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Apple must answer questions to ensure loyalty, its survival

Apple Computer Inc. is like a battleship that has taken a torpedo hit below the waterline.

Everyone on board knows the ship is filling with water, so the most immediate task is to start patching the hole and bailing out the water.

That's what Apple chairman Gilbert F. Amelio, captain of the SS Cupertino, did March 14. He announced plans to eliminate 4,100 jobs _ almost one-third of Apple's 13,400 workers _ and cut a number of projects he thinks are diverting Apple off course.

But bigger strategic challenges have to be addressed.

Apple can't simply sit dead in the water. If it doesn't start moving forward again _ becoming consistently profitable and putting out cutting-edge products _ it could be headed for the mothball fleet. Such a sorry end could mean being acquired by a larger company, devolving into a boutique software supplier with little influence, or gradually shedding more and more workers until shutting down entirely.

Customers, software developers and employees, if they are to stay on board, need to see answers to key questions facing the Cupertino company, including:

What will be the ultimate role of the Macintosh personal computer in a market dominated by PCs running Microsoft Corp.'s Windows?

This challenge comes down to figuring out how to be different enough to attract customers but not so different that users are left isolated in an increasingly connected world.

That's why Apple is now stressing how the Mac operating system, which controls a computer's functions, will fit into corporate networks that include Windows and the Unix operating system.

Yet Apple also wants the Mac to retain enough unique features that customers will find a compelling reason to buy a computer based on an operating system used in only 10 percent of the world's PCs, while Windows has about 80 percent of the market.

In December, Apple paid $430-million to buy Next Software Inc. of Redwood City, Calif., controlled by Apple co-founder Steve Jobs. The goal was to acquire Next's operating system software and use it as the basis for a new version of the Mac OS, called Rhapsody, due in mid-1998. Rhapsody promises to deliver a long list of exciting new features that, in some cases, will exceed what today's Windows systems can do.

But operating systems are complicated and notoriously difficult to deliver on schedule, and Apple has an unprecedented technical and management challenge in melding the best from Apple and Next.

What's more, Apple has to convince independent software developers that Rhapsody will have enough of a market to justify the time and effort to create applications that take advantage of its power.

That proposition will be a tough sell if the Mac OS continues to lose ground as it has for the past four years; only about 7 percent of computers sold last year were Mac-compatible.

For now, at least, Apple appears to be tacitly acknowledging that it can't quickly reverse its sliding market share.

Guerrino De Luca, head of marketing, said March 14 that Apple's top priority was "focusing on those who own or want a Mac." In the 90-minute call with analysts and reporters, no Apple executive talked about pulling customers out of the Windows camp.

One big problem is that Apple faces essentially the same expenses in developing the Mac OS as Microsoft must spend on new versions of Windows. Yet Microsoft can spread those costs over four-fifths of the worldwide PC market.

Getting out from under this disparity would require drastically expanding the Mac's market share. Yet even the most optimistic Apple boosters would have a hard time imagining that the Mac OS could control more than 20 percent of the market within the next few years.

Can Apple keep its current customers on board?

Amelio's three-year turnaround plan went off track in the last three months of 1996, with a loss of $120-million.

The single biggest cause was a huge shortfall in sales of Macs in the United States.

Such a crisis of confidence, if it spreads more widely to other parts of the world _ where Apple's troubles have not been as extensively reported _ or to professional and corporate buyers, could prove fatal.

Such customer nervousness could make it tough for Apple to accurately forecast demand. Moreover, Apple could have a hard time in forecasting because of high turnover among its sales and marketing forces _ the front-line troops who keep their fingers on the pulse of demand. Inaccurate forecasts leave the company vulnerable to further overproduction, triggering more losses, or underproduction that would frustrate customers.

Will Apple manage to downsize manufacturing in sync with the rise in licensing?

In 1994, Apple decided to allow other computer manufacturers to build "clones" of its flagship Mac line. Licensing got off to a slow start, however, and clones didn't become a significant force until the second half of 1996.

But licensing is now inescapable. About 10 percent of sales of PCs running the Mac OS are now clones _ mostly from three manufacturers: Motorola, Power Computing and Umax.

The presence of clones is good for consumers, who get lower prices because of the competition. And it could be good for Apple in the long run if it helps increase the universe of Mac users.

Currently, though, licensing is causing Apple considerable pain. Because cloners don't have the overhead of developing new Mac OS software, they can under-price Apple _ forcing Apple to cut its prices to the point where it will be tough to make money selling hardware. And, for now at least, clones appear to be taking sales away from Apple rather than pulling customers from Windows.

Does Apple have the financial resources to complete its transformation?

Here, finally, there is some good news.

Amelio refinanced Apple's balance sheet last year, and the company held an impressive $1.8-billion in cash on Dec. 27, the last day of the most recent quarter _ perhaps explaining why the company put a pink porcelain piggy bank on the cover of its 1996 annual report.

Even with the restructuring changes announced March 14, Apple probably will still have more than $1-billion on hand at the end of the current quarter. That's enough to get the company through at least another year of moderate losses.

Amelio last year made plans to scale down Apple to be profitable with annual sales of $10-billion, from the 1995 peak of $11-billion. That goal proved too ambitious. Now he is shrinking Apple to the point where it can make money on $8-billion sales, with the hope of returning to profitability before the end of this year instead of, as planned, in this quarter. This quarter's losses are likely to be at least $600-million, meaning Apple will have lost nearly $1.5-billion in the last year and a half.

Red ink would continue to flow if sales drop much below the $8-billion mark.

On the other hand, Apple could even return to favor on Wall Street if it meets Amelio's targets. Financial analysts tend to look at "return on investment" _ the profit a company makes on the amount of money contributed by shareholders and lenders. That block of capital now stands at about $3-billion.

Wall Street generally expects a return of about 10 percent from companies such as Apple, or about $300-million in annual profits. Apple earned more than $300-million every year from 1987 to 1995, with the exception of 1993 _ even though sales didn't exceed Amelio's current target of $8-billion until 1994.

While none of the challenges facing Apple have certain answers, Amelio still appears to have time to get his foundering ship back on course.