Apple's coming notebook transition

Apple is readying a major product transition. We know because they told us so. In the quarterly financial crime call chief financial Officer Peter Oppenheimer referred several times to a "...future product transition which I can't discuss today".

That was interesting for two reasons. First, the CFO was trying to explain why they were forecasting a large drop in Apple's gross margins for the coming quarter, from 34.8% to 31.5%. Secondly, of course because the famously secretive company does everything it can to maintain the element of surprise.

But this transition's costs are too big to bury. So it is going to be big.

Running the numbers Managing Wall Street means managing Wall Street's expectations. Successful companies - companies that deliver above expectations - have healthy stock prices. So the key is to talk down one's prospects and consistently do better.

Press reports of the call have tended to emphasize the difference between Apple's reported gross margin of 34.8% and the forecast gross margin 31.5%. But that isn't the right way to look at it.

The real difference is between what they forecast for the June quarter and what they are forecasting the September quarter. The gross margin forecast for the June quarter was a 33%. Thus the drop from the June quarter to the September quarter is a 150 basis points drop.

Starting with that and depending on how you forecast growth, Apple is looking at an investment in the current quarter's Back-To-School promotion and the "product transition" of from $120 million to as much as $400 million. The average iPod goes at the door at $150 - so if they sell 1 million BTS Macs, the promotion will cost (price less GM) on the order of $100 million, probably much less since they only sold 2.5 million Macs in the June quarter.

So the product transition has a war chest of anywhere from $60 million to - on the high side - $300 million. Let's split the difference on the conservative side and say $150 million for the transition.

What product transition could cost $150 million? While iPod and iPhone sales are big and getting bigger, Macs are still over 60% of Apple's revenue. The iPhone has just been refreshed and so have most of the iPods.

The Mac unit split is 60/40 'Books/desktops. The iMac desktop line has just been refreshed and the Mac Pro line, while the packaging is getting old, has state of the art workstation innards.

Other than the MacBook Air though, the 'Book line hasn't had a major design refresh in years. That is where the transition will be. It has the volume and the aging designs to require a change.

What will be in the new 'Books Apple doesn't play with pricing very much. They intro a product at a set price and it generally stays there until the next refresh. They use declining commodity prices to increase their margins.

When they do a refresh they add in features, such as faster processors, larger hard drives or improved backlighting. These things are all more expensive at the beginning of the refresh, but add to the perceived value.

There are several expensive features in the Mac book line that are due for significant upgrades.

• Quad core processors. The differentiation between the Mac book pros and the vanilla MacBooks has been declining for several quarters. The easiest way to reestablish their high-end credentials is through the recently announced Intel Quad core processors.
• Power management. Intel and others have announced a slew of more power efficient chips. Not only processors but multimedia decoding chips, networking chips, graphics, DRAM and hard drives. Maybe even solid state disks. Taken singly none of these warrant a redesign, but together a significantly more power efficient notebook can be built - either lighter or with a longer battery life.
• Blu-ray optical drives. Macs in general are simply not with the Blu-ray program, which is odd since Apple and Pixar have been longtime supporters of the Blu-ray program. Apple codecs do not support it and there are no factory installed Blu-ray capable drives available. That will change.
• Design. The MacBook Air points to several design themes that we can expect to see in the new Mac pros. These include larger track pads for multi-touch use and beveled edges to make the system look and feel slimmer.
• Motherboard flexibility. Intel's current chipset architectures are reaching their limits. They have a number of new initiatives in I/O, memory, and system interconnect that Apple, with its focus on high-end notebooks, will incorporate.

The Storage Bits take Given those size of the investment, this is no ordinary product transition. Some people are forecasting a whole new product line for Apple, such as a netbook entry. But that would be out of character. Let other people establish the market. Look how long they waited to enter the smart phone market.

There is also the chance that Apple will lower prices. Portable growth has been trailing, in percentage terms, desktop growth. Since portables are more profitable than desktops Apple clearly has incentive to goose up 'book sales.

Plus they have to stay cool.

Comments welcome, of course.