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Apple's Down-Market Gamble

By Peter Burrows There's a big buildup every time Apple Computer Chief Executive Steven P. Jobs takes the stage for the annual Macworld trade show -- but none more than this year. Web sites dedicated to stealing Jobs's thunder posted what turned out to be accurate details of new Apple products, in one case complete with surreptitiously taken photos of one low-price Macintosh computer.

Nonetheless, as a capacity crowd, including Apple (AAPL) board member Al Gore, waited in San Francisco's sprawling Moscone Convention Center for Jobs's keynote speech on Jan. 11, those who knew the truth could hardly curb their enthusiasm. "This is going to go down as an important event in Apple history," enthused Mike Gartnenberg, an analyst with JupiterResearch who had been briefed the night before on what Jobs was going to announce. While Gartenberg wouldn't give up any details because he was sworn to secrecy, he hinted, "It'll be interesting to see how he articulates this."

Indeed, while the Apple acolyte sites captured many of the features of the new products, they couldn't capture how it all adds up to Apple's most aggressive play for market share in years.

STARTING AT $499. As the rumor mill predicted, Jobs unveiled a cheaper iPod digital music player that's about the size of a good cigarette lighter. Instead of using a PC-style hard drive, the new model, with a price that starts at $99, uses so-called flash memory that has lower storage capacity but is cheaper to produce.

Jobs also took the covers off the "Mac mini," a full-functioning Macintosh computer that's about the size of two paperback books and sells for as little as $499. That doesn't include a monitor, mouse, or keyboard.

Discount prices like that may seem terribly un-Apple-like. But analysts say it points to a bigger, long-term strategy: Build from the iPod's success and win a whole new generation of converts to Apple technology. Many faithful may also give the offerings a try. But these products are aimed squarely at people who shy away from Apple price tags.

No question, iPod, is a great platform to build from. Apple sold 4.5 million units, despite prices starting at $249, during the Christmas quarter -- just about meeting aggressive Wall Street sales expectations.

SOARING SHARES. Now, music fans who merely want a cheap way to listen to music on the go can do it with the new "iPod Shuffle." Priced competitively with other flash-based players, its one drawback may be that it lacks the tiny screen of rival products. Instead, it just plays song lists, or randomly "shuffles" through a digital music collection.

No doubt, Jobs is taking a risk -- and some investors may have preferred he left well enough alone. iPod-mania has lifted Apple's shares more than 200% in the past year, to $64.56 at the end of trading on Jan. 11. Even with no new products, most analysts figured Apple will be able to hold share in digital music and gain share, for the first time in years, in the PC market.

The big concern will be over cannibalization. How many customers will opt for a $99 Shuffle, rather than a $249-plus iPod, or a $500 Mac mini rather than a $1,300 iMac? Investors were clearly spooked, driving Apple shares down 6.38% on the day of Jobs's speech.

UP-SELL OPPORTUNITY? But analysts' initial impression is that Apple's down-market move would bring more gain than pain. While it's a latecomer to the flash music-player market, it's taking on a fragmented stew of rivals such as iRiver, Creative Technology (CREAF), and Samsung -- none of which can approach Apple's brand appeal.

Indeed, for the most part that's the same crowd Apple vanquished with the iPod when it entered the market in 2001. Also, this may be a classic "up-sell" opportunity. If consumers buy the cheap iPod Shuffle and want more capacity or features, such as navigation between songs, they may pony up for the more expensive models.

As for the Mac mini, analysts at the keynote say it amounts to Apple's best chance at achieving Jobs's original goal for the Macintosh when it was introduced in 1984 -- a computer for "the rest of us." As Apple watchers know, that didn't quite happen. Apple ended up in the high end of the PC business. Even now, the cheapest iMac costs $1,300, roughly double the price of an average PC. The Mac mini fulfills that original promise.

LONG-TERM IMPACT. It also exposes a new audience to Apple's software. Jobs spent much of his keynote singing the praises of Tiger, a new version of the Mac operating system that he says is on schedule to ship by midyear. He also highlighted and upgraded versions of Apple's iLife software, which includes programs for managing photos and videos and for making DVDs, as well as the iTunes music jukebox.

Will these new products revolutionize the PC market and vault Apple to the stratosphere? Not anytime soon. While cheaper products will no doubt expand the market for Apple products, they will, in fact, lead to some cannibalization. For example, many of the folks who forked over $249 and up to buy a 1 of those 4.5 million iPods as a gift this holiday season may go with a $99 Shuffle next year. If too many consumers snap up these products in place of Apple's pricier gear, the financial benefits could be muted indeed.

But for now, the Apple faithful -- and perhaps some new fans -- can revel in the notion that Apple technology is, at long last, affordable to "the rest of us." Burrows is BusinessWeek's Computer editor in the Silicon Valley bureau

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