Commoditization Of High-Tech Computer Pdts Changes Mkt
[Article from today's WSJ. --Duker]
By Mark Boslet
PALO ALTO, Calif. (Dow Jones)--Sales of high-tech computer hardware are booming, but prices have fallen so far that revenue at manufacturers is slowing and margins are shrinking.
That's because even in this industry of rapid innovation, complex electronics are increasingly becoming commodities.
Following the steel, copper and machine goods that fed the factories of earlier industrial eras, high-tech hardware is turning into just another ware.
The markets for disk drives, microprocessors, DRAM memory chips, network adapters and modems have changed so considerably that many manufacturers are looking outside their traditional lines of business for opportunities with fatter profits. Disk drive maker Seagate Technology Inc. (SEG), for instance, has focused on new opportunities in software. Intel Corp. (INTC), the leading maker of computer microprocessors, is pursuing networking chips and an Internet-services business. 3Com Corp. (COMS), the networking and modem company, has shifted future investments to new product areas with better growth.
"In all the hardware markets, there has been increased commoditization," with companies using price to fight harder for market share, said Gigi Wang, senior vice president at the market research firm International Data Corp.
Worldwide unit sales of desktop disk drives, for example, rose 10.2% in 1998 after a 23.9% rise in 1997, according to figures from IDC. However, sales in dollars actually declined 12.2% in 1998 and rose only 17.5% in 1997.
Shipments of desktop and workstation microprocessors rose a healthy 16.8% in 1998. But dollar sales were up only 8.6%, Semiconductor Industry Association data show.
Perhaps the most dramatic example of commoditization is the computer microprocessor industry, where competition and product performance have risen simultaneously. Advanced Micro Devices Inc. (AMD) and National Semiconductor Corp.'s (NSM) Cyrix Corp. created new competition with low-cost chips able to do what Intel's more expensive processors can do.
Cheap Chips Change Market
Chip performance also improved rapidly, outpacing the needs of users. Sub-$1,000 personal computers with processors containing far less punch than Intel's marque 500 MHz Pentium III processor have enough power for most computing tasks.
"Commoditization has driven down prices to new levels," said Linley Gwennap, publisher of Microprocessor Report. Behind this trend is that for the first time, computer makers can buy similar products from several vendors, he said.
Commoditization also is driving the market for consumer PCs by increasing the penetration into new households. "Far from the end of the PC, I think this is a new beginning, with the PC getting into more places than it has before," Gwennap said.
High-tech executives say the commoditization is brought on by two key trends. First, manufacturing processes have improved to the point where complex products can be made with high reliability and performance in large enough volumes to lower costs. Second, industry standards assure product from different makers are interchangeable.
"We actually tried to go to this point; we tried to get to commoditization," said Jef Graham, senior vice president of the personal connectivity business at 3Com. To win in the market, "you've got to be the big fish," or dominant producer.
For 3Com, that meant mass producing the adapter cards that permit computers to communicate with networks. But in the case of 3Com's once lucrative network card business, competitor Intel slashed prices and a price war erupted. Margins evaporated.
Manufacturers of computer memory chips suffered a similar fate. They built so many factories over the past several years that capacity bulged and prices collapsed. Product demand, measured by megabits of memory capacity, jumped, but the price of a megabit of memory fell from an average of $3.75 in 1995 to less than 16 cents.
Dog-Eat-Dog Market
Disk drives have an equally harrowing story. The industry developed standard interfaces governing the way drives work and desktop products with more capacity than people needed. Production volumes rose as companies lusted after market share gains. However, prices tumbled so low that some manufacturers' profits disappeared.
As long as a drive product is reliable and fast, "you've created a commodity," said Crawford Del Prete, an analyst at IDC. "That's why the business is so dog-eat-dog."
Companies try to differentiate their products with extra features, higher speeds, more capacity, or recognized brand names. But either the features don't lead consumers to dig deeper into their pockets, or just as rapidly as one competitor breaks a new speed or capacity barrier, another catches up.
Another answer has been to cut production costs. Companies are "absolutely being forced to be more efficient and more innovative to meet the demands of the marketplace," said Joseph Regan, vice president of worldwide sales at Solectron Corp. (SLR), an outsourcing company with an expertise in product assembly.
Experts say commoditization will spread to new high-tech products. In the networking industry, switches could be next, said Frank Dzubeck, an analyst with Communications Network Architects. As more and more of a switch's intelligence is put into the "silicon," or chip, the cost of the product goes down, he said.
One reaction to commoditization at 3Com is to drive into new markets. Despite being able to wring 10% to 20% annually out of production costs in traditional lines, the company is gearing up to produce equipment for such emerging markets as xDSL high-speed network connections and cable modems.
Driving a product line to high-volume commodity production allows the company to make these transitions, said 3Com's Graham.
Some experts also expect the current trend to reverse itself over the next several years - at least in product categories where hardware development has gotten ahead of the software development. New, more powerful and demanding software from Microsoft Corp. (MSFT), such as Windows 2000, along with three-dimensional computer-screen interfaces, videoconferencing and voice-recognition technologies could increase the demand for powerful processors and high-capacity disk drives.
"These things do go in cycles," said analyst Del Prete, and things "will cycle back."
"Applications are coming and they are continuing to get better and more and more exciting," said Dan Russell, director of platform marketing at Intel, who objects to characterizing computer chips as commodities.
"It's hard to call any industry a commodity when you see change happening so rapidly," he said.
In any event, the "trends are going to shift back" to where consumers once again find increased value in the chip and the platform, he said.
- Mark Boslet; 650 496-1366
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