Apple 2004
...int where they now have the highest inventory turnover in the industry. This feat has significant implications. Dell’s core competency is in their direct model that leverages JIT inventory. They pioneered this method and had a first mover advantage for quite some time, yet Apple has been able to surpass their arch rival in terms of inventory turnover. In 1999 and 2000, Apple’s operating and profit margins exceeded industry averages. (See Exhibit 2.) Although 2001 was a dismal year, this was more due to industry wide demand contraction as industry sales declined by over 5%. (See Exhibit 3.) If Apple had maintained its 3 year growth rate, their operating and profit margins would have been competitive with Dell, Compaq, and HP. 3. FUNCTIONAL ANALYSIS Using Porter’s value chain analysis, we are able to identify differentiation potential for Apple. Porter’s method divides a firm’s endeavors into 5 primary activities encompassing inbound logistics, operations, outbound logistics, marketing and sales, and service. (See Exhibit 4.) Inbound logistics involve relationships with suppliers and include all the activities required to receive, store, and disseminate inputs. Inputs for an Apple personal computer include an operating system, chassis, memory, CPU, etc. Apple practices horizontal and vertical integration of computer components to a greater extend than any other PC manufacturer. As a result, the firm’s ability to influence quality control of inputs and intermediate processes such as logistics is greater. Apple can specifically define its specifications for product form and features and can logistically control where and when they are manufactured. A higher degree of quality of components and materials is therefore perceived by the end user as a differentiating factor and to the company, a key value added activity. Supporting activities such as technology development also plays a major role in developing value added activities in the inbound logistic environment. Apple allocates the most amount of capital to R&D when benchmarked against competitors. This allows Apple to produce highly innovate products and technologies. With an R&D rate of 8% in 2001 (See Exhibit 10), Apple has introduced several successful products such as the iBook and iPod, technologies like Fire Wire and Blue Tooth, and a superior operating system. Historically, Apple hasn’t been on the forefront of integrating efficiencies into the manufacturing process. Operation activities refer to all the activities required to transform inputs into outputs. In general, operation activities refer to production or assembly. It is here where assembly line innovations, inventory management, and supply chain management drive down costs and act as value added activities. However, as mentioned, Apple has made significant improvements to its operations, streamlining them to a great extent. Restructuring efforts such as closing facilities, outsourcing specific manufacturing tasks, and centralizing core functions improved Apple’s operating efficiency. From 1997 to 1998, operating margins improved by 20% and continued to approve in 1999 and 2000. (See Exhibit 2.) Human resource management plays a significant supporting role in operations. By downsizing, more is expected from workers and productivity has to increase per employee. Training and hiring skilled employees that can immediately contribute their skills to the production process is in itself a value added activity. Jobs also recruited an executive team that instituted and managed these drastic operational improvements. Outbound logistics refer to the activities required to collect, store, and distribute the output. Apple specifically excels in these activities. Their efficient web site order processing allows them to have the highest inventory turnover rate in the industry. The firm infrastructure supports these fast response capabilities through investments in MIS and knowledge sharing systems. Apple also eliminated thousands of resource draining distribution outlets and complemented their direct selling efforts with wholly owned retail boutiques. Additionally, Apple expanded their presence in national chains. These value added outbound activities translated into reduced distribution time and increased delivery reliability to the end user. Marketing and sales activities act to build brand reputation and stimulate sales. In 1998, Apple demonstrated its competencies in marketing with the unveiling of the iMac. Backed by a $100 million campaign, clever strategic advertising helped sell 278,000 iMacs in just six weeks and 6 million in 3.5 years. This massive advertising campaign generated positive buzz for Apple and helped reinvigorate its image. This campaigned strategically targeted young and contemporary market segments and helped position Apple as a differentiated product with plug and play multimedia peripherals that seamlessly complemented the PC. This advertised differentiation was by no means an accident. The iMac sold 6 million units at premium prices compared to its PC counterparts because the marketing campaign succeeded in communicating the differentiation advantages of the iMac over the cheaper PCs. Service represents the last primary company activity in Porter’s value chain analysis. Service activities include all the activities required to keep the product or service working effectively for the buyer after it is sold and delivered. Here, Apple demonstrated value by creating nation wide support groups. Leveraging the ubiquitous attributes inherent to the Internet, Apple was able to establish regional and local software and technical support groups for its installed customer base. Strategically, Apple forged alliances with over 400 software developers to provide more than 1200 new software applications for Apple. The company’s ability to continually add functionality to its PC line via new software availability is a key value driving activity. What good is it from the customer’s perspective to have a quality product that is limited to a few functions? To summarize, Apple’s distinctive core competencies lie within their ability to provide quality products through their vertically integrated inbound activities. Not only are Apple’s finished goods differentiated by quality, they are innovative and cutting edge. Innovation is driven by consistent investment in R&D. Although the company has excelled in delivery and order processing, it still has yet to prove its operational efficiency. Therein lies Apple’s principal weakness. In the past, Apple has failed to reconcile the added cost of differentiation with operational efficiencies in production and distribution. Apple has also shown competencies in building brand reputation and generating buzz for its products. Their marketing campaigns have been successful and remain a value added activity. Financially, the company remains liquid with substantial cash reserves and is not highly leveraged in debt. (See Exhibit 10) Opportunities exist for Apple to emerge as a leader in providing a complete system that seamlessly integrates peripherals as these complements become more prevalent and adopted. By horizontally integrating, Apple can maintain stringent conformity standards and ensure all its peripheral offerings are compatible with its PC offering. Please see Exhibit 5 for a more a complete SWOT analysis. 4. COMPETITIVE ANALYSIS 4.1 PRODUCT LIFE CYCLE Domestically, the PC market seems to be in its maturity stage characterized by a slowdown in sales growth as a result of mass acceptance. (See Exhibit 6) Following its worst year ever in 2001, unit growth is expected to exceed revenue growth, indicative of falling prices and profit erosion, both characteristics of a mature market. The industry consists of well entrenched competitors whose basic drive is to gain or maintain market share. A commonly used statistic to measure market structure is the Herfindahl index. The Herfindahl index equals the sum of the squared market shares of all the firms in the market. If perfect or monopolistic competition exists, then index should be below .2. Anything above .2 reflects either an oligopoly any anything above .6 usually points to a monopoly. The Herfindahl index for the PC industry in 2001 is ..05 or 5%. The top 9 market share leaders dominate 60% of the world wide industry. (See Exhibit 7) Firms with a market share of .01 or lower are too small to significantly affect the final calculation 4.2 PORTER FIVE FORCES ANALYSIS Unfortunately, the PC industry is presently experiencing a contraction period after achieving impressive expansion during the last two decades. Demand has been stagnating with a 5% drop in sales for 2001. Accordingly, each individual firm has been experiencing larger than average excess capacity. These two factors have elicited intensified competition among current incumbents. Factors such as the ability for consumers to switch from one competitor to the other with relative ease, the absence of any cooperative pricing, and the ability of incumbents to adjust prices quickly all attribute to intense internal rivalry within this industry. And as a result, these factors have exerted a downward pressure on prices. In fact, prices are expected decline by 6% going forward to 2005. This is consistent with the internal rival theory, where increases in rivalry will result in further price competition and erosion. Aside from Apple, there is little differentiation among sellers and cost differences among sellers are relatively low. (See Exhibit 8) Threat of entry into this industry is relatively low for this industry. With an industry consisting of over 100 incumbents ranging from powerful brand names such as Dell and Compaq to no name cloners, it is reasonable to conclude that the industry has reached a certain saturation point. This accompanied by several structural barriers to entry make it highly unfeasible for new companies to enter the market unless significant consolidation or exit occurs within the incumbent group. Economies of scale, learning curve advantages, access to distribution channels, and relationship specific investments into direct sales channels all make the threat of entry highly unlikely. (See Exhibit 8) Currently, substitutes are becoming more of a realized threat to the industry as they become closer in functionality to the PC. With the ability of PDAs, WebTV, and SmartPhones to handle email, word processing, communication, and other ancillary functions, the demand for a bulky home desktop or laptop computer is being flanked. One could argue that these some of these devices are complements to the PC an one should pursue a differentiation strategy that incorporates these devices into a product offering such as Apple’s strategy. Nevertheless, as computer technology continues to evolve and bandwidth increases, a PDA may soon be able to duplicate most of the functions inherent to the PC. (See Exhibit 8) Supplier power is relatively high in this industry. Two major components are a computer’s operating system and CPU. These two components are supplied by their respective industries that are more consolidated than the PC industry. Intel and AMD own over 80% of the CPU market and Microsoft owns 90% of the operating system market. There are few substitutes for these input devices. Firms make relationship specific investments that creating extensive switching costs if a change were to be made in the choice of operating system or CPU chip. Although these firms pose little to no threat of forward integration, they can charge PC manufacturers premiums due to their market dominance. (See Exhibit 8) Buyer power is relatively low to medium in the PC industry. Because firms make relationship specific investments by choosing to adopt a OS and CPU chip, they are forced to maintain long lasting relationships with their suppliers. The PC industry is more fragmented than the OS and CPU industries and PC manufacturers pose little threat in their ability to backward integrate. Apple has already accomplished this feat with its own proprietary OS. Because price elasticity is high for the PC industry, and increase in price will adversely affect sales and profit for PC manufacturers. This exerts downward pressure on component prices. The key success factors associated with this industry can be generalized into rapid technological innovation. Technological innovation has consistently stimulated the demand for more powerful products in the areas of performance (computing speed), reliability, and data storage. The proliferation of the Internet has also been a major factor affecting PC adoption rates. Likewise, a steady and continual flow of complementary products that enhance the “computing experience” also has positively affected the industry’s success. PC companies must keep up with the pace of technological innovation to remain competitively viable. Systems must be able to comply with new and innovative complementary products and performance must match what component suppliers such as Intel are providing. With that said, is Apple’s competitive strategy aligned with the industry’s dynamics? I would argue that Apple’s differentiation strategy is uniquely aligned with the changing dynamics of the industry. The following industry characteristics serve as supporting premises to this argument. Firstly, Apple owns the only viable alternative to a “Wintel” machine. All other major computer manufacturers are only slightly differentiated because they are forced to conform to the “Wintel” standards of an Intel chip and Microsoft operating system. They are limited to differentiating themselves based on accessibility, service, and marketing. Differentiation has been realized by the way the industry evolved and Apple is positioned as the only alternative to the PC. If differentiation results in a highly inferior yet differentiated product, then this strategy is doomed to fail. However, Apple has developed a superior product because it controls a large degree of input components, peripherals, and the operating system. The result is a differentiated product that outperforms PC competitors on speed, design, style, ease of use, and peripheral integration. Additionally, Apple is not subjected to the same degree of supplier power as PCs. It has the advantage of picking and choosing which technological innovations to pursue based on what will perform best on their system whereas PC’s are forced to deal with Windows and the associated software incompatibilities that may arise with new releases. Long term, PCs are subjected to increased competition from small brands that use alternate, yet inferior components, allowing these manufacturers to offer comparable products at discounted prices. Companies like eMachines and other small brands are undercutting costs by adopting alternative components from lesser well know brands such as AMD versus Intel. You can’t clone an Apple. Therefore Apple is not directly subjected to the same threats as PC manufacturers are. A major weakness in Apple’s differentiation strategy is in its operating costs. As PC prices fall, Apple must remain somewhat competitive by narrowing the gap in production costs. This provides a continuous challenge for Apple. How high of a premium can Apple justify for their differentiation strategy? In times of economic contraction, large discrepancies between the selling prices of a PC and an Apple can result in a loss of market share for the company. An additional weakness to Apple’s differentiation strategy is that by adopting its own operating system, the company limits itself to the availability of software. With a significantly dwarfed customer base, software developers are more inclined to save costs by not developing Mac compatible versions. This remains a critical competitive issue that needs to be addressed. 5. CRITICAL ISSUES & RECOMMENDATIONS FOR ACTION The major issue facing Apple executives is how to return the company to profitability and regain market share. Although the entire industry contracted in 2001, sales for Apple declined by 32% while Dell’s sales increased and Compaq, HP, and IBM revenues were reduced by 21%, 7%, and 3% respectively. Apple lost strength in every market segment including its core niche markets and the company still lacked mainstream consumer awareness and adoption. Consumers weren’t buying into the premium price tag associated with Apple’s differentiation strategy and a major hurdle existed in overcoming the widely accepted perception that Apple computers were incompatible with major software vendors. Supplementing these issues are Apple’s operating costs. Apple failed to initiate cost containment counter measures during the industry wide contraction period. In fact operating cost increased during 2001 even though sales decreased by 30%. Going forward, should Apple appeal to the mass market or entrench during economic uncertainty and focus on their niche market strongholds? Can Apple compete on cost with its PC counterparts or will they always be regarded as the “BMW” of personal computing? My recommendations for action will be based on an analysis utilizing the Balanced Scorecard approach developed by Robert Kaplan and David Norton. Central to this approach is vision and strategy. This approach will attempt to complement financial measures with operational measures on customer satisfaction, internal processes, and the company’s innovation and improvement activities. These measures are the drivers of future financial performance. Apple’s corporate mission or vision is to deliver a highly innovative and superior solution to a customer’s personal computing needs. This vision is strategically accomplished by differentiating Apple from its competitors on the basis of quality, design, performance, and peripheral integration, hence the term “Digital Hub.” With this vision and strategy in mind, we now will examine the four elements to the scorecard approach: customer perception, internal business perspective, innovation perspective, and financial perspective. (See Exhibit 9) How do customers see Apple on the basis of quality, performance, service, and cost? Apple’s customer base is unparalleled in loyalty and satisfaction. Customers view Apple as the only integrated alternative to the chaotic interoperable PC alternative. When paired head to head with a PC, Apple fairs very well, much better than what its current market share demonstrates. Therefore actions need to be taken to change the market’s perception. The objective here is to communicate to the various market segments what Apple’s current customers feel about their computing “experience.” Apple needs to overcome the myth that its products are severally limited on the software side. To do this, Apple needs to leverage its value added marketing competency and initiate a testimonial like campaign that stresses the quality, performance, and functionality of Apple products, in essence, its differentiating features. Measures such as new user adoption rates need to be continually monitored so that Apple can see if their marketing efforts are succeeding. Internally, how will Apple be able sustain its ability to change and improve? Strategically, Apple needs to continue to be on the forefront of innovation. This can be accomplished thr...