The computer industry is on the cusp of a revolution. Just as Asian car makers undermined the profitability of Detroit with their cheap and reliable subcompact vehicles, now the Asian tech industry is threatening to do the same to Silicon Valley with netbooks, simplified mini-laptops optimised for web browsing that will retail for as little as $250-300. Despite disappointing Q1 sales, this structural change in the computing industry will profoundly affect some of the biggest tech names. About 25m will be shipped this year, and growth looks set to explode across the emerging world as local middle-class consumers graduate from cellphones to their first computer.
They were originally conceived at MIT as a solution for the computing needs of schools in developing countries and typically have a 7-10 inch LCD screen, a couple of USB ports, Wi-Fi and sometimes a 3G antennae, and run on Intel’s Atom chip or the ARM11 processor. They are inherently lower-margin for the industry in the same way as selling a subcompact is compared to a fully loaded SUV for Ford, but they offer the promise of reaching millions of new consumers in emerging markets who can now graduate from a mobile phone to a computer. While US manufacturers were slow to see the potential, Taiwanese and Chinese firms have moved quickly to create a whole new market based on a lower rather than higher product spec.
This year PC shipments globally are likely to decline 10-15% but the value decline will be closer to 20 percent. The launch of Microsoft's Windows 7 is set to fuel the flight to lower-cost, simplified PCs because it’s configured to run on the lowest common denominator in terms of configuration. This is the first Windows upgrade ever not to require a hardware upgrade. For Microsoft, accepting lower margins is strategically rational to keep Google's Linux-based Android operating system at bay in the netbook market. Interestingly, mobile phone operators like Vodafone are now offering 'all you can eat' mobile broadband on monthly subscription with a free netbook thrown in; computers are now following the model created by the phone industry. While volumes will soar over coming years (although forecasts of 120m by 2012 look like typical industry hype, any more than half that would be a good result) it will to some extent be at the expense of the replacement cycle for high-margin laptops and PCs. The net impact on the bottom line for the computer industry may prove negative, but as always amid a structural upheaval, there will be both winners and losers. “A broad shift in the consumer market toward low-cost PCs would clearly put pressure on the revenues of nearly every player in the value chain, from component suppliers to retailers,” analysts at Sanford Bernstein wrote last month in a note, and it's hard to argue with that conclusion. When Renault launched their Logan low-end 'world car' for emerging markets a couple of years ago, they were astounded to find most sales were actually in developed markets as consumers traded down. I'd expect a similar trend in PCs. The lesson of netbook's sudden rise is that hardware is taking a backseat to software and services, as we move to the 'cloud computing' model ie devices access the applications they need remotely and as required rather than storing them.
In February, Windows based laptops fell in average price by a whopping 22 percent to $560 dollars a time.As well as demonstrating quite how panicked the laptop makers are about the netbook threat and weak demand, it also reflects the fat margins previously enjoyed. Apple doesn't have the scale economies to fight a price war, although Macbook prices fell 7 per cent fall in February, unusual for a company committed to premium pricing and differentiation. I wouldn't be surprised to see even Apple enter this market despite their stated unwillingness to 'trade down', albeit at the top-end of the current price range at say $500, to pre-empt erosion of their market share and exploit strong brand loyalty. Currently, Taiwanese PC makers Acer and Asus have the market to themselves, but a flood of new launches from Dell, HP etc will occur this year. Broadly, Google looks like being a big winner, both because its Android operating system(teamed with the UK based ARM's chipset) looks like becoming a major player via netbooks, and the fact that these devices will expand the global reach of all web service companies by reaching the 'next billion' in emerging markets. Google's emergence in the wireless space also gives it an opportunity to catch up with Baidu in the key Chinese market. The Intel/Microsoft duopoly, so long dominant in the PC market, is now losing leverage rapidly, and recent downbeat comments by both seem justified by the strategic outlook. They look like remaining tech 'value' stocks with huge cash generation but little top line growth.
The guts of a netbook are very similar to asmart phone, and indeed the convergence between the PC and phone industries opens up opportunities for guerilla tactics from web service players like Google which span both markets. Qualcomm, Freescale Semiconductor Nvidia and Samsung Electronics all design and/or make the cheap, power-saving chips used in cellphones which are now competitive in the PC market via the emergence of netbooks; makers of low backlight OLED screens (replacing LCDs) will be in a profitable niche also. In a way, netbooks bridge the gap between the booming smart phone market and traditional laptops and will probably end up cannibalizing both as they evolve.With a few years, for consumers the web will consist largely of hundreds of millions of tiny computers in a pocket or backpack, connecting wirelessly to access software applications remotely as required rather than carrying a copy on-board. They will absorb the functions of many discrete gadgets from gaming consoles to navigation devices. Netbooks will seal the triumph of the insurgent wireless industry over the PC by combining the best features of both. As prices tumble under $200 later this year, the rise of the machines will be a seminal event in Silicon Valley history and will likely upend the industry's current leadership, leaving wireless hardware and web service giants to dominate the Wintel alliance.
