Getting Played by Apple

The problem for many of Apple's partners is that they are so small, while the iPod business is so big, that Apple's business can become a huge part of their overall sales.

PortalPlayer may have been an anomaly among public companies for its overwhelming dependence on the iPod, but other players have significant exposure.

For instance, some 34% of Synaptics' sales in its last fiscal year were iPod-related, as were some 15% of Sigmatel's (SGTL Quote) sales last year.

But the size of their exposure is not the only problem facing these iPod partners. When a partner provides that much of a company's revenue, the company tends to devote more time and resources to that partner at the expense of other present or potential customers, says Gregory Quirk, a technology analyst with the research firm Semiconductor Insights.

"As time goes on, you become more and more dependent," Quirk notes.

And the dependency is a problem not only for the companies, but also for investors. Many investors and analysts had come to see companies such as PortalPlayer and Sigmatel as proxies for Apple's iPod business and the MP3 market.

That seemed a smart move when those companies were seeing their sales and share prices soar. But it's clear in retrospect that those stocks were much riskier than they might have seemed.

"Any investor who invests in a company with this much customer concentration should be fully ready to take these types of risks," says one fund manager.

Regardless of whether the risk was factored into the smaller companies' shares, Apple's shares have outperformed them, notes a second fund manager who is long Apple.

"If people really want to play the iPod, they should just buy Apple. Don't bother with these guys," says the fund manager.

Given what happened with PortalPlayer, that looks like sound advice.