Apple's Bold Swim Downstream

Apple Computer CEO Steven P. Jobs always has gobs of new products to unveil
to the Mac faithful at the Macworld trade show each January, and this year he
showed up with a more startling bag of tricks than usual. The company that has
become synonymous with high-end style in computers and music players unveiled
not one but two new products aimed at Joe Mainstream.

Taking clear aim at the low end of its two core markets, Jobs first announced
the Mac mini, an impossibly small $499 PC that is Apple's first entry into the
sub-$700 market that now accounts for almost 70% of all home PC sales. Then he
brought out the iPod shuffle, which is smaller than a pack of Wrigley's gum
and starts at just $99 - a far cry from the $249 the Cupertino (Calif.)
company now gets for its cheapest music player, the iPod mini. "I think we're
going to bring in a lot of new customers to Apple," said Jobs in a
post-keynote interview, his iPod shuffle draped on its lanyard around his neck.

Riding High

The packed house of Macolytes loved it-and most analysts are applauding as
well. Still, the new strategy is not without risk. Chief among the fears: that
by moving into crowded entry-level sectors, Apple could cannibalize its
higher-priced products, putting at risk the strong profits it needs to finance
innovation. Jobs's shift comes even as many analysts were expecting the
company to gain PC market share in 2005 for the first time in years-without
having to stray from its more lucrative high-end niche. "Some people will
ask: Should they have left well enough alone?" says First Albany Capital
analyst Joel Wagonfeld.

Clearly, Jobs & Co. believe the time is right to broaden out: Thanks to
the phenomenal popularity of the iPod, the company is riding high. On Jan. 12,
Apple announced that its fiscal first-quarter net earnings quadrupled, to $295
mn, over the previous year, on revenues up 74%, to $3.49 bn. Sales of the
red-hot iPod alone hit 4.5 mn units, a 500% increase. Apple also sold 26% more
computers than it did during the same period a year ago. Those numbers sent
Apple's shares soaring in after-hours trading.

Crucially, many of the folks who bought the music player last quarter are
Windows users. With iPod mania running full tilt, Jobs figures there's an
opening to grab PC market share by drawing in users who want Apple's famous
style and ease-of-use. Until now, Apple products have been too expensive for
most PC users, but Jobs is betting that the $499 mini could make Apple a viable
contender at the core of the market. To simplify things even further, Apple made
sure PC users can plug their existing display, keyboard, and mouse into the
unit. "This is the most affordable Mac ever," Jobs told the crowd.
"People who are thinking of switching will have no more excuses."

Low cost isn't the only lure. Jobs is also betting that once PC users
finally get a chance to use Apple's highly regarded operating system and
software suites, there'll be no turning back. The deluge of viruses and
spyware targeted at Windows has reached such a pitch, Jobs figures, that people
will be ready to embrace Apple's relatively safe OS. Apple intends to press
its software advantage hard: While Jobs devoted a few minutes of his two-hour
speech at Macworld to the Mac mini, he spent most of the speech extolling the
Mac OS and the latest iteration of Apple's iLife software suite, which makes
it easier than ever for users to manage photos, music, and video.

New Apples in the Orchard Apple has stuck to upmarket products in recent years, squeezing maximum profit from die-hard fans. Now it hopes to build on the iPod's success by going more mass-market in two promising growth areas: Home PCs and low-end music players. How does the new Mac mini and iPod shuffle fit into the lineup: PCs POWERMAC G5 Apple's most powerful computer is aimed at corporate creative types—many of whom have moved to Windows PCs in recent years $1,500-$3,000* POWERBOOK G4 Thanks in part to the iPod "halo affect," this powerful notebook is popular among students $1,600-$2,800 iMAC G5 Introduced last fall, the all-in one flat-panel machine won raves, but it's too costly for most consumers $1,30O-$1,900 iBOOK G4 The rugged notebook is targeted at budget-conscious schools and consumers $1,000-$1,500 eMAC This budget-price all-in-one machine is the choice for many schools $800-$1,000 MAC MINI With its new low-priced contender, Apple hopes to lure unhappy Windows PC owners $500-$600** Music Players iPOD PHOTO Designed to store images as well as tunes, sales have lagged other iPods since its debut in October $500 iPOD SHUFFLE A simple, inexpensive device for folks who need to carry around only a dozen or so CDs' worth of music $100-$150 iPOD Apple's best-selling product hooks music fans who want a device to hold their entire music collections $300-$400 iPOD MINI Capable of storing 1,000 songs, its lower price and smaller size have made it popular with the gym set $250

Jobs may have hit upon a winning strategy. Just ask Michael Wood. Having
already fallen hard for his wife's iPod and intrigued by a $499 Macintosh
computer, the Shelby (N.C.) auto salesman is now considering a Mac. Citigroup
Smith Barney analyst Richard Gardner expects the mini could double Apple's
market share in PCs, to 4%. That may not sound like much, but it would translate
into an extra $4 bn in revenues for Apple.

Undercutting

What about the iPod shuffle? Having dominated the hard-drive segment of the
digital music-player market, Apple is ready to take a run at cheaper players
that use flash memory. Now that market is fragmented among dozens of players
that charge roughly $150 for devices that hold 120 songs.

What Jobs has done is deliberately undercut the competition. The base model
of the new shuffle costs $99 and holds 120-plus songs. To get to that low price,
however, he has designed a bare-bones player that may not appeal to everyone.
Unlike many other flash players, Apple's gadget boasts no screen - meaning
users can't see or control what they're playing.

Apple is betting that there are plenty of low-budget buyers out there who
will find the shuffle enough gadget for their needs. It also hopes they'll be
tempted to move up into a pricier iPod, especially if they get hooked buying
music from the company's iTunes Music Store, which currently plays solely on
Apple products. Even Dan Torres, vice-president for marketing at music player
rival Rio, expects the shuffle to expand Apple's empire. "This is going
to be another piece of the pie for them," he says. "It will attract
new customers-and be the third or fourth iPod for many customers>."

But couldn't the cheaper products prompt some customers to shun the
higher-priced ones? For example, the hordes of people who bought iPods as gifts
this year may be content to get that favorite niece a less pricey shuffle next
year. Apple has done what it can to prevent that from happening by segmenting
its lineup. With its far greater storage and better controls, the original iPod
is a very different gadget from the shuffle. Likewise, Jobs, who shrugs off
fears of cannibalization, has made sure the new mini lacks the power and many
features found in the iMac and the company's higher-priced computers.

Keep it Simple 

Still, Apple will have to tread carefully as its enters the low end of the
PC market if it is to avoid succumbing to the profitless prosperity that has
dogged so many others.

To beat the odds, Apple will keep its costs low so it can maintain its profit
margins and thereby have the resources to keep innovating. That's one reason,
analysts say, that the company has opted to keep its new products simple, with
fewer or less expensive components. The iPod shuffle lacks a hard drive,
enabling Apple to benefit from tanking prices for flash memory. The Mac mini has
a slower chip and less storage than Apple's pricier machines. And leaving out
the display, keyboard, and mouse cuts costs even further.

The upshot: Smith Barney's Gardner says Apple should churn out 15% gross
margins for the mini, about what it gets for the iMac G5. And because Apple has
already paid for the Mac operating system and its retail stores, says Gardner,
nearly half of every gross profit dollar the mini generates will drop to the
bottom line.

At the end of the day, most analysts agree Jobs has played his cards
shrewdly. If cannibalization gets too severe or margins erode, Apple could back
away from the low end. Indeed, the company seems to be proceeding somewhat
tentatively. For an outfit that typically hypes its new hardware to the heavens,
Jobs is notably low-key when it comes to the Mac mini. Nor is he predicting an
overnight market share grab. "We have our ideas about how many we can sell,
but it'll be either too few or too many," he says. "I'll know in a
month or so." Either way, it's not likely to end the good times in
Cupertino.

By Peter Burrows in San Francisco, with Andrew Park in Charlotte,
N.C. in New York in BusinessWeek. Copyright 2005 by The McGrraw-Hill Companies,
Inc