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Author: Plato90s Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 200680  
Subject: The mystery that is Apple Retail Date: 12/29/2002 10:57 PM
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Apple Retail, besides a high profile venture, is also a very mysterious segment in that its account practices doesn't seem to make any real sense.

To begin with, it's necessary to understand how Apple handles its internal accounting. If you already know this, skip to the next section.

Apple runs its business in terms of geographical segments, with Retail being a separate one from Apple North America.

Apple's accounting is done in such a way that it assigns a Cost of Goods Sold [COGS] to its various business units to account for production and overhead costs. The determination of this value is used to determine the profit/loss of the unit, and doesn't have to be directly linked to any real-world logic or events. All other expenses go into Corporate and shows up as SG&A or R&D.

In practical terms, Apple's gross margins (revenue minus COGS) is determined directly by the assumptions the CFO want to use. If Fred Anderson says the COGS for the base model iMac in N. America is $1100, that's what it is. He can say the same for the iMac sold in Japan, even though shipping costs may be lower from the factory in Taiwan to Japan. As long as he can come up with some economic model justifying it, the accounting rules allows the CFO broad latitude in this matter.

That's because it's the assumption that net profit is what's important, and you can't fudge the net profit by messing around with the COGS.

-------------------------

Apple Retail can't be easily compared to regular retail companies because it doesn't have to bear the capital expenses for store construction. Capital expenditures are close to $200M, but Retail doesn't have to carry that on the profit/loss of its own segment books.

Apple Retail has 807 employees, but the costs for these employees aren't fully accounted for in Retail, but exists, at least in part, in SG&A as corporate expenses. That can be seen on page 29 of the 10-K when Apple disclosed its SG&A expenses went up due to Retail.

So Apple Retail doesn't operate like any kind of standard retail venture. Without having to pay capital expenditure and some operational expenses, Retail should be pretty profitable.

It's not, because the CFO, Fred Anderson, decided to set the COGS for Retail a lot higher than any other geographic segment. The result is that after taking expenses from Retail into SG&A, Apple pours back some of the "profit" from Retail by adjusting the COGS. That appears as "offsetting benefit" in the 10-Q and 10-K's.

The problem is that the COGS is not adjusted in any consistent manner.

(I'm using unit shipment instead of revenue to cut out peripheral/software for which Apple can't adjust COGS)

In Q1, Apple recognized a $8.6M in offsetting benefit on 14k unit shipment.

In Q2, unit shipment increased by 71% but the offsetting benefit only increased by 44% to $12.4M.

In Q3, unit shipment dropped by 17% and the offsetting benefit dropped by 19% to $10M. Note the big disparity with Q2's correlation of unit shipment to offsetting benefit.

In Q4, unit shipment increased 70%, but now the offsetting benefit increased by 100% to $20M. Note there's now an opposite correlation with Q2, where the "benefit" increase outstrips unit sale increase.

-----------------------------------

The numbers suggests that there is actually no discernible and consistent business model being used to determine how the COGS for Retail is determined.

If a consistent COGS was used for all 4 quarters, Apple would not be able to show a smooth transition from small losses in Retail in Q1 to a slight profit in Q4.

I posted a while back about how Apple changes its tax rate to smooth earnings.

http://boards.fool.com/Message.asp?mid=17668146

and I believe Apple (more specifically, Fred Anderson) is doing the same thing with Retail. It's useful as a tool to create good buzz and the profitability can be easily manipulated since it's still such a small part of Apple's overall revenue bases.
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Author: agentpreppie Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 80531 of 200680
Subject: Re: The mystery that is Apple Retail Date: 12/29/2002 11:09 PM
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Apple's accounting is done in such a way that it assigns a Cost of Goods Sold [COGS] to its various business units to account for production and overhead costs. The determination of this value is used to determine the profit/loss of the unit, and doesn't have to be directly linked to any real-world logic or events. All other expenses go into Corporate and shows up as SG&A or R&D.
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I posted a while back about how Apple changes its tax rate to smooth earnings.

http://boards.fool.com/Message.asp?mid=17668146

and I believe Apple (more specifically, Fred Anderson) is doing the same thing with Retail. It's useful as a tool to create good buzz and the profitability can be easily manipulated since it's still such a small part of Apple's overall revenue bases.


Between those two little sections you made some excellent points Plato. However (you knew that word was coming, admit it), all manufacturing companies that operate retail centers will manipulate the COGS to it's various units however they feel like doing it. It's one of the big things they teach you in managerial (aka, cost) accounting. As for tax smoothing, it's another one of the big things you learn when you get an accounting degree and it goes hand in hand with manipulating the COGS. The governments of the world have caught onto the little trick and companies can now work with the IRS (I believe other countries taxing authorities are starting to do the same) to come up with acceptable costing methods for the companies to work with and not be fined. In other words, what you are pointing out as an Apple accounting trick is actually standard practice among all businesses.

Agent

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Author: FoolBalance Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 80532 of 200680
Subject: Re: The mystery that is Apple Retail Date: 12/30/2002 1:25 AM
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As I noted a few days ago, nobody will ever give Apple credit for its retail segment working in its favor... though I didn't expect Plato to jump on that bandwagon quite so quickly.

http://boards.fool.com/Message.asp?mid=18298085

Paul

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Author: Plato90s Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 80537 of 200680
Subject: Re: The mystery that is Apple Retail Date: 12/30/2002 8:12 AM
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"However (you knew that word was coming, admit it), all manufacturing companies that operate retail centers will manipulate the COGS to it's various units however they feel like doing it. It's one of the big things they teach you in managerial (aka, cost) accounting. As for tax smoothing, it's another one of the big things you learn when you get an accounting degree and it goes hand in hand with manipulating the COGS. The governments of the world have caught onto the little trick and companies can now work with the IRS (I believe other countries taxing authorities are starting to do the same) to come up with acceptable costing methods for the companies to work with and not be fined. In other words, what you are pointing out as an Apple accounting trick is actually standard practice among all businesses.

Agent "


Yes, I'm sure that accountants know how to manipulate the numbers. Arthur Anderson helped Enron do it, and Worldcom did it without the assistance of external accountants.

That doesn't change the fact that these companies are giving investors a false impression of the viability of their business by number manipulation.

This is why I find the British system of financial accounting preferable, because they don't use precise guidelines which can then be narrowly interpreted then manipulated.

One might argue that it's equally "standard practice" for company insiders to manipulate stock prices, grant options, and exercise them based on insider information. That doesn't mean that the behavior should be excused or overlooked.

"As I noted a few days ago, nobody will ever give Apple credit for its retail segment working in its favor... though I didn't expect Plato to jump on that bandwagon quite so quickly.

http://boards.fool.com/Message.asp?mid=18298085

Paul "


The point I am trying to make is that the "numbers" will continue to look good because the "numbers" Apple present to investors have only a tenuous link to the reality of how well Retail is actually doing. It's not operational excellency or marketing genius propelling Retail to profitability - it's the manipulating of expense allocation.

If Apple had to account for the Retail segment as a completely separate entity, with all operational, marketing, and capital costs being accounted for separately, Retail wouldn't even be close to profitability.

Retail is profitable in the same way a dot-com was viable - only on paper.

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Author: sandhillroad Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 80538 of 200680
Subject: Re: The mystery that is Apple Retail Date: 12/30/2002 8:31 AM
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Let us start with the belief (if not fact) that accounting is as much art as it is science.

Even further, profit is really a concept that applies best to the total organization, not to a business unit. The profit of a business unit is even more art than science, and it is sometimes difficult to see whether it serves a useful purpose. The reason? Much of the cost of an organization is the cost of doing business as a total organization, not as an addable collection of separate entities. Who pays for research and development of the next generation of products? Who pays for projects that fail? Who pays for legal services? Who pays for advertising? The answer is the organization as a whole, not particular business units.

Also, the price sensitivities for various products in various markets will be different, so the optimum margins for those situations will be different as well. Therefore, you can not really compare margins and say one is doing better than another, for they the one with the better margin might actually be not as well at the one with the poorer margin, taking all factors into account.

The best approach is to select one reasonable method for allocating costs and be consistent, unit by unit and year by year in its application. This way, you may at least have a chance of knowing when things are getting better or worse.

So I just shrug my shoulders and comments regarding whether a particular business is making a profit or not. The only way to really know is to back up time, do it another way, and compare the results on the total organization. The question is, then, whether Apple, as a total entity, would be better off with or without the retail operations, taken over the long term. It is a hard question to answer, because you can't possibly consider all the second and third order effects that must be considered to arrive at the answer.

That's why the analysis should be done, but used as only one factor in making decisions, but not taken more seriously than it deserves.



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Author: FoolBalance Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 80544 of 200680
Subject: Re: The mystery that is Apple Retail Date: 12/30/2002 4:26 PM
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Retail is profitable in the same way a dot-com was viable - only on paper.


What a load of horse manure..

Anyone who thought dot-coms were generally viable, that they had viable business plans were looking through the rosiest of glasses. Dot-coms tried to say that the world had changed, that profit and revenue no longer mattered, etc. I remember the dozens of investors on these boards saying so, the advertisements by brokerages saying the rules had changed, that the old bricks and mortar economy was what had become non-viable, etc...

I laughed and laughed because the fundamentals of economics don't change and you can find my posts saying as much at the time.

What you are saying is that Apple selling computers by a model which is fundamentally the same as that used for millennia by merchants in every culture (put your product on a shelf in an attractive location with lots of foot traffic and tell them how good it is, when sold, exchange the product for something of value: money nowadays) is somehow the same as the dot-com malarkey???

LOL!!!!

Paul

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Author: Plato90s Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 80546 of 200680
Subject: Re: The mystery that is Apple Retail Date: 12/30/2002 4:48 PM
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"What you are saying is that Apple selling computers by a model which is fundamentally the same as that used for millennia by merchants in every culture (put your product on a shelf in an attractive location with lots of foot traffic and tell them how good it is, when sold, exchange the product for something of value: money nowadays) is somehow the same as the dot-com malarkey???

LOL!!!!

Paul "


As Steve Jobs and Apple like to repeat, Apple Retail is nothing like other computer stores.

Apple Retail has oversized physical space which provides comfort for shoppers, but is also wasteful of capital resources and increase lease expenses.

Apple Retail doesn't do the hard sell, a proven model for selling elctronics.

Apple Retail doesn't have sales, because it can't undercut the prices of the Apple Online Store.

Apple Retail pays its employees more than the industry average wages.

Apple Retail over-staffs by employing non-sales personnel to be on-site (aka "Genius Bar").

The successful computer retailers which are left, like Best Buy, don't do any of these things. They sell a wide variety of products - packed in tightly, employ minimum wage staff, and watches the bottom line closely. Apple Retail flies completely in the face of all of these conventions, and that's the way it was designed to be.

It's theoretically possible for Apple Retail to be profitable in time and without using accounting measures. If it does, it would have done so by doing the opposite of what every other computer retailer has done.

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Author: agentpreppie Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 80549 of 200680
Subject: Re: The mystery that is Apple Retail Date: 12/30/2002 6:39 PM
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Apple Retail has oversized physical space which provides comfort for shoppers, but is also wasteful of capital resources and increase lease expenses.

Yeah, everyone loves walking around in a store packed like sardines.

Apple Retail doesn't do the hard sell, a proven model for selling elctronics.

Bullsiht. When I worked in the computer section of Best Buy in high school I was one of the best salesmen because I didn't do the hard sell. If my customers had questions, I'd answer them honestly but I never leaned on them to buy right then.

Apple Retail pays its employees more than the industry average wages.

So are you adverse to paying better employees more money? Trust me, the majority of people that work for Best Buy/Circuit City/CompUSA are barely worth employeeing as sales staff with their lack of knowledge about what they are selling.

Apple Retail over-staffs by employing non-sales personnel to be on-site (aka "Genius Bar").

Wow, so does Best Buy with their computer repair center though all they really do is act like they know what they are doing, then screw up the machine more and have to ship it off to actually get fixed.

Agent

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Author: FoolBalance Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 80550 of 200680
Subject: Re: The mystery that is Apple Retail Date: 12/30/2002 7:07 PM
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As Steve Jobs and Apple like to repeat, Apple Retail is nothing like other computer stores.

Apple Retail has oversized physical space which provides comfort for shoppers, but is also wasteful of capital resources and increase lease expenses.

Apple Retail doesn't do the hard sell, a proven model for selling elctronics.

Apple Retail doesn't have sales, because it can't undercut the prices of the Apple Online Store.

Apple Retail pays its employees more than the industry average wages.

Apple Retail over-staffs by employing non-sales personnel to be on-site (aka "Genius Bar").


Saturn is a different kind of car company. It has many of the features you describe above in its business model. It appears to work for Saturn.

Paul

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Author: TheBMann Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 80551 of 200680
Subject: Re: The mystery that is Apple Retail Date: 12/30/2002 8:20 PM
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The successful computer retailers which are left, like Best Buy, don't do any of these things. -- Plato90s

And that's why they suck. Plain and simple.

The idea that you can go into Best Buy (or practically anywhere, FTM) and actually receive viable guidance as to your purchase is utterly ludicrous.

Perhaps the hard sell is a proven way to sell electronics to morons, ie., the majority of computer/electronics purchasers at the Best Buys of the world...but it's not the Apple way.

And I don't want it that way.

What you understand, Plato, you understand very well. What you don't understand, however, well...

Apple cannot simply follow the footsteps placed before it by computer retailers. It cannot survive that way and has not survived that way up until now.

We can certainly argue exactly how successful Apple *really* is but that's not the point in this discussion.

Just as with everything, Apple has to be different with regards to retail and the common "wisdom" of the day. Speaking only for myself, I absolutely detest Best Buy because the friggin' place is like trying to cross your legs in an airline seat. You hit a fat guy going up, knock over somebody's drink going over and get smacked upside the head going down.

I adore retail outlets with oversize. And I suspect there are enough people out there that agree with me to make it worth Apple's while.

Just because it's different doesn't mean it WON'T succeed.

B*Mann



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Author: BeLkMike Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 80552 of 200680
Subject: Re: The mystery that is Apple Retail Date: 12/30/2002 8:59 PM
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Saturn is a different kind of car company. It has many of the features you describe above in its business model. It appears to work for Saturn.

<Troll on>

Bad Example.

Other variants and additional Saturn vehicles are planned, which will eventually put the division into profitability, Lajdziak said. "We're on a path to profitability," she said

http://www.saturnfans.com/Cars/Future/saturnboost.shtml


<Troll off>


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Author: dex22 Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 80555 of 200680
Subject: Re: The mystery that is Apple Retail Date: 12/31/2002 10:16 AM
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Saturn is a different kind of car company. It has many of the features you describe above in its business model. It appears to work for Saturn.

This analogy doesn't follow through. Saturn is renowned for making savings by using exotic materials and for making reliable motors that cost less to run.

Oh, wait... :o)

Dex22



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Author: goffperu Big red star, 1000 posts Old School Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 80566 of 200680
Subject: Re: The mystery that is Apple Retail Date: 1/1/2003 9:10 AM
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The qualities Plato described are ESSENTIAL to its success. Several people have noted previously that the Retail unit is not really about profits. It is MARKETING. It is like an exhibit at a trade show. It has to be a comfortable, inviting place for consumers to visit, or else it won't draw in people who are comfortable with their PeeCee misery.

My step father is a perfect example. He used to be a PC diehard, and engaged in regular Mac bashing despite having never touched one. I took him to the Apple Store in Chandler, AZ, and he now tells me he is going to buy an iMac in January. He spent over an hour in the store, much of that time grilling the salesman (Mike). Mike never acted like he wanted to leave, like he had other things to do, or that he would be disappointed if he didn't close the sale that day. I believe that all of these things contributed to my step father's decision.

If Retail pulls in a profit, that is pure icing for me. I would be happy if it breaks even.

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Author: TheBMann Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 80573 of 200680
Subject: Re: The mystery that is Apple Retail Date: 1/1/2003 2:11 PM
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Yup, goff. Your Dad is the exact type of customer Apple is looking for.

He may be PC-centric but is open-minded enough to entertain alternative ideas - and smart enough to see good ideas when they present themselves.

Not the same as those folks at Best Buy, et al, who go up to the sales clerk and say "WTF is that computer? I can't remember the name of it but it was $699"


B*TheyCanHaveThem

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Author: dsheehy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 80634 of 200680
Subject: Re: The mystery that is Apple Retail Date: 1/3/2003 7:02 PM
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The successful computer retailers which are left, like Best Buy, don't do any of these things. They sell a wide variety of products - packed in tightly, employ minimum wage staff, and watches the bottom line closely. Apple Retail flies completely in the face of all of these conventions, and that's the way it was designed to be.


Isn't that a good reason that Apple SHOULDN't do that? Don't you know how much those stores suck?

I for one, applaud someone trying to do things properly, rather than just copying everyone else's strategy.

Also - how do you know what the sales figures for the stores are when you make your assertion that they "have no sales"?

David

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Author: dsheehy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 80636 of 200680
Subject: Re: The mystery that is Apple Retail Date: 1/3/2003 7:30 PM
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The qualities Plato described are ESSENTIAL to its success. Several people have noted previously that the Retail unit is not really about profits.

Now, if it is ESSENTIAL for success to have a cramped store with lousy under-trained salespeople, then explain this.

Plato mentioned that many of these stores are out of business. However, they ALL used the over-cramped, under-trained business model.

So in actual fact, you will find that 90% of BANKRUPT retail operations have the qualities Plato describes. On the other hand, I can't think of ANY retail venture that has gone under lately that has had trained salespeople and lots of space.

So it seems that statistically, Apple is doing the right thing, and Best Buy is doing the wrong thing.

As an example, around here, low-end music and hi-fi stores go under all the time. But the ultra-high end audiophile places never go out of business.

David

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