The iPod/iTunes “halo effect” is paying off for Apple. Sales of desktops and laptops have risen--by 26 percent. Apple’s iPod and iTunes Music Store sales also added 20 percent in top-line revenue in 2004. For the first quarter, ended December 30, 2004, Apple reported its highest quarterly revenue and profits in the company’s history: Revenue for the quarter was $3.49 billion, up 74 percent from a year ago. Gross margin for the quarter was 28.5 percent, up from 26.7 percent a year ago. Apple shipped 1,046,000 Macintosh® units and 4,580,000 iPods during the quarter, representing a 26 percent increase in CPU units and a 525 percent increase in iPods over the same quarter last year.

Apple is now an even more serious contender for the much coveted consumer computing/entertainment/edutainment market. The Mac mini launch was timed and orchestrated brilliantly to take advantage of the post-holiday season iPod halo effect. It’s not just the price point--low enough to get consumers’ attention without giving away all the margin--it’s the positioning, the form factor, the gestalt. Let’s face it, it’s the Apple brand experience. The iPod has made portable music a reality for over 10 million non-geeks. And, in addition to making it easy and economical for Windows users to convert by just plugging in their existing peripherals, the Mac mini makes the idea of a home entertainment computer a reality as well. Why would I struggle with Windows when I can have an intuitive, easy-to-use media center that lets me organize my photos, my music, and, soon, my movies?

My prediction is that Apple will gain major traction in the home computing market in 2005. Whether consumers buy the Mac mini and reuse displays and keyboards they have lying around, or decide to up-sell themselves to an Apple media center with more memory and easy extensibility (without having to pry the case open), the iPod halo effect will result in greater market share in the home computing market for Apple and less for Microsoft.

The consumer market is critical for Microsoft and critical for HP. That’s why HP is hedging its bets and reselling iPods and--presumably, soon--other Apple gear. HP doesn’t really care whether you use the Microsoft or Apple OS as long as you use HP ink to print your grandkids’ pictures. IBM has walked away from the consumer/home computing market. Sun never tried to gain entry. (Was this perhaps a strategic blunder on Sun’s part? Hold that thought!) Consumer/home computing/entertainment isn’t just an important market segment generating billions per year in hardware and software sales.

Consumer computing is also significant because, as Pat Kerpan, the CTO of Borland, continues to remind us, the consumer platforms of today are the corporate computing platforms of tomorrow. Consumer products spawn commodity pricing and better user interfaces. Corporate computing users get annoyed when they have to switch from elegance and seamlessness at home or on the road to clunkiness in the office. That’s exactly why Microsoft can’t afford to lose the consumer market to Apple (or anyone else).

What’s Apple’s secret sauce? Besides Apple’s uncomplicated and enjoyable user experience, there are three factors in Apple’s winning equation: mobility, information portability, and control. Steve Jobs did what any real strategic planner does well: He watched what customers actually wanted, and he packaged the solution seductively. In my book, The Customer Revolution, published in 2001, I described the now-obvious customer requirements that Napster users were demonstrating. The requirements were (and are):

* I want to download music by the track.
* I want to make my own mixes.
* I want to share my mixes and my favorites with my friends (and the public).
* I want to take them wherever I go.

These are the customer requirements that Steve used to craft the iTunes Music Store business model. He paid up-front royalties to the RIAA to license music legally, and he offered consumers a legal and convenient way to buy and share music and to digitize and organize the music they already owned. It worked. Apple invented the business model that the music industry had been unable to produce, even though it was right in front of their collective faces. The results are:

* Apple has sold over 10 million iPods to date.

* In January 2004, the iPod family had a market share of 31 percent, flash memory-based music players had 62 percent, and other hard disk drive-based players made up 7 percent.

* By January 2005, the iPods had a 65 percent market share, flash memory-based players had 29 percent, and other hard disk drive-based players had just 6 percent. Apple attributes a significant amount of the improvement to the iPod mini.

* The iTunes Music Store has sold 250 million songs to date across 15 countries--that’s $250 million--with a current run rate of 1.25 million songs per day and a projected total of $1.25 billion in 2005, based on the current run rate. That’s also 70 percent of the current digital music market. The iTunes Music Store just turned profitable in the quarter ending December 2004. Now that sales volumes are high enough to pay back the royalty streams, we expect iTunes Music Store sales to generate a modest but steady profit. (iTunes Music Store profits will remain modest because Steve J knows that music buyers won’t put up with corporate fat cats putting much profit in their pockets. Consumers react to high margins on music the same way they react to high margins on printing supplies--it’s unfair, it’s corporate greed, hell no, we won’t go!)

* Apple has seen a halo effect of 40 percent--that’s the increase in “new to Mac” sales that Apple’s management attributes to the popularity of the iPod and the renewed interest in Apple’s brand.

* Apple now has a good opportunity to gain a hefty market share in the personal/home computer/entertainment market.

* We expect an additional halo effect as users of iPods, iMacs, G5s, and Mac minis at home begin to switch over to the Mac OS on the road and at the office.

WHAT ARE THE LESSONS IN APPLE’S SUCCESS FOR THE REST OF US?

* Watch what early adopters are doing. Run around in front of their parade and give them what they want.

* Don’t let business models get in your way. Invent a new business model optimized around customers’ real requirements and moments of truth. (Netflix also did a good job of this--see my report on Netflix and moments of truth.)

* Make mobility and portability the center of your product and service designs.

* Give customers personal control.

WHO DOESN’T GET IT?

The music industry is all abuzz as more and more music aggregators are beginning to compete with Apple’s iTunes Music Store using Microsoft’s digital rights management (DRM) system, which lets customers pay for and download music and store it on a variety of devices. However, the license has to be rechecked each month to make sure it’s still in force. Although this rights management approach might work for business publishers, consumer music customers aren’t happy with this idea at all. Blogger Brad Hill’s reaction to the new Napster to Go service, based on Microsoft’s DRM, is:

“My ten bucks a month is well spent for desktop access to unlimited Napster downloads. I can make them portable by the arduous process of converting them to MP3 (an unauthorized and difficult process). I can also purchase individual tracks for 99 cents, then burn or convert them (authorized). But don’t charge me extra every month for the ‘privilege’ of moving my rented music off the desktop. Get over yourselves and make the music portable to start with.”

WHAT’S YOUR IPOD STRATEGY?

I’ve been a long-time reader of Mark Anderson’s Strategic News Service (SNS--a members only weekly newsletter--www.stratnews.com). In his recent report entitled “What’s Wrong with our Best Companies” (published January 25, 2005), Anderson said:

“What to do if you are one of the Afflicted? [Once great companies that are no longer growing at 20% per year]…. I’d take a cue from Steve Jobs. You don’t need fifteen new divisions, you only need one, but it has to work. And, if at all possible, it has to benefit from, and contribute to, the success of your other one or two big products. Hate the word ‘synergy?’ Try telling it to Jobs. Inventing this isn’t easy, although often someone else, as in his case, has already done the basic inventions (online music, MP3 etc. players). You don’t want 12 warring divisions, each committing to 15% earnings growth (the old Motorola). You want one iPod.”

So what’s the equivalent of the iPod for any company faced with a broad product line and a maturing market? I found myself thinking about Sun Microsystems’ current dilemma and comparing the iPod brand excitement to the excitement that surrounded Java in the early days. Java absolutely revitalized the Sun brand. And Sun did a good job of nurturing early adopters’ enthusiasm.

Lew Tucker built a vibrant Web community around Java--still one of the best examples of online community creation. But Sun hasn’t managed to leverage Java to sell hardware for many reasons, including Microsoft’s treachery, IBM’s adoption of Linux and Java, and the commoditization of the hardware platforms. But when I think about the design center of portability, mobility, and personal control, I think of mobile phones--about gaming and messaging on mobile phones, and about the fact that Java is one of the two preferred development environments for mobile phones. How can Sun create a brand experience for consumers and developers that will drive sales of Sun Tone? Should Jonathan Schwartz spend some time with Steve Jobs?