Disk storage industry (from WSJ)
Interesting article (some analogies with Nand Industry)
online.wsj.com
Costly Memories
Behind TiVo, iPod and Xbox:
An Industry Struggles for Profits
Disk-Drive Makers Provide
Backbones of New Gadgets
But Miss Out on Rewards
A Promising Year Turns Sour
By SCOTT THURM
Staff Reporter of THE WALL STREET JOURNAL
October 14, 2004; Page A1
The TiVo video recorder, the iPod music player and the Xbox game machine all owe their existence to the same high-tech innovation: smaller, denser, cheaper disk drives. For nearly 50 years the disk-drive industry has driven advances in computers and gadgets by supplying new ways to store data.
But there's one thing drive makers can't produce: sustainable profits. Even during the tech boom, when makers of other high-tech innards like software and chips feasted, drive makers collectively lost money in 1998 and 1999. More losses followed during the bust.
For a few shining months last year, the $22 billion-a-year industry looked ready to pull out of its long slump. Sales and profits rose with the first whiffs of a tech recovery. A consolidation wave had reduced the field of competitors, and fertile new consumer markets were opening. Instead, the next 12 months became the industry's latest debacle, as drive makers repeated their mistakes of the past.
Encouraged in part by aggressive sales forecasts from computer makers, they overproduced. Looking to recoup their investments in research, they began targeting each other's markets. Inventories of unsold drives mounted, sparking deep price cuts that erased drive makers' razor-thin profit margins.
[storage problem]
The travails are a potent reminder that even the most useful technologies do not always bring returns. Drive makers today are back in a familiar grim position, where a failed effort to shave 35 cents in production costs can roil the market, and bad news at one company can hurt, rather than help, rivals.
All three of the main independent suppliers have been suffering. Net income at No. 3 Western Digital Corp. fell 17% in the fiscal year ended June 30. For the quarter ended that same date, Seagate Technology, the No. 1 maker, and No. 2 Maxtor Corp. each posted losses and laid off workers. Shares of the three companies are down an average of 51% from a year ago, while the Nasdaq Composite Index is down less than 1%.
Disk drives, formally known as hard-disk drives, are the long-term memories of computers. Few products are more central to the spread of computing and the Internet. Employing chemistry, physics and mechanics, a modern drive crams eight billion bytes of information -- the equivalent of 8,000 books -- in a square inch. That mass of data is manipulated by a tiny magnet flying less than a millionth of an inch -- the height of 35 atoms -- over the surface of a coated aluminum disk. The cost: less than $1 for one billion bytes of storage, down from $560,000 in 1976.
But computer makers long ago relegated drives to being interchangeable parts and have reined in the pace of disk innovation ever since. With the cost of adding a new production line relatively low, drive makers continually add just enough capacity to create a glut, forcing prices down and slashing profits.
Executives lived by a "must-win, scorched-earth mentality," recalls William Schroeder, who spent 18 years at several drive makers. "If I can't win it, I'm going to ruin it for the next guy." Between 1998 and 2002, independent drive makers lost a collective $800 million, according to market-researcher Gartner Inc. The drive units of bigger tech firms, such as International Business Machines Corp. and Hitachi Ltd., lost hundreds of millions more.
Computer users have benefited handsomely, in effect hitching a free ride on drive makers' red ink. Gartner estimates that drive makers invested more than $6.5 billion in research and development between 1998 and 2002, while posting big losses. Today, those investments are evident in ways unimaginable just a few years ago: the 1,000 songs that can be stored on the drive in Apple Computer Inc.'s popular iPod mini, or the 140 hours of television that can be stashed on the drive of a TiVo Inc. digital-video recorder. A basic personal computer can store 40,000 digital photos, on a drive costing about $50.
Manufacturing disk drives is "the longest-running industrial philanthropy" in history, quips Roger Johnson, former chief executive of Western Digital and now a board member at Maxtor. Mr. Johnson says he is speaking as an individual and not as a Maxtor representative.
The free ride could end if the disk makers' losses finally force them to curtail investment and slow technological advances. Already, the torrid pace of the 1990s, when the amount of data that could be squeezed onto a disk roughly doubled every year, has slowed.
Hard to Profit
The events of the past 12 months show just how tough it is to profit by selling disk drives, how fewer competitors can mean more competition, and how prices and revenue can fall amid improving demand.
It didn't look that way at first. The big losses of the late 1990s had forced unprofitable drive makers to exit, reducing the number of global players to seven, from roughly double that. The casualties included IBM, which invented the disk drive in 1956 but was losing roughly $400 million a year on drives when it sold its unit to Hitachi in 2002.
With each of the remaining players specializing in different types of disks, tamer competition fueled a surge in profits. Through the first nine months of 2003, the three big independent drive makers recorded more than $680 million in net income, putting them on pace for one of the industry's most profitable years. Prices, which typically decline, held stable. And consumer-electronics sales began to register meaningful gains.
Then, drive makers fell victim to their own exuberance. As early as July 2003, Matt Massengill, chief executive of Western Digital, says he heard rumors from suppliers that Seagate and Maxtor were cranking up assembly lines.
Both had big plans: In June 2003, Seagate, which spends heavily on innovation, resumed selling drives for laptop computers, after a five-year hiatus, openly aiming for 10% market share within a year. Meanwhile, Maxtor, already working to build a brand name by marketing direct to consumers, set its sights on the low-volume, high-profit drives used in corporate computers, Seagate's biggest source of profits. Maxtor CEO Paul Tufano told investors in July 2003 that his company wanted 20% of corporate-storage sales by the end of the year.
Seagate Chief Financial Officer Charles Pope says the company didn't undercut rivals to win market share as it re-entered the laptop market, but he says it was surprised by "proactive, reflexive" price-cutting by others. Maxtor's Mr. Tufano says his 20% goal was intended as an internal "rallying cry" for employees. He says Maxtor was not the "aggressor" in cutting prices.
At Western Digital, Mr. Massengill worried most about his rivals' plans to boost output of drives for desktop PCs, the biggest, but least profitable, slice of the industry -- and Western's traditional domain. Drive makers have faced terrible economics in PCs ever since the early 1980s, when computer makers dictated that drives be standardized parts. That made it hard for any drive maker to gain, and hold, a technological lead over rivals, as Intel Corp. did in microprocessors. Big PC makers such as Dell Inc. and Hewlett-Packard Co. have gained even more clout as the PC industry consolidated.
Mr. Massengill had been adapting Western Digital for these conditions ever since he assumed the CEO post in 2000. The longtime company engineer concluded that drives were nothing but a commodity and "not a high-tech business." While Seagate spent $666 million, or 11% of revenue, on product development in the last fiscal year, Mr. Massengill spent just $201 million, less than 7% of revenue.
His strategy stresses lean operations and frugal spending over cutting-edge products. Shortly after taking over, Mr. Massengill shut a unit making drives for corporate computers that he had once led, trimmed outlays on new computers for internal use and shifted more manufacturing to Asia. In planning sessions, he told aides to assume that no drive would sell for more than $50, or yield profit of more than $7.50.
Out of the Way
As the hum of his rivals' assembly lines grew louder in the summer and early fall of 2003, Mr. Massengill chose to get out of the way. He slashed Western Digital's production plan for the third quarter by about 7%, or nearly one million drives, adjusting the schedule as often as daily.
It wasn't enough. Collectively, drive makers shipped 70 million drives in the third quarter of 2003, eight million more than computer makers needed, according to market researcher Trend Focus Inc., Los Altos, Calif. That sparked unusual price cuts, at a time of year when drive makers typically raise prices amid strong demand. The average price for a standard 40-gigabyte drive for a desktop PC declined to $62 in the third quarter, from $66 three months earlier, according to Trend Focus. Prices for laptop drives fell even more steeply.
Then, manufacturing glitches upset the delicate balance of supply and demand. In October, some users of Seagate desktop drives reported malfunctions under hot, humid conditions. Seagate quickly traced the problem to a 35-cent part designed to absorb moisture that the company had eliminated in an effort to shave costs. The tiny change, if it had worked, could have boosted Seagate's net income by as much as $28 million a year, or 5% in the fiscal year ended June 30.
Seagate quickly fixed the problem, but the damage had been done: Several PC makers forced Seagate to retest and recertify its drives, meaning Seagate lost access to some big customers for more than a month at the busiest time of the year. PC makers bought drives elsewhere, but Seagate had made or ordered millions of parts for anticipated orders that wouldn't materialize.
To compensate, analysts say Seagate sold additional drives to lesser-known distributors, who don't test drives as rigorously -- helping to swell inventories in the market. John Monroe, a Gartner analyst, says Seagate "stuffed" drives into the distribution chain at discount prices.
Mr. Pope, the Seagate finance executive, says Seagate reduced production following the manufacturing hiccup and sold as many drives to distributors as it planned. Distributors' inventories rose because of weaker-than-expected demand, Mr. Pope says.
PC makers compounded drive makers' woes with their own bad forecasts. Fearing component shortages, H-P bought an extra $150 million of parts at the end of 2003. H-P's purchases helped Seagate reach its 10% market-share goal for laptop drives six months early.
But the extra demand for laptops never materialized. Goldman Sachs analyst Laura Conigliaro estimates that H-P bought 600,000 more laptop drives than it needed in the fourth quarter. This year, Seagate's sales of laptop drives plunged, to 450,000 in the second quarter, from 1.9 million at the end of last year, according to Trend Focus. An H-P spokesman declined to comment.
Inventory continued to rise through the early part of 2004, and prices continued to fall. W. Don Bell, chief executive of disk-drive distributor Bell Microproducts Inc., says he noticed increased numbers of drives at brokers and "gray market" dealers, particularly in Asia, late last year.
Mr. Bell says drive makers think they can hide excess inventory by selling drives to dealers in Asia. But it costs only about 50 cents to ship a drive from Asia to the U.S., he says, so the drives quickly make their way around the globe. Drive makers "wind up cutting their own price," he says.
Write to Scott Thurm at scott.thurm@wsj.com1 |
