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Cover Story: Inside the Channel's Battle With Apple

Although retail-oriented companies are among the most acutely impacted today by Apple&'s current business practices, the fear among many involved in the Apple market is that the manufacturer&'s ever-expanding ambitions may put it on a collision course with all sorts of partners, including vertical-market specialists, consultants and systems-integrators.

Some days, Andy Gold starts his morning thinking nostalgically about 13045 West Alameda Blvd., in Lakewood, Colo. That's the setting where he operated The Neighborhood Computer Store for 24 years. Now the 2,400-square-foot facility is a tai kwan do training center. And Gold? He's closer to Denver, in a 900-square-foot house on Wadsworth Boulevard. Though he's literally only a few minutes, depending on traffic, from his former address, Gold is figuratively years away from where he stood as a proud reseller of Apple's computers. Sadly, it seems aptly fitting for a business that has lost 70 percent of its revenue in three years.

Suffice to say, Gold never dreamed he would wind up this way. During the years, he survived everything imaginable from Apple: regime overthrows, product cancellations, program changes, corporate restructurings and strategy overhauls, just to name a few scenarios. The Neighborhood Computer Store took them all in stride--all except for the opening of Apple's retail stores, which began in May 2001.

In the three years since the first retail store opened in Colorado, and the two since the second store followed, The Neighborhood Computer Store has seen its business collapse to the point where Gold, one of the longest surviving Apple resellers in the country, foresees a day when he'll have to close his door for good.

He's not alone. Thomas Armes, owner of Elite Computers, of Cupertino, Calif., has already shuttered his five Apple stores. Others, including Kent Leung, owner of MacMedia, of Chester, N.Y., have simply stopped selling Apple's products. Leung's company got out of that business a year ago, following years of dwindling margins and Mac sales.

The fate of these and other Apple partners begs an interesting question: At a time when Apple is on the rise, why are the Apple businesses of so many Apple partners falling down? The answer, some believe, is a master plan by Apple to control as much of the Apple market as possible. That includes everything from where customers large and small buy products, their experiences with the Apple brand, how they are serviced and the types of solutions they eventually deploy.

This is the story of what has happened to several Apple partners and why their experiences may spell trouble for others. Although retail-oriented companies are among the most acutely impacted today by Apple's current business practices, the fear among many involved in the Apple market is that the manufacturer's ever-expanding ambitions may put it on a collision course with all sorts of partners, including vertical-market specialists, consultants and systems-integrators.

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Steve Jobs can smile over recent success, but Apple's practices are killing loyal resellers.

Already, companies including Precision Consulting of Fairfield, Conn., are finding themselves colliding with Apple more frequently. Once a 20-plus person strong consultancy, Precision Consulting is down to just six people, though not for lack of success. The company was key in helping Apple successfully deploy some 38,000 computers for the state of Maine. However, despite helping with follow-up deals involving other institutional organizations, Adam Schechter, CEO and founder of Precision Consulting, finds himself at odds with Apple's salesforce more frequently.

"It sort of feels like Apple has changed its business model, and we haven't been told [officially]," he says. While Schechter does no retail whatsoever, he feels for his brethren who rely on foot traffic and wonders what's to become of companies like his--a.k.a. fellow members of the Apple Consultants Network. "I do think the retailers are canaries in tunnel, and that other Apple third parties should be concerned," Schechter says.


The Lesson of the Canaries

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But of all the complaints Apple resellers have, two stand out. They involve pricing and availability of product. Simply put, Apple resellers cannot consistently secure the products they need to compete with Apple stores, nor can they get them at reasonable prices when they do get allocation. "My chances of survival are slim to none," Gold says. "Not unless Apple is willing to change its ways when it comes to pricing and allocation."

For Elite Computers' Armes, the turn of events couldn't be more heart-breaking. In one sense, no Apple partner could claim to be as close to Apple as Armes' company was--it was situated directly across the street from Apple's worldwide headquarters in Cupertino. The one-time liquor store and deli in the heart of Silicon Valley turned out to be the perfect spot to base an Apple-oriented business. Ultimately, Armes' company grew to five stores and 75 employees. But he was especially proud of the store he had established in Cupertino, which served as his headquarters until he shut it down in May 2003. Shutting that store particularly irked him. Not only had he essentially lost his entire business, which three times made Inc. magazine's list of the 500 fastest-growing private enterprises in North America and topped out at $20 million in sales in 2002, but he also lost what amounted to a second home. Armes spent $15,000 on designer glass shelves to display Apple gear. He cultivated corporate accounts and developed a team of top technologists, he says. He also spent $25,000 on signage.

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While Apple opens more stores, resellers including Thomas Armes close theirs. Armes once owned five stores that sold only Apple computers. They've since gone out of business.

Just as he suspects that Apple stole some of his business, so, too, does Armes believe that someone at Apple was behind the removal of his signs. Not long after Armes draped a "going out of business" banner over the store, his signs went missing. Armes called the local authorities and told them he suspected that someone at Apple ordered his signs removed, but couldn't prove anything. After applying some pressure, Armes says Apple arranged for the return of the property its lawyers said Apple never had.

Like Gold, Armes never figured his years of Apple reselling would wind up this way. After all, he did much of what experts advise companies like his do. He emphasized value add, for example, and built a professional services business that was on track to account for 40 percent of sales. He also investing in marketing.

A self-starter, Armes began selling Macs out of the newspaper in the late 1980s when he noticed Apple products listed for sale by a small number of sellers with the same phone numbers. He quickly realized that some sellers were Apple employees who bought products with their discount and hoped to flip them for a quick buck. By tracking who sold what and for how much, Armes figured out the true market value of the goods. Eventually, he started a business on his mother's kitchen room table reselling used equipment. As the business expanded, he added leaves to the table. When he ran out of leaves, he added tables. When he got to five, he opened his first office in Cupertino in June 1989.

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Armes' business thrived. One reason: creative marketing. When Apple unveiled the iMac in May 1998, for example, he hosted an event at midnight and kept his store open so shoppers could be the first on the block to buy one of the new breakthrough machines. The party attracted local media, whose coverage of Elite Computers helped put the company on the local retail map.

In March 2001, Armes thought he would try the same trick and threw another party for the arrival of the long-awaited Apple OS X. He secured 10 search lights and had the software driven to the store in a caravan of Hummer SUVs at the stroke of midnight. More than 800 people showed up. The highlight of the evening was when Apple co-founder Steve Wozniak himself showed up and posed for pictures. "It was one of the best days that I can remember," Armes says.

His joy, however, was short-lived. Less than two months later, Apple opened its first two retail stores, one in Glendale, Calif., and one in McLean, Va. The plan was to roll out 25 during the first wave and then fill in the white space in major cities and in key suburbs and secondary markets.

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Thus far, the stores have been a success. In fiscal 2004 ended Sept. 25, 2004, Apple's retail stores racked up $1.2 billion in revenue, almost double what they did in the same period the year before. What's more, they posted $39 million in operating income compared with a loss of $5 million the year before. As of Sept. 25, 2004, the company had 86 stores, up from 65 one year before. Same-store sales are up on average 36 percent, year-over-year.

Today, retail accounts for 14.3 percent of Apple's overall revenue. And it's growing as a percentage of overall business. In contrast, the percent of business Apple does through third parties is shrinking, according to Apple. Notes Roger Kay, a PC market analyst at IDC: "I also see Apple shifting its mix of channels to more direct, both store and online."

For smaller, authorized resellers, the Apple stores have turned out to be the bane of their existence. One big reason: Apple stores always seem to have products when third parties don't. Armes, for example, immediately saw his fortunes decline after Apple opened its store in Emeryville, Calif. Before long, Armes found it impossible to secure products in any predictable manner. When Apple announced a new flat-panel display for the iMac, for example, more than 500 customers put their names on a waiting list with Armes' company. Many even prepaid with the hopes that their flat panels would soon come in. But the displays never reached Armes' stores. When word got out that Apple stores had inventory, 95 percent of his customers withdrew their orders.

It's the same story at L.A.-based Praxis Computing. Praxis, which did significant business in media and entertainment markets, enjoyed a number of years as an Apple authorized reseller. But when the Apple stores opened, support from the manufacturer waned, and Praxis wound up dropping the very first vendor partner it ever had. "[Apple is] not a channel-friendly company, never has been and, with that culture, they never will be," says Praxis sales vice president Jennifer Roback.

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In three years, Apple has opened enough retail stores so that half of America lives within 15 minutes of one of them.

For his part, Armes thought he could salvage things with one more marketing event, which he planned for the rollout of OS X version 10.2, code-named Jaguar, in July 2002. Hoping this event would be as big as his previous one, he ordered 1,000 cookies cut in the shape of an "X" and painted in the colors of the cagey cat. He also arranged for a caravan of Jaguar automobiles to deliver the software at midnight. But try as he did, Armes couldn't re-create the magic. When the Jags drove up, just 75 or so people huddled in his store. Armes suspected business elsewhere was faring better, so he hopped in a car and drove to Apple's store at the Valley Fair Mall in nearby Santa Clara, Calif. Though well into the night, the store was still packed, with a line just to get in. Shocked and saddened, Armes returned to his store, picked up his colleague, Michelle Souza, and drove to the Palo Alto Apple Store on University Avenue. Armes estimates there was hundreds of people lined up at 1:30 a.m. There was a 30-minute wait just to get in to the store. Souza spied several Elite customers, whom, she was told, had been invited via e-mail by Apple to attend the event. "It was devastating," she says.

Then and there, Armes knew his fate was sealed. With his margins down to as low as just 6 percent on certain hardware, and Apple offering goods for sale on certain products for 10 percent less than what he could buy products for, Armes realized, "There was no way to survive as a business, no matter what I did." With tears in their eyes, the duo drove home in near silence.

Today, Santos is the driver behind reseller lawsuits against Apple. He has done the most research on Apple's business and is passionate about getting justice--if not revenge.

Unlike others who have succumbed to pressure put on by Apple's own stores, though, MACadam continues to cling to its spot off Union Square in downtown San Francisco, just blocks from the closest Apple Store. Some days, Santos sells gray-market goods. Other days, he sells equipment at cost purchased from nearby authorized Apple resellers. In addition, he, Armes and others spend a great deal of their time amassing information that they can use in their lawsuit against Apple. Their principle method for gathering information is a site they established on the Web, www.tellonapple.org, which, in a few short months has attracted more than 2 million hits (see "Taking a Bite Out of Apple,"). Visitors including current and former Apple resellers have provided a treasure trove of information about Apple's tactics both in the field and at the corporate level.

All told, the information gathered paints an ugly--albeit incomplete--picture. Santos is convinced that Apple is skimping on warranties, callously lying to resellers about the true aim of its retail stores, manipulating markets and bullying resellers into signing renewal contracts that dramatically reduce their power.

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One of Apple's most outspoken critics, MACadam Computers owner Tom Santos estimates he has sold 25,000 Macintoshes on behalf of Apple in 15 years. Though no longer authorized, Santos still supports Macs while simultaneously suing Apple.

Not all partners, however, agree the stores have been such a bad thing. That includes Michael Oh, owner of Tech Superpowers, in Boston. He recalls touring the first Apple Store in Boston at the North Shore Mall shortly before its opening in 2001. Like others, Oh worried the store would ruin his business. But he quickly realized that he was insulated from the damaging effects of the store because he catered to business customers who rarely stepped foot into retail stores. "It's not that I don't feel sorry for those who have been impacted--I do. But my business is focused on other segments, so I don't feel the effects," Oh says.

Oh might feel differently if an Apple Store were to encroach upon his business, which is quite possible given Apple's new direction.

Crystal Clear
If there were ever any doubt as to Apple's intentions before, there can be little now. In the company's filings with the SEC, Apple has disclosed its strategy for the seven "high-profile" Apple stores that it has developed in New York, Los Angeles, Chicago, San Francisco, London and Tokyo and Osaka, Japan.

"These high-profile stores are larger than the Company's typical retail stores and were designed to further promote brand awareness and provide a venue for certain corporate sales and marketing activities, including corporate briefings," the company's year-end 10-K states.

On top of this are additional pressures resellers are expected to feel from the new Apple mini stores. Unveiled in October, these stores promise to do for smaller secondary and tertiary markets what the bigger stores did for tier one markets. Though smaller in scale than their counterparts, the mini stores feature the now familiar Apple Genius Bar, plus offer on-site repair and other services. At least six stores are open now, and at least a half-dozen more are on the way. That put Apple on a path to have as many as 100 retail locations open by the end of 2004.

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Apple's flagship SOHO store in Manhattan in one of eight that serves New York.

What all this means, simply, is this: Those partners who have felt insulated from Apple's encroaching ways because they don't cater to foot traffic or compete in areas outside Apple's perceived sphere of influence are soon going to have to come to grips with the fact that Apple is planning on directly engaging customers in more ways and in more places than ever before. Couple that with the fact that Apple is increasing its service business--it was up 13 percent year-over-year in fiscal 2004--and it's no wonder why more partners feel pinched by Apple's strategies and policies.

Hoping to make a buck servicing out-of-warranty Apple products, for example? Think different. Apple has significantly increased the sale of AppleCare Protection Plan extended maintenance and support services, cutting off partners from potentially millions of service dollars. The same is true for those hoping to sell products. Consider Apple's Price Matching plan for business customers, which simply states: "If you see any Apple hardware or software for less at another store, the Apple Store will match the price." These and other practices are frustrating even staunch allies.

"It's a challenge when your biggest supplier is your competitor," says David Lerner, co-founder of TekServe, a New York City-based reseller and service specialist that caters to some of Apple's largest media clients. "When we fight over discounting to make the same sale, that to me is not efficient use of resources."

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