Apple ( AAPL) may be turning to an old recipe to maintain its dominance in the digital music market. According to recent news reports, the iPod maker talked with Samsung earlier this year about investing in the production of flash memory chips. Although the talks were called off, some analysts expect Apple to pursue a similar deal with Samsung or some other vendor. Apple's strategy may be unusual, but it's a response to recent success, says Tim Deal, an analyst with Technology Business Research. "The unprecedented success of the iPod ... has become the prime strategic focus of Apple," says Deal. "As a result, it's changed the way the company normally does business." The specifics of the deal contemplated by Apple and Samsung are unclear. An Apple representative declined to comment, and a Samsung representative would only say in a statement that the two companies earlier this year considered a joint investment in NAND flash memory production. Flash memory is a nonvolatile form of storage on semiconductor chips, of which NAND is the type used most commonly in digital music players because it's often less expensive than NOR flash, the other main type. Because it has no moving parts, flash memory is considered to be more stable than hard drive-based storage. But at larger capacities, flash memory modules tend to cost far more per gigabyte than hard drives. With the proliferation of portable drives and storage cards for digital pictures and songs, the demand for flash memory has been booming. Apple has only added to that demand. Earlier this year, it rolled out the iPod shuffle, which quickly became the top-selling flash-based player. And last month,
the company unveiled the iPod nano, a flash-based player with a color screen that sold more than 1 million units in its first 17 days on store shelves.
Demand for flash has been leading to spot shortages of the component. Apple moved to lock up flash supply by agreeing to buy up to 40% of Samsung's NAND flash capacity in the second half of this year, according to analysts. But that may not be enough. The company has seen a backlog of orders for its iPod nanos, and its retail stores have frequently been sold out. And on a conference call earlier this month, Apple COO Tim Cook blamed the backlog on "supply constraints" and said that the company didn't know if it would be able to meet demand. Cook didn't specify the supply issue, but analysts believe that flash memory is at its root. "Apple is already starting to complain about shortages, and they're in one of the better positions," says Joseph Unsworth, an analyst at Gartner, a market research firm. He added that the shortages in the flash market "are only going to get worse." A move to invest in the capacity of a flash memory maker might help solve Apple's supply issues, analysts say. The deal could take a number of forms. Typically, a new, state-of-the-art fabrication plant would cost about $2 billion to $4 billion to build and equip, analysts say. But that doesn't mean Apple would necessarily pony up half or even a significant fraction of that cost. More likely, say analysts, is that Apple would make a nominal investment -- say $100 million or so, that would essentially represent a down payment on products coming out of the plant. In return, Apple likely would get preferential prices and access to the flash memory produced by the plant. The arrangement would be similar to a deal Apple struck in 1999. Soon after launching its consumer-targeted iBook laptop computers, Apple invested $100 million in Samsung's LCD production capacity to ensure adequate supply of the displays at a time when they were hard to come by.
If anything, Apple is in a better position to make a similar investment today -- and has more reason to do so. At the end of last quarter, the company had $8.3 billion in cash and short-term investments on its balance sheet, so it certainly has the means. But the iPod nano is replacing the company's iPod mini, formerly the most popular model in Apple's player lineup. Considering that iPod sales have accounted for the lion's share of its revenue growth over the past several years, success of the nano is crucial to Apple. "The iPod line is so important to Apple -- so high profile -- they want to be sure that they don't have recurring
component shortages," says Shyam Nagrani, who covers the consumer electronics industry as an analyst for iSuppli, a market research company. But an investment in a flash memory maker's production capacity could do more than just assure supply. It could also give Apple favorable prices on flash memory. The company could either use the savings to pad profit -- or to cut prices in the face of heightened competition. Although Apple is known for offering pricey computers, iPods tended to be competitively priced; new products such as the shuffle and the nano have set new, lower price levels for competing products. "Apple is looking to get as favorable pricing as possible," said Unsworth, noting that getting even lower prices through an investment in a fabrication plant could help Apple "squeeze their competition." Though the Samsung deal seems to have fallen through, some analysts expect the company to sign another deal either with Samsung or with one of the chipmaker's rivals, such as Micron Technology ( MU) or Hynix Semiconductor. Indeed, a deal with one of Samsung's competitors is more likely than a deal with Samsung, analysts say. Samsung has enough resources to not need Apple's money to invest in further flash capacity, they note.
But Samsung's rivals could use help in expanding their capacity, and they'd likely be willing to give Apple a better deal in return for its cash. "This is not necessarily something they have to do with Samsung," says Unsworth. "They don't have the leverage over Samsung that they do with some of
Samsung's competitors." Of course, not everyone is convinced that Apple is serious about investing in flash production. Even without an investment, the company was able to secure a huge chunk of Samsung's flash capacity at a discounted price, says analyst Jim Handy, who covers the flash memory market for research firm Semico. And a production investment would essentially lock Apple in with one supplier. That could make it difficult for Apple to change course if the supplier had quality-control problems or if another supplier developed better technology. "I'm still questioning whether this deal ever existed. I'm really skeptical of stuff like this," says Handy. "It would be a very big change in strategy by Apple for them to do this." It would be, but Apple has done it before.