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Will Uncle Sam Like the Taste of Apple?

In just 2 1/2 years since introducing its popular iPod music player, Apple (AAPL) has begun to morph from a computer maker into a consumer-electronics outfit. While most users today associate Apple with groovy music and fashionable gadgets, the company has also made major inroads into another less sexy but potentially more profitable market: the government sector.

Uncle Sam's coffers, which have long remained elusive for Apple, are finally opening up. iPod's success has "strengthened Apple's brand and made many people in the government reconsider Apple's other products," says Max Peterson, vice-president of federal sales for reseller CDW (CDWC) in Herndon, Va. A year ago, Apple's Mac OS X operating system was added to the government's approved-purchases list, which previously included Windows and Java.

As the federal technology budget ballooned -- it's expected to reach $46 billion this year -- Apple's market share in computers sold to the government rose from 1.6% in the first quarter of 2003 to 2% in the same period of this year, estimates analyst Roger Kay of market researcher IDC. Today, Apple is the government's No. 6 computer supplier -- and climbing.

GOOD CORPORATE PUBLICITY. While Jobs & Co.'s government business is still miniscule -- just over $200 million of its $6.2 billion in yearly sales -- it's "going to develop into a meaningful business for Apple," says analyst Charles Wolf of Needham & Co., who owns Apple shares. The outfit's PC sales to public agencies could grow by 50% in the next few years, he figures. Revenue from server sales to the government could enjoy double-digit gains as well. And since Uncle Sam tends to buy high-end, higher-margin products, additional government sales will boost Apple's bottom line.

This increased credibility should give Apple "the best shot they've had [at the corporate market] in 10 years," says analyst Laura DiDio

In turn, public-sector sales could help rev up Apple's sluggish corporate revenues. Government-contract wins, such as Apple's June 11 sale of Xserve servers to build a new supercomputer, "is good publicity with potential corporate customers," Wolf says, especially since many corporate and government clients' hardware requirements are becoming more alike. High-performance computing products are increasingly moving from labs into the mainstream. Financial institutions need supercomputer-like power for advanced business-intelligence analysis and credit scoring. And auto makers require more computing oomph to do risk assessments and design.

This increased credibility should give Apple "the best shot they've had [at the corporate market] in 10 years," says analyst Laura DiDio of market consultancy the Yankee Group. She figures that as Apple debuts new products, such as its new operating system, the outfit could gain 2% to 5% share in the corporate market in the next 18 months. That would add a few hundred million dollars to Jobs & Co.'s top line.

GROWING SHARE. Moreover, market consultancy Dataquest expects the federal technology budget to rise by an average of 4% annually for the next five years. That's down from the 5% to 10% annual growth of the past decade, but increases in state and local government spending next year could make up the difference. Computer makers will benefit from that growth the most since many government organizations haven't replaced their gear for more than three years.

If last year is anything to go by, Apple should get a growing percentage of that spending. In 2002, Apple's gear accounted for 5% of government reseller PC Mall Gov's sales. That climbed to 7% in 2003 as the vendor's government sales rose 30%, to $82 million, reports Alan Bechara, the outfit's president.

One reason for Apple's better traction is the success of its Xserve servers and storage products, first introduced in 2002. They're priced on par or below rivals' equipment and are easy and quick to set up. Plus, they're based on G5 processors from IBM (IBM). These powerful, 64-bit chips help graphics and data-intensive applications run faster -- a major selling point: After Apple released its Xserve models based on G5 in March, its server unit sales more than doubled, according to IDC. Vendors say the servers have been Apple's No. 1 seller with the government.

DEFECTORS FROM MICROSOFT? Apple equipment's underlying software also appeals to many government tech managers looking for alternatives to Windows. Based on open-source Unix code, Mac OS is easier to use than Linux. It also comes with more than 10,000 applications, which is a lot more than what Linux can offer. And it's about to get better: Early next year, Apple will release its so-called Tiger OS, featuring easy file-finding, video conferencing, and better interoperability. Microsoft's (MSFT) new version of Windows, called Longhorn, is expected to offer many similar features, but it isn't due until 2006.

Apple's comparative immunity to viruses wins lots of fans, too. According to antivirus software maker Sophos, the first half of 2004 saw the release of 4,677 new viruses, nearly all of them targeting Windows. That's a 21% increase over the first half of last year -- and a major headache Mac users didn't have to endure. "For us, it's just a non-existent issue," says Ngozi Pole, the administrative and systems manager for the D.C. and Boston offices of Sen. Edward Kennedy (D-Mass.). But techies at non-Mac offices on Capital Hill spend the majority of their time battling viruses, he says.

Microsoft's recent decisions also help Apple's cause. Come Jan. 1, 2005, the Redmond giant will discontinue support of Windows NT Server 4.0. And on July 28, the software maker said it would delay its releases of operating systems for the 64-bit, faster functioning computers and servers until the first half of 2005. "These various issues are going to get buyers looking at other possibilities, and some of them will switch," says analyst Gordon Haff of tech consultancy Illuminata in Nashua, N.H. Resellers say they haven't seen much of a reaction to Microsoft's moves so far, but that any impact, if it happens, will become apparent in the fourth quarter.

Apple's success in the government and enterprise spaces depends on how much resources it devotes to these markets

BACK SEAT NO LONGER. Once Apple's servers and storage devices are in back offices, it could have an easier time selling its other products, such as desktop and notebook computers. That's the theory, at least. Many users still feel that the Mac OS doesn't have enough application support. To fight its image of the high-end seller, Apple also needs to price more aggressively, says DiDio. And Apple has recently had supply problems, though a glitch at IBM that limited the flow of G5 processors was to blame.

Another potential problem is government buyers' propensity to standardize on a single platform, says Valerie W. Perlowitz, president and CEO of tech-services provider Reliable Integration Service, which counts government agencies among its clients.

More important, though, Apple's success in the government and enterprise spaces depends on how much resources it devotes to these markets, which have historically taken a back seat to its main, consumer business. But that could be changing. "Government has great synergies with higher education and enterprises," says Philip Schiller, Apple's senior vice-president of worldwide product marketing. And, he says, the company wants to continue pushing into all these markets.

Apple's government business is still tiny and could take years to grow. Still, rivals Dell (DELL), Hewlett-Packard (HPQ), and IBM would be wise to watch out: Apple has long been known as an innovator and a design pioneer. What's more, "Apple is a religion to many users," says Bechara. "You have followers, not users." And chances are the outfit could see more converts in the coming months. By Olga Kharif in Portland, Ore.

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