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Weekly Column

Divide and Conquer: Why Apple Has an iPod Division

Status: [CLOSED]
By Robert X. Cringely

Back in January, I moved from the California Wine Country to Charleston, South Carolina, trading my 47 acres of ticks and foxtails for a 152 year-old Victorian House with vintage termites. The wonder of the move is that after five months, hardly anyone has noticed. Charleston is precisely nowhere in the geography of high tech, but it really doesn’t matter because I’m more or less virtual. When I moved the 100 miles from Silicon Valley to Santa Rosa in 1999, only my area code changed. This time, thanks to VoIP, not even that happened: It was easier to make my old numbers ring in Charleston than to tell my 3,309 friends a new number. Back in 1999, I worried that not being IN Silicon Valley would hurt my work, but it didn’t. I averaged one day-trip down per month. Now I make a similar monthly trip, only it is a 5,600 mile round trip, and I stay for two to three days. So moving to Charleston has actually meant I spend more time, not less, in Silicon Valley. And I was in California this week when Apple Computer announced a reorganization I find to be especially significant, and which suggests dramatic changes at Apple that have yet to come.

The news, broken Wednesday by the New York Times, was that Apple was creating a separate iPod division because the little music players are such a huge success. Conventional business school wisdom also says that starting a separate division is a way of isolating startup costs, making them more obvious to Wall Street and thus minimizing negative impacts because of course, even Apple has to spend money to make money. Or, like 3Com did with Palm Computing (and even Apple once did with Claris before changing its mind), you can structure a division to spin-off or have a separate IPO. This all makes sense on the surface, but then I recalled something I was told more than 20 years ago by a much younger Steve Jobs. Back then Apple had three divisions � Apple II, Lisa, and Macintosh. Why have separate divisions? “Because it’s easier to shut one down,” said Steve.

Something is stirring at Apple. The company just had yet another big layoff at its Sacramento manufacturing plant. In an effort to further lower costs, Apple is essentially getting out of the business of making its own products. Given that everyone else is doing this, too, it isn’t such a surprise, but Apple was always different, always special. And now comes this reorg, in which Apple’s head of hardware engineering becomes the head of engineering for the new iPod division. Think about that. Why would they take someone used to producing products like the G5 workstation and turn his attention to little music players? It’s hardly a comparable challenge.

Steve Jobs likes to be bold and he likes to be in charge. Apple was licensing clone makers for a time, remember, and Steve shut that down when he took over as interim CEO. What most people don’t know is that Apple, with the assistance of Intel, a few years ago ported all its software to run on Intel’s Pentium processors. But at the last moment Steve pulled the plug on that project, too. He enjoys doing that, though Intel felt burned. Steve enjoys that, too.

So what’s going on at Apple? I think it comes down to a combination of structural changes in the industry and Apple trying harder to cut costs, which really means raising profit margins.

Look at the company and its new structure. There are Retail, Applications, iPod, and Mac divisions. Retail is the Apple Stores and mail order, Applications is primarily FileMaker and the media apps like Final Cut Pro. The iPod and Mac divisions are what they are, or at least what they appear to be. In a bid to keep more profits for itself, I wouldn’t be surprised to see Apple eliminate non-specialized resellers and try to keep the retail business all for itself, following a Dell model. Look for this to happen first: the Apple Store will become the ONLY store where you can buy a Mac.

But not an iPod, since that product requires the widest possible distribution. Heck, you can by an iPod at Target. So at least part of this new structure is aimed at isolating channel conflict.

If switching to a direct sales model for Mac hardware goes well, that may be as far as the change will go. But what if sales don’t rise significantly, or they rise for a few quarters and then plateau or even decline? Under that scenario, I can imagine that Apple might stop Mac sales entirely and become a consumer electronics and software company. Think about it. The upgrade to G5 cycle isn’t going as well as Apple had hoped it would, but if the company did an Intel upgrade cycle EVERYONE would move up. That’s 20 million users instead of four to five million. Such a move would boost profits (the software’s already paid for, remember, so the margins can be HUGE) and make the company look even better, at least for awhile.

But what’s “awhile?” Awhile is until the new cash crop can grow to maturity. Maybe that means iPod, but I don’t think so, not literally. The new crop is digital content for which at the moment paying $249 for an iPod Mini is the cost of entry.

In order to pay for new business adventures, parts of the company that are viewed as likely to die are starved of funds and milked of cash. Look for this to happen eventually for the Mac division.

The new business has to do right now with music more than anything else, but the trend here, too, is toward software and away from hardware. What is an iPod, for example, but a little box of music? It’s the music that counts. Apple said it sold 70 million iTunes songs the first year of the Apple Music Store, but their target, believe it or not, was ONE million songs. That was the expectation Apple set with record company executives.

When you beat your sales target by a factor of 70, something really important is happening.

I think iPod really means “not Macintosh.” It wouldn’t surprise me if the company did more types of consumer devices, but the point is not to sell a workstation you get paid for once, but to create a revenue stream that pays you every week. That’s what Steve is groping for, I’m sure of it.

Then there is the role of IBM, maker of Apple's G5 processor chip. At E3, IBM and Sony announced that Big Blue would be selling a workstation based on its upcoming Cell Processor, which even in its first iteration will be the functional equivalent of at least four G5s. In addition to game development, the Cell workstation will be aimed at content creation and rendering, which have been popular markets for Macintosh computers. How should Apple react to this arrival of the Cell? If the Cell is what they claim, Apple would be wise to build a workstation using the chip. But what if IBM has no interest in supplying such a chip or if their commitment to Sony and the PlayStation 3 won't leave enough extra chips for Apple? How about a Cell workstation running OS X?

Apple is being ravaged from both ends of the market. The U.S. Government has told them they can't claim to be the fastest PC because they aren't. So Intel and AMD are nibbling away. Even Pixar uses Intel-based hardware in its rendering farm. Now imagine IBM and Sony attacking from the other end with inexpensive Cell hardware that beats the heck out of Pentium AND PowerPC. Well, the best reaction to that is to follow the Microsoft model, and target a high-margin OS and applications at the low-margin hardware platform built by a third party. Voila, Apple becomes a software company that also sells little hardware devices, again following the Microsoft model.

I'm not saying this is going to happen, but I think it will happen if Apple has any trouble at all maintaining its margins under the current strategy. Absolutely look for the rape of the resellers, and then MAYBE look for the end of Macintosh hardware. But iPods and iTunes will be everywhere, even here in Charleston, which has a Target store, but is more than 100 miles from the nearest Macintosh dealer.

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