Impact of Netbooks

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.