APPLE COMPUTERS, INC.

Fine-Tuning Strategy - Re-Aligning Resources – Maximizing Shareholder Value

"Final Professional Challenge Paper"

Geoff Miller 19 September, 2005
MBA9140- Professor Blagg
Part 1- The Ultimate Purpose of this Report
After considering many aspects of Apple's business in previous segments of this report,
we now come to the central question:

How should Apple apply its financial and other resources today
in order to maximize shareholder value in the future?
The bond refunding section of this report provided a glimpse of our final
recommendations.
1. The brand image and foundation of Apple's strength comes from its ability to
provide innovative, intuitive, useful products to a very loyal customer base.

2. The lifecycle of the computer hardware industry has reached a level of

maturity in which its products are becoming price-driven commodities. This
situation is diametrically opposed to Apple's strengths. Therefore, resources
should be directed toward the development of new, industry leading products and
applications rather than a narrow, hardware-focused approach that competes on
price. Apple's hugely successful iPod and iTunes projects were cited as examples
of this philosophy already in action.

3. The heart of Apple's Research and Development efforts should be focused on

funding an "Imagineering" based "Skunk Works" type of experimental laboratory.
All other departments should realign themselves to support these new product
development efforts.

This final portion of our report will provide more in-depth justification for those actions
and will specify how resources should be allocated.

Part 2- Forces at Work in Our Marketplace Today

While Apple began primarily as a computer hardware maker, software and other
applications have become an increasingly important part of its product offerings. For that
reason, we will consider the current state of both the hardware and software industries
within the technology sector.

Hardware:
The price of personal computers has fallen dramatically over the past decade while their
capabilities and performance continue to improve. Dell Computers has made the most of
their working capital: developing an extremely efficient supply chain and using "Just-In-
Time" delivery methods to become a leader in providing high quality computers at
exceptionally low prices. (Brigham, E.F., & Ehrhardt, M.C., 2005, pg.742) Apple's
focus has never been on a super-efficient supply chain or leading on price. It has been on
enhancing the computer user's experience with innovative, high-quality, easy-to-use
products.

"Apple's business strategy leverages its unique ability, through the design and
development of its own operating system, hardware and many software applications and
technologies, to bring to its customers around the world meaningful new products and
solutions with superior ease-of-use, seamless integration and innovative industrial
design. The Company believes continual investment in research and development is
critical to facilitate innovation of new and improved products and technologies."
(Apple Computer, Inc. 2004 10K SEC filing, 2005)

The outcomes of these two very different strategies can be illustrated by comparing two
identically-priced Dell and Apple models. Both the Dell Dimension 3000 and the
MacMini sell for $499. The MacMini is almost totally stripped-down. Only the Dell
includes a monitor, keyboard and mouse.
APPLE "MAC-MINI" DELL DIMENSION 3000

"It is ludicrous to expect that someone buying a Mac is going to want to plug in a pizza-
stained three-year-old keyboard and a mouse chock full of desk scum."
(Jayson, S., 2005)

Apple would be ill-advised to focus on price competition because:

1. It would require major changes in supply chain and manufacturing processes.
2. Low price is not the foundation of Apple's customer loyalty. The company would
likely lose existing customers in order to attract competitor's customers.
3. It is not in line with stated corporate goals.

Software:
For many years, Microsoft Corporation has been the 500 pound gorilla of software
applications. One reason for this has been their history of sharing their operating system
codes with third party software developers. Apple kept their code proprietary. In the
early years of personal computing, this lead to a plethora of PC compatible software
applications compared with those for Apple. That imbalance is no longer so prominent,
yet the myth persists that buying an Apple means having limited software choices.
(www.apple.com/myth)

To Apple's benefit, Microsoft's open code policy has also left their operating systems
vulnerable to attacks by viruses and spy ware, problems that Apple users do not
encounter.
Today, Microsoft's emphasis on code-sharing has turned to the use of Extensible Markup
Language (XML), a sort of cross-platform "common tongue" that they believe will usher
in the web services era. The web services concept is that software based on XML will be
accessible to anyone, using any computer system and will be based on the internet rather
than loaded onto individual machines. Rather than pay for software, users will pay for
access to applications. Microsoft chairman, Bill Gates believes that the web services
model will morph the software industry into a utility-like business, similar to gas, water
and electric services. (VS launch webcast, Fawcett Publications, 2005.) These
developments may seem like formidable competitive challenges, but things do not look
so grim when we turn our attention to…

Part 3- Harnessing Apple's strengths to take advantage of opportunities.

"Play to your strengths" may be a cliché, but that is exactly what we are recommending.
While competitors ask themselves, "What can the computer do?" touting their
machine's megabytes of RAM and hard drive capacities or looking for answers in re-
written software code, Apple should ask a different question:

"What can PEOPLE do?"

With a long history of intuitive, useful products, Apple has developed a loyal following
and reputation for creating practical, user-friendly products. That is why we are
recommending a renewed focus on Research and Development based on the needs and
desires of computer users, revealed by through market research. Here is how that
approach can help Apple to overcome the competitive challenges it faces:

Countering Threat #1: Low cost hardware.

We recommend a judo-like approach in which the firm just lets low-cost competitors
continue to do what they are doing, responding instead with smart, inspired counter-
attacks based on new products that people love, (and that also happen to maintain Apple's
traditionally-high profit margins.) How confident are we that such an approach could
work? It already has. Q3 2005 profits are the highest in the company's history, thanks in
large part to Apple's music-based products and services. (www.apple.com/investors)
Consider this: A $499 Dell with Windows Media Player will play tunes AND perform
scores of other computing tasks, yet Apple sold millions of $200+ iPods that could not
run a spreadsheet or a paint program to save their little lives. Conclusion: A product's
ability to fulfill buyer's needs is often more important than the product's price.

Something else to consider is that sales do not automatically equal profits. This is
especially true for a business like Dell, that competes on low margins. If profitability is
reflected in the price of a company's stock, it seems that Apple's strategy is already
proving itself successful compared to this low-cost competitor:
 APPLE COMPUTERS, INC. DELL, INC.

(Charts generated by MSN Money. http://moneycentral.msn.com/investor/charts )

Countering Threat #2: The dominance of Microsoft

Apple's approach to gaining market share vis-à-vis Microsoft should contain both a
general strategy and a specific tactic. We recommend an overall strategy based on this
question: "Who cares what they do?" If Apple pursues a customer-focused approach to
developing new products that prove to be popular and profitable, the actions of any
competitor will only be relevant to the extent that they attempt to copy Apple products.

"The iPod is revolutionizing the music download, listening and broadcasting

habits of millions of Americans. Everyone from Disney to Newsweek to NPR is
now offering podcasts and Apple Computer recently made it a whole lot easier to
find and download them." (Associated Press, 2005)

While Microsoft focuses on re-writing software code, Apple is already finding success in
a wide range of products and services that go far beyond traditional computing. Here is a
small sample:
PRODUCT DESCRIPTION
iPod Extremely successful. Not a computer.
iTunes World's leading online music download
store. Also not a computer.
Motorola's ROKR phone from Cingular Alliance with Cingular allows wireless
can download and play music from iTunes. access to Apple music products. Wireless
is now a distribution channel for music
sales.
Final Cut Pro film /video editing software Apple takes the lead in yet another line of
business—media post-production.
"Apple's Final Cut Pro has been the
industry standard for professional
filmmakers for years." (Plumer, C. 2005)

That being said, we will now totally contradict ourselves by recommending one specific
tactic. Apple is and has been missing an opportunity to exploit Microsoft's weaknesses.
Beginning immediately, Apple's should aggressively promote the superiority of their
desktop and laptop computers over those running Microsoft operating systems, especially
in the professional market. They are faster, more stable, extremely powerful and
functional. The "lack of software" myth is exactly that. Switching to Macs will
eliminate costly losses caused by viruses and other malicious software.

Part 4- Fine-tuning Apple's structure and resources to meet these challenges.

To summarize, we are recommending a strategy that contains three elements:

-(market research)-
What is the most effective strategy for creating innovative products that people are eager
to use? The Microsoft approach would be to turn inward to find ways to improve their
software codes. For Dell, it might mean finding a lower-cost way of adding more
memory and hard-drive capacity to their machines. Apple should take a more
enlightened approach. The best way for us to create innovative products that people love
to use, is to ASK THEM… ask them what they like and don't like about existing
products… ask them to dream and describe their ideas of "perfect" products.

-(product research & development)-

Given a clear idea of what people really want, Apple can then combine its engineering
and operations skills in a "Skunk Works" Research & Development environment. This is
not a re-invention of Apple's wheel. It is merely placing a clear, company-wide emphasis
on using input from customers to guide the development of new, profitable products in a
free-wheeling, creative environment in which there is no box for anyone to think outside
of.

-(follow through with efficient Marketing, Manufacturing and Distribution)-

When new product lines are ready, Marketing can then test and mass-market them while
Operations manufactures and distributes them. More details on these aspects appear
below.

Part 5- The Financial Strategy that is the foundation of this plan.

Before making a commitment to such a plan, several questions must be addressed:

1. R&D can be an expensive gamble, especially if done in the free-wheeling manner

described. Is the investment worth it? Is now the best time?
Yes and yes. Again, we can point to the success of the iPod as evidence that product
innovation is key to Apple's future profitability. Speaking of which, recent profits have
been among Apple's highest ever. If there was ever a time that the firm could afford to
invest in R&D, it is now.

2. Which other functional areas will also require increased capital expenditures?
The strategy begins with extensive market research. Compared to the costs of
manufacturing or advertising, this effort will require a relatively small budget, yet it will
surely require more funding that it currently gets. Advertising and other Marketing
initiatives will be required to promote the new products created by R&D. If successful,
operating costs could rise sharply as raw materials, labor, energy and shipping costs grow
to meet demand, so Operations would require additional initial funding. Cash flows
generated by those sales should provide satisfactory returns on these investments.

3. Should Apple's Capital Structure be changed to meet these new challenges? Should
new expenditures be funded with debt, equity or a combination of both?
This equation will change as new products begin to hit the market. To begin with, we
recommend a combination of reinvested equity from recent record profits and the
comparatively low-cost debt made available through the $80M bond refund, as explained
in the previous installment of this report.

As new product lines gain acceptance and popularity, they will produce new cash flows
that should allow the firm to return to its traditional capital structure that contains very
little if any debt. Funding to continue and expand new product development should be
able to come from reinvested equity. This will work if and only if stockholders are
convinced that the Net Present Value of new product cash flows will be greater than the
amount invested in developing them. After all, the ultimate goal of this strategy is to
maximize stockholder value.

4. Where and how can we cut costs without cutting corners on important functions?
Despite the extensive need for capital this strategy demands, there are ways that each
aspect of it can be made more efficient.

Finance- The single most powerful weapon at our disposal, in terms of making this
initiative as efficient and profitable as possible is careful, skillful financial management
that leverages the maximum value out of every asset, operation and individual.

Market Research- Apple's omnipresence on the internet can provide many opportunities
for low-cost market research, using web-based surveys. Data mining will also be used to
lift customer feedback and ideas from the customer service and technical support
departments.

Research & Development- Although this area will be heavily funded and unregimented,
bonuses and other rewards should be tied directly to cash flows generated by the
products that each individual was responsible for developing. This emphasis on
accountability should reduce agency risk and prevent researchers from pursuing
unprofitable pet projects.

Operations- While we do not recommend pursuing the low-cost strategy employed by

Dell, Apple can nonetheless borrow some tactics from their playbook. Product orders
probably already come via the internet, whether from customers on the website or retail
store managers placing bulk restock orders. If turnaround times allow, Apple should
adopt a "Just-In-Time" supply chain strategy that shifts more of the inventory costs to
suppliers. Internet orders could automatically generate orders to vendors for raw
materials that will be needed for those orders.
Since a variety of products may require a variety of raw materials to produce, one idea to
consider is to de-centralize manufacturing operations to whatever part of the world
production can be accomplished at the lowest cost.

Distribution can be economized by using web-based purchasing that would allow

products to be shipped directly from the factory to the customer, rather than from the
factory to a warehouse to the customer.

All of these strategies for streamlining operations will have to be studied before they are
implemented. Consider these to be ideas to be investigated rather than direct
recommendations, especially those related to Operations.

Part 6- The Bottom Line

Imagine living on a planet that spins so quickly that the sun rises every four hours instead
of every twenty-four. While other businesses may live an Earth-like existence, the
technology sector has always spun rapidly on its axis, with new products constantly
rising, setting and changing. This is not an environment in which a firm should find itself
in a position of trying to keep up. It is far better to t lead and let competitors worry about
keeping up. That is why we are recommending increased capital investments focused on
Research and Development, supported by spending on market research, production and
promotion of new products. Creating exciting new products that are based on a clear
vision of what people want should be the basis of Apple's future success, profitability and
value to shareholders. That's the bottom line.

References:
Brigham, E.F., & Ehrhardt, M. C. (2005). Financial management: Theory and practice
(11th ed.). Mason, OH: South-Western.

Website: Fawcette Technical Publications

Bill Gates launches Visual Studio.NET. Retrieved February 1, 2003 from
www.fawcette.com/reports/vslive/gateswebcast/default.asp

Jayson, S. (2005). Apple's magic act. The Motley Fool 1/12/2005 Accessed 8/26/05
http://www.fool.com/news/commentary/2005/commentary05011203.htm

Website: www.apple.com/investors Third Quarter Earnings Report, pdf download.

8/25/05. Also, Apple Computers, Inc. Form10-K, filing with the US Security &
Exchange Commission, 2004

The Associated Press, 2005. Podcasting spurs a media land grab. Published in
NewsMax Magazine, September, 2005. Newsmax Media, West Palm Beach, FL.

Website: About.com Plumer, C. 2005. Desktop Video- Apple Final Cut Pro.
Accessed September 23, 2005 from
http://desktopvideo.about.com/od/softwarereviews/gr/FinalCutPro4_RO.htm