PARADISE LOST APPLE'S QUEST FOR LIFE AFTER DEATH AFTER A SECRET, DECADE-LONG SEARCH FOR A PARTNER, THE COMPANY THAT INVENTED PERSONAL COMPUTING WILL LIKELY DISAPPEAR. BUT ITS TECHNOLOGY COULD LIVE ON TO CHALLENGE THE HEGEMONY OF MICROSOFT AND INTEL IN THE AGE OF THE INTERNET.
(FORTUNE Magazine) – IT'S ENOUGH to break your heart. By the time you read this story, Apple Computer--that paragon of California creativity that seems to have come unglued before our eyes--may well have agreed to merge into Sun Microsystems, or Philips Electronics, or some other taker. If it accepts a suitor, the quirky cult company that roared out of a Silicon Valley garage to launch one of the most important industrial trends of the 20th century will end its wild ride as an independent enterprise.
For anyone who has ever used a Macintosh--Apple has sold some 22 million and has an army of fanatically loyal customers--and lots of other computer lovers besides, this is a big deal. Ever since two hippies and a thirtysomething retiree founded Apple 19 years ago, it has been the font of innovation for the PC industry, a wellspring of technologies we now take for granted but which, without Apple, would have taken years longer to appear.
For shareholders, meanwhile, Apple's exit from the stock listings could mean yet another disappointment. Despite its marketing panache and blockbuster products, the company has been a chronic underachiever. Bloodied by price wars, it has failed to halt the decline of margins or gain back market share from rivals that make Windows machines--PCs that incorporate industry-standard microprocessor chips from Intel and software from Microsoft. Apple's erratic performance has given it the reputation on Wall Street of a stock a long-term investor would probably avoid. (Over the long term, Apple has turned in nowhere near the financial performance you'd want from an industry founder. A $1,000 investment in Apple stock ten years ago would be worth $2,900 today. The same $1,000 investment in Compaq would be worth roughly $22,000.)
The merger taking shape as FORTUNE went to press could leave shareholders even more distressed. With Apple shares trading recently around $31, Sun's offer was said to be no higher than $33 and more likely in the middle 20s. Yet Mike Markkula, the reclusive chairman who has always been the real power at Apple, seems intent on closing a deal. As the talks were going on, he suggested to FORTUNE that price isn't that important if a merger makes sense for the long haul: "A professor once told me, 'Don't hold the penny so close to your eye that you can't see the dollar behind it.' "
Remarkably, Markkula is ready to sacrifice Apple's independence to renew a war that many would say was lost long ago. He wants to create a force in computing powerful enough to challenge Microsoft, a company he believes to be dangerously close to dominating key segments of the digital economy, including personal computers, corporate networks, digital entertainment, and the Internet. "Every day and week and month that goes by without a challenge brings the folks in Redmond closer to controlling our fates," he says. "I don't think preserving the legal entity that is Apple is as important as preserving our organization, philosophies, brand name, employees, customer base, and technology." Got that, shareholders? That a deal hasn't been sealed quickly indicates, however, that Markkula is resisting Sun's efforts to low-ball.
The chairman's devotion to the anti-Microsoft crusade wasn't the only confusing aspect of the merger talks. Apple was being forced into another's arms, the conventional thinking went, because of a deadly confluence of poor business strategy, flawed execution, and its stubborn wish to stay independent. In just three months starting last October, Apple seemed to come unglued. There were product shortages and gluts, executive departures, even an embarrassing recall: A long-awaited new series of PowerBook laptops turned out to have faulty batteries that caused a few computers to burst into flames.
Any company can have a wretched quarter, but the common wisdom in the industry was that something deeper was at work. Apple was finally getting its comeuppance for years of arrant refusal to enlist allies by widely licensing its designs to other computer makers. Because it had dragged its heels on creating a Mac clone industry, went the rationale, Apple now found itself drowning in a flood of inexpensive Windows machines. It faced a catch-22: To preserve market share, it had to cut the prices on Macs; but the resultant squeeze on margins meant it could not simultaneously make money and support crucial R&D. Moreover, Apple's puny share isolated it in the marketplace, as software developers put a higher priority on the much larger Windows segment.
But as is typically the case with this quicksilver company, things are not as they appear. The truth is, Apple's troubles are in large part a consequence not of standoffishness but of the very opposite: a secret, decade-long quest by its leaders to marry the company off. The goal: to create a computer superpower to lead what CEO Michael Spindler calls "an alternative industry of players that could stack up against Microsoft." This may be the right time. The Internet phenomenon has forced Microsoft to swerve to keep its software squarely on the information highway.
For years, though, Apple's ambition was more like a fatal distraction. Not only did it divert the company from making the most of the Mac, giving Microsoft the opportunity to whittle away at Apple's technological lead, but it prompted Apple to enter a disastrous three-year dalliance with its former nemesis, IBM. That dysfunctional romance fell apart in 1994 and has led to many of Apple's present woes.
Spindler, a gruff and intense German who has been depicted as the mulish champion of an independent-at-almost-any-cost Apple, is actually Mr. Merger. He hatched the risky strategy years before he commandeered the CEO job from John Sculley in 1993. And Markkula has been behind him all the way. Said Markkula, during the latest round of merger talks with Sun: "This isn't anything new. Since 1986, we held serious discussions with DEC, Kodak, Sony, Sun, Compaq, IBM, and other companies I'd rather not name now. They were very thoughtful discussions. We considered everything from 'Let's trade technology' to 'Let's put the companies together' with each one of them." LOSING CONTROL In technology, the mistakes you make often don't show up for many years. --Bill Gates, on Apple's recent woes What a difference three months can make. Last fall Apple proudly boasted record sales and strong profits for its fiscal year, which ended in September. But in retrospect, 1995 has to go down as the most trying year in the company's turbulent history.
There were signs of trouble long before the blazing laptops. In August, Apple, itself a pioneer of event marketing, could only stand by and watch as Microsoft triumphantly launched its Windows 95 operating system. It gave ordinary PCs a far more Mac-like look and feel, and went a long way toward erasing public perception that Apple held a technological lead. Windows 95 was hardly a surprise--it appeared more than a year later than promised--and Apple could have protected its image with a dazzling product launch of its own. But it had none to launch.
Public awareness soon shifted to the burgeoning Internet--a market in which Apple is remarkably strong. Macs are the most popular machines for Internet content creation, and Mac servers for World Wide Web sites rank No. 2 behind those of Sun. But Apple was unable to use those strengths to create buzz for itself. Instead, it seemed determined to fill the news with reports of its gaffes.
First the company sheepishly disclosed that it couldn't meet demand for its most popular new Macs as a result of component shortages. (IBM had more than a little to do with this. See below.) Then came management turmoil: CFO and director Joe Graziano quit following a boardroom showdown with Spindler. Dan Eilers, Apple's top marketing executive, claimed to have reorganized himself out of a job and checked out, followed by more than a half-dozen vice presidents.
Meanwhile, a bloody price war broke out in Japan, Apple's most lucrative overseas market. Thus, even though Apple sold 50% more units there in the Christmas quarter, it wound up losing money. Back in the U.S., demand during the usually lucrative Christmas season went flat; Apple recklessly cut prices in a vain attempt to clear out bloated inventories of low-end Macs.
It all added up to the big losses for the quarter. Spindler responded with a plan to cut costs by firing 1,300 of Apple's 17,000 or so employees. Wall Street answered him by hammering the stock. In two days Apple shares dropped 8%, to a 52-week low of $29.88. Even Apple loyalists were running out of patience. "I've given up on them," said Stewart Alsop, executive vice president of InfoWorld Publishing Co., on the day after the announcement. "I don't like to say that because I am one of those loyal Mac users. But I'm frustrated, because despite all of their talk of great new technologies and strategies, the Mac isn't much better than it was five years ago. They just can't seem to execute. And now this."
LONELY AT THE TOP I don't think anyone can manage Apple. --John Sculley, former Apple CEO
The lightning rod for frustrated customers and shareholders is Mike Spindler, of course. He's been blamed for botching demand forecasts, for bad product planning and poor inventory management, and for all the other operational glitches, even though he had delegated many of those responsibilities to executives who are now gone. He's even been called paranoid about his subordinates.
The latest rap against Spindler is that he is moving too slowly in restructuring Apple to help raise gross margins. "You can't win either way," he sighs. "The spreadsheet would say take deep cuts. Okay, so you cut off your arm, and now you don't weigh as much. But then you don't have an arm."
Spindler's unpopularity may also stem from his awkward and mysterious public personality. He isn't exactly reclusive or shy--he gives three or four major speeches a month--but he cuts a low profile compared with predecessors Sculley and Steve Jobs. Yet the beefy Berlin native has inexplicably managed to develop a vivid reputation for, among other things, suffering stage fright and being an autocratic wonk who buries himself in details.
In fact, he never has been a detail man. He's really a marketing strategist. Before coming to Apple to help run its European operations in 1980, he was a product marketer in Europe for Intel and later DEC. When Sculley brought him to Cupertino in 1990, he named him chief operating officer. The title was a misnomer: Spindler's real job was to cook up strategy. "I never was an operations guy," he says, shaking his head. "That's not my strength at all."
Apple CEOs have two things in common: They all get into big trouble; and Markkula always sorts out the mess. That's what happened in 1985 when co-founder Jobs clashed with Sculley, the executive recruited from PepsiCo. Markkula sided with Sculley; Jobs resigned.
Sculley lasted ten years. But by 1993 he had become so absorbed in promoting his pet project, the Newton electronic note pad, that he lost interest in the main business. When it became clear the Mac was losing ground both technologically and in market share, Markkula, a director and Apple's largest shareholder, swiftly pushed Sculley aside. "I have to admit that our biggest weakness at Apple is managing succession," Markkula says. "Lord knows we've tried, but this is a volatile business."
An Apple director throughout its history, Markkula, 54, is the company's gyroscope. An elfin engineer who retired from Intel in his thirties to fool with investments and teach math in a public school, he wrote Apple's original business plan and gave Steve Jobs and Steve Wozniak the first $50,000 to get it all started. He is an inveterate tinkerer; recently he received his fifth patent for a semiconductor design. He also has a philosophical streak: He underwrote something called the Center for Applied Ethics at the University of Santa Clara.
Markkula rarely talks to the press and precisely chooses his words when he does. When Apple isn't in crisis mode, he spends most of his time minding other business interests: He owns an executive jet charter service and an Alpine ski manufacturer. He and a partner, Silicon Valley entrepreneur Ken Oshman, run a startup called Echelon that makes chips for networking home electrical appliances and fixtures. Oshman, incidentally, is a director of Sun.
BOY CRAZY Apple has always been one to go for the big date rather than the cheap date. --Scott McNealy, Sun Microsystems Apple's plan to enlist one or more powerful allies in the war against Windows started as a brilliant idea seven years ago when Spindler transferred to the U.S. The plan he and John Sculley hatched seemed radical even for Apple. It envisioned pairing Apple's brand name and software with the market muscle and boardroom credibility of a Digital Equipment or IBM or Hewlett-Packard. The right combination would throw a boulder in the path of Microsoft and Intel.
Spindler and Sculley relished the notion of Apple's allying with a company much larger than itself--and setting that company's direction. The thought seems ludicrous in retrospect, but at Apple, self-absorption was par for the course. Apple, after all, has always been as much a social experiment as a business, driven more by technical genius, idealism, and arrogance than by the desire for profits, which in any event came easily in those days. Recalls Jobs: "It's amazing how different reality looks when you are inside Apple."
Even so, Apple wasn't alone in thinking grandiose thoughts. Sun Microsystems, though less than half Apple's size, flirted with AT&T and Kodak, allowing each to buy a substantial equity stake. Sun also was one of the first companies to worry about how powerful Microsoft and Intel could become.
That's one reason co-founder Bill Joy, a legendary software savant, set Sun's sights on Apple. Between 1988 and last year he led three futile attempts to woo Apple into a merger. Last fall he gave Fortune his rationale: "There has to be two brands of PC. The old IBM proved that monopolies kill innovation in this business. The question is: What is the cost of establishing a brand to challenge Windows computers?"
Apple told Sun to buzz off each time; Spindler and Sculley were intent on lining up a more established partner. They courted Digital Equipment first and thought they had a deal to manage its floundering microcomputer business. But, recalls Spindler, DEC founder Ken Olsen balked at the thought of a maker of "toy computers" telling DEC what to do.
For a while Spindler and Sculley lay low. But in 1990 the pair realized that the Mac would need a new microprocessor to leapfrog the growing legions of IBM-compatible PCs. Its supplier, Motorola, had hot technology in the works, but the chips were too expensive. So Apple again went partner hunting.
At this time the IBM/ Microsoft collaboration on the OS/2 operating system was dying; Gates would soon introduce Microsoft Windows against IBM's wishes. Playing on the tension, Sculley and Spindler convinced IBM to complete the design of a new chip, the PowerPC. Apple also persuaded Motorola to join with IBM to make the chips. As an added inducement, Apple agreed to divert some of its brightest engineers to two joint ventures with IBM to pioneer future software technology.
At first it looked like an ideal match. When the alliance was announced in 1991, Apple stock hit its all-time high. IBM delivered the first PowerPC chips right on schedule, enabling Apple to rejuvenate the Mac line in 1994. Its success in getting customers to shift from the Motorola-based Macs to those with PowerPC chips was probably the smoothest product transition the computer industry has ever seen. For Spindler, by now CEO, the rollout was a major coup.
Impetuously, Apple molded its strategy around its huge partner. It assumed, for example, that IBM would quickly start building Mac clones and scaled back plans to license the design to other, smaller companies. Spindler and Markkula had high hopes that IBM might even acquire Apple and put it in charge of both companies' PC businesses.
But IBM was undergoing its own management upheaval. As new CEO Lou Gerstner asserted his authority toward the end of 1993, there were signs that Big Blue's priorities were beginning to shift. IBM and Apple clashed over a standard hardware design that would make PowerPC machines cheaper to produce and easier to clone. Says Spindler: "Who owned what technology began to matter too much, and you couldn't get anything done."
Apple ignored the clouds on the horizon. But in late 1994 the typhoon hit. IBM experienced a resurgence in demand--for mainframes, not PCs. The margins in mainframes are far greater than those in the cutthroat PC business. Gerstner questioned why IBM would want to step up its involvement; soon the executives most keen on working with Apple left. With them went any chance of merging or even working together very closely. Struggling not to sound bitter, Markkula says: "There were lots of people there who gave us good confidence that we were going to be able to do this. Really serious. Unfortunately, IBM had a nice uptick in the mainframe business, so we didn't matter so much."
Apple now finds itself in a loveless marriage, forced to rely on IBM for the designs of the PowerPCs that it has made the heart of the Mac. Says Markkula ruefully: "The big mistake we made was not having a Plan B." From that arose many of the problems now pushing Apple toward a merger. Big Blue's tardy delivery of two souped-up versions of the PowerPC disrupted Apple's production schedules, resulting in the recent damaging shortages and gluts.
WAY COOL TECHNOLOGY Apple is a lot like Italy. It's a highly creative company, but with that comes chaos. --Regis McKenna, the legendary Silicon Valley marketing guru What made Apple a charmed company for so long was its vaunted technology. It was Apple that first put a color screen on a personal computer with its Apple II; that popularized graphical point-and-click computing with its Macintosh; that invented desktop publishing by marrying the Mac and the laser printer; that was the first to include stereo sound and network connections as standard equipment in a PC; and that opened the world's eyes to the vivid potential and sheer fun of multimedia. So beguiling are the products that they have convinced millions of people that computing isn't just productive, it's cool--and, well, personal. Apple's R&D labs are teeming with still more of what founder Steve Jobs liked to call "insanely great" technologies.
Though the company seems shell-shocked and woozy, Apple's technology strategies for the next year or two are more coherent and promising than in nearly a decade. The big question--the perennial question with Apple--is whether it can execute its ambitious plans.
The linchpin of Apple's strategy is its long-awaited overhaul of the Mac operating system. Experts familiar with the software, code-named Copland, say it will make Windows 95 seem as quaint and feeble as DOS. Due for delivery late this year, Copland won't look all that different on the computer screen. But it will revolutionize the way users organize and keep track of all the documents and files in their machines.
Among Copland's secret ingredients is something called a relational database engine, software that automatically and almost instantly can read and analyze the content of every file, document, drawing, or any other scrap of information in the Mac, and sort it on demand. A Washington journalist, for instance, could ask his Mac to find every document in his hard disk that was created after June 6, 1994, that mentions the flat tax, Dick Armey, and the Office of Management and Budget, but that wasn't by Rush Limbaugh. Copland would create a file folder containing icons representing all the documents bearing those keywords for easy retrieval. No longer will users have to remember file names to find documents.
Copland will be able to work the same magic on documents flowing into a computer via the Internet or a private network. During an Internet surfing session, for example, a user could download dozens of texts, pictures, and other files, have the Mac analyze them as they arrive, and automatically put them where they belong in the user's hard disk files.
Copland is a vital element in Apple's plan to unleash a much broader Mac clone industry. Apple management has been criticized for years for dragging its feet on licensing the Mac design to other manufacturers. So far just three have signed up; only one, Power Computing in Cupertino, has been a roaring success. Spindler contends that Apple had to go slow with its initial licensing because today's Mac designs are simply too persnickety to be easily and economically copied.
Later this year, at about the same time that the Copland software is expected to ship, Apple hopes to make a new Mac hardware design widely available. Co-developed with IBM, the design does away with expensive customized chips and instead uses many of the same cheap, widely available components as a Windows PC. The result should be a much cheaper Mac that, when coupled with Copland, will offer better performance than Windows machines and enable cloners to make better profits. As an added attraction for corporate buyers, the machines will work equally well with Windows NT, IBM's OS/2, and Copland.
Apple is also hedging its bets with a new genre of computer/CD-ROM game machine/Internet terminal/TV set-top box called the Pippin. It hopes the machine will crack open the consumer electronics market, as well as prove a new business model. This month Japan's Bandai Co., best known for its Mighty Morphin Power Ranger action figures, will start selling the first Pippins in Japan, bundling with the $650 machines Internet service and the ability to play interactive games online against other Pippin owners. Says Bandai CEO Makoto Yamashina: "We are very serious about the Pippin, and not just in Japan. We'd like to start selling them in the U.S. in May." South Korea's Samsung also plans to make and sell Pippins.
While the Pippin looks a lot like a Sony or Sega videogame player, it's a real computer that attaches to your TV. Software and games come on CD-ROMs. And any Pippin title can also work on a Mac. The target audience is families who don't want to spend $1,500 on a computer but want a game player that can run some real computer programs, such as an Internet browser or an educational CD.
What's in it for Apple? This is the company's first stab at the Microsoft model of doing business--a pure software play. While Apple helped design the machines, Pippin licensees will build them. Apple will charge Bandai, Samsung, and other licensees $20 or so per machine, and will get a couple of dollars' royalty from each Pippin CD-ROM disk that is sold. If the machines sell in the millions, as Apple hopes, the revenues and profits could be substantial.
Apple engineers have also rehabilitated the much ridiculed Newton, an electronic note pad that John Sculley championed before being ousted from the company. The Newton--now getting raves in the computer press--can read both printing and cursive writing with much better accuracy. It can double as a Filofax/address book, an Internet terminal, and an E-mail and fax machine. Markkula crows: "Everybody's talking about building $500 Internet terminals. Well, the Newton is a portable one that's here and now."
Finally, Apple has big plans to use DVD, the industry's next generation CD that can hold vast amounts of any kind of digital data--video, computer code, audio, and graphics. The technology will finally bring conventional video to computers. Says David Nagel, Apple's R&D chief: "Apple is moving into the consumer electronics space. We think DVD can be the bridge to take us there."
WHO WILL PUT THE BITE BACK INTO APPLE? Apple doesn't need to be reengineered; it needs to be engineered. --Guy Kawasaki, Apple Fellow Regardless of whether Apple gets acquired or not, what it needs now, more than anything, is a little discipline. That is to say, it must start behaving like a business. Armchair analyst Bill Gates agrees. He told FORTUNE: "Business professors love to talk about strategy, and as Apple has declined, the basic criticism seems to be that Apple's strategy of doing a unique hardware/software combination was doomed to fail. I disagree. Like all strategies, this one fails if you execute poorly. But the strategy can work if Apple picks its markets and renews the innovation in the Macintosh."
To Spindler's and Markkula's credit, Apple seems to be moving in this direction, despite the distractions of the merger negotiations. One of Spindler's first actions after announcing the $69 million loss in January was to promote Satjiv Chahil, a marketing whiz who runs Apple's multimedia and entertainment operations, to senior vice president in charge of corporate marketing and Apple's Internet strategy.
Chahil is masterminding an approach to marketing and operations that will focus Apple on its strongest and most profitable markets--multimedia home computing, content creators in business, and education. The idea is to concentrate on selling high-end machines, where the profits are--to become the BMW of the computer industry rather than, say, a Toyota. Says Chahil: "Our customers are intelligent people who care about the aesthetics of their computing experience. They are willing to pay a little more for quality, and we plan to deliver that.'' The company won't cease making low-end Macs but increasingly will cede that territory to clone makers as more come onboard this year.
A 45-year-old native of Amritsar, India, who sports color-coordinated turbans, Chahil wants to trumpet the Mac's ability to serve as the ideal Internet computer. Says Chahil: "We've been too quiet about how much we already are a big part of the Internet phenomenon. As the Internet becomes more of a platform for multimedia expression, there's no reason Apple and the Mac shouldn't be leading rather than following."
If Apple winds up merging with Sun, it would find itself reporting to a stern taskmaster in CEO Scott McNealy. Unlike Spindler, McNealy is an operations guy. He's also notoriously cheap, so Apple, which is famously extravagant, might have to cut down on custom-embroidered denim jackets and other promotional freebies.
As far as technology goes, the companies are quite complementary. Sun historically focused on selling networks of high-powered workstations for serious number crunchers, software developers, and design engineers. In recent years the company has been selling file servers that make up the backbones of corporate data networks, as well as tens of thousands of Internet servers. But Sun has never sold directly to consumers.
The common denominator between the two companies is the Internet, although each is approaching that market from a different direction. Apple hopes to take advantage of its skills at making computers and software effortless to use, while Sun is developing software and hardware to make the Internet a hardier and richer computing environment. It's hottest new product--a programming language called Java--is the latest sensation on the Internet because it makes it possible for downloaded programs and data to be used on any computer, no matter what brand it is. Apple is a big fan because Java promises to reduce the Mac's isolation, and would like to help Sun make it an Internet standard.
Sun would probably have more success at fixing Apple's gravest and most persistent weaknesses--its inability to manage innovation and execute its strategies. But what really draws the companies together is their mutual antipathy for Microsoft. If anything, McNealy is an even sterner critic. Says he: "I've been to China and to the former Soviet Union, and I've seen what controlled economies are like. They suck. If Microsoft dominates the computer business the way Bill would like to, our industry would suck too."
For Spindler, the game appears to be winding down. Markkula, who recruited him from Intel and is a close friend, clearly feels torn between loyalty and business reality. He has taken to saying things like: "He's a tremendous intellectual resource for this company. Nobody could replace him. I've supported him and will continue to support him. We may be forced to change the way Michael participates in the company. If something like that does happen, I hope that we don't lose Michael's contributions or participation." Ask Spindler what he thinks of turning over responsibility for day-to-day operations to someone else, and he shrugs, "Sure, that would probably be a good thing."
Even if Spindler quits or is fired, and even if a deal with Sun or Philips falls through, his strategy to build a last-ditch anti-Microsoft coalition will live on. Chairman Markkula will see to that. Says he: "There is a sense of urgency for our mission to find partners. The longer a viable alternative to Microsoft can't be articulated, the more they get along and the farther we fall behind."
What does Steve Jobs say about the plight of the company he started and the strategy of the man who wrote its first business plan, put up the first cash, and ultimately cast him out? Not much: "To me it's simple,'' he says. "If I were running Apple, I would milk the Macintosh for all it's worth--and get busy on the next great thing. The PC wars are over. Done. Microsoft won a long time ago."
REPORTER ASSOCIATE Michael H. Martin