Macworld Magazine, September 1991

 

That Vision Thing

by Cheryl England

Low-cost Macs have transformed Apple. For the better?

 

The three Macintosh computers Apple introduced last October, the Classic, the LC, and the IIsi, didn’t seem that special. They ran the same system software and applications as previous Macintoshes, but there was a difference—price.

 

The trio has had mixed success as a group, but up to March, the Classic was selling 100,000 units a month. In the six months after Apple introduced the low-cost Macs, U.S. market share more than doubled, rising to almost 20 percent, and price-sensitive foreign markets, such as those in Asia and South America, expanded.

 

Revenues, too, continue to grow. By the end of March, worldwide revenues were up 19 percent from the same quarter a year ago. With total sales of $5.6 billion, Apple is still the largest personal computer company, ahead of IBM, Compaq, and Tandy.

 

Apple has a strong balance sheet, with lots of cash and virtually no debt. The bad news is that profitability is sharply down, and operating costs are up.

 

As a result, Apple underwent a large-scale reorganization in the first half of 1991, which resulted in its first significant round of layoffs since 1985; up to 10 percent (1500 employees) of its worldwide work force is expected to be cut. To reduce operating expenses further, the company also consolidated its five U.S. regional sales divisions into three units, eliminating regional headquarters in San Jose, California, and Chicago, and made plans to move some departments out of leased buildings in Cupertino, California, to lower-cost areas in other parts of the western United States. Apple USA was reorganized—for the fifth time in as many years. Even engineering and advanced technology staffs are facing cuts, and development projects are being squashed. Morale is plummeting, and many people, both inside and outside Apple, are questioning whether CEO and chairman John Sculley has the savvy to lead Apple into the next decade (see sidebar entitled “The 16.7 Million-Dollar Man: Is He Worth It?"").

 

Why the turmoil amid the success? The answer lies partly in Apple’s history. A company with remarkable products and inspired engineers, Apple historically offered premium products at premium prices, yielding one of the highest profit margins in the industry.

 

But by late 1990 Apple was in a bind. Its U.S. market share had plummeted to 9 percent—down from a high of 15 percent in 1987. Fast-paced sales in Europe and Japan kept the company’s overall profits from dipping (see “The Global Competitor”), but developers, the press, and customers were hounding Apple to offer more affordable options. The resultant low-cost Macintoshes were not so much an inspired vision as a reaction to market demand.

 

Apple was clearly unprepared for the success of the new machines.

 

Sales far exceeded the company’s projections. By November 1990, Apple had back orders for $525 million worth of computers. Those accelerated sales for the low-cost machines meant lower profit margins. Net income increased while profits plummeted.

 

Problems that have languished beneath the surface—insufficient manufacturing capacity, high marketing costs, trouble with sales channels, and a lack of key products—have become glaringly obvious. To deal with these new dynamics, Apple is attempting to transform from a vendor of low-volume, high-profit products to one of high-volume, low-profit products. But does Apple have the vision and ability to adapt?

 

 

 

Cost Consciousness

The heart of Apple’s current woes lies with its falling profit margins. Traditionally Apple has fared extraordinarily well against its competition. While IBM PC-clone manufacturers such as Compaq survive with profit margins of little more than 40 percent, and second-tier companies such as Dell run lean on profit margins of 30 percent or less, Apple has enjoyed profit margins as high as 53 percent. “The days of averaging 50 percent gross margins are gone,” says Joseph A. Graziano, Apple’s chief financial officer. Apple publicly states a drop to the low 40 percent range, but the Classic’s 30 percent margin most likely brings the real average down to 35 percent or less.

 

As profit margins drop, Apple must become increasingly cost-conscious—operating costs in the second quarter of 1991 accounted for an overwhelming 37 percent of Apple’s revenues. Besides cutting employees from the payroll, Apple is slashing budgets for travel, conferences, and bonuses. Research and development projects are being curtailed.

 

Lavish product introductions and glitzy promotions must also be scaled back. In 1990 Apple spent a whopping $750 marketing each Macintosh it sold. That’s almost the retail price of the Classic.

 

Apple hopes to reduce marketing costs by introducing products in batches—much as it did with the low-cost trio. But some products scheduled for introduction in late 1991 are already slipping into 1992 and beyond. Product introductions are increasingly plagued with costly missteps, changes, and delays. The long-rumored 68040-based workstation is yet to be seen, and no one at Apple will commit to a ship date for a laptop, even though one has been promised by the end of the year. Plans for a Sony-manufactured CD ROM player have been delayed.

 

The company can’t afford to make marketing mistakes, either. Although the LC was introduced at the same time as the Classic and IIsi, it didn’t ship until three months later, a delay that hurt its sales. Compounding the problem, customers didn’t understand why they should purchase the LC over the IIsi. As a result of these missteps, U.S. sales of the LC are well below Apple’s projections. With a huge inventory of unsold LCs sitting in warehouses, Apple was forced to relaunch the product with a costly advertising campaign.

 

 

 

 

 

Oiling the Supply Chain

Apple must also increase its manufacturing capacity and improve its forecasting abilities. During the first two quarters of fiscal 1991, Classics were on back order. “We were going into a recessionary period with products that were nice but not revolutionary,” says G. Frederick Forsyth, Apple’s general manager for Macintosh hardware and worldwide manufacturing. “We underestimated how well received they would be.”

 

To eliminate the back orders, Apple ran its manufacturing plant in Singapore 24 hours a day, 7 days a week. Plants in Fremont, California, and Cork, Ireland, were already running at capacity. Although Apple had experience with high-volume manufacturing on the Apple II production line in Singapore, the company was taking a huge risk. But the production system held—so well, in fact, that Apple ended up with a surplus of Classics as it headed into its third fiscal quarter, a time when sales are traditionally flat.

 

Still, the risk they had taken threw a scare into Apple. In a record 90 days, Apple’s board of directors approved the purchase of a new U.S. manufacturing site; the company scouted locations; and it signed a contract for a 400,000-square-foot plant in Colorado Springs, Colorado. Once the new plant is running—sometime in early 1992—Apple can manufacture its U.S.bound low-cost products there rather than in its Fremont plant, where operational costs are higher.

 

Why couldn’t the company predict theClassic’s popularity? After all, shortly before the roll-out, Apple had initiated a special European promotion—SEs were offered to the German, Danish, and Spanish education markets for about $1500—and the machines sold like the proverbial hotcakes. Apple desperately needs to refine its understanding of its customer base.

 

 

 

Dealers Beware

Macintoshes have generally been sold through Apple-authorized dealers, but the overhead associated with supporting the dealer channel has become too costly. “Apple was one of the founders of the retail sales concept for personal computers,” says Graziano." We did it because the traditional model of selling mainframe products was too expensive. The irony is that over the years our model has become as expensive as theirs.”

 

In an attempt to make the dealer channel more profitable, Apple has changed its authorization requirements and sales quotas for dealers at least three times in the last few years. The strategies haven’t worked. Instead dealers are confused and frustrated. Recessionary times haven’t helped either. In the last two years the number of Apple dealers in the United States has dropped from 2000 to slightly more than 1500. In 1990 Apple demanded that dealers meet a $350,000 minimum-sales quota. This move cut sales outlets throughout the rural United States.

 

Sculley says that Apple won’t abandon the retail channel. Still, the company is openly looking for new ways to sell the low-cost Macintoshes. Superstores—large warehouse-style stores that cater to knowledgeable computer buyers—are one option. Unlike authorized dealers, superstores operate on low overhead and offer little in the way of customer hand-holding.

 

Apple has been quietly experimenting with selling Macintoshes through two Micro Center superstores—one in Columbus, Ohio, and one in Atlanta—for several months. In early June Apple announced that it had struck a more substantial deal with CompUSA, a superstore chain with 20 outlets in the United States, to sell the low-cost Macintoshes and Apple’s personal printers. More announcements will surely follow—of the 200 retail outlets Apple may add this year, half could be superstores.

 

Superstores, however, could be potential land mines for Apple. In order to successfully sell products through mass merchandisers, Apple must ensure product availability—something it was unable to do with the Classic at first—and it has to ensure product demand—something it could not do with the LC. And Apple risks alienating its dealers, potentially causing much damage in international markets where dealers are traditionally very important. “I’m a fanatic about supporting our resellers,” says Ian Diery, president of Apple Pacific. “I would hate to add in volume merchandisers without planning it with the resellers.”

 

While superstores may help Apple distribute low-cost products, they won’t help Apple raise sales to corporations. Therefore, Apple has reached an agreement with CompuCom that allows the chain to sell not only Apple’s entire product line to corporations, but also installation, training, and support services.

 

Even if the superstores and the unbundling of services are a success, they are not a long-term solution. Both technology and the buying habits of customers are changing rapidly. “The channels are not static,” says Robert L. Puette, president of Apple USA. “Superstores are a 1991-1992 phenomena.” Apple’s challenge is to anticipate the changes and wisely prepare for them.

 

 

 

 

Pushing the Product Envelope

At the same time that Apple is attempting to expand its manufacturing capacity and guarantee distribution for its product lineup, the company plans to accelerate new-product development. The schedule calls for new products every eight months.

 

Apple’s real challenge will be to produce technologically advanced products—on time—and to fill in the gaps in its current product line. Some product decisions will be easy. A faster version of the Classic is slated for this October and should take only a few months to ship.

 

Other product decisions will not be so easy. How will Apple configure its RISC machine, currently slated for 1992? Whose chip should the company use? What type of imaging model should replace the aging QuickDraw? Should Apple invest in non-Mac, consumer items? Apple is working on a pen-based system, but in-house fighting over product design already threatens the timeliness of its introduction.

 

 

And then there’s the laptop question. “The most important product for Apple’s financial health is one we don’t even have out yet—the laptop,” says Graziano. Sales for laptops had already topped $7.5 billion by early 1991. Because they come in one package, require little or no configuration, and need little after-sale support, laptop computers appeal to mass merchandisers.

 

 

 

 

Strategic Alliances

Apple has a reputation as a company determined to remain self-sufficient, but if product development is to follow Apple’s proposed schedule, the company must build alliances. Rumors—which Apple neither confirms nor denies—abound that the company is talking to IBM about using its rival’s RISC chip in a workstation. Other, more long-standing, rumors say that Apple is working with Sony to produce a laptop.

 

Whether Apple can successfully negotiate with either company remains to be seen. IBM and Apple have been heated rivals for too long, and Apple’s business with large Japanese conglomerates has been restricted to the purchase of components. Perhaps hedging its bets, Apple is considering RISC chips from Motorola, Hewlett-Packard, and Acorn, as well as custom silicon solutions. As for the alliance with Sony, Sculley claims that Apple is designing several laptops by itself.

 

On other fronts, Apple has begun aggressively licensing AppleTalk and its Data Access Language to third-party developers, thereby leveraging its research and development efforts. The company has also spearheaded an effort to petition the FCC to reserve a portion of the radio broadcast spectrum for data communication. Apple’s system software group pushed to join a consortium composed of the major computer vendors promoting a universal standard for encoding text. All of these efforts could benefit the entire industry.

 

In spite of such bold moves, Apple still carries vestiges of its traditional snobbery about proprietary technology. A much ballyhooed alliance between DEC and Apple three and a half years ago has yet to yield any real connectivity solutions. Apple’s numerous lawsuits will hinder its efforts to work with other companies.

 

A botched deal with Hewlett-Packard may have cost the company market share in the printer realm. “We formed a partnership to produce a printer,” says John P. Moon, Apple’s vice president of imaging products. “That lasted until we sued them. There went two years of work down the drain.” Apple finally released the StyleWriter early this year, but Hewlett-Packard had already shipped its version of the contested printer, the hot-selling DeskWriter.

 

In another aborted exchange of technology, Apple announced last year that it would work with Microsoft to support TrueImage (a clone of Adobe PostScript, the language Apple uses in its printers). Apple and Adobe’s partnership subsequently split, but when the alliance with Microsoft came to nothing, Apple renewed its partnership with Adobe.

 

 

 

A New Apple

All these pressures—the decreased profits, the manufacturing and distribution problems, the lack of key products, the need to nurture strategic alliances—are taking their toll. Apple’s reorganization broke the company into smaller groups in an attempt to facilitate accountability for expenditures and deadlines.

 

Michael H. Spindler, president and chief operating officer, now controls Apple USA, Apple Europe, Apple Pacific, and worldwide manufacturing. In addition, he heads three new groups—Macintosh Hardware, Macintosh Software, and Enterprise Systems (a group devoted to guaranteeing that Macintoshes can connect to other systems). John Sculley has taken on the role of chief technology officer, heading up the Advanced Technology Group as well as two new groups—Object-Based Systems and Consumer Products. “John trusts Michael to run the operations,” says Apple’s general manager Forsyth. “John can explore other areas and help define Apple’s future. That’s hard to do when you have operational problems to pull you back in.”

 

The new Apple may be short on such visionaries as Steve Jobs and Jean-Louis Gassee, but its managers and pragmatists promise to implement standard business controls that will rein in spending and speed up production. For instance, Spindler now holds monthly business-forecasting and manufacturing-planning meetings—meetings that were never held regularly before.

 

Some people bemoan the structure as a sign of Apple’s creeping stodginess. Others believe Apple can stand a bit more control. John Moon has a favorite analogy. “Apple,” he says, “is like a football team where the players won’t play their positions.” Amusing, and typical of the Apple myth, but does Moon like playing a game in which the rules go unheeded? “Well,” he says, “it gets in the way sometimes.”

 

More than just get in the way, Apple’s nontraditional structure and frequent reorganizations sometimes mean serious financial blunders. Take, for instance, one of Apple’s biggest goofs—the Macintosh Portable. At one crucial point during the Portable’s design, the marketing department was too busy reorganizing to offer feedback. One of the engineers forgot to add a door to access the battery, no one caught the mistake until late in the process, and the Portable was set back nine months.

 

 

 

 

Shaking Down

For the most part the setup under Spindler makes sense. Apple has reduced redundancy in some operations and has moved projects to the areas where they fit best. “The reorg is good because previously the AppleTalk drivers and server software were all part of the networking group,” says Dave Feldman, a software engineer on the System 7 team. “Now the server software is part of the system group where it belongs.”

 

But the Enterprise Systems group, which is important for Apple’s success in large businesses, still lacks a leader and a clear plan for products. Apple’s communications products have a reputation for being weak, not working properly, and being consistently late to market. Many people fault Gursharan Sidhu, the head of the networking and communications group, which was disbanded and folded into the Enterprise Systems group during the recent reorganization. “The people who work for Sidhu think he’s incredibly good, incredibly bright. They think he’s right for the job,” says Hazel Holby, a former employee who worked at Apple for nine years. “But it’s hard to get products out through him. It’s the not-invented-here syndrome.”

 

Many of the engineering groups are also in disarray. Working teams have been split up, managers are scrambling to line up the best people for new teams, and some jobs are in jeopardy. With Apple’s heavy product introduction plans for late 1991, engineering can’t afford to lose much working time to this sort of turmoil.

 

Sculley’s groups are faring worse. Even the Advanced Technology Group (ATG) is succumbing to cuts, downsizing, and changing goals—normally Apple’s research and development groups are spared hardships. The Consumer Group is only vaguely defined—Apple originally thought it would introduce the first of its consumer products in late 1991 or early 1992. But the low-cost Macintoshes proved that Apple is not ready to become a consumer company with profit margins of only 5 to 8 percent and readily available products that are attractive to mass merchandisers. In addition, consumer products must be introduced at a much faster pace than Apple is accustomed to. “Sony introduces five products a day,” says Sculley. “If we do five a quarter, we are having an outstanding quarter.”

 

Sculley also controls two spin-off companies. General Magic and Claris Corporation. General Magic is led by two of the most innovative members of the original Macintosh team, Andy Hertzfeld and Bill Atkinson. The duo is rumored to be working on either a pen-based computer or a programmable software interface for consumer products. Apple funded the group, and Sculley sits on its board of directors, but the company is quite separate from the rest of Apple. “We want to isolate entrepreneurs,” says Forsyth. “We don’t expect revenue from them, but ideas. The other part of the organization has to deliver predictably, boringly good products.”

 

Claris, with its successful application products, is a more curious case. Originally, Apple planned to spin off the company to appease developers who felt threatened by the competition. Apple changed its mind, apparently after only a couple of days of deliberation. Most people speculated that the reintegration of Claris was a knee-jerk reaction to the fear that Microsoft Windows’ popularity would lure application developers away from Apple, with Claris leading the way.

 

The toll that rapid decision is taking is only now becoming apparent. Seven of the nine executives who originally formed Claris have either left or are planning to leave the company. According to one insider, Claris’s president and former head of Apple’s venture capital group, Dan Eilers, is standing up to Sculley in an effort to run Claris as he sees fit. Along with the infighting, plans are under way to cut paint, forms, and CAD products from Claris’s line, and product development has ground to a halt. Claris is at a complete standstill.

 

 

 

Can Apple Adapt?

Apple is no stranger to market fluctuations, rapid growth, and leadership turnover. The layoffs, restructuring, and cost-cutting efforts may well help Apple to cope with its current crises.

 

This time, however, Apple may be trying to do too many things at once. The company touts its self-sufficient creativity, but it lags behind in major markets such as laptops, workstations, and now pen-based computers. Is the company stretching itself too far? Like IBM, Apple competes in hardware and networking solutions; like Microsoft, Apple competes in system software and applications; and like Sun, Apple competes in development tools and UNIX systems.

 

To grapple with this multiple personality, Apple is still reorganizing to clarify divisions and make internal communication and planning more effective. Yet much of the reorganization is not clearly thought out, engineering is in disarray, and Apple’s ability to resolve its many problems is being hampered. Sculley seems to realize that Apple needs a more practical organization and a focused plan, but just how clear Apple’s future is to him no one seems to know.

 

Clearly, Apple has a tough few years ahead. If the company can throw away old perceptions, catch up on the technology, and fix its organizational problems, it can buy the time it needs to come up with a clear plan for the next decade. If not, Apple may well become a bit player in tomorrow’s technology market.

 

Sidebar 1 of 2: The 16.7 Million Dollar Man. Is He Worth it?

On the sixth floor of De Anza 7—a modern tinted-glass building in Cupertino—sits a typical Silicon Valley high-tech office. It's small and has no windows that open to the outside. The decor is clean and modern: shelves and desktops are a chic black; oversize red-plastic paper clips and bright-pink folders add hints of color. A round, wooden table with red leather chairs dominates the middle of the room. Several Macintoshes, including one custom-painted to look as though it were made of marble, take up most of the desk space. In the background are aquarium sounds, which turn out to be the electronic gurgling of fish moving across a computer screen.

 

Welcome to the world of John Sculley, the man who's been at the helm of Apple as it has grown from $982.8 million to $5.6 billion in revenues. He's done well and deserves to be rewarded. But many people are questioning the size of the reward, especially in light of Apple's recent raft of financial problems and layoffs. One of the highest-paid CEOs in America, Sculley reportedly made $16.7 million last year in salary, stocks, and bonuses.

 

A soft-spoken man with a casual, easy manner, Sculley doesn't come across as a dynamic leader. Analysts and the press are unimpressed with him; employees criticize his salary and his growing inaccessibility. But some who work closely with Sculley have a higher regard for him. Albert A. Eisenstat, an executive vice president and Apple's secretary, who is often credited with serving as Apple's stabilizing force over the years, claims that Sculley has brought a more orderly marketing perspective to Apple, as well as a genuine love for technology. Others such as Bill Campbell, former head of Claris and current president of Go Corporation, became cynical about Sculley's leadership over the years, complaining about his penchant for second-guessing his staff's decisions and changing his mind on decisions agreed upon long before.

 

Still, many people credit Sculley for forcing the hard, quick decisions that brought the low-cost Macintoshes out of the prototype stage and into the market. "John should be given a lot of credit for things that work," says David C. Nagel, vice president of the Advanced Technology Group. "He actually does do more than he is credited for on the outside when it comes to making things work technically."

 

But Sculley frequently seems to lose his grasp of reality. He speaks of Apple's plans to introduce products in all major market areas by the year's end; yet by midyear he was still creating breaks in the company's current organization and groping to define goals for Claris. At a time when Apple needs to work closely with third-party developers to create new products, Sculley has aggravated a generally touchy situation. The low-cost Macintoshes have not helped developers sell products, and Apple continues to compete with developers by selling more of its own peripherals and software.

 

When speaking in public now, such as at the developer conference in May, Sculley's speech is halting and nervous—he seems uncertain. There's little he can do to stem the current hostility—even though he cut his salary by 15 percent, most people deem the move too little too late. Only by pulling Apple out of its current dilemma and coming up with a workable plan for the next few years can Sculley redeem himself. And with the state Apple is in, that's a job worth $16.7 million.

 

 

Sidebar 2 of 2: The Global Competitor

While Apple's U.S. market share has had its ups and downs over the last few years, the company's international sales have been growing at an astounding pace. During the second fiscal quarter of 1991, over 50 percent of Apple's revenues came from international sales. The European market alone accounted for 31 percent of Apple's revenues during that period. Other countries such as Japan are just now beginning to take off—1990 revenues were $240 million, and Apple expects fiscal 1991 revenues to skyrocket to $350 or $400 million.

 

Certainly much of the explosive growth can be attributed to Apple's introduction of the low-cost Macintoshes. Customers in some countries, such as those in Europe and Asia, are buying the low-cost Macintoshes for the same reason customers in the United States are—they recognize a bargain. In financially troubled countries such as Australia and Canada (where a recession has forced resellers out of business and the personal computer market is shrinking), low-cost products have helped Apple maintain impressive market shares of 18 percent and 17 percent, respectively. And in countries such as those in Latin America and the Far East, where homespun, sub-$2000 personal computers reign, Apple is finally beginning to compete. Currently 65 percent of the units Apple ships to Latin America and the Far East are low-cost Macintoshes.

 

The rate of international growth shows that Apple is making a conscious effort to understand and operate as an insider in international markets, rather than simply viewing those markets as supplemental income. One indication of this outlook is Apple's success in a difficult market such as Japan. After four false starts, Apple has finally earned a reputation as a serious business in Japan. Apple became the first NASDAQ company to be listed on tho Tokyo Stock Exchange, developed KanjiTalk, and hired Japanese nationals for top positions at Apple Japan. Apple's market share in Japan is now 5 percent and growing.

 

Apple is working to earn respect in many other countries as well. A few years ago Apple localized its system for only a few select languages; today the company supports 38 different languages. The company designs new products with international requirements in mind—for instance, designing monitors that work correctly in the magnetically different Southern Hemisphere, producing peripherals in countries that have import/export quotas, and localizing keyboards. Product roll-outs, such as the one for the low-cost Macintoshes, are also made simultaneously worldwide—international markets no longer play second string to the United States. "Apple introduced the new Macs in 15 countries in Europe at the same time as they did in the U.S.," says Soren Olsson, president of Apple Europe. "And they shipped the products at the same time. They didn't wait to localize products for the international markets later."

 

As Apple becomes a more sophisticated player across the globe, it is starting to take world dynamics into account. For instance, Apple initially priced products differently in various European countries because each country had a different cost of doing business. This system, however, created a gray market and left an opening for multinational companies to purchase products wherever they were least expensive. Both to forestall these practices and to prepare for 1992, when Europe may adopt a single currency and ameliorate trade barriers, Apple began implementing a consistent pricing structure across Europe two years ago.

 

Admittedly, lower profit margins have forced many international subsidiaries to cut costs, and political unrest prevents Apple from opening branches in some areas such as South Africa. The Soviet Union's slowness to convert to a market economy also prevents Apple from having any near-term success there. Yet Poland, Hungary, and Czechoslovakia look promising—Apple is setting up resellers in those countries.

 

Government restrictions sometimes hinder Apple's ability to exploit potentially hot markets such as those in Brazil and India. Still, Apple keeps working to open the markets—the company actively lobbies the Brazilian government to open trade, and it has won India's approval to sell dedicated desktop publishing systems. Apple's recent entry Into Mexico shows how important easing of restrictions can be. When the Mexican government instituted a free-trade agreement with the U.S. a year ago Apple entered the market, easily garnering a 4 to 5 percent market share.

 

Apple may have problems, but right now international growth isn't one of them.