Since early 2003, Apple shares have increased from $6 to more than $74 (the shares are up 44% in the past year alone), with the 12-fold increase largely being driven by the iPod phenomenon. Apple now has a market capitalisation of US$63 billion, considerably more than rival Dell (US$52 billion) despite Dell’s earnings being one billion dollars more than Apple last year.

Despite the iPod being arguably inferior to many rivals (such as the iRiver which allegedly has better sound quality, or Phillips HDD which has a far superior battery life) it commands a staggering 75% of the US digital music player market. The iPod story is a model of how an supposedly inferior product can dominate due to stunningly successful marketing and understanding the consumer. While Apple certainly wasn’t the first company to sell digital music players, it was the first to make them cool. It was also the first to make it easy to download and play music with only a cursory knowledge of computers.

But how long Apple’s domination of the digital music player market lasts is another question entirely. Fortune recently reported that Microsoft will unveil its 30 gigabyte Zune portable music player prior to the Christmas shopping period this year. Unlike the iPod, the Zune will have wireless connectivity for easy sharing of photos and songs. Fortune also noted that memory card maker SanDisk has unveiled an eight-gigabyte flash MP3 player which has double the storage capacity of Apple’s iPod Nano plus an FM radio tuner but costs only US$1 more.

While Apple’s “cool” factor will continue to drive iPod’s sales in the short term, it seems inevitable that Apple’s market share will dramatically reduce in years to come. If not from the current batch of worthy competitors, the next generation of mobile phones will pose a major challenge. While Apple was able to increase sales of the iPod by 128% in the six months ending April 2006 (compared with the corresponding period the previous year) revenue per unit decreased by 9%.

In the six months to April 2006, iPod and iTunes contributed more than half of Apple’s sales, if and when Apple’s competitors start to bite into the iPod’s sales (as well as its margins), Apple’s growth prospects will come to a grinding halt.

The market does not seem overly concerned about the threats posed to Apple’s most important profit driver. Apple shares currently trade on the very generous PE ratio of 34. And despite Apple recently becoming embroiled in an options-backdating scandal, the market clearly doesn’t expect the iPod music to stop any time soon.

Peter Fray

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