproductintroductions,reviewscorrespondingmarketing
campaigns,andapprovesnewproductdevelopmentguidelines.Inadeparturefromtheir
turbulenthistory,Jobs"enteredintopatentcrosslicensingandtechnologyagreements
withMicrosoft."(Linzmayer,290)Afteryearsofunimpressivemarketsharegrowthand
cannibalizationofaloyalconsumerbase,thedoortotheexpansivePCmarketwasnow
moreaccessibletoApplethaneverbefore.Applecontinuedtocommandamarket
premiumforproducinga"bettermousetrap"throughoutitshistory.

CustomerService

HowhasAppleretainedsubstantialcashreservesduringtheexplosivegrowthand
dominanceofPCsworldwide?Applecreatedavirtualloveaffairwiththeircustomer
basebydeliveringtechnicallysuperiorproducts(iPodsvs.otherMP3players,Macsvs.
PCs,etc.),andaggressivelypursuinghardwareandsoftwareupdates.Appleintegrated
theirprimaryactivitiessowellthatitistransparenttotheconsumerwhereoneactivity
beginsandtheotherends.AperfectexampleofthisisApple'swillingnesstodevelop
softwaretorunWindowsXPonitsnewIntelbasediMacandthenpostitonlinefreeto
iMacusers.(Wingfield)Insuchanenvironment,customerservicemerelybecomesthe
realizationofreceivingalittlemorethanexpected.

AlthoughAppleemploysmanyresourcesandcapabilitiestosupporttheirprimary
activities(humanresources,supplyprocurement,etc.),themoststrategicallyrelevant
wouldbeLegalServices.

LegalServices

Inamarketclimateofconstantchangeandinnovation,itisinevitablethatthedriveto
expandproductandserviceofferingswillsubjectAppletopatentandcopyright
infringementclaims.ThedisputeovertheApplelogoonitsiTunesMusicStore,for
example,continuesdespiteapreviouslyreachedsettlementwithBeatles'AppleCorps
Ltd.in1991.(DowJonesNewswires)WhilesuchlitigationasMicrosoft'sWindows
infringementonMacOSpatentshasbeenhighlypublicized,useoflegalguidanceto
driveacquisitionversusinternaldevelopmentstrategiesforsuchproductsasGarageBand
andiMusichaveprovenhighlyvaluable.(Linzmayer,1724,250)Intellectualpropertyis
sacredtoApple.Therewasarecentattempttouncovertheidentitiesofinternal"sources
wholeakedconfidentialinformationaboutanunreleasedproducttoonlinemediaoutlets
in2004."(Wong)

SWOTAnalysis

Althoughparticipationinsuchactivitiesmayaddvalue,theymaynotbeasourceof
competitiveadvantage.Ultimately,thevalue,rarity,inimitability,and/ororganization
(VRIO)ofanactivityorresourcedetermineitssustainabilityasasourceofcompetitive
advantage.Withinthiscontext,wecanidentifyafirm'sstrengths,weaknesses,
opportunities,andthreats(SWOT).
Strengths

TechnicalsavvyProductlinesareeasytouseandstable.Recentintegration
withMicrosoftproductslinesandIntelprocessorsdemonstrateabilityandwillingnessto
adapttoadiversecustomerbase.(Mossberg)Suchinnovation,however,wouldnotbe
sustainablewithoutalearningenvironmenttolerantofmistakes.Whilethepuretechnical
expertisealoneisnotavaluableorrareresource,itbecomesverycostlytoimitatewhen
itexistswithinthesociallycomplex,entrepreneurialcultureofApple.

FinancialvitalityCashreservesremainedrobustandstabledespitestagnant
marketsharegrowthinthecomputerhardwareandsoftwarearenas.Appleexploitedthis
byresistingmarketpressurestoreducecosts,tightlyintegratingproductpackages,and
formingstrategicalliances(i.e.securingthebackingofallmajormusicdistributorsinthe
supportofiTunes).

BrandloyaltyTheonlywaythatApplecouldmaintainthefinancialvitality
describedaboveisviaafanatical,almostcultlike,affairwithitscustomerbase.Such
brandloyaltyisextremelycostlyandtimeconsumingtoimitate.

SteveJobsAsdiscussedearlier,JobsprovedtobeavitalcomponenttoApple's
success.Duringhisabsence(19851996),Appleexperiencedthemostturbulent
(financialandinnovative)timelineinitshistory.Immediatelyuponhisreturn,he
replacedmostoftheBoardofDirectors,prunedandfocusedthenewproductideas,and
deliveredsevenconsecutivequartersofpositiveearningstoshareholders.(Linzmayer,
28999)Assuch,Jobsiscertainlyavaluable,rare,andhardtoimitateresourcethat
Applefullyexploits.

Weaknesses

MarketshareApplehashistoricallybeenstrongestintheUSgeographicaland
educationalverticalmarkets.Withtheeducationalmarketfacingtighteningbudget
constraintsandtheUSapproachingaPCsaturationpoint,Applemayneedtoburncash
morequicklyandsuccumbtomarketcostpressuresonitsproductswithoutastrategic
innovation,integration,ordivesture.

SteveJobsForvirtuallythesamereasonsJobsisastrength,heis
simultaneouslyaweakness.Theaggressivedrivetobringinnovativevisionstolifewas
noticeablyabsentandpainfullyfelt(especiallybyshareholders)duringhisdeparture.The
apparentabsenceofsuccessionplanningcoupledwithalustforthelimelightpositioned
JobsasApple'ssingleconsciousnessintheeyesofconsumersandshareholders.

Opportunities
 ConsumerelectronicsWiththestartlingsuccessoftheiPodandiTunes,Apple
enteredtheconsumerelectronicsmarket.ByexpandingtheiTunesconceptto
downloadablemobilephonefeaturesandmovies(podcasts),thedoorisnowopento
developnewandpotentiallyprofitablestrategicallianceswithperipheralcomponent
manufacturers(speaker,homestereo,etc.)andmediatransmissiongiants(Disney,TBS,
Verizon,etc.).

PChardwareandsoftwaremarketgrowthWithcrosslicensingofoperating
systemplatformsinplace,Appleenteredthehighvolumebusinessenvironment
traditionallydominatedbyWindowsbasedPCs.TheintroductionofIntelbased
processorspromptedbusinessestoreplacePCswithiMacs.Theydidthistogainalevel
ofstabilityandreliabilityintheirbusinessapplicationsthatPCsfailedtoprovide.An
exampleisJapan'sAozoraBankLtd.,whoisreplacing2,300PCswithiMacs.
(Wingfield)Applemustestablishthemselvesasacredibleplayerinbusinessdesktop
applicationstoovercomethe"desktoppublishing"stereotype.

Threats

LegalrisksInamarketthatliterallychangesatthespeedofthought,patentand
copyrightinfringementrisksremainhigh.Aslongasoperatingsystemsandsupport
softwarepackagescontinuetoconvergeandremainrelativelyeasytoimitate,presentand
futurelawsuitsareinevitable.TheApplerecordsclaimagainstiTunesremains
unresolved.

CompetitionThisthreatoccursprimarilyontwofronts:PChardware/software
andconsumerelectronics.Forthesamereasonsdiscussedintheopportunitiessection,the
threatofimitability(cloning,pirating,etc.)increases.Asrelativenewcomerstothe
consumerelectronicsarena,willAppleretainacompetitiveadvantageastheydiversify
theirofferings(speakers,homeentertainmentsystems,etc.)?

FinancialAnalysis

2ndQuarter2006

Apple'sfinancialperformancecontinuedtostrengthenoverthelastseveralquarters.In
themostrecentearningsannouncement,Applereportedsignificantgrowthinnet
revenuesdrivenbythestrongperformanceofitsiPodproductline.Netsalesforthe2nd
quartergrewto$4.36billion,whichisa34%increaseover2ndquarter2005results.Net
incomeincreasedby41%to$410million.(AppleReports)

TheiPodproductlinecontinuestodrivethefinancialperformanceofthecompany.Inthe
2ndquarteralone,Applesold8.5millioniPods,representinga61%increaseoverthe5.3
millionunitssoldinthe2ndquarteroftheprioryear.Macsalesshowedslightgrowthof
only4%.(AppleReports)
Apple'syeartodaterevenuestotaljustover$10billionandearningstotaljustunder$1
billion.Forthe3rdquarter,CFOPeterOppenheimerstated,"weexpectrevenueof
about$4.2to$4.4billion"whichwillpushtotalsalesabovelastterm'sannualnumbers.
(AppleReports)

HistoricalPerformance

Althoughsalesremainedstagnantduring19982002,salesmorethandoubledsince(see
graphbelow).Thisdramaticshiftinperformanceisprimarilyduetotheincreaseinsales
fromtheiPodproductline.

(AppleComputer,2005)

StockPricePerformance

AnotherinterestingwaytoconsiderthefinancialperformanceistoevaluatehowApple's
stockpriceperformedagainstthemarketandagainstitsmaincompetitors.Aswesee
fromthechartabove,Apple'sperformancehasbeeninconsistentoverthelast20years
comparedtotheS&P500.Italsohasnotperformedatthesamelevelasitsmain
competitors,DellandMicrosoft.However,performanceimprovedsince2003.

ProfitabilityMeasures

Applesubstantiallyimprovedinitskeymeasuresofprofitabilityinthelastfewfiscal
years.Intermsofreturnonassets,returnonequityandprofitmargin,Applestrengthened
financiallyandnowhassimilarratiostothatofitscompetitorsandtheoverallcomputer
hardwareindustry(seetablebelow).

2003 2004 2005 Microsoft'05 Dell'05 Industry'05 S&P500

ReturnonAssets 1.01% 3.43% 11.56% 19.75% 15.42%

11.98% 8.13%

ReturnonEquity 1.63% 5.44% 17.88% 28.56% 67.31%

36.61% 19.61%

ProfitMargin 1.11% 3.33% 9.58% 31.57% 6.39% 6.36% 13.75%

P/ERatio 33.89 22.63 18.51 26.32 22.09

InreviewingApple's1stand2ndquarter2006earningsreleases,grossmarginsdropped
slightly.Appleattributesthisdeclineprimarilytopricepressures,especiallyintheiPod
productline.(1stQuarter10Q)Thiswillcontinuetoaffectperformanceovertime.
However,Apple'sabilitytomaintainthemomentumitbuiltinthemarketplacewill
controlthespeedwithwhicherosionwilloccur.

LiquidityandLeverageMeasures

Applehistoricallyheldverylittlelongtermdebt.ThetablebelowcomparesApple's
liquiditymeasurestotheircompetitors,theirindustry,andthegeneralmarket.Duringthe
periodofstrongfinancialperformance,Appleaccumulatedcash.Thisstrengthens
Apple'spositionshouldtheychoosetoaccessthecapitalmarkets.

2003 2004 2005 Microsoft'05 Dell'05 Industry'05 S&P500

CurrentRatio 2.5 2.6 3 2.88 1.11 1.81 1.82

QuickRatio 2.47 2.59 2.9 2.85 1.08 1.45 1.31

ProductUnitSales

Inthelastseveralyears,therehavebeendramaticchangestoApple'sproductsalesby
category.Applebreaksitsunitsalesintofourprimarycategories:desktops,notebooks,
iPods,andperipherals.ThegraphbelowshowstheproductmixforApplein2002.Note
thedominationbydesktopsandnotebooksandthesmallcontributionbyiPods.(Apple
Computer)

Whenyoucomparethesamegraphfor2005,youseedramaticdifferencesintheproduct
mixforApple.TheiPodsalesnowaccountfor32.5%comparedto2.5%for2002.The
combinedsalesofcomputers(desktop/notebook)lostshare,droppingfrom79%to45%
ofsales.ThisdropmerelyrepresentsashiftinApple'sproductmix,nottheirglobal
computermarketshare(whichremainsstableinthe23%range).Meanwhile,salesof
peripherals(includingwirelessconnectivityandnetworkingsolutions),remainedstable.
(Hoover's)

OperatingSegments

Applebreaksitssalesintofive"operatingsegments".Thechartbelowshowsthesalesby
segmentforeachyear20022005.Onapercentagebasis,onlytheretailsegmentappears
tobeoutperformingtheothers.(AppleComputer,Hoover's)

Netsalesintheretailsegmentgrewto$2.35billionin2005.Inthe1stquarter2006,sales
growthcontinuedintheretailsegmentto$1.1billion(a91%increaseoverthesame
periodlastyear).Thisincreasewasduetogrowthinthenumberofstores(from101to
135)andtoa41%samestoresalesgrowth.(1stQuarter10Q)

Althoughtheretailsegmentwastheonlysegmenttorealizegrowthasapercentageof
totalsales,allofthesegmentshadsolidgrowth.IntheAmericas,salesincreased65%
andcontinuedtorepresentapproximately47%oftotalworldwidesales.SalesinJapan
andEuropegrewby92%and47%,respectively.(1stQuarter10Q)

MarketValueAnalysis

WeusedDiscountedCashFlow(DCF)analysistoassesstheappropriateequityvalueof
Apple.Tocompletethisanalysis,wedevelopedaproformaincomestatementand
extractedfreecashflow.Wethendiscountedthesecashflowsusingacalculated
WeightedAverageCostofCapital(WACC).Apple'sWACCequaledtheircostofequity
sincetheycarrynolongtermdebt.WeusedtheCapitalAssetPricingModel(CAPM)to
calculatethecostofequity.

CAPMconsistsofariskfreerate,amarketriskpremium,andacompanyBeta.Theyield
onthe10yearTreasuryisthestandardforariskfreerate.Todeterminethemarketrisk
premium,weusedtheaveragereturnthataninvestorwouldrequireforaninvestment
withaveragerisk.(Higgins)WeuseddataavailableonlinetodetermineApple'sBeta,
projectedtobe1.46.(Google,4/21/06)ThebelowchartsummarizesApple'scostof
equity.

CostofEquity/WACC Note Value

RiskFreeRate10YrTreasury 5.12

MarketRiskPremium (Analysis) 4

Beta FromGoogle 1.46

AdjustedAppleRiskPremium 5.84

CostofEquity/WACC 10.96
ProFormaIncomeStatement

Wemadeseveralkeyassumptionsincompilingaproformaincomestatement.First,to
completetheestimateforthe2006data,wemerelyannualizedtheearningsforthefirst
twoquarters.Wethenprojectedadecliningrateofgrowthinsalesforthenextfourfiscal
termsof30%,20%,15%,and10%,respectively.Wedonotbelievethatthegrowthin
iPodsissustainableforthelongterm.Wealsousedthepercentofsalesmethodto
calculatecostofgoodssold,research&development,SG&A,andinterest.Weapplied
the2005taxrateforallfutureperiods.Asthetablebelowshows,themidtermearnings
growthispositive.

2005 Annualized2006 2007P 2008P 2009P 2010P

NetSales 13931 20216 26280.8 31536.96 36267.50 39894.25

CostOfSales 9888 14353 18659 22391 25750 28325

R&D 534 809 1051 1261 1451 1596

S,G,A 1859 2628 3417 4100 4715 5186

OperatingIncome 1650 2426 3154 3784 4352 4787

InterestIncome 165 239 311 374 430 473

Taxes 480 705 916 1100 1265 1391

NetIncome 1335 1960 2548 3058 3517 3869

EPS 1.57 2.31 3.00 3.60 4.14 4.56

SharesOut(000's) 848,612 848,612 848,612 848,612

848,612 848,612

ProjectedFreeCashFlowandEquityValuation

WeassumethatApplewillcontinuewithoutlongtermdebt.Wealsoassumethatthere
willbenosignificantchangesincapitalexpendituresandnetworkingcapital.Thus,free
cashflowwillequalnetincomeplusdepreciation.GivenWACC,weareabletodiscount
cashflowsbackusinghalfyearPVfactors(wearethroughthefirsthalfof2006).We
calculatedourterminalvalueusingaperpetualannualgrowthrateof7%,whichis
slightlyabovetheindustrygrowthrateof5.6%.(Datamonitor)

FreeCashFlows 2006A2007P 2008P 2009P 2010P Terminal

NetIncome 1960.00 2548.00 3058.00 3517.00 3869.00

Depreciation 239.00 310.70 372.89 428.86 471.78

FreeCashFlows 2199.00 2858.70 3430.89 3945.86

4340.78

WACC 10.96 10.96 10.96 10.96 10.96

PVFactor 0.9505 0.8565 0.7715 0.695 0.626 0.626

TerminalValue 109615.6

PVFCF 1862.98 2182.36 2359.25 2444.32 2421.99

68619.42

SumofPVofCF 11270.90

PVofTerminalValue68619.42

FMVofInvestedCapital 79890.32

LessExistingCashBalance 8261

IntrinsicValueofEquity 71629.32

Givenintrinsicequityvalue,weestimatethepersharestockprice.Giventheirparticular
marketcondition,Appleappearsundervalued(seetablebelow).

EquityValue

TotalShares(000's) 848612

Value(000's) 71629000

Value/Share $84

CurrentPrice(5/5/06) $71.89

Strategy
WecandescribeApple'sstrategyintermsofproductdifferentiationandstrategic
alliances.Ineachofthesestrategies,weexaminewhatAppledidhistoricallyandthen
discussalternativesforApple'sfuture.

ProductDifferentiation

Applepridesitselfonitsinnovation.WhenreviewingthehistoryofApple,itisevident
thatthisattitudepermeatedthecompanyduringitspeaksofsuccess.Forinstance,Apple
pioneeredthePDAmarketbyintroducingtheNewtonin1993.(Linzmayer,203)Later,
AppleintroducedtheeasytouseiMacin1998,andupdatesfollowing1998.(Linzmayer,
2946)Itreleasedahighlystableoperatingsystemin1999,andupdatesfollowing1999.
(Linzmayer,297)

Applehadoneofitscriticalpointsinhistoryin1999whenitintroducedtheiBook.This
completedtheir"productmatrix",asimplifiedproductmixstrategyformulatedbyJobs.
ThismoveallowedAppletohaveadesktopandaportablecomputerinboththe
professionalandtheconsumersegments.Thematrixisasfollows(Linzmayer,297):

ProfessionalSegment ConsumerSegment

Desktop G3 iMac

Portable PowerBook iBook

In2001,ApplehitanotherimportanthistoricalpointbylaunchingiTunes.Thismarked
thebeginningofApple'snewstrategyofmakingtheMacthehubforthe"digital
lifestyle".(Linzmayer,299)Applethenopeneditsownstores,inspiteofprotestsby
independentAppleretailersvoicingcannibalizationconcerns.(Linzmayer,300)Then
AppleintroducedtheiPod,centraltothe"digitallifestyle"strategy.PhilipW.Schiller,
VPofWorldwideProductMarketingforApple,stated,"iPodisgoingtochangetheway
peoplelistentomusic."(Linzmayer,300)Hewasright.

ApplecontinuedtheirinnovativestreakwithadvancementsinflatpanelLCDsfor
desktopsin2002andimprovednotebooksin2003.(Linzmayer,3012)In2003,Apple
releasedtheiLifepackage,containingimprovedversionsofiDVD,iMovie,iPhoto,and
iTunes.(Linzmayer,302)InreferencetoApple'srecentadvancements,Jobssaid,"We
aregoingtodofordigitalcreationwhatMicrosoftdidfortheofficesuiteproductivity."
(Linzmayer,302)Thatisindeedaboldstatement.Timewilltellwhetherthathappens.

ApplecontinueditsdigitallifestylestrategybylaunchingiTunesMusicStoreonlinein
2003,obtainingcooperationfrom"TheBig5"MusiccompaniesBMG,EMI,Sony
Entertainment,Universal,Warner.ThisallowediTunesMusicStoreonlinetoofferover
200,000songsatintroduction.(Linzmayer,302)In2003,Applereleasedtheworld's
fastestPC(MacG5),whichhaddual2.0GHzPowerPCG5processors.
Productdifferentiationisaviablestrategy,especiallyifthecompanyexploitsthe
conceptualdistinctionsforproductdifferentiation.ThosethatarerelevanttoAppleare
productfeatures,productmix,linkswithotherfirms,andreputation.(Barney,26671)
Appleestablishedareputationasaninnovatorbyofferinganarrayofeasytouse
productsthatcoverabroadrangeofsegments.However,itslinkswithotherfirmshave
beenlimited,aswewilldiscussinthenextsectiononstrategicalliances.

Thereiseconomicvalueinproductdifferentiation,especiallyinthecaseofmonopolistic
competition.Theprimaryeconomicvalueofproductdifferentiationcomesfromreducing
environmentalthreats.Thecostofproductdifferentiationactsasabarriertoentry,thus
reducingthethreatofnewentrants.Notonlydoesacompanyhavetobearthecostof
standardbusiness,italsomustbearthecostsassociatedwithovercomingthe
differentiationinherentintheincumbent.Sincecompaniespursuenichemarkets,thereis
areducedthreatofrivalryamongindustrycompetitors.Acompany'sdifferentiated
productwillappearmoreattractiverelativetosubstitutes,thusreducingthethreatof
substitutes.Ifsuppliersincreasetheirprices,acompanywithadifferentiatedproductcan
passthatcosttoitscustomers,thusreducingthethreatofsuppliers.Sinceacompany
withadifferentiatedproductcompetesasaquasimonopolyinitsmarketsegment,there
isareducedthreatofbuyers.WithallofPorter'sFiveForceslower,acompanymaysee
economicvaluefromaproductdifferentiationstrategy.(Barney,27781)

Acompanyattemptstomakeitsstrategyasustainedcompetitiveadvantage.Forthisto
occur,aproductdifferentiationstrategythatiseconomicallyvaluablemustalsoberare,
difficulttoimitate,andthecompanymusthavetheorganizationtoexploitthis.Ifthere
arefewerfirmsdifferentiatingthanthenumberrequiredforperfectcompetition
dynamics,thestrategyisrare.Ifthereisnodirect,easyduplicationandtherearenoeasy
substitutes,thestrategyisdifficulttoimitate.(Barney,2817)

Therearefourprimaryorganizingdilemmaswhenconsideringproductdifferentiationas
astrategy.Theyareasdepictedbelow.

Toresolvethesedilemmas,theremustbeanappropriateorganizationstructure.AU
Formorganizationresolvestheinterfunctionalcollaborationdilemmaifthereare
productdevelopmentandproductmanagementteams.Combiningtheoldwiththenew
resolvestheconnectiontothepastdilemma.Havingapolicyofexperimentationanda
toleranceforfailureresolvesthecommitmenttomarketvisiondilemma.Managerial
freedomwithinbroaddecisionmakingguidelineswillresolvetheinstitutionalcontrol
dilemma.(Barney,294)

Fiveleadershiproleswillfacilitatetheinnovationprocess:InstitutionalLeader,Critic,
Entrepreneur,Sponsor,andMentor.Theinstitutionalleadercreatestheorganizational
infrastructurenecessaryforinnovation.Thisrolealsoresolvesdisputes,particularly
amongtheotherleaders.Thecriticchallengesinvestments,goals,andprogress.The
entrepreneurmanagestheinnovativeunit(s).Thesponsorprocures,advocates,and
champions.Thementorcoaches,counsels,andadvises.(Barney,295)

Applehadissueswithinitsorganization.In1997,whenApplewasseekingaCEO
acceptabletoJobs,JeanLouisGasse(thenCEOofBe,exProductsPresidentatApple)
commented,"Rightnowthejobissodifficult,itwouldrequireabisexual,blond
Japanesewhois25yearsoldandhas15years'experience!"CharlesHaggerty,thenCEO
ofWesternDigital,said,"Appleisacompanythatstillhasopportunitywrittenalloverit.
Butyou'dneedtorecruitGodtogetitdone."MichaelMurphy,theneditorofCalifornia
TechnologyStockLetter,stated,"Appledesperatelyneedsagreatdaytodaymanager,
visionary,leaderandpolitician.Theonlypersonwho'squalifiedtorunthiscompanywas
crucified2,000yearsago."(Linzmayer,289)

SinceJobstookoverasCEOin1997,Appleseemstohaveresolvedtheinnovation
dilemmas,evidencedbytheirnumerousinnovations.Tocontinueaproduct
differentiationstrategy,Applemustcontinueitsappropriatemanagementofinnovation
dilemmasandmaintainthefiveleadershiprolesthatfacilitatetheinnovationprocess.

StrategicAlliances

Applehasahistoryofshunningstrategicalliances.OnJune25,1985,BillGatessenta
memotoJohnSculley(thenCEOofApple)andJeanLouisGasse(thenProducts
President).GatesrecommendedthatApplelicenseMacintoshtechnologyto35
significantmanufacturers,listingcompaniesandcontactssuchasAT&T,DEC,Texas
Instruments,HewlettPackard,Xerox,andMotorola.(Linzmayer,2458)Afternot
receivingaresponse,GateswroteanothermemoonJuly29,namingthreeother
companiesandstating,"IwanttohelpinanywayIcanwiththelicensing.Pleasegive
meacall."(Linzmayer,249)

In1987,SculleyrefusedtosignlicensingcontractswithApolloComputer.Hefeltthat
upandcomingrivalSunMicrosystemswouldovertakeApolloComputer,whichdid
happen.(Linzmayer,24950)Then,SculleyandMichaelSpindler(COO)partnered
ApplewithIBMandMotorolaonthePowerPCchip.SculleyandSpindlerwerehoping
IBMwouldbuyAppleandputtheminchargeofthePCbusiness.(Linzmayer,250)That
nevercametofruition,becauseApple(withSpindlerastheCEO)seemedcontradictory
andwasextraordinarilydifficultinbusinessdealings.(Linzmayer,2512)

Appleturnedthecornerin1993.SpindlerbegrudginglylicensedtheMactoPower
Computingin1993andtoRadius(whomadeMacmonitors)in1995.However,Spindler
nixedGatewayin1995duetocannibalizationfears.(Linzmayer,2523)GilAmelio,an
avidsupporteroflicensing,tookoverasCEOin1996.UnderAmelio,Applelicensedto
MotorolaandIBM.(Linzmayer,2534)In1996,Appleannouncedthe$427million
purchaseofNeXTSoftware,markingthereturnofSteveJobs.(Linzmayer,216)Amelio
suddenlyresignedin1997,andthestagewassetforJobstoresumepower.

Jobsdespisedlicensing,callingcloners"leeches".Hepulledtheplug,essentiallykilling
itslargestlicensee(PowerComputing).ApplesubsequentlyacquiredPowerComputing's
customerdatabase,MacOSlicense,andkeyemployeesfor$100millionofApplestock
and$10milliontocoverdebtandclosingcosts.Thebusinesswasworth$400million.
(Linzmayer,2557)

Amassivereversaloccurredin1997and1998.In1997,Jobsoverhauledtheboardof
directorsandthenenteredAppleintopatentcrosslicensingandtechnologyagreements
withMicrosoft.(Linzmayer,28990)In1998,JobsstatedthatApple'sstrategyisto
"focusallofoursoftwaredevelopmentresourcesonextendingtheMacintoshoperating
system.Torealizeourambitiousplanswemustfocusallofoureffortsinonedirection."
(Linzmayer,293)ThisstatementwasinthewakeofAppledivestingsignificantsoftware
holdings(Claris/FileMakerandNewton).

Thereiseconomicvalueinstrategicalliances.(Barney,37084)InthecaseofApple,
therewastheopportunitytomanageriskandsharecosts(Barney,3734),facilitatetacit
collusion(Barney,3745),andmanageuncertainty(Barney,3789).Itwouldhavebeen
applicabletotheindustriesinwhichAppleoperated.Tacitcollusionisavalidsourceof
economicvalueinnetworkindustries(Barney,380),whichthecomputerindustryis.
Managinguncertainty,managingrisk,andsharingcostsaresourcesofeconomicvaluein
anyindustry(Barney,380).AlthoughAppleeventuallyrealizedtheeconomicvalueof
strategicalliances,itshouldhaveoccurredearlier.

ThefollowingaresomecommentsaboutApple'snolicensingpolicy.(Linzmayer,2459)

"IfApplehadlicensedtheMacOSwhenitfirstcameout,Windowswouldn'texist
today."JonvanBronkhorst,RobertsonStephensanalyst,SanFranciscoChronicle,
August8,1994

"Thecomputerwasnevertheproblem.Thecompany'sstrategywas.Applesawitselfasa
hardwarecompany;inordertoprotectourhardwareprofits,wedidn'tlicenseour
operatingsystem.Wehadthemostbeautifuloperatingsystem,buttogetityouhadto
buyourhardwareattwicetheprice.Thatwasamistake.Whatweshouldhavedonewas
calculateanappropriatepricetolicensetheoperatingsystem.Wewerealsonaveto
thinkthatthebesttechnologywouldprevail.Itoftendoesn't."SteveWozniak,Apple
cofounder
"Ifwehadlicensedearlier,wewouldbetheMicrosoftoftoday."IanW.Diery,Apple
ExecutiveVP,Newsweek,August29,1994

"IamawarethatIamknownastheGreatSatanonlicensingIwasneverfororagainst
licensing.Ijustdidnotseehowitwouldmakesense.Butmyapproachwasstupid.We
werejustfatcatslivingoffabusinessthathadnocompetition."JeanLouisGasse,Be
CEOandexCEOofApple,admittinghemadeastrategicmistake

Astrategicalliancecanbeasustainedcompetitiveadvantageifitisrare,difficultto
imitate,andthecompanyhasanorganizationtoexploitit.Ifthenumberofcompeting
firmsimplementingasimilarstrategicallianceisrelativelyfew,thestrategyisrare.If
therearesociallycomplexrelationsamongpartnersandthereisnodirectduplication,the
strategyisdifficulttoimitate.(Barney,3849)

Whenorganizingforstrategicalliances,afirmmustconsiderwhethertheallianceisnon
equityorequity.Anonequityallianceshouldhaveexplicitcontractsandlegalsanctions.
(Barney,390)Anequityallianceshouldhavecontractsdescribingtheequityinvestment.
(Barney,3925)Therearesomesubstitutesforanequityalliance,suchasinternal
developmentandacquisitions.However,thedifficultieswiththesedrivetheformationof
strategicalliances.Itisvitaltoremember,"Commitment,coordination,andtrustareall
importantdeterminantsofalliancesuccess."(Barney,395)

Conclusions

WefeelthatApplemustfocusonseveralkeyaspectstocontinuetogrowandsucceed.
Theymustcontinueastablecommitmenttolicensing,pushforeconomiesofscope
betweenmediaandcomputers,andbecomealearningorganization.

Appleapparentlymadeacommitmenttolicensing.Althoughitshouldcontinue,Apple
maywanttoconsiderotherformsofstrategicalliances.Anequitystrategicalliancemay
offerAppletheopportunitytoobtainadditionalcompetencies.Aneffectivewayfora
companylikeAppletoaccomplishthiswouldbeintheformofajointventure.

Appleshouldcontinuepushingthenewlineofmediacentricproducts.Meanwhile,
Appleshouldnotlosefocusonitscomputers.Macintoshcomputerswere39%ofApple's
salesin2005.(Burrows)Thisveryinnovativecompanyexploitsitssecondmover
position.Inthefuture,theywillneedtocontinueinnovatingtoexpandtheboundariesof
bothmediaandcomputers.

OnepersistentelementofbothcompetitiveadvantageandriskisSteveJobs.Heisboth
synonymouswithApple'ssuccessandhasalargeequityinterestinAppleandDisney.If
heweretodivesthisleadershipposition,thereactionofboththemarketandconsumers
wouldbeuncertain.Givenhispositionwithintheorganizationaswellasthehistoryof
thecompanywhenhewasgone,Applemustfindawaytolearnasanorganization.This
willallowthecompanytowithstandadeparturebyJobs.

Basedontheactionsoftheorganization,wefeelthatthemidtermperformanceofApple
willbestrong.ThisperiodallowsApplethetimetoovercometheirchallengesifthey
moveswiftly.Forthisreason,wefeelthattheywillcontinuetosucceedandwillcontinue
tooutperformtheirpeers.

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