Apple CFO Fred Anderson and Corporate Controller Peter Oppenheimer, recently spoke to investors and analysts at the Morgan Stanley Semiconductor & System Conference. In a session about 45 minutes long Oppenheimer and Anderson covered some interesting points about Apple’s business strategy, its success with the iPod and iTunes, and how it plans to continue making money and improving margins.
Anderson indicated that despite an economic downturn in recent years, Apple has increased its annual research and development spending from $300 million to $500 million since 1999. That work has netted Apple four major releases of Mac OS X, new hardware like the Xserve, Power Mac G5 and many other machines, “iApp” development, and, of course, the iPod and iTunes Music Store.
“Controlling more of the point of sale”
Anderson also pointed to Apple’s retail efforts, where the company has opened more than 70 retail store locations across the United States and recently in Tokyo, Japan as well. Anderson explained that Apple is focused on “controlling more of the point of sale.”
When asked about Apple’s long-range retail store plans, Anderson said, “We do not have a Gateway strategy,” referring to the beleaguered Windows PC manufacturer that recently announced the pending layoff of about 2,000 employees. Gateway opened hundreds of its own retail stores across the country, but wasn’t able to make many of them profitable.
“We’re only interested in profitable stores,” said Anderson — Apple’s goal is not to saturate the market, he said. Anderson also indicated that Apple wants each retail location to be profitable within the first year of operation.
“Ron Johnson is focused on increasing store sales,” said Anderson, referring to Apple’s Senior Vice President of Retail.
To that end, Apple is employing initiatives that may further alienate Apple Authorized Resellers who have had unfettered access to specialty markets for decades. Anderson mentioned that almost every Apple retail store now features at least one employee who is focused on sales to small businesses, for example.
The “Switch” ad campaign was a strong theme in the early days of the Apple retail store effort, and those efforts continue. Anderson said that 40 to 50 percent of the CPUs sold through Apple retail stores are to non-Mac users.
iTunes and iPod
When asked to characterize Apple’s efforts to sell music through the iTunes Music Store and the iPod digital music player, Anderson called it “a grand slam home run.” Seventy percent of the legal music download market in the U.S. belongs to Apple, he said, and iPod represents more than 50 percent of total revenue for the MP3 player market.
“It sure feels good to be competing in the total market rather than our less than five percent marketshare,” Anderson said. He also mentioned that Apple’s management is focused on maintaining its current advantage in that market by taking what he called a “broad distribution approach” by making iPods available in stores like Best Buy, Circuit City, Target and others.
Oppenheimer called Apple’s decision to strike a deal with HP to make HP-branded iPods “a win/win for both companies.” HP gains access to the best-selling MP3 player, while Apple gets iTunes for Windows installed on the desktops of many of HP’s consumer PC models.
Oppenheimer also said that HP has a broader reach than Apple does particularly in Europe and Asia. What’s more, Apple’s alliance with HP wouldn’t preclude the company from establishing other partnerships as well, where they made sense to do so.
Critics have had much to say about competing Digital Rights Management (DRM) and audio standards now supported by major music download services and the large-capacity MP3 players they work with. Anderson cited the iPod’s current market dominance as an indication that Apple will win out with AAC and FairPlay, which said had “tremendous momentum” in being established as the standard.
“So our philosophy is that traffic to the music store will lead to iPod sales and iPod sales will lead to the sale of Macs,” said Anderson, especially for those users who already have a PC and decide later to look at another system — preferably a Mac — so “they can get their hands on the additional lifestyle applications.”
Apple’s financial future
Apple continues to post profits, and recently became debt-free, but those are not the only indications of the fiscal health of the company. Oppenheimer said that Apple’s goal is to “grow [its] top and bottom lines.”
“We’d like to become a $10 billion company again,” said Oppenheimer. “We’d like to see our revenues grow at 15 percent a year going forward.”
For its fiscal year 2003, Apple recorded about $6.2 billion in net sales. Oppenheimer hopes to see Apple maintain gross margins at 27 to 28 percent, with operating expenses at about 20 to 21 percent, thus driving a 7 percent operating margin.
“Back in 2000 our operating margin — being an $8 billion company — was 8 percent, so this is a range we’ve been in before,” said Oppenheimer. He added that operating margins won’t be as strong this time around thanks to Apple’s efforts on research and development and direct sales.
Some criticism has been laid at Apple’s feet for not getting a value-priced Mac to market. Its least expensive system — the CRT-based all in one eMac — cost consumers about $800. It’s trivial to find Windows-based PCs with significant higher clock speeds than the eMac for half that price. The iMac starts at almost $1,300.
“We’re not focused on shipping four, five, six hundred dollar PCs. We don’t think there’s a good way to innovate there or differentiate, and we don’t think people are making a lot of money,” said Oppenheimer.