by Matt Deatherage
Once again, Apple Computer has looked competition squarely in the face and, to borrow an American football metaphor, punted on third and long.
The Power of Apple's Eye -- Apple last Monday announced its acquisition of leading Mac OS clone manufacturer Power Computing's "core assets," including the customer database, key personnel, and Power Computing's Mac OS license. In return, the private investors who bankrolled Power Computing get $100 million in Apple common stock. That's more than half of what Power Computing valued itself at - in late June, the company announced now-withdrawn IPO plans to sell three million shares of stock at $8 to $10 per share, out of an authorized 17,720,000 shares, giving an initial total market value of between $142 million and $177 million.
Power's investors may think that the $100 million in Apple stock is a good deal, considering how difficult Apple was making their future business plans. Apple's Mac OS licensing has all but ground to a halt under the xenophobic administration of Steve Jobs - and more seriously, the company has also stopped all licensing that would let clone makers design their own motherboards. Monday's announcement is the latest sign that Apple is reliving the past, choosing any route feasible to avoid the most fundamental task of a public corporation: competition.
Chip Wars -- Power Computing, although suffering some initial quality and timeliness problems, has been kicking Apple's six-colored posterior in both performance and public opinion. Using blazingly fast state-of-the-art PowerPC chips that aren't available in the quantities Apple needs for global manufacturing, Power Computing has built a reputation for making the fastest computers on the planet, offering 225 MHz and 250 MHz models that beat Pentium Pro speeds earlier this year. The company's latest offerings include systems based on the new "third-generation" PowerPC 750 processor from Motorola, and preliminary results show that these systems, which start at 275 MHz, may be twice as fast as the older 250 MHz machines thanks to the incredible performance gains in the PowerPC family over the past two years, including the new chip's advanced cache architecture.
Apple, on the other hand, has no systems ready to go using these new chips, often still referred to by the code-name Arthur. Instead, Apple's latest systems are based on the Mach 5 PowerPC processor, the latest incarnation of the PowerPC 604e, with speeds up to 350 MHz. The Mach 5 chips are fast - faster on a per-megahertz basis in systems than the 604e chips they replace thanks to better caches - but they're not as fast as Arthur processors, and they're more expensive. That leaves Apple's fastest systems, historically those with the fattest profit margins, in extreme danger of irrelevance at the hands of Apple's own licensees.
Licensing Theory and Reality -- Theoretically, Apple shouldn't care, because licensing should be a profitable business that grows the Mac OS market and makes the platform healthier. In reality, Apple's licensing agreements, spanning the terms of the last two CEOs (Michael Spindler and Gil Amelio), give Apple fees based only on Apple's cost to produce and support the Mac OS, not based on the value it has to the clone makers. Apple was apparently trying to match the relatively low per-computer charges that Microsoft charges for Windows, but in the process Apple virtually guaranteed that only by expanding the Mac OS market could licensing be profitable. If a clone manufacturer went after existing Apple customers, instead of into the areas Apple couldn't reach but felt other companies might, then the lost hardware profits would more than offset the licensing revenue.
To Apple's ongoing annoyance, this is in large part what Power Computing was doing. In an effort to build a reputation, Power Computing focused its marketing efforts on existing Apple and Macintosh customers. Once Apple had done the relatively difficult job of selling customers on the Mac OS instead of Windows, Power Computing went for the jugular and convinced these folks to buy the Mac OS systems from them instead of Apple - especially the high-end systems, using those speedy chips Apple couldn't get in sufficient quantities. Four months ago, Apple was selling 180 MHz machines with 512K Level 2 caches for more than Power Computing was selling 210 MHz machines with 1 MB of Level 2 cache.
With Apple losing money faster than ice melts in an Austin summer, the company had to take remedial steps. Apple's average unit price hovers around $2,000, and the company enjoys a relatively steady 20 percent profit margin, so each sale lost to licensing cost around $400 in normal revenue (complete with all the risks, like building a bunch of machines and hoping someone buys them) and brought in around $50 of risk-free revenue (and perhaps three times that much in hardware royalties for motherboard licensing fees). It would seem obvious that licensing would never be as profitable as Apple's own hardware sales, so the logical course of action for Apple would be to produce highly competitive machines that forced clone manufacturers scramble to keep up, while boosting licensing fees enough to at least accommodate cannibalized sales.
What About Competition? That, of course, is the logical way, not the Apple way. For a while, the two coincided under the reign of recently deposed CEO Gil Amelio. In a recent interview with MacAddict magazine, Amelio explained one reason he expressed support for Mac OS licensing was that Apple had to learn to compete. "Apple does not know how to compete. It knows how to innovate, but it doesn't know how to compete, and they're different. ... [Apple's] things are great, but in the final analysis, if you can't compete, you can't make it attractive in the marketplace, and if you can't have people lusting after buying it, it doesn't matter." Amelio intended that the company would learn, by fire if necessary, how business actually works.
Time and again, Apple's products have been challenged by similar entries from competitors, and time and again Apple has either lost the battle or refused to show up for the fight. When Microsoft's Windows brought many of the graphical Macintosh advantages to the DOS-based market for the first time, Apple focused less on improving than they did on avoiding competition by suing Microsoft, an ultimately unsuccessful strategy. When Windows 95 blurred the lines further, Apple responded with smug "Been there, done that" ads that did little to encourage any new computer purchaser to buck the Windows trend. Apple's latest effort, Mac OS 8, includes "innovations" like pop-up windows, but those same windows were awarded patent protection for Apple four years before. A company that knows how to compete, as Amelio puts it, would not have waited so long to reap the benefits of innovation.
It's easy to see why Amelio was asked in July to resign as Apple's CEO and Chairman. The man makes far too much sense to survive in Apple management. In a late Monday press conference discussing the Power Computing asset purchase, Apple CFO and stand-in leader, Fred Anderson, made it clear that licensing is over as far as Apple is concerned. The company will honor existing agreements for Mac OS 7.6 (and clone manufacturers PowerTools and Umax have renegotiated licenses so they can distribute Mac OS 8) and existing motherboard designs that Apple has chosen to license. Apple has no intention of authorizing system manufacturers to use the CHRP specification to, for the first time, design their own motherboards instead of using Apple's designs. Apple doesn't even intend to release a version of the Mac OS capable of running on CHRP machines. The company insists that licensing was unprofitable, which is clearly the case, but rather than face the competitive market head on, they're ending the game so they can declare themselves the winners.
Apple sees it differently. Executive vice-president of marketing Guerrino de Luca told the press conference that licensees were not expanding the Mac OS market and were not paying fees high enough to cover Apple's entire cost of producing and marketing the Mac OS, including R&D, developer support and platform marketing. However, de Luca bristled at the suggestion that Apple is once again backing away from competition. "If you look at the economic consideration, every time a licensee shipped a clone, we were subsidizing that clone with several hundred dollars. We want to, and we will, compete fiercely in the marketplace (and in the PC marketplace as well), but we're not planning to subsidize anybody in this competitive space. Actually, it is because we want to be able to compete that we're taking this position."
The idea that Apple is subsidizing clone makers by charging low fees comes from looking in the mirror through rose-colored glasses. Apple is only subsidizing Mac OS licensees in that clone sales earn less for the company than Apple hardware sales, but there is no guarantee that the inability to purchase a Mac OS clone will return a customer to Apple: there are reasons why those customers left in the first place. Arrogantly, Apple is implying that Power Computing's direct marketing and build-to-order sales system that are mainly responsible for defections from the mother ship; Apple discounts the idea that the well-received Power Computing machines had anything to do with it, and confirms as much when they say they have no plans to bring any in-progress Power Computing products to market.
Anderson says that Power Computing's database of 200,000 Mac OS customers is a key asset in the purchase, and Apple expects to get a fair number of those purchasers back as customers. Yet Anderson also said that licensing was not expanding the Mac OS market, and that "99 percent" of clone purchasers were former Apple customers. If that's the case, Apple already has their names, but hasn't been building products strong enough to attract their sales dollars; purchasing updated name and address listings isn't likely to change this situation.
The Source of the Problem -- The real motive behind all this is far more suspect, and far less encouraging for Apple aficionados and Macintosh users. Henry Norr of MacWEEK magazine pointed out statements, on the record, that Apple had in June reached financial agreements on Mac OS 8 and CHRP licensing fees with Power Computing and other major clone makers, to be finalized by 28-Sep-97. These are the same agreements that Anderson and de Luca said Monday could not be achieved while still providing "shareholder value" to Apple. Norr asked what changed between June and July to make these term sheet agreements unprofitable, and Anderson confirmed most rumors on the subject: it was a "change in leadership."
Read that as "Steve Jobs." The Apple co-founder is now a "special advisor" to the board of directors, where he also has a seat, and is spending up to half his time setting directions and strategies for Apple, even though he turned down the job of Chairman and CEO. Jobs has reason to avoid the captain's chair - with his current arrangement, he's effectively running the show without a title and can exercise power without any responsibility... or any blame in case his vintage-1982 strategies turn sour. Jobs was always against licensing the Mac OS and was opposed even to having expansion slots in the machines.
Jobs's product vision is a matter of fact - he foresaw the entire personal computer business; he foresaw the utility of a graphical interface; and he today foresees a day when ubiquitous high-speed Internet connections mean you don't have to take information with you to access it. It's his business savvy that's a matter of fiction. Microsoft could have dominated entire continents with an operating system as advanced as Jobs's NeXTstep and OpenStep (on which Rhapsody will be based), but Jobs couldn't get more than a small but loyal following for the system in ten years, even after abandoning an expensive hardware business and making OpenStep run on standard Intel-based computers. He has twice sold large blocks of Apple stock at low prices; just last month, Jobs confirmed for Time Magazine that he sold 1.5 million shares he acquired as part of Apple's purchase of NeXT at record low prices. He has changed personnel policies at Apple (at the cost of losing the company's head of human resources) and lectures the employees about being more "entrepreneurial" when he, as the putative head of the company, has no personal investment in it whatsoever. An employee who wrote a biting satire of Jobs's sanctimonious preaching is lucky he or she did so anonymously, because Jobs told the entire rank and file the culprit will be fired if discovered.
Now Jobs is again leading Apple's retreat from the battles it must win to return as a major force in personal computing. Jobs's field of dreams still whispers in his ear: "If you build it, they will come." Never mind that Apple is building some of the best computers on the planet, and the customers are not coming. Instead of building better, or competing better, Apple hopes to keep others from building. Never mind that Apple's systems wouldn't be as strong today as they are if competition, specifically from Power Computing, hadn't raised the standards.
Past comments from Jobs include remarks about how Apple should "milk" the Mac OS until it's dry and then move on to the next big thing, perhaps board member Larry Ellison's beloved network computers based on the reabsorbed Newton technology. If this is what Jobs is doing, while telling the public exactly the opposite (not exactly a new move for him, as Apple II owners can attest), he may think that the Mac OS has less than two years of useful life left because the single-source strategy he's now adopted for Apple won't win new converts for the platform. Frittering away what could be a viable platform in favor of using your customer's money for something potentially unrelated doesn't build customer confidence.
Apple fans can continue to hope that Jobs will one day understand that bizarre repetition of failed strategies is less often recognized as a sign of genius than as evidence of dementia. Until then, the company is again pulling defeat from the jaws of victory in its struggle to become profitable, alienating the most intense Mac OS supporters. Now that customers have seen the benefits of free-market Mac OS competition, they're unlikely to accept Apple's word that the company's products are the best that could exist.
Apple, which still aspires to be a champion, still hasn't learned that winning the title belt requires staying in the ring, not fleeing when you're behind at the end of the fourth round, or the eighth, or the fourteenth. The real question is if Apple will figure it out before receiving a knockout punch or running out of time.
[Matt Deatherage publishes the Macintosh newsletter MDJ, which is currently on hiatus.]