4.

11 November 1996

Opportunity Cost
How a deep-seated corporate obsession with the education market baked Apple.
By Lewis J. Perelman

In recent months, market analysts and industry observers have recited a litany of blunders to explain the decline and fall of Apple Computer. What they left out was an underlying force that led four generations of Apple management to make moves at every juncture that dissipated Apple's leadership of the personal computer industry the company created. And that underlying force is none other than Apple's longeststanding, most deeply held commitment: education. Privately, I found that industry analysts agree that Apple's obsession with educational sales was a significant contributor to the company's problems. How big a contributor? "Fifty percent sounds right," says Tim Bajarin, president of the Santa Clara-based market research firm Creative Strategies. Steve Tirone, an analyst at International Data Corp. in Framingham, Massachusetts, puts it this way: "Apple's almost religious devotion to the education segment insulated the company from having to compete in the mainstream market. Avoiding competition made Apple increasingly uncompetitive.'' True, Apple's dominance in education - still roughly half of all school sales - is one of the few things the company's new management has to boast about in its current come-back ads. But that only proves the relevance of economist Kenneth Boulding's rule that "nothing fails like success." At the heart of that rule - and the core of Apple's problem - is the inadequately appreciated economic concept of opportunity cost, in effect the cost of not doing something. Apple "lost" big on education because the resources spent pursuing school customers could have been deployed more profitably elsewhere. And Apple's education sales force became a kind of tumor that spread throughout the corporate body ,steadily sapping the company's overall strength. The result: Apple lost the opportunity to become a global force like the Wintel complex that dominates more than 80 percent of the world's computer market. Here's how: Apple's early and ongoing dependence on education for a large share of its sales and income led the company to commit too much of its resources to a market that will never be more than a niche in the overall computer industry, much less in the whole "information'' sector.

This persistent, misplaced focus devoured resources that might have been targeted on the "mainstream" market that Apple never really reached for, much less grasped. Worse, education progressively stifled Apple's core business competency by entrenching an unholy alliance of customers, vendors, and staffers, who promoted and rewarded technological sloth and cultist delusion. Even the supposed legion of loyal future buyers failed to materialize. "Apple's strategy was based on the belief that kids hooked on one brand of computer would become devoted customers," says Harvey Long, a former IBM education industry consultant. "The problem is you have to wait far too long for a payoff." Throughout the 1980s, schools and colleges accounted for about half of Apple sales; more recently, education provided nearly one-third of the company's revenues. And that doesn't count parents buying Apple products for their kids to use at home or sales to corporate training departments. To protect and cultivate what seemed to be its base, Apple not only tailored its product line to its scholastic customers, but assembled a massive education sales force, which quickly became the tail that wagged the dog. "You have to understand that sales has always been the power base at Apple," one of the battalion of recently departed Apple executives says. "And education was by far the biggest power in sales." How big? Right up until the end of the Michael Spindler era in February 1996, some 30 percent of Apple's total sales force was committed to education (and more to K12 schools than to colleges). That was augmented by a roughly equal number of Apple-authorized "sales agents," who were guaranteed exclusive rights and a generous cut off the top. For a long time, there was plenty of profit to go around. "In the mid-'80s, Apple was getting margins from 35 to 45 percent," says Bajarin, a widely respected Apple watcher. And back then Apple's sales were doubling nearly every year. But rising sales and fat profits, short-term indicators of success, were leading Apple down the wrong strategic path. It's another aspect of opportunity cost: winning the battle and losing the war. Well, the war clearly has been lost. Apple's overall market share has shriveled to single digits. In the first quarter of this year, unit sales fell 22 percent while the rest of the PC industry's sales leaped 15 percent. In the second quarter, Apple's 6 percent market share declined to 5.3 percent. And Apple diehards who shrugged off a US$60 million loss in January 1996 as a minor bump in the road were stunned by new chief executive Gilbert Amelio's subsequent opening act: a massive $700 million write-off and a huge recall of defective products. Apple's faithful may not understand opportunity cost, but the company's investors have had their faces rubbed in it: over the last five years, Apple's market valuation has drifted slowly down - and occasionally dropped calamitously - while the value of every other major vendor in the PC market has grown at least 25 percent. It didn't have to be that way. The introduction of the Macintosh in 1984 gave Apple its best chance to escape the scholastic quagmire and rejoin the commercial mainstream of the PC market. And the Mac did in fact give Apple a powerful presence in another market niche that the Mac did much to create: desktop

publishing, along with the graphic, video, and audio design and production applications that eventually congealed as "multimedia." Indeed, if there is any strength left in Apple's business, design and publishing is it. But as in the schools, Apple's competitors are making inroads here, too. And whatever its worth, the publishing market is and will remain a niche. Unfortunately, by the time the Mac dbuted, the power center of Apple's dominant education division had become rooted in the company's organization and culture: half or more of the huge education sales force had been recruited directly out of educational institutions, mostly public schools. Educators were not just outside reps, they spread throughout the organization - up to and including Apple's head of American sales operations, James Buckley. The company's education sales force was able to move product and make the numbers that assuaged Wall Street. It also stymied management's ability to reorient the company to pursue the vast "real world" market outside the classroom walls. But in that pseudomarket of heavily bureaucratized school systems, the competitive and consumer forces that drove innovation and growth in the PC mainstream were missing. In contrast to school buyers and PTA donors, the industry-standard PC cus-tomers generally spend their own precious money for tools to do their own work. What they want from vendors is not love or charity but solid value and practical "solutions." In the IBM-compatible, Microsoft/Intel maelstrom, intense competition and savvy customers shrank product life cycles from less than three years down to as little as six months. Meanwhile, Apple continued supplying classrooms with mountains of increasingly obsolete Apple II products for more than 12 years. Ironically, the labor-intensive and bureaucratic nature of Apple's education sales machine made it slightly less profitable than its corporate counterpart and several percentage points less profitable than the publishing/media segment. So, as good as Apple's financial performance may have seemed with its big education push, it could have been doing better - both in the long range and in the short - if the company had found the will to reallocate resources that were being squandered on the academic niche. Moreover, critics often blame Apple's dire straits on management's failure to overcome "internal resistance" to licensing the Mac OS. Where did that come from? "The education sales group killed licensing every time it came up," an Apple executive says, "because it meant more competition and lower margins for them." But of all the ironies of academia's corrosive influence on Apple - a company founded, after all, by college dropouts - perhaps none is more definitive than the famous TV commercial that launched the Macintosh during the 1984 Super Bowl, portraying IBM as an Orwellian Big Brother. Its punch line: The Computer for the Rest of Us. Who were the Rest of Us? Presumably the independents, the artistes, the radicals, the cool - the Cult. In reality, though, it turned out to be the leftovers, the margin, the fringe, the niche - the 6 percent that Apple's overall market share has withered to now. The Mac was supposed to be the symbol of independence and individualism. But, in reality, it was the horde of competitors in the IBM-PC world that unleashed a flood of

ever-evolving boxes, peripherals, gadgets, and software that the individual user could select, cobble together, and tweak to meet personal needs and tastes. And however lumbering the IBM Corporation may have been, it was a paragon of lithe, entrepreneurial enterprise compared with the authoritarian, conformist, and arrogant quasi-socialist bureaucracy of academia, where the lion's share of Apple's sales and its own corporate cadre had their roots. Can Amelio turn this around? Maybe. For starters, he has to stop using learning and education interchangeably and realize that they are two drastically and strategically different things. The key to that distinction is the ongoing rush into on-demand learning, what author and consultant Stan Davis calls the "knowledge for profit'' revolution. Collectively, I call these new processes kanbrain, from the Japanese for just-in-time delivery. Kanbrain learning includes new technologies with names like performance support, groupware, knowledge-based systems, and intranet. They are designed to create, move, and apply knowledge to help workers serve customers' needs. Not to deliver instructional courses or churn out diplomas. Perelman's Law of Knowledge-Age Management holds that it is a debilitating, maybe fatal error to confuse kanbrain learning with institutionalized education and training, as companies like Apple have defined them. Indeed, Apple's decline and fall are Exhibit A. Spindler blew a recent chance for Apple to have a role in this revolution. More than two years ago, training director Lucy Carter had replaced most of Apple's corporate classrooms with on-demand, kanbrain-style systems. Carter went on to help form a "learning systems market" group, with the aim of refocusing Apple's whole market position. (Full disclosure: I was a consultant to that group.) In December 1996, Spindler jettisoned the project in one of his dumber 11th-hour downsizing moves. By this summer, Amelio had in fact substantially shrunk Apple's educational marketing force, subordinated all sales to the various product divisions, and replaced some of the education cadre's capos, including Buckley. Constructive steps, but not enough. Amelio should outplace "educational" sales entirely to third-party vendors or perhaps a spin-off company. That would at least give what's left of Apple a second chance. Building on the company's remaining core of technology and creativity, with its potent brand name and significant base in multimedia design and production, Apple might yet be reborn as a powerful, even premier builder of the engines that are driving the knowledge revolution. Tools, not schools, are the key to Apple's future. Lewis J. Perelman (kanbrain@concentric.net) is executive editor of Knowledge Inc. (www.knowledgeinc.com/), a newsletter from which this is adapted.

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