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At the date of this writing, Apple is holding at 3% market share. That number worries many people. It would be better for Apple and better for Mac users if they could increase this market share. With an increase in the number of computers sold, Apple could lower the price per unit. Market share is important, but if Mac users can continue to pay the premium price we pay for our premium computers, it should not affect the company's financial health.

When you analyze a company, there are a few things that you need to look at. Pay close attention to the characteristics of the industry. What is the competition like? In the computer industry, it is fierce. What are the gross margins prevalent in the industry? In the computer industry, they are tight (see Note 1). Aside from industry concerns, you need to look at the balance sheet of the company. Is the company leveraged (see Note 2)? Many manufacturers have high capital requirements and leverage themselves in the hope it will increase their ability to compete. Since the computer industry is rapidly changing, many computer makers are leveraged.

Besides the financial analysis, companies must be viewed in terms of market position. The following simple example illustrates this concept.

The low cost leader versus the high cost leader:

The low cost leader competes on price only. When Ivory first started selling soap, the soap market was young. Most producers made foul smelling yellow lye soap. Ivory offered a clean alternative. One day, the company produced by accident a batch of soap whipped with too much air, so much air that the soap floated on water. The owners liked the idea. They had a gimmick and more air in the soap meant that they saved money on ingredients. They marketed this as 99.99% pure soap, a stark contrast to the yellow soap they competed against at the time. They were the quality leader. Their market dominance was soon threatened with the introduction of Dove and Dial. Dove had moisturizers that softened the skin. Dial had an anti-bacterial agent that killed germs. Both soaps were sold at a premium because each one in their particular niche represented the highest of quality.

Ivory had a decision to make. Do we add moisturizer or anti-bacterial agent and compete with these new competitors on quality? How will this affect our market position? Ivory chose not to change its soap. It chose to change its market position. Ivory could no longer call itself the high quality leader. They were selling plain soap whipped with air in comparison to Dove and Dial's quality-added products. Where in the past Ivory was way above its competitors in quality, now it offered nothing to match Dove's moisturizer or Dial's anti-bacterial agent. Ivory chose to become the value or low cost leader.

The value leader attempts to offer the best product at the cheapest price. They do not compete on quality. They compete on value for the buck. If you ever happen to see an Ivory commercial today, you may notice that the pitch is always about price. Ivory is the least expensive branded-soap on the market. The next time you are in a store, compare Ivory's price with Dove's price, big difference. On the other hand, the next time you see a Dove commercial, notice that they don't mention price. They stress quality. Dove's advertisements talk about how good the product is for your skin. Most people expect to pay more for quality. Ivory has made a tremendous success of their strategy. They sell more soap than Dove or Dial but at a cheaper price. Dove and Dial are also successful. They sell less soap than Ivory but at a premium.

Where does Apple fit into this? I would suggest that Apple is the quality leader. They do not compete on price. Companies tend to compete on price when they are unable to compete in any other category. With that in mind, Apple charges more for its products and its users expect to receive high quality or at least perceived high quality. This puts Apple in a niche market sector. They do not market their product on the same scale as Windows clone makers.

Niche producers do not market to just anybody. They push for a unique identity in a market crowded with generic look-a-likes. Apple has never been the majority leader in the industry. In the 1970's, Radio Shack and Tandy sold the most home computers. In the 1980's, Commodore sold the most home computers. The 1990's saw the rise of Wintel and the cloners. But through it all, Apple's sales have increased every year and its installed base has continued to grow. This is true even though Apple's market share has fallen a few points in the last few years.

How can that be? Simple, the size of the pie has grown. If you were selling computers in 1984 and had 30% of the home market under your control, you would be selling to far fewer people than you would be in 1994 with 5% of the market. That is because the number people buying home computers was substantially smaller in 1984 than in 1994. Furthermore, the companies around in 1984 would not have the capacity to support a 1994-size market. With that in mind, let me tie it all together.

Apple has high gross margins (see note 1). Some years it has been as high as 35%. That means that they are making products efficiently and cover those costs by selling at a premium. Apple has consistently shown a net profit for the last few years. That means that even in the face of heavy competition and constant reinvestment in research and development, the company is still coming out ahead. Apple is modern but not leveraged. In other words, they have the power of leverage without any debt. They currently have a 4 billion dollar cash reserve. Finally, Apple has an established niche. They do not compete with Wintel on price. They compete by using product differentiation. They compete by offering high quality.

The Windows world competes primarily on price with notable exceptions like Alienware or Sony. Clone makers experience stiff competition and have tight gross margins. They are highly leveraged and produce a lot of units. They may out produce Apple but they certainly do not net their owners more money than Apple. How can this be? Keep reading.

Let's do a hypothetical scenario. The figures I am using are for demonstration purposes only and are used to approximate Apple's financial performance.

Suppose Brand X Windows cloner has 15% of the home computer market. They produce 20 million computers a year with an 11% gross margin. Their annual sales revenue for the year is around 20 billion dollars, which would put their gross profit at 2.2 billion dollars (20 billion X 11%). Let's assume that competition was considerable last year. Cut-throat cloners got into a price war. The company had to spend a lot of money on advertisement and customer service. Brand X spent 2.1 billion dollars on general and administrative expenses, and debt maintenance due to leverage. This brings their net profit (see Note 3) down to a mere 100 million dollars.

Let's look at Apple. Suppose in the same year as Brand X's 100 million dollar profit, Apple sold 4 million computers with annual revenues of around 6.4 billion dollars. Apple's computers are sold at a higher price than Brand X's and so they take in more per unit sold. With Apple's higher gross margin of 25%, the company's gross profit was 1.6 billion. Apple spent a lot of money on advertising, opened up many new Apple Stores, and introduced several new form factors. All that contributed to general and administrative expenses of 1.5 billion dollars. This brings their net profit to a mere 100 million dollars.

From the fictional example above, you can see that even with the different gross margins and market position of each company, the net profits were about the same. Brand X uses economies of scale and less expensive computer components to sell five times more computers than Apple yet ends up with about the same net profit.

Market share is definitely important but it is not fatal for Apple. More market share is better, no question. Each company in a competitive market must find its own niche. For Apple, it is the high cost, quality leader. Hopefully, Apple will increase its market share. More volume in sales translates into less expensive Macs for everybody.

Note 1:
Gross profit is sales revenue minus the cost of the goods sold. Gross margin is gross profit expressed as a percentage. Gross margin is total sales revenue minus the cost of goods sold divided by total sales revenue. If I told you that company B's gross margin is 35%, I am saying that for every 1 dollar in sales revenue, 35 cents is gross profit. The cost of goods sold is equal to the manufacturing costs of the products sold. It is an important indication of the efficiency of a manufacturing concern. Apple has the highest gross margins in the industry.

Note 2:
Leverage has to do with a company's debt level. High leverage indicates a higher dept level. The reason it is called leverage is because the company has positioned itself for growth by taking on debt to increase the company's capital. With more capital, i.e., better equipment, etcetera, a company is better able to take advantage of high demand in a good economy. However, that same company is stuck with the fixed cost of debt maintenance, and will suffer more than a non-leveraged company with lower fixed costs if the economy turns bad. Apple has a 4 billion dollar cash reserve and very little debt.

Note 3:
Net income (or net profit) equals total sales revenue minus all the costs incurred to earn the total sales revenue. Simply put, net income equals sales revenue minus costs.