What's Really Driving Apple's Recovery

If you believe the common wisdom in the business press, Apple Computer Inc. was saved from being turned into cider by the return of cofounder Steve Jobs and the advent of a new product, the hot-selling iMac.

Truth be told, that's only half the story. It's a fact that in 1996-97, the Cupertino, Calif.-based computer maker lost nearly $1.9 billion. It's also true that last year a 40% smaller Apple -- a pared-down core of its 1996 self -- earned $309 million, with the iMac representing about one-third of total Macintosh sales during the latest quarter.

But beneath all of the iMac's new colors, what's really driving Apple's resurgence is a whole new strategy for manufacturing and supply-chain management conceived by a former Compaq Computer Corp. executive.

That's not to say that Jobs, the legendary industry visionary, doesn't deserve his share of the credit for Apple turning in five consecutive profitable quarters.

Having taken over in mid-1997, Jobs accelerated the company's restructuring. On his watch, the company shed 15 of 19 products including printers and the slow-selling Newton personal digital assistant, closed plants, and laid off thousands of employees.

Jobs instilled new confidence among investors, with Apple shares rebounding from a low of $12.75 a year ago to $39 in February. He even had the audacity to sell Apple stock to archenemy Microsoft Corp. in exchange for a cash infusion of $150 million.

Finally, Jobs enlisted a new executive team, paying signing bonuses where needed to get the best people to keep an already tarnished Apple from spoiling altogether.

Of the seven-person executive team, only CFO Fred Anderson joined the company before 1997.

Perhaps the most important of those executives Jobs brought on board was Timothy D. Cook, whom Jobs lured away from industry leader Compaq with a $500,000 signing bonus and a $400,000 base salary to become Apple's senior vice president for worldwide operations.

At Compaq, Cook was vice president in charge of corporate materials. A computer-industry veteran, Cook also worked for a major computer reseller and spent a dozen years at IBM Corp., where he was head of North American fulfillment.

Remaking Apple's Bloated Supply Chain

Cook has been religious in his fervor and dedication to remake Apple's lazy, bloated supply chain and wring out inefficiencies in its production processes. Aiming at twin goals of slashing inventories to the bone and cutting order-to-delivery times, Cook has pushed Apple as if there were no floor under the accelerator pedal.

"I'm really big on asset velocity," he says, referring to how fast a company can turn its inventory. "For a PC manufacturer, that's perhaps the most key metric. In the business we're in, the product gets stale as fast as milk."

Historically, one of Apple's greatest weaknesses has been its supply chain. Managers did a poor job of matching production to demand. One reason for the mismatch was that sales forecasts often were way off.

"Apple's problem was a supply-chain management problem," says Tom Grace, senior manufacturing analyst at AMR Research Inc., an IT research firm in Boston. "They always had shaky forecasting ability."

As a result, the company either missed potential sales because it couldn't fulfill demand or piled up huge excess inventory that later had to be written off at a crippling cost.

For years the company struggled with the twin demons of insufficient supply and excess inventory. Most of Apple's huge losses, in fact, can be attributed to sloppy inventory management, Cook says.

"The company lost $1 billion in 1997 mainly as a result of asset problems, such as being too long on inventory," he says. "We had five weeks of inventory in the plants, and we were turning inventory 10 times a year."

In general, other manufacturers in the industry were turning inventory about 10 to 12 times, although Dell Computer Corp. was at 40 and Gateway Inc. somewhere in the middle.

"We set our eyes on beating Dell," Cook says. "We're looking at how to leapfrog them and be better."

Cook contends that Apple not only has caught Dell in the last year, but bettered the direct-sales PC leader in inventory speed in the latest quarter. The company, whose latest marketing slogan is "Think Different," finished December with just two days' worth of inventory in its plants, compared with seven days' worth for Dell.

"We've gone from 10 turns to 180 turns," Cook says. "That's a direct metric of your supply chain. We've now gone past Dell. In a year or two, I'd prefer to be able to talk inventories in terms of hours, not days."

A spokesperson at Austin-based Dell confirmed that the PC giant currently is turning inventory 52 times a year, or roughly every seven days.

The numbers bear out Apple's steady improvement in this area. In fiscal 1997 Apple had $437 million tied up in inventory, or a full month's supply on the books. But by the close of fiscal 1998 last Sept. 25, the company had slashed inventory levels to just six days, or $78 million worth -- an 80% reduction. A further reduction down to $25 million worth -- for a total reduction of 94% -- was achieved in the quarter ended in December.

"And we're not letting up," Cook promises. "I consider any internal inventory to be a defect."

Since Christmas, Apple has begun using SAP AG's R/3 system, which has helped speed the filling of custom orders. Cook is pushing to chop the custom-order-to-delivery time from 10 to five days.

Yet another essential link in Cook's supply-chain scheme is the shift of most manufacturing and assembly work to contract manufacturers, which tend to be more efficient at various steps in the process than Apple.

"There are many very good companies with economies of scale in the board-manufacturing business," Cook says. "We're going to leverage outside partners for that."

Last summer, Apple formed a partnership with a Singapore firm to build computer boards at sites closer to each of Apple's assembly plants, a move other PC manufacturers are making.

"A lot of suppliers in the PC industry are building replenishment plants right next to the OEMs' plants," observes AMR's Grace.

To further streamline its supply network, Apple announced on Feb. 1 plans to discontinue building the iMac at its Elk Grove, Calif., plant, shifting production to LG Electronics, a Korean contract manufacturer that has plants in Seoul and Mexico. As a result, Apple will shed up to 350 workers, including 25 permanent employees and 300 temps at the California plant, which will continue to produce custom-order iMacs and the higher-end G3 computers.

LG also will take over production of iMac units from Apple's plants in Ireland and Singapore, according to a company spokesperson. The reason? "We are trying to improve our inventory management."

Representing one of Apple's most egregious supply-chain anomalies, parts produced at an Apple supplier in Asia were shipped to the Apple plant in Ireland and later shipped back to Asia.

"It was not a bright supply chain," Cook admits.

Now, with a partner in Taiwan, the assembly is fully handled in Asia.

"We've achieved a dramatic reduction in cycle time and a corresponding reduction in cost, plus we're able to get to market faster," he adds.

Apple also has outsourced much of its logistics and transportation planning.

"I don't want to own an airplane or a truck," Cook says. "We've let someone else negotiate rates and execute the warehousing portion of the business for us."

After looking at different supply-chain-planning software packages, Apple began using i2 Technologies Inc.'s Rhythm about six months ago. The PC maker is using several Rhythm advanced planning modules and plans to install more during the next year.

"SAP is the cornerstone, but i2 is a key piece of what we do," says Cook. "We've separated planning and execution."

Plan Weekly, Execute Daily

Several computer manufacturers use i2, including Compaq, Dell, Gateway, Acer, Hewlett-Packard, IBM, and Silicon Graphics. Now, instead of building hundreds of thousands of computers in advance to meet a sales forecast, Apple projects sales each week and adjusts production schedules daily.

"We plan weekly and execute daily," says Cook. "I'm relentless on that."

Indeed, in PC manufacturing, the ability to respond swiftly to changing market conditions is critical, industry experts say.

"You cannot win with just quality and product design," says Sanjiv Sidhu, Chairman and CEO at i2 Technologies in Dallas. "You have to be able to react quickly. The profitability of making computers depends on the velocity of your organization."

Careful management of suppliers is increasingly critical to Apple's success. The company lets its suppliers keep in inventory certain "industry standard" parts and components, Cook says. With the company's powerful G3 computer, for instance, the main options for customers are different microprocessors, various storage options, a CD/ROM or digital-video-disc-player choice, and different modems.

"Some of these are industry standards, and we have our suppliers hold these in inventory for us," Cook explains. "There's a limited number of parts, but you can put them together in different ways."

Apple also overhauled its distribution channels. In mid-1997 the company began reducing the number of its national reseller chains from five to the current one -- CompUSA Inc. Although the PC manufacturer won't release sales figures, Phil Schiller, vice president for worldwide product marketing, says Apple is doing "extremely well" selling iMacs, Powerbook laptop computers, and G3 computers direct to consumers and small businesses via the Apple Store, which opened in late 1997 on its Web site at www.apple.com.

Certainly, online sales offer Apple a tremendous opportunity -- Dell, for example, does an estimated $2 billion annually in online sales.

Of course, even the new Apple under Cook's supply-chain mastery has struggled at times. Look at what happened to the company last August and September, when the iMac was first being shipped. The colorful blue computers were selling faster than the PC maker was able to crank them out. According to Jobs, it took the company a few weeks' production to eliminate its order backlog for both the iMac and the G3.

Cook says last autumn's experience was only natural for the debut of a popular product, and it also was an indicator of the company's return to being an industry leader.

"Anytime you have a new product as popular as the iMac, you'll never be able to fill all those orders the first day," he says. "And if you can, you don't have a hot product. You try to fill those orders within a reasonable time. We got a significant supply of iMacs out very fast."

Apple sold 800,000 iMacs in the first four and a half months.

"It is the No. 1-selling computer model in America," Jobs boasted at the MacWorld show in San Francisco in January.

In addition to the order backlog, Apple has had other hurdles to clear. During the darkest months when the company was fighting to survive, Apple began charging consumers $35 for access to product support. The only problem was, doing so meant breaking an earlier promise of free technical support for life for consumers who bought its products from 1992 to 1996.

After customers complained, the Federal Trade Commission stepped in, forcing Apple to make good on its commitment. The company agreed to reinstate the "Apple Assurance" program, offering free support to purchasers. Furthermore, Apple agreed to reimburse consumers who had paid the fee since the company began charging for the service in October 1997.

Perhaps one of the most damaging endeavors -- from an internal standpoint -- that Apple launched was its botched first attempt to install SAP's enterprise-resource-planning software. The company spent years and tens of millions of dollars on software licenses and consultants in an attempt to adapt its business processes to fit the complex SAP R/3 software, with minimal success.

"The project was not managed very tightly," Cook says.

The initial consultant on the project, Andersen Consulting, was replaced by another major firm. Ultimately, though, the project stalled.

"The company wrote off a bunch of it," Cook says.

Following the SAP debacle, CIO Joe Riera left the company to join DHL Airways Inc. as CIO. Apple elected not to replace him. Instead, when Jobs returned, he smartly took a page from one of the PC industry's leaders, hiring Cook from Compaq. The SAP effort was resurrected and refocused to support the slimmed-down operations that remained following the company's enterprise-wide restructuring.

Unlike what happened to the earlier effort, when managers and employees reportedly resisted changing their ways of doing work to fit R/3, this time around the company took the project seriously, marching faithfully to the SAP tune.

"We changed our business processes to map to the SAP system," Cook says bluntly. "The SAP installation is a really big deal for us."

In addition to the accounting package, the main pieces of R/3 Apple is employing are for manufacturing, order management, and order fulfillment.

In another potentially more embarrassing misstep, Jobs announced at the January MacWorld show that the new Macs with the powerful G3 microprocessor, when equipped with a $49 third-party software package, Virtual Game Station from Connectix Corp. of San Mateo, Calif., are capable of running Sony game CDs.

"This turns the Mac into a Sony game station," Jobs said.

Unfortunately, no one bothered to check to see what Sony thought about the idea. Sony Computer Entertainment Inc. remains mum on what, if any, action it plans to take.

"It's a sensitive situation," says a spokesperson for Sony, which makes its own proprietary PlayStation machines and the CD games that run on them.

Jobs' Divided Attention

Finally, there is the question of leadership. Many in and outside the computer industry wonder if Jobs can effectively run Apple indefinitely as "interim" CEO, given his simultaneous responsibilities as CEO of Pixar, the animation firm.

If anything, his entrenched role with Pixar appears to have affected his steerage of Apple, since the company appears to be evolving into a manufacturer of computers primarily aimed at multimedia and graphics applications. In fact, many of the new features of the upgraded G3 model are graphical or multimedia-related, such as video editing, 3-D graphics, and computer games.

"We are totally committed to making the Macintosh the best game platform in the world," says Jobs, noting that Macs now run several popular titles, including SimCity 3000, Fly!, Rainbow Six, Starcraft, and Tomb Raider II.

Ironically, it's in the multimedia world -- not operating systems, where Apple continues to offer one of the few alternatives to Windows -- that Apple has its biggest tiff with Microsoft.

"Our relationship with Microsoft is like a marriage -- 99% of the time it's great," Jobs says. "But 1% of the time we argue about stuff -- usually multimedia."

Asked if Apple is turning its back on the computing needs of business, marketing chief Schiller responds, "Everybody else in the computer industry wants to be like IBM. We do have enterprise business customers, but that's not our primary focus. We are a great consumer company, but we also have a unique specialty professional business in publishing."

One favorable sign for Apple -- besides stringing together five quarters of profits -- is that it's no longer merely selling to its existing base of Macintosh followers. Nearly one-third of the 800,000 iMacs sold were purchased by first-time computer buyers. Another 13% of iMac buyers were what Jobs refers to as "Wintel converts." The remaining 55% were purchased by Mac owners either adding new machines or replacing older ones.

"That means 45% are new to the Mac platform," says Jobs. Admittedly, the January launch of the new multicolored iMac, with its five striking hues, adds a sudden layer of complexity that gives supply-chain guru Cook reason to pause.

"I've lost a little hair over it," he says. "But we've figured out a way to manage the color detail."