Earnings season..... Oh Boy! The deluge is about to begin.
Last week, actually on April Fool's Day, there was an article in the NYT that talked about the trends in the portable computing world: Light and Cheap, Netbooks Are Poised to Reshape PC Industry. Notable were the comments from Intel's Sean Maloney: “When these things are sold, they need clear warnings labels about what they won’t be able to do,” said Sean M. Maloney, the chief sales and marketing officer at Intel. “It would be good to wait and play with one of these products before the industry gets carried away."
Hmm... They've really been downplaying this. Makes you wonder.
In general, it's a timely product for challenging times. I believe, and this was noted in the article, the rise of the netbook will have implications for margins. I've attached two research reports related to this for your consideration. Back in February I made some comments about the UBS report and sent them out but didn't get much feedback (seems to be a common theme these days) so, for posterity, I'm sending them along with a few minor edits.
My comments follow the quoted (in blue) excerpts from the UBS report.
“Our conclusions generally support our thesis that notebook cannibalization of netbooks is limited”. I don't buy it. The survey question is poorly targeted - netbook against a stationary desktop PC. It did not explore the possibility of the netbook being a lighter weight substitute for a laptop.
- “Current netbook pricing of $300-500 is generally within user expectations." Compare that to a similarly equipped laptop or sub notebook. Where is the difference in bill-of-materials coming from? Basically it’s the CPU and the O/S.
- “Intel is promoting WiMAX as alternative to existing wireless broadband services,”</span> This has less to do with core issue of netbooks, but as a factual matter the Intel WiMAX effort is behind expectations (and yes, I realize some of the overseas opportunities are progressing). Note the last reported quarter where Intel took nearly a $1bn charge against its WiMax consortium effort. Its other consortium partners have taken charges as well. This comment has the appearance of being an Intel tout, or being behind the information curve.
- “Nearly half of the respondents would prefer a full PC Microsoft operating system.” Agreed. The issue is XP is perfectly adequate for the uses Netbook denizens prefer, largely Internet access and reading/responding to emails. Vista, er, Windows 7,is not appropriate with its higher system resource requirements. Those higher priced O/S’ offer nothing obvious to the netbook users’ experience. Knowledgeable folks will point to better security features in the latter, more recent O/S’, but the everyday consumer cares little for that as XP is ok, and the price difference in hardware significant.
- “For Microsoft, the impact from netbooks warrants monitoring.” Nothing like barely taking a position. These are soft words for a shift toward the unanticipated life extension of the aging, but familiar and adequate XP operating system. This presents marketing problems. Microsoft is scrambling to prove and stimulate a reason to upgrade to the new, improved and much more expensive Windows 7 O/S in the non-netbook installed base of users. It’s similar to choosing between a well-equipped sports car and the model with a few more airbags in the rear seats for a lot more money.
-“Given that any version of Windows 7 should run on a netbook, the overall weighted ASP that Microsoft receives for netbooks could be higher than the $27” (of XP).” Well not necessarily. Netbooks are: 1) Small format for portability. 2) Full featured defined as running a mass market O/S and key applications (browser, Office suite). 3) Sold at a much lower price point. A more expensive O/S is not needed nor is it within the netbook cost model. Note the two highest margin components in a PC are the CPU and O/S. Couple that with the 3 highest ASP items in a Notebook, the CPU, the screen and the O/S. The screen size limits what can be done to lower prices between a laptop and a netbook, given similar dimensions. But the CPU and O/S, that is where the cost savings will be focused. Either XP remains or a stripped down, lower cost Windows 7 is substituted. The netbook O/S model is dependent on a low cost O/S. If Microsoft becomes aggressive and pushes upward price migration it will result in a massive manufacturer outcry. That alone runs the risk of</span> fueling alternative O/S’ market share gains. Don’t like Linux, how about Apple’s O/S dominating netbooks? Microsoft will not allow it.
One should be very careful touting Intel’s increased ASPs excluding Atom. Intel has just launched new processors at a time when it still maintains decent pricing power. That's good for Intelbecause their customers really got squeezed in the Q4'08 and the Q1'09 downturn. Server and desktop ASPs, as well as mobile, have come down and now Intel needs to move product. This is one reason why Intel may show a loss in Q1'09. Pricing was so questionable at the start of the quarter Intel was saying they did not have sufficient visibility to give guidance. Seems to be some obvious reasons for this.
- A different way to examine the netbook phenomena is by asking this question: What do laptop and netbook users do with their mobile products? How big are the differences between the laptop and netbook when used in the field? If mobile use is 90+% Internet access for both, then one should definitely expect cannibalization of laptops for cheaper netbooks. This is especially true for the consumer space, and even more so for the increasingly mobile, ever adaptable, tech-savvy youth.
- Microsoft is in a quandary. The end-of–life strategy for XP has gotten pushed out. Does this set an uncomfortable pricing point as reference for its new, improved and more expensive Windows 7? Will netbook manufacturers and customers care to pay up for Windows 7? The only solution I can surmise is to expect a stripped down Windows 7 for netbooks, but still priced at or about where XP is today. Then the question becomes, how do you migrate pricing models and expectations to non-netbook market segments. I believe this bears watching.
- Intel is in a quandary. This could be one reason we hear management talk somewhat negatively about the netbook sector. Atom has a lesser ASP than the other Intel mobile CPUs. Yes, it is less powerful, but it is powerful enough. If you double the onboard memory cache the user receives a perceptible increase in performance. This is especially true for the primary use - web surfing and Office apps. Some manufacturers have gone as far to manufacture desktop Atom products for those that are extremely cost sensitive. You have to wonder if the solution for Intel is to sell more Atoms into all manner of products to make up for the ASP decline in the offering mix. Ultimately this might include home entertainment centers, home controls, as well as netbooks and cheaper laptops and desktops. The cannibalization issue is real, and it is a more likely scenario in a recession economy where price becomes more important to the purchase decision by both consumers and industry.
In sum, I think it is important not to become a stenographer for management with items like this; “…commentary from Microsoft and Intel management suggests that netbooks are likely to be more incremental, which implies a net revenue benefit for Microsoft.” Do not expect Microsoft or Intel management to suggest anything other than netbooks being incremental, inferring success in that space will not alter their historical business models. They see no need to spook the market while waiting to see how things shake out. Rest assured, outside of the PR campaign, they are concerned with what mass acceptance of this lower price point product will do.
Microsoft and Intel are doing what they must to live in a technology market, constant improvement of the price/performance ratio to move product. For 30 years the status quo was to replace PCs for technological reasons sooner vs. running the product to end-of-life. Upgrading every 2-4 years was a given even though the installed base of products worked and worked well for easily twice that amount of time. Admittedly there were significant improvements in the technology and in most instances that made early upgrades valuable but today the end user seems to be indicating that it has adequate performance which implies that the price will now become the primary focus. Called to duty, Intel and Microsoft pricing points are being lowered.
Longer term one has to wonder if the global recession will allow the total addressable market will grow. Seems fairly clear that the TAM will shrink for economic reasons. That, coupled with a shift to less expensive product, means lower margins. This is not what Microsoft or Intel would prefer, but price/performance imperatives, adequate PC performance, coupled with a global economy in decline are all issues pointing to mounting pressure to lower prices. All this fits with the "industrial tech" mantra I have been talking about for the last eight years. There's plenty more in the reports. I certainly do not have all the answers. Feedback (and subscriptions to the mailing list - see link below - and yeah, I know it is a shameless plug) are very much welcome.