When it comes to allowing other companies to share in the popularity of its iPod music players, what Apple Computer ( AAPL) giveth, it also can taketh away. That point was made particularly clear last week, when PortalPlayer ( PLAY) announced that Apple had decided
not to use the company's next-generation media chips in its upcoming iPod music players. In response, PortalPlayer's stock bled 45% of its value in two days. PortalPlayer's dependence on Apple was extreme: About 95% of the company's sales are iPod-related. But the small chipmaker is only one of many companies that have attempted to cash in on the iPod phenomenon. While there's considerable money to be made doing so, as PortalPlayer has demonstrated, there's also a lot of danger, too. "It is risky when you've got a vendor as dominant as Apple is, and you've tied your future to that vendor," says Rob Enderle, principal analyst at the Enderle Group, a technology consulting firm. Other technology companies have had products whose dominance approximated that of the iPod or whose market strength was more powerful than Apple's, analysts say. But Apple has long had a contentious relationship with many of its partners, says Roger Kay, founder and analyst at the consultancy Endpoint Technologies. The company has been unapologetic about directly competing against some of those partners or cutting off relationships with little warning, he says. "When doing business with Apple, be aware that your risk is probably higher than doing business with other people in the industry," says Kay. An Apple representative did not return a call seeking comment about the company's relationships with vendors and partners. Apple has had marked success with the iPod. Although sales of the device in the company's most recent quarter were lighter than expected, the 8.5 million units the company shipped was still up more than 60% from the same period a year earlier. Perhaps more significantly, for two quarters in a row, Apple has gotten more revenue from its iPod sales than from its Macintosh computer sales.
With iPod sales growing so rapidly, a swarm of companies has attempted to cash in on the business. These include component manufacturers such as PortalPlayer that provide the technology underlying the iPod, and companies such as Bose and Griffin Technology that make an assortment of accessories for the devices, including external speakers and car-stereo adapters. Although it's an extreme case, PortalPlayer illustrates the lure of the iPod opportunity. Thanks to iPod-related sales, the company's revenue jumped from just $20.9 million in 2003 to $225.2 million last year. Meanwhile, the company's bottom line swung from an $8 million loss in 2003 to a $48.2 million profit last year. But as last week's announcement indicates, keeping that growth going is anything but certain. "It's in a very difficult spot right now," says one portfolio manager who is short PortalPlayer. The problem facing PortalPlayer and other companies trying to cash in on the iPod's success is that they need Apple and the iPod far more than Apple needs them. And Apple's not afraid to let them know. Indeed, even when Apple hasn't had as much leverage as it has with the iPod, it has often been a difficult company for partners to deal with. Many
Apple resellers have complained in recent years that Apple's growing suite of retail stores is eating into their business, for example. Back in the late 1990s, the company basically killed off a number of start-up companies that had begun sell Macintosh clones after Steve Jobs decided he would no longer license Apple's operating system. Dominant technology products or platforms can often create tension between the companies that make them and their suppliers and partners. Microsoft ( MSFT) and eBay ( EBAY), for instance, have both had difficult relationships with software developer partners. In terms of the iPod platform, an early example of the potential perils of depending on that business came last year, when Synaptics ( SYNA) lost its exclusive contract to make the click-wheel for the iPods. The company's sales and earnings have slumped ever since. In recent months, iPod accessory vendors have also gotten a glimpse of the precarious situation they are in as Apple has started to introduce its own line of iPod add-ons, such as an FM tuner and an external speaker system.
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) 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.