Some interesting press coverage over the past todays about Psystar’s announcement that they will be selling a $399 Mac clone:

Psystar Sells $399 Mac Clone: Return of the Mac Clones?

A quick snippet from the post:

Budget conscious Mac shoppers can save a bundle on a $399 mid-level Macintosh computer running OSX called an OpenMac sold by a Florida-based company called Psystar. That beats comparable offerings from Apple, whose cheapest similar computer, a Mac Pro, starts at $2000.

Now for the catch. The Psystar computer appears to violate Apple’s end user license agreement (EULA) for Macintosh OSX, which prohibits running the operating system on anything other Apple-branded computers.

The Leopard compatible Mac is built using standard computer parts with specs that include a 2.2GHz Intel Core 2 Duo, 2GB of DDR2 memory, Integrated Intel GMA 950 Graphics, 20x DVD+/-R Drive, four USB ports and a 250GB 7200RPM drive, according to the Website MacRumors.com. I would’ve pulled the specifications from the Psystar Website myself, but the site was not functioning and, the last time I checked, displayed the message: “Site is currently offline due to the massive influx of users in the last 24 hours.”

So, obviously, coverage like this is sensationalist.  This $399 machine is nowhere close to the specifications of the $1999 Mac Pro.  It’s much closer to the Mac Mini, which is $599 to start, although this offers more expandability.  However, everyone loves to talk about Mac clones, so you can forgive the urge to create a big story here.

Since I happen to be at Apple in 1997 at the time when Apple killed clones, I feel somehow irresponsible if I didn’t remind everyone why Apple launched clones in 1995, and why they killed clones in 1997.

• First answer: market share.
• Second answer: economics.

Here is the explanation in the article:

In 1997 Apple decided to halt its MacOS licensing program. Back in the Mac OS 8.0 days, Jobs–who was only a consultant for Apple at the time, though he soon became “acting CEO” –reportedly called Mac clones “leeches.”

Circa 1997 you could buy a Mac clone made by Power Computing, Motorola, or Umax that was faster and cheaper than anything Apple was selling.

At the time, Apple was losing OS market fast, so Mac clones were viewed as an important strategy for Apple to survive. PC World’s Charles Piller wrote: “Furthermore, no single company–no matter how creative and dynamic–can compete against an entire industry. The engine of innovation that will keep the Mac competitive has to include clone makers.”

Jobs didn’t agree with Piller’s analysis.

In one of his first major decisions as acting CEO for Apple, Jobs yanked the clone program. He saw Apple’s profits in selling computers, hardware, not licensing software. Microsoft, it was widely accepted, had already won the OS licensing race.

Sorry… this just isn’t accurate.

Gil Amelio launched the Mac clone market in a belated attempt to boost Apple marketshare.  The thinking was that clone makers would expand the Mac hardware base into niches that it didn’t currently occupy, growing the base of Mac users and Mac hardware for developers to target.  They assumed some small amount of cannibalization, but it was assumed that the overall pie would get bigger.

The problem was, the Mac wasn’t set up to clone easily, and Apple really didn’t have the infrastructure to support a large number of clone makers.

That, by itself, could have been just growing pains.  But after just a couple years, it was clear that Apple had to kill the clone market.

Why?  Economics.

The clone makers were not, in fact, expanding the Mac user base.  Market share for Mac OS machines was not improving.

However, that wasn’t the worst of it.  The real problem was profits.

Now, I know what you are thinking.  “Microsoft has huge profits!  Selling just the OS is far more profitable than selling hardware!  What are you talking about, profits?  Apple would mint money if they licensed the OS…”

It’s the difference between profit margin and total profit.

Let’s say Apple sells a $1500 Mac with a margin of 20%.  That’s $300 in profit.

Let’s say a clone maker sells an Apple clone for $1500.  Apple sells the clone maker a copy of Mac OS for $50, with a margin of 98%.  That’s $49.

Uh-oh.

That’s right, to replace the margin dollars of an Apple machine, you have to sell several clones.  That means the clone makers have to expand market share by 5+ machines for every one they cannibalize.

But it’s actually worse than that.  Manufacturing computers has a lot of fixed costs.  So, theoretically, if you cannibalize enough machines, the margins on product lines can decay.  You can hit a point where you aren’t even making money on the machines you are selling, without raising prices.

Now, Apple could have raised the OS price to the clone makers, but as you can see, not enough to make a difference.

The reason I tell this story now is that, fundamentally, Apple’s economics for Mac hardware haven’t really changed that much.  They still get 20% margins.  And Apple hardware is still, on average, about $1200-$1500.

Now, Apple is a much bigger company, and theoretically, it could eat the profit hit today, if it wanted to.  But make no mistake, it would be a real hit to profits.  And that means a hit to earnings, and that means a crashing stock price.  It’s not obvious how Apple can cross this chasm without multi-billion dollar dislocation in profits over a transition period.

As a final note, I really enjoyed this lesson when I learned it back in 1997.  In the 1990s, it was conventional techie & MBA wisdom that OS licensing was an obvious win for Apple, and that it was something that “had to happen” for Apple to survive.  Both, of course, were proven to be categorically false.