Apple's Retail Grab: Crunch Time

This quarter is crunch time for the Apple Retail Stores - if they can't trade profitably in the run up to Christmas, in the busiest retail quarter of the year, and after all the opening publicity, then there isn't much hope.

Fortunately all the signs from Cupertino are positive, even if statements about making a small profit have been revised to a small loss in the wake of September 11 and the recession. The dire November sales figures are in from the clothing chains, but with manufacturers like HP and eMachines talking up their retail sales, the PC business is looking more like the fairly strong, incentive driven, car market than any other model. Even a small profit still looks possible, but we will all know more in January.

But if Apple Retail Stores and having Apple sales staff in CompUSA outlets leads to a substantial increase in sales, can Apple afford not to control the buying experience in all outlets?

The rollout of the Apple stores and putting Apple sales people in the chains radically improves the buying experience. It also has some more subtle benefits: Anyone shopping for a computer will see Apple computers always running properly, find Apple staff more knowledgeable than most of the computer staff, and because of these factors will see more people in the Apple section enjoying the latest and greatest. Crowds beget crowds, and they reinforce the perception that things are happening in the Apple world, giving even nonusers a more positive feeling towards Apple.

This positive feeling will quickly disappear when customers enter a Mac outlet where the sales staff, "the experts," are pushing Wintel and are uninterested in Macs. Apple needs to staff these locations or the quality of the buying experience will be patchy, which will itself keep sales depressed.

This need to increase the sales staff to cover both new Apple Retail Stores and Stores within a Store (SWAS) is bound to increase the head count and hence the break-even point over the next 12 months. The recently reported "stealth cuts" have managed to maintain roughly the same head count level until the success of the new retail program is proven. In future quarters, though, retail expansion will have to come though profitability, so the head count increases should be self-financing.

So if the best way of increasing retail sales is through dedicated Apple sales staff, does Apple need so many chain outlets?

Clearly SWAS will become the minimum requirement in any store, possibly combined with a program where Apple and the chain share the gross margins of the additional Mac sales generated by the Apple sales person. The additional margin could then help Apple pay for and retain better staff.

However, given the likely retail environment next year, it won't be surprising if at least one major chain is unwilling to go with this or Apple is unwilling to commit to the staffing levels required. So we should expect some contraction. If Apple is indeed the BMW of the PC business, this contraction should be seen positively. All luxury car manufacturers require a substantial investment in premises and staff so that the sales and after sales experience is as positive as possible. It is this that builds brand loyalty. So while Apple needs to have enough retail outlets for new customers to easily buy one, resources are best concentrated on those outlets willing to invest in giving the best Mac experience. This should increase both the number of Mac users and the high likelihood of them buying Mac again in the future.

All of this looks positive, but another retail factor can depress the share price. The last reported figure for Apple's US market share was 4.7% in October, up from 4.5% in September. However, a recent report suggested that the Apple retail market share was falling in November, with the inevitable effect on the share price.

The problem, particularly with interim reports, is that they make an estimate based on a very limited sample of outlets. This is unlikely to include any Apple retail stores but may include, for instance, chain stores selling Macs in the same area as an Apple retail store but without an Apple sales person.

Since nearly all reported buying experiences say how bad these outlets are, many of their Mac customers will buy at the Apple store where they know their business is appreciated, leading to an apparent fall in sales. This is in some ways a short term problem as those sales will show up in the quarterly reports from Cupertino but may lead to a rush of doom sayer articles in the press prophesying Apple's imminent disappearance, which will inevitably reduce the trickle of converts from Windows.

If retail stores can be shown to be adding to Apple's sales and bottom line, we will certainly hear about it when earnings are released in January. Management has taken a calculated risk and deserves any credit. It is after the Q1 earnings are out that the retail factor will start to be a serious part of the share price.

However, retail share analysts favorite yardstick is comparative sales in stores open for at least one year. For this we will have to wait another year.

Apple's Retail Grab will be continued next week.