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

HuzefaA. N. Deepti

Dinesh GauravVinay

Harmanjeet Singh

Under the guidance ofPROF. DEBAJYOTI MAJUMDAR

THE INDIAN INSTITUTE OF PLANNING AND MANAGEMENTHYDERABAD

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:

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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.

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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.

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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)

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CONTENTS

EXECUTIVE SUMMARY………………………………………………………………………. 7HISTORY OF APPLE………………………………………………………................................ 8MISSION AND VISION……………………………………………………………………….. .15THE PC INDUSTRY……………………………………………………………………………..16THE ONLINE MUSIC INDUSTRY…………………………………………………..................17THE FUTURE OF APPLE……………………………………………………………………… 17

PERSONAL COMPUTERS- A SHIFT IN STRATERGY……………………………. 17APPLE IN THE LIVING ROOM……………………………………………………… 19STRATEGIC ALLIANCES……………………………………………………………..20

EXTERNAL ANALYSIS……………………………………………………………....................21TECHNOLOGICAL ENVIRONMENT……………………………………....................21

PERSONAL AWARENESS-STYLE AT A PREMIUM……………………... 21INTEROPERABILITY……………………………………………………….22TECHNOLOGY AND THE DIGITAL LIFESTYLE………………………..23

REGULATORY ENVIRONMENT……………………………………………………24INDUSTRY ANALYSIS USING PORTER’S FIVE FORCES MODEL………………………25

WHICH EXTERNAL THREATS ARE MORE SIGNIFICANT……………..............26ADDITIONAL EXTERNAL THREATS……………………………………………………….28

SECUTITY…………………………………………………………………………….28VERTICAL INTEGRATION OF COMPETITORS…………………………………..29

VALUE CHAIN ANALYSIS…………………………………………………………………...30TECHNOLOGY AND PRODUCT DESIGN…………………………………………30PRODUCTION………………………………………………………………………..31SALES AND MARKETING………………………………………………………….31CUSTOMER SERVICE…………………………………………………………… ..31

LEGAL SERVICES…………………………………………………………………...32SWOT ANALYSIS……………………………………………………………………………..33

STRENGTHS………………………………………………………………………….33WEAKNESSES………………………………………………………………………..34OPPORTUNITIES………………………………………………………………..……34THREATS…………………………………………………………………….………36

FINANCIAL ANALYSIS…………………………………………………………….………..362ND QUARTER 2006…………………………………………………………………36HISTORICAL PERFORMANCE……………………………………………………36STOCK PRICE PERFORMANCE…………………………………………………..37PROFITABILITY MEASURES…………………………………....………………..38LIQUIDITY AND LEVERAGE MEASURES………………………………………38PRODUCT UNIT SALES……………………………………………………………39OPERATING SEGMENTS………………………………………………………….39

MARKET VALUE ANALYSIS………………………………………………………………40PROFORMA INCOME STATEMENT……………………………………………...41PROJECTED FREE CASHFLOW&EQUITY VALUATION………………………42

STRATEGY……………………………………………………………………………………43PRODUCT DIFFERENTIATION…………………………………………………....43STRATEGIC ALLIANCES………………………………………………………….47

RECOMMENDATIONS………………………………………………………………………50CONCLUSION………………………………………………………………………………..51INDEX…………………………………………………………………………………………52BIBLIOGRAPHY……………………………………………………………………………..53

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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.

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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, 14-

5)

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)

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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.

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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

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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

‘Lemmings’ commercial during the Super Bowl. In what was becoming Apple’s typical

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)

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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

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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)

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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.

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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."

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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

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Sh

are

of

Ma

rke

t

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

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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)

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

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from a myriad of systems based on the Intel processor, while a consumer running Apple’s OS X

must purchase Apple hardware.

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

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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)

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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.

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

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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,

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)

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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)

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 flash-

memory-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)

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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)

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

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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.

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(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

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Threat of New Entrants

Bargainingpower of Suppliers

Threat of Substitutes

Bargaining power of Buyers

Level of Threat in an Industry

Figure 7: Summary of Industry Threats (Computer Equipment and Entertainment Distribution)Type and Severity of Threat

Organization Examples

Entry – High Threat

Verizon Streaming audio and video with V CAST.

Amazon On demand online services to purchase music (similar to iTunes).

Google They make everything.

The “Next Google” New entrants with disruptive technology.

Rivalry – High Threat

Microsoft Windows Operating System, Windows Media Player for playing music and video.

Linux Competition to Mac OS X Operating System.

Napster, Rhapsody Online music sources – alternatives to iTunes Music Store.

Dell, HP, Lenovo Alternate sources for computer hardware.

iRiver, Samsung, Creative

Small, stylish MP3 Players.

DreamWorks Animated movies.

YouTube.com Online video.

Substitutes – Moderate Threat

XM, Sirius Satellite Radio for music.

XBox, PS2 Entertainment Media, Media and Music.

Various Internet Streaming Radio and Podcasts.

Music CDs, DVD-Audio and SuperAudio CD

Alternative means to acquire music.

Broadcast, Cable, Satellite, NetFlix, TiVo, Theatres

Alternative sources for video.

Suppliers – High Threat

Motorola, IBM, Intel, Samsung

Suppliers of Processors and computer memory.

Microsoft Strategic Alliance / Supplier of Office for Mac.

The Big Five - BMG, EMI, Sony, Universal, and Warner

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)

Disney, ABC, NBC, CBS, Fox, Pixar, Sony

Suppliers of Television and Movies. Will they sign exclusive contracts with other online services? Note that this threat is reduced for Disney / Pixar.

Buyers – Moderate Threat

Consumers and Illegal peer-to-peer file sharing

Consumers share music using peer-to-peer networks without paying for music.

Distributors 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)

Consumer Attitudes and Behaviors

Consumers or businesses may reduce spending on personal computers or non-essential (potentially high elasticity of demand) music players if they fear economic downturns.

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Consumer Refresh Cycles

Consumers and businesses may continue to use previous-model iPods and Macs rather than upgrade to current iPods, iMacs, or OS

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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

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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)

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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)

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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

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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

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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)

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SWOT Analysis

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).

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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 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

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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

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. The Apple records claim against iTunes remains

unresolved.

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

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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 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.

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Apple Revenue Growth

0

2000

4000

6000

8000

10000

12000

14000

16000

1998 1999 2000 2001 2002 2003 2004 2005

Ne

t S

ale

s

(Apple Computer, 2005)

Stock Price Performance

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

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financially and now has similar ratios to that of its competitors and the overall computer

hardware industry (see table below).

  2003 2004 2005 Microsoft '05

Dell '05 Industry '05

S&P 500

Return on Assets

1.01% 3.43% 11.56% 19.75% 15.42% 11.98% 8.13%

Return on Equity

1.63% 5.44% 17.88% 28.56% 67.31% 36.61% 19.61%

Profit Margin 1.11% 3.33% 9.58% 31.57% 6.39% 6.36% 13.75%P/E Ratio     33.89 22.63 18.51 26.32 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 2004 2005 Microsoft '05

Dell '05 Industry '05 S&P 500

Current Ratio 2.5 2.6 3 2.88 1.11 1.81 1.82Quick Ratio 2.47 2.59 2.9 2.85 1.08 1.45 1.31

Product Unit Sales

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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)

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)

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2002 Product Sales

Desktops

Notebooks

iPod

Peripherals

Sales by Region Segment

0

2000

4000

6000

8000

10000

12000

14000

16000

2002 2003 2004 2005

Year

To

tal S

ale

s Other

Retail

Japan

Europe

America's

2005 Product Sales

Desktops

Notebooks

iPod

Peripherals

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

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

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.

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Cost of Equity/WACC Note ValueRisk Free Rate 10 Yr Treasury 5.12Market Risk Premium (Analysis) 4Beta From Google 1.46Adjusted Apple Risk Premium   5.84Cost of Equity/WACC   10.96

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 Annualized 2006 2007P 2008P 2009P 2010P

Net Sales 13931 20216 26280.8 31536.96 36267.50 39894.25

Cost Of Sales 9888 14353 18659 22391 25750 28325

R&D 534 809 1051 1261 1451 1596

S,G,A 1859 2628 3417 4100 4715 5186

Operating Income 1650 2426 3154 3784 4352 4787

Interest Income 165 239 311 374 430 473

Taxes 480 705 916 1100 1265 1391

Net Income 1335 1960 2548 3058 3517 3869

EPS 1.57 2.31 3.00 3.60 4.14 4.56

Shares Out (000's) 848,612 848,612 848,612 848,612 848,612 848,612

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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)

Free Cash Flows 2006 A 2007P 2008P 2009P 2010P Terminal

Net Income 1960.00 2548.00 3058.00 3517.00 3869.00  Depreciation 239.00 310.70 372.89 428.86 471.78  Free Cash Flows 2199.00 2858.70 3430.89 3945.86 4340.78  WACC 10.96 10.96 10.96 10.96 10.96  PV Factor 0.9505 0.8565 0.7715 0.695 0.626 0.626Terminal Value           109615.6PV FCF 1862.98 2182.36 2359.25 2444.32 2421.99 68619.42Sum of PV of CF 11270.90          PV of Terminal Value 68619.42          FMV of Invested Capital 79890.32          Less Existing Cash Balance 8261          Intrinsic Value of Equity 71629.32          

Given intrinsic equity value, we estimate the per share stock price. Given their particular

market condition, Apple appears undervalued (see table below).

Equity ValueTotal Shares (000's) 848612Value (000's) 71629000Value/Share $84Current Price (5/5/06) $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.

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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 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

Consumer Segment

Desktop G3 iMacPortable PowerBook 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

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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.

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

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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

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.

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

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Inter-Functional Collaboration

Too Much (Lockstep) Too Little (No Collaboration)

Institutional Control

Too Much (Bureaucracy)

Connection to the Past

Commitment to Market Vision

Too Much (History as Constraint)

Too Much (Foresight)

Too Little (Chaos)

Too Little (No Sight)

Too Little (No History)

Slows Innovation No learning makes implementation difficult

Stifles Innovation Lack of Direction in Innovation

No Innovation Can Take Place Fail to Exploit Historical Advantage

Lack of Flexibility in Uncertain Market Lack of Direction in Innovation

Organizing Dilemmas

Source: Barney, 290

resolves the commitment to market vision dilemma. Managerial freedom within broad decision-

making 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

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).

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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)

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

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million to cover debt and closing costs. The business was worth $400 million. (Linzmayer, 255-

7)

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

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

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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

“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 non-

equity 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.

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It is vital to remember, “Commitment, coordination, and trust are all important determinants of

alliance success.” (Barney, 395)

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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

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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.

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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

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BIBLOGRAPHY

www.appleinc.com

www.google.com

http://trad.org

http://www.divisiontwo.com/articles

http://www.cnet.com

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