Apple to Take a Stab at Retail with Apple Boutiques

Background Information

Apple's partnership with CompUSA has turned out to be a minor success in just over a year and a half. On the other hand, the company's relationship with BestBuy fell to shambles after an inventory dispute regarding iMac flavors, and a venture back into the world of Sears retail appears to need more than a push and a shove to get things rolling in the right direction. But as with anything new, there is always a transition period.

In the meantime Apple is making great strides towards cleaning up their manufacturing-distribution, while lowering channel inventory, and increasing outsourcing of unit production. According to sources, a new strategy that Apple intends to unveil sometime this year will help them accomplish all three of these goals in addition to providing a superior buying experience for the Apple customer.

An Apple Retail Chain

The rumor is that Apple is carefully planning to launch a number of Apple branded "Centers" or "Boutiques" in a few select cities around the country. Initially, five to ten of these stores will be spread out through major cities such as Orange, California; Atlanta, Georgia; San Jose, California; Austin, Texas; and possibly Boston, Massachusetts. In the long run, Apple has intentions of leveling off at up to 100 stores nationwide, sources said.

The Apple Boutiques will be similar to Gateway's well accepted Country Stores, and will focus extensively on putting Apple hardware in the hands of customers, faster. The boutiques will give buyers the feel of purchasing direct from Apple but in a hands-on retail environment with true Apple customer assistance. Additionally, rumor is that customers will be allowed to custom configure their computers on the spot, to be assembled in the back of the store and made ready to bring home and plug in that very day.

Inventory and Efficiency

The manufacturing-distribution model above (read from left to right) forms the backbone of Apple's operation (as you can see how it compares to Dell's). Efficiency is key in today's cut-throat PC market. To achieve efficiency, one of Apple's primary goals over the last two years has been reducing in-house inventory, cutting it from nearly $2 Billion down to $7 million over this time period. (This was achieved through a reduction of the number of retail models, the introduction of the standard configuration iMac, etc.). Although these measures have helped to dramatically improve Apple's operational efficiency and gross margin, the company is not sitting on its laurels.

Lower Channel Inventory

While Apple's "internal" inventory is now extremely low, at any given point in time there are about 4-5 weeks of inventory in Apple's retail channel worldwide (worth about $500-700 million). Even though the depreciation of these machines in the channel doesn't go on Apple's balance sheet directly, ultimately Apple, retailers, and consumers all must swallow the results of this inefficiency. When products sit on shelves for too long, retailers suffer from the depreciation of their inventory, Apple pays for it in the form of price protection, and consumers bear the burden of higher prices and lost utility.

Currently the only compelling reason to purchase directly from Apple is to take advantage of the option of Built-to-Order (BTO), but turnaround times can range up to and well beyond two weeks. One of the rumored benefits of having Apple Boutiques nationwide is that all orders placed through the Apple Online Store will be forwarded to the retail location closest to the customer — yielding much faster turn around times. This strategy will allow Apple to focus more on custom built computers, enabling them to safely eliminate some of their retail configurations without undermining consumer choices.

Fewer retail configurations have a direct effect on reducing the amount of inventory in Apple's retail channel at any given time. For example: currently there are four retail configurations of PowerMacs. An increased focus on BTO may eventually allow Apple to eliminate one of these configurations and run with three standard retail configurations in the Pro space: Customers needing additional options would turn to the more accessible BTO option.

This alone will improve channel inventory drastically — by at least over the 25% that a fourth configuration weighs. Fewer configuration also aids an increase in product outsourcing due to simplification.

Increase Outsourcing

It's pretty clear that Apple is slowly moving towards a model where it will rely on outsourcing for most of its manufacturing operations. Outsourcing unit production allows Apple to take advantage of lower production costs of contract manufactures while lowering its own overhead. This allows the company to focus its effort on product design, marketing, and distribution (especially with Built-To-Order).

Of the 4 product lines, PowerBooks have been outsourced to Taiwanese manufacturer Quanta since mid 1998, iMac production was outsourced to LG Electronics of Korea in April, and the much anticipated Consumer Portable is expected to be made by Alpha-Top. Outsourcing not only improves gross margins but it also allows Apple to establish strong alliances with major contract manufactures.

These kinds of co-operative and synergistic relationships with major contract manufacturers are extremely valuable as the PC industry becomes increasingly competitive. For example, the strong tie and outsourcing arrangement Apple developed with motherboard maker NatSteel of Singapore helped NatSteel to report record profits. Presumably NatSteel reciprocated the favor by offering to produce motherboards for Apple at competitive prices. It's a win-win situation for both companies.

A drawback with outsourced production is that it makes it more difficult for Apple to control product quality. However, by reducing the number of retail configurations it simplifies the manufacturing process and makes it easier to manage production. This new form of strategy will also allow Apple to outsource an even larger percentage of their total production. As a direct result, Apple will see a drop in manufacturing costs and will quite possibly be able to do away with their Cork facility in Ireland.

BTO's Slow Start, Retail Partners will Remain

While Apple's online Apple Store has a great deal of potential, retail sales from the Apple Store has been hovering around $25 million per quarter. This is lint in Apple's pocket compared to their total quarterly revenue which ranges upwards of $1.6 billion. One of the reasons for this is because Apple has yet to capitalize on the BTO aspect of the Apple Store.

If the Apple Boutiques would do their part to improve the BTO purchasing experience, it would make purchasing from Apple Store a far more compelling option. Such a development will help Apple achieve its long term goal of increasing revenue from its direct sales branch. By eliminating the middleman (resellers) Apple would produce higher gross margins.

A revised chart (above) depicts what Apple's manufacturing-distribution model would look like with the new Apple Boutiques strategy fully implemented. The model more closely follows Dell's, and would improve all of the manufacturing and distribution points we highlighted earlier.

As you can see from the chart, Apple Resellers will never really go away. Unlike Dell, Apple plans a long and healthy future with retail partners such as CompUSA and Sears that will complement its Apple Boutique strategy.

True to common thought, rumor has it that when Apple mentioned the retail strategy to CompUSA executives, they immediately threatened to pull their integrated "Apple Stores." However, more recent information suggests that due to some major restructuring on the part of CompUSA — as they plan to shut down some stores and move towards a more consumer electronics store model — Apple's presence in CompUSA locations will eventually be effected. Though the consensus appears to be that regardless of an Apple Boutique strategy, CompUSA would continue to carry Apple product.

Implementation

Although our sources tell us that developments regarding Apple's boutique strategy has matured to a point that the strategy could be announced this summer, it remains to be seen exactly when Apple will make these plans public. One thing that's for certain is that Apple's management team considers improving its distribution model a top priority. The company hinted to such an effort at its shareholders' meeting earlier this year as well as in recent conference calls.

Apple's announcement in May that it would add Millard Drexler, CEO of Gap Inc., to its Board of Directors clearly shows that Apple was interested in Drexler's extensive retail expertise. And while numerous bits of confirmation have been received over the past few months, Drexler's presence might be the most reassuring.