Commoditization of PCs

• Article
• Discussion
• Edit
• History
• Bookmark

Bulls Perspectives Feeling Bullish? Be the first to explain why this would make a good investment Bears Perspectives Feeling Bearish? Be the first to explain why this would make a poor investment Send the authors a comment or suggestion Itunes has recently become the largest seller of music in the US, passing Wal-Mart, Best Buy and ... more [Dismiss] [Done] See All Suggestions

Top Contributors Ish S. Dugal Kirk Bangstad Related Articles Apple (AAPL) Hewlett-Packard Company (HPQ) Microsoft (MSFT) Advanced Micro Devices (AMD) Western Digital (WDC)

This article describes a concept which could impact a variety of companies and industries. The article lists companies that could benefit or be harmed by the trend. To see what companies and articles reference this concept page, click here.

The current trend began in the 1990s, when the power of personal computers increased radically, blurring the formerly sharp distinction between personal computers and multi-user computers such as mainframes. PCs, although networked in the office, became the norm both at home and at work. Today, processing power, once the largest differentiator in price, is becoming less of a factor. Mobility, i.e. notebooks vs. desktops, has also traditionally been a large price differentiator, but the gap between notebook and desktop prices has narrowed. Lower prices, along with mobile wireless capabilities, helped notebook sales increase about 22% from 2005 to 2006, while desktop sales remained flat. PCs are moving towards commoditization as traditional price differentiators become marginalized and price itself become the main purchase differentiator.

Increased PC commoditization could hurt PC manufacturers, who are facing price pressure that could drive down their operating margins and profits. If PC manufacturers are negatively impacted by commoditization, then so will the hard drive, operating system, and microprocessor OEM's who supply products that are embedded in PCs. Those who should be optimistic about commoditization include PC hardware innovators (those not selling a commodity PC), and network technology focused OEMs who could see increased demand for their products as traditional PCs both become cheaper and less valuable to computing.

[edit] Factors Influencing Commoditization?

As PCs are increasingly compelled to become as commoditized as the polymers they are enclosed in, there are a few primary PC market drivers to keep in mind.

[edit] Processing Power and the Lack of Differentiation

As Moore's Law predicted, computer processing power has increased at meteoric rates. As the power of microprocessors continues to increase, there are fewer and fewer business and consumer computing needs that cannot be met with off-the shelf commodity computers. At some point it seems logical that incremental increases in CPU power will not drastically affect the user experience, as it has in the past. Computers today are so powerful that we don’t need to upgrade them as often. If PCs largely have the same capabilities, then how will OEM's differentiate themselves? The answer is with lower prices - the decrease of which is driving commoditization.

[edit] Emerging Market Sales

Many emerging economies have per capita incomes below $5,000, and therefore can only be significantly penetrated using low-cost, commodity machines. Emerging regions are helping to drive commoditization because they are accounting for the majority of new PC sales growth worldwide. Emerging markets accounted for half of PC sales and about 53% of worldwide PC growth in 2006, while the U.S. logged a modest 3.6% CAGR in the same year. For example, a Chinese manufacturer recently introduced a $203 PC to the market. PC market leaders may really have to stretch themselves to compete with such price competition.

[edit] Central Computing

The trend toward central computing and storage has led companies to look for more performance outside of desktops, with many adopting a thin client strategy. Some evidence of this trend is the increased adoption of blade servers and grid-computing technologies. Grid computing is an emerging model of distributed computing that employs a dynamic pool of dispersed commodity computer resources (often desktop computers) to tackle large, time-consuming tasks.

[edit] Companies Who Will Gain from PC Commoditization

Apple (AAPL) is a PC innovator that makes designs, experiences, and technology that are unique and differentiated and will have the opportunity to steal market share from commodity OEMs. Apple's iMac, which has a widely recognized design, could see demand surge as users search for alternatives. Between the third calendar quarter of 2005 and the third quarter of 2006, Apple's U.S. Mac unit shipments grew 31% from 744,000 units to 975,000 units. We may see more manufacturers take various computer hardware attributes and put them together in different ways, targeting them at specific industries. For example, some PC OEM's are creating specialized divisions to cater to the needs of health care, manufacturing, transportation, education, or life sciences in an effort to differentiate their offerings.

RealNetworks (RNWK) and again Apple (AAPL) are digital media companies that may see gains as PCs become more and more inexpensive to purchase due to commoditization. Today, 70% of U.S. consumers--93% for ages 18-24--listen to music on their PCs. Here, Apple's iTunes and RealNetworks (RNWK) are in beneficiary positions. Other notable software categories to watch include computer security, and PC video games developers.

Cisco Systems (CSCO) and Sun Microsystems (SUNW) are network hardware providers that could benefit as enterprise computing becomes more centralized. Companies are paying less attention to PCs and more attention to network-centric technologies - servers, gateways, routers etc. Also, companies with finite IT budgets, as they spend less on PCs, may use a greater portion of their dollars on network infrastructure. This indicates a growing need for companies such as Electronic Data Systems (EDS), which provides third-party infrastructure services to clients who lack the requisite networks on their own. It is also important to note that some leading PC OEM's such as Dell (DELL) sell network infrastructure equipment in addition to PCs.

NVIDIA (NVDA) and ATI Technologies (a subsidiary of Advanced Micro Devices (AMD)) are two leading graphic card makers that may see demand increase with commoditization. As PC OEM's look to differentiate themselves, many are shipping graphic cards as standard hardware in new PCs - instead of offering them as costly upgrades as was previously the case. NVIDIA and ATI are the two leading players in the high-end graphics market.

Red Hat (RHT) and other open source companies that have figured out a way to make a profit from the commoditization of both hardware and software will stand a good chance of doing quite well.

[edit] Companies Who Will Suffer from PC Commoditization

PC manufacturers such as Dell (DELL) and Hewlett-Packard Company (HPQ) have the most to lose from commoditization. If prices continue to plummet, OEM's will face increased pressure to differentiate their products to increase prices - or suffer as a result of the financial stress on margins. Dell (DELL), until recently a prominent cost leader in the PC market, is rapidly losing its lowest-cost position. In 2006, Dell cut its prices in an effort to maintain its 19.2% market share. However, this move also cut profit margins by more than half, from 8.7 to 4.3%. Hewlett-Packard Company (HPQ) has differentiated itself from competitors by making a push into the less commoditized notebook side of the business, where it is currently the market share leader. HP has also refocused around its imaging and printing group, which is the company's most profitable division. Many PC OEMs are mitigating the effects of PC commoditization by venturing into new technology areas, such as hand held computers, high-definition TV's, servers, storage hardware, etc. Those who are able to protect their margins while clearly differentiating themselves in the marketplace will have limited negative exposure to commoditization. Others, such as Acer (ACID), which has set up a subsidiary in India called Acer India, could put itself in an enviable position by successfully penetrating large emerging markets before its competitors.

Intel (INTC) and Advanced Micro Devices (AMD) are microprocessor OEMs that may suffer as margins for PCs decrease and PC OEMs will likely continue to put pressure on microprocessor to reduce prices. If chip prices are reduced, these companies will have lower revenues, operating margins, and profits. On the other hand, Intel (INTC) and Advanced Micro Devices (AMD) have very few close substitutes to the computer processors they manufacture, with the two firms together control about 90% of the current PC processor market. Time will tell if microprocessor OEM's have enough leverage over PC OEM's to hold their price points.

Microsoft (MSFT) is the operating systems leader, with a 90% market share of the OS market and could find itself in a tight position. PC OEMs are likely to put pressure on MSFT to reduce the price of their ubiquitous OS, the cost of which currently makes up 25% of the total price of a low-end PC. If Microsoft does not comply, PC OEM's could start shipping machines with free Linux-based open source operating systems. It is important to reiterate that most of the growth in the PC market is coming from emerging countries, where pirated software can be as high as 90% of all installed software. As a result, Microsoft rarely makes any money in these markets. However, Microsoft has been able to utilize the strategy of SKU differentiation in order to maintain relatively high margins. By enabling different sets of features on their "Starter", "Basic", "Home Premium", and "Ultimate" operating systems, they are able to sell extra features at a premium to users who can afford them, while still offering low-cost solutions to those who cannot.

Seagate (STX) and Western Digital (WDC) are the two largest standalone hard disk manufacturers in the world and they may be pressured by PC OEM's to reduce their prices. Seagate, which as of August 2005 had 31% of the HHD market, has maintained around a 43% market share of the high-end PC market. The world’s second largest HDD maker Western Digital, with a market share of 18.5%, ships a majority of its HDDs to be embedded in low to mid level desktop computers, leaving it very exposed. On the flip side, if a majority of PC users who spurn buying new PCs instead decide to upgrade existing machine hard drives, these firms could mitigate their exposure.