HEAD-TO-HEAD
Mac Death Match, Round Four: Chaffin vs. Enderle

Today in Round Four, Chaffin and Enderle comes to blows over the topic. This time, the gloves are off.

ENDERLE THROWS CHAFFIN AGAINST THE ROPES

Ah, I see. I actually answered the question, and Mr. Chaffin took what was likely the better path and basically restated it to point out that Apple (Nasdaq: AAPL) is a platform company more similar to IBM (NYSE: IBM) (on servers and mainframes) and Sun than Microsoft (Nasdaq: MSFT) and Intel (Nasdaq: INTC) . Or, in other words, it is tied to a rapidly-declining model that was created in the 1950s and not tied either to the model created in the 1980s (Microsoft) or the emerging model that IBM and Microsoft are now chasing, which is more services-based.

I think Apple, particularly if you look at its iTunes/iPod-driven financials, could actually be driving more rapidly into the Web services model than either Microsoft or IBM. While this certainly showcases that the company is leaving its hardware, and maybe most of its software, behind, it also suggests that, having missed the interim change, it may be better able to move to the now-current model and resurge -- albeit as a different company.

Software Subsidizes Hardware

I disagree that Apple uses hardware to subsidize software. The company cycles its software much more rapidly than Microsoft and, by my recent estimates, actually generates more annual software revenue from each of its active customers than Microsoft does its corporate users. In fact, it's somewhere between two times and three times as much. Granted, Microsoft has more volume, but Apple makes more per user. That goes a long way toward keeping it profitable while other similarly sized PC companies are not.

By creating these subsidies, Apple can continue to price against at least the midrange products, even though it still cannot price against the low end. The PC makers have massive cost advantages due to channel efficiencies and economies of scale; if Apple didn't do this they wouldn't be competitive.

In other words, it looks to me like software and services are carrying hardware, not the other way around.

What Would You Choose?

And, if people are buying the hardware to get the software, wouldn't it make more sense (given the margins) to dump the hardware and just compete with the software and services? What Apple is currently doing resembles the old IBM model: Use software to get folks to buy the hardware, and it works as long as people don't have a choice.

But if I have to choose between buying iLife for US$50 or buying iLife for $50 and then a $1,000 PC on which to run it, I would take the $50 option even if the software were inferior. I think most would agree with me on this. As soon as choice showed its ugly head in the 1980s, IBM bled revenue like water and almost went under.

Achieving Financial Success

If you were an investor, wouldn't you rather have an Adobe (Nasdaq: ADBE) , which is rated by StockScouter as a 10 at $43.24 and showing steady growth, over an Apple that is rated as a 5 at $26.28 and flat? I'm sure you know they rate Microsoft a 7, Dell an 8, and IBM a 6, putting Apple dead last. If I were Jobs, I'd want to be a 10, not dead last on this list, and it looks to me that, by losing the hardware, he would have a good chance of getting there.

Note that Sun is using a similar model to the one Chaffin has highlighted, and that company is a 4, indicating that technology investors and buyers are rejecting this hardware-software systems approach.

CEO's are measured, not by the number of toys they make, but by the overall financial success of the company. Right now Apple isn't competitive with the market leaders in hardware or software. Dropping hardware could fix that and at least give Jobs a shot at leading one of these segments.

Jobs also recently was placed on a list of overcompensated CEOs. That typically does not speak well of a top executive's competence. I would think he would want to fix that perception as well.

Apple's software, accessories and services are carrying Apple's hardware. It looks to me that it is time for Apple to move into the current decade -- and it looks to me like it is doing just that. My only question: Why is it taking so long?

CHAFFIN BEATS BACK ENDERLE

Apple has indeed diversified its product strategy. The company is selling more software and has introduced profitable services to its mix as well. However, there is no evidence that Apple is "exiting the traditional PC hardware business."

None.

In fact, it's one of the most unsubstantiated things I have yet heard Mr. Enderle say.

As I have said about Apple's overall direction, the company does indeed have a major gap in its Mac marketing (in that it isn't properly marketing the Mac), but Mac sales still form the vast majority of its revenue.

Look at the Numbers

Indeed, if you took away Mac sales from the company's latest quarter, and instead looked at only its software, services, iTunes Music Store (iTMS), and iPod business, you would have a company doing about $500 million in sales per quarter -- and that's with a big chunk of those software sales being for Mac-only software. To point out the obvious, no Macs equals no Mac software sales.

$1.9 billion (Apple's Q2 2004 revenue) minus $500 million is $1.4 billion. Last year Apple turned in sales for the March quarter at $1.475 billion, a figure that also included iPod sales, software sales, and other services.

So this means that Apple is growing its business with these outside services, not supplanting its traditional PC business. This isn't to say that Apple's loss of market share isn't something that needs to be addressed -- because it is.

Grasp Different

In point of fact, however, while Apple's unit sales (and revenue sales) grew at a slower pace than the rest of the PC industry, those sales still grew. How then, can one say rationally that Apple is exiting its traditional PC hardware business?

Enderle is either stunningly wrong, or is attempting to appear prophetic, but no evidence exists today that supports his argument.

Instead, I will say again that Enderle, like many others, simply cannot grasp that Apple is both a software and a hardware company. Apple cannot offer its user experience, its software -- the whole "Mac thing" -- without controlling the whole widget. An Apple that made Windows machines would be just another PC clone that couldn't afford to innovate the way it does. That means no iTMS, no iPod, no GarageBand or iLife, and so forth. These are very fundamental issues that cut to the heart of what Apple does.

Serving the Facts

To further back up his argument that Apple is exiting the hardware market, Enderle says that Apple showed "virtually no new hardware" at last January's Macworld. That's true -- unless, of course, you count the Xserve. Apple introduced the Xserve G5 and updated the Xserve RAID at that particular Macworld, both major developments in the company's Mac OS X server strategy.

Enderle then references Dell's heretofore ill-fated attempts to enter the storage market. Of course, he seems to ignore the fact that Apple isn't directly targeting the sorts of traditional enterprise storage markets that Dell was targeting, making his observations irrelevant.

In addition to higher education, Apple's target market with the Xserve and Xserve RAID is the creative market, specifically the burgeoning digital film market. That's a market in which Apple is already a major player. Perhaps it is because of these markets that Apple is seeing increased sales in its server and server-storage product lines every quarter.

Enderle also suggests that Adobe is kicking Apple's butt -- without offering any evidence to that effect. The reality is that Final Cut Pro has been taking the digital-film world by storm, and Apple's other high-end digital-film products are already major players. This is the only market where Apple and Adobe directly compete, and so far it is Adobe that has retreated, not Apple. This is more unsubstantiated "fear, uncertainty and doubt" from analyst Enderle.

All in all, several things are obvious: Apple's Macintosh marketing is sorely lacking; its hardware business is growing, but at a slower rate than the industry; and the company has added new products and services alongside its core hardware business, with most of those products and services being Mac-based. To me, these facts demonstrate Apple is both a hardware and a software company -- and that it's not perfect.

Check back May 13th for Round Five.