Strong Apple Earnings May Not Stop Microsoft Market Increase

Apple reported strong earnings for the last fiscal quarter, including sales of over 3.05 million Macs. But while Apple dominates many markets, including digital media and smartphones, and has increased its PC market share, it may not be able to prevent a slowdown or even erosion in market share once Windows 7 is released on Oct. 22.

Apple posted strong numbers during its earnings call on Oct. 19, representing welcome news for an industry otherwise beaten down by a long-running economic recession.

Despite Apple's tradition of conservative reporting, which led it to post summer estimates of $8.7 billion to $8.9 billion for the fourth fiscal quarter of 2009, the company ended up reporting revenue of $9.87 billion and a quarterly profit of $1.67 billion. Strong sales of the iPhone 3GS, which sold over a million units in the three days following its June release, helped buoy that bottom line.

Those sales numbers included about 3.05 million Macs, a 17 percent year-over-year quarterly rise from 2008. In an Oct. 19 earnings call, Apple Chief Operating Officer Tim Cook said sales had exceeded the company's internal targets and the rise in sales of laptops was 35 percent year over year.

Even with such robust figures, though, Apple could potentially find itself challenged by the Oct. 22 release of Windows 7, which could potentially spark a massive tech refresh through 2010 and help Microsoft reverse a trend of declining revenues.

More to the point, Windows 7 may slow Apple's recent gains in the PC market, or even cause a modest correction in sales numbers. Whether that will happen is partially dependent on whether Apple's gains have truly come as a result of people fleeing the Windows ecosystem due to Windows Vista, which, despite corrective service packs issued since its 2007 release, has maintained a reputation as bloated and unreliable.

"Over the past three years, I can't think of a product-except maybe Windows Me-that has damaged Microsoft in the way that Vista has; since Vista's launch, Microsoft's reputation has really taken a major hit," Charles King, an analyst with Pund-IT Research, said in an interview with eWEEK. "During that same time, I can't think of a time when Apple hasn't been, to a greater degree, ascendant."

That period saw Apple come to dominate the digital media market through its iPod ecosystem, which includes the iTunes online store. It has also muscled its way into the smartphone market with the iPhone, currently a favorite of consumers. However, Apple has only managed to gain a few more points of PC market share, reaching about 10 percent. "Apple was the cat's meow of the PC industry," King said, "and all they could do was gain three points. Losing or gaining three points is not a big deal in the PC space."

Some analysts see the Windows 7 release as potentially leading to a slight increase in Apple sales, at least in the short term.

"Windows 7 will likely do some damage, but it could also raise store volume enough to drive an uptick across the board, including Apple," Rob Enderle, an analyst with the Enderle Group, said in an e-mail to eWEEK. With regard to the current quarter, "I was expecting Macs [sales] to be strong because the PC was hamstrung due to the October Windows 7 launch," he said.

"The Windows 7 stuff is going to put massive pressure on their margins," Enderle added. In that light, Apple's claims during the earnings call of lower gross margins for the next quarter seem logical: "It makes sense that they want to lower expectations a lot, otherwise they'll likely miss."

Part of the reason for Apple's inability to seize a more substantial proportion of the PC market might trace back to the late 1990s, when returning CEO Steve Jobs made the decision to kill the Mac clone business. According to Leander Kahney's book "Inside Steve's Brain," that decision was controversial but proved beneficial from a brand-consolidation perspective.

"It instantly allowed Apple to capture the whole Mac market again by eliminating the competition," Kahney wrote. "Customers could no longer get a cheaper Mac from Power Computing or Motorola or Umax. The only competition was Windows, and Apple was a different proposition."

The Mac clone market had not proven particularly successful, anyway, with sales staying relatively flat and Apple itself reporting a $69 million loss and 1,300 layoffs for the first quarter of 1996.

With Apple in a stronger position 12 years later, though, the decision to not clone out its operating system-even in a tightly controlled, very limited way-could have denied the company a few points of market share while Microsoft reeled from the initial effects of the reaction to Vista.

"Jobs' decision to kill the clone market for the Mac and stake everything [on what was] under the company's own roof is hard to justify from a market volume or market-share standpoint," King said. "It's been great for profitability, and they make terrific products, but if your goal is to get out into the market, then Apple denied itself a mechanism [with which] to make that happen."

Nonetheless, analysts' predictions ahead of Apple's earnings call had the company posting robust numbers, although the potential for clouds on the horizon exist.

Many of Apple's strongest areas are associated with the mobile device market. The iPhone is now available in over 80 countries; cumulative shipments since June 2007 have reached 26.4 million units. On top of that, "Apple continues to gain share across its major product lines (MacBook notebooks, Mac desktops, iPod digital music players, iPhone smartphone and the iTunes application)," Brian Marshall, an analyst with Broadpoint AmTech, wrote in an Oct. 12 research note. "Its business model is becoming stronger over time as well with continued penetration of international markets."

On top of that, Apple's net cash hoard stands at roughly $31.1 billion, eclipsing the reserves held by Cisco Systems ($25 billion), Microsoft ($24 billion) or Google ($19 billion). Moreover, Apple has traditionally shied away from acquisitions, making it more likely to hold onto the bulk of this cash reserve in the short term.

However, Marshall suggested, there are also downward pressures exerting themselves on Apple. Specifically, Apple's gross margins peaked at around 36.9 percent in June 2007 and have declined since, to 34.7 percent at the end of 2008.

"This trend should continue as pricing pressure will intensify going forward," Marshall wrote, "as the company aims to maintain its market share in a declining economic environment."

From a technological perspective, Apple also faces a cannibalization of the traditional iPod market by both the iPhone and the iPod Touch, although the company's executives have suggested that the phenomenon was anticipated.

During a July 21 earnings call, Apple Chief Financial Officer Peter Oppenheimer said the 7 percent year-over-year decline in iPod sales was due to "reduced channel inventory" and self-cannibalization as the touch-screen form factor became more popular with consumers than the iPod's traditional form factor.

Lastly, the carrier subsidies that Apple earns for the iPhone are, in Marshall's eyes, unsustainable. "It is estimated that Apple receives approximately $450 from AT&T Wireless on the activation of an iPhone 3GS as part of a carrier subsidy program," he wrote. "It is also estimated that Apple receives an average subsidy of $300 from its international carrier partners as well."
These subsidies are much higher than those earned by other device makers, such as Research In Motion, and could be forced to the negotiation table once the original subsidy agreements expire.

Whether or not Windows 7 turns out to create a revenue drag on its competitor, Apple predicts revenues of $11.3 billion for the quarter ending in December.