January 9, 2004 4:00 AM PST

Push into living room is a gamble

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LAS VEGAS--Computer companies face major obstacles in the consumer electronics market despite optimistic claims that it represents a promising new frontier for a waning PC industry.

Practically all the major PC manufacturers are expanding into home entertainment products, specifically targeting the flat-panel television sets that have boomed in the last year. Large computer makers such as Gateway, Dell and Hewlett-Packard have entered the TV market, hoping to undercut traditional electronics leaders such as Sony, Philips and Panasonic.

News.context

What's new:
From Gateway to Dell to HP, tech companies are touting digital entertainment products at the Consumer Electronics Show in Las Vegas.

Bottom line:
While profit margins on consumer electronics can be high, increasing competition and a history of rapidly falling prices (DVD players now sell for $40) means the strategy is not a sure bet.

Complete CES coverage

In the near term, the strategy may pay off: With their direct distribution systems and other cost efficiencies, computer companies are well-positioned to lower prices on these products while still maintaining profit levels that exceed the margin range of 8 percent to 15 percent historically earned from PCs. However, if prices on flat-panel sets plummet as expected, it is unclear how the computer companies will respond to extreme competition in an unfamiliar territory.

Already, the average price for flat-panel TVs in the 26-to-30-inch category has dropped from about $6,700 in 2002 to roughly $3,200 at the end of last year, according to research firm iSuppli/Stanford Resources, and will likely plunge to about $1,800 by the end of this year with increased competition. In addition to the PC companies, other players such as Samsung, Motorola and Epson are joining the flat-panel rush.

Competition gets intense
"Five or six years ago it was a peaceful marketplace, now people from the outside are coming in like hunting tribes," said Hideki "Dick" Komiyama, president and chief operating officer of Sony Electronics, who was here for the annual Consumer Electronics Show this week.

The introduction of digital technology has unleashed enormous volatility in the electronics business, which has in turn produced wild price swings that have undone the expectations of 30 percent to 40 percent profit margins typical of years past. DVD players that originally sold for hundreds of dollars just a few years ago, for example, are available today for less than $40.

Such commoditization of many products has cut into the bottom lines of businesses throughout the consumer electronics industry, from manufacturing plants to store shelves. Sony, the king of consumer electronics products for a generation, cited weak sales in laying off more than 20,000 employees last year. On the other end of the industry chain, Circuit City shares fell 12 percent Wednesday after it reported disappointing sales figures for December.

In spite of the inherent risks, however, PC companies may have little choice but to join this treacherous terrain as their core computing business continues to struggle. Recent surveys indicate that corporate customers expect only moderate increases in technology spending for 2004, keeping any full recovery at bay for the foreseeable future.

"In the long term, they have to do this to protect themselves," said Stephen Baker, analyst at research firm NPD Group. PC companies are desperate to ensure that computing technology is at the center of tomorrow's homes, rather than TVs, DVD recorders, set-top boxes or video game consoles made by other industries.

Gateway was the first PC maker to recognize the potential of consumer electronics with its flat-panel TVs, particularly as a way to help offset losses in PCs. Matt Milne, executive vice president of Gateway's consumer group, cited some key reasons that the company has been able to compete on plasma TVs. First, the television industry is shifting from analog technology--where Japanese companies owned a number of patents--to digital products, which can be made from components from a variety of suppliers.

Second, electronics manufacturers have long relied on complex and lengthy distribution chains. Products come from Japan, but may go through a few distributors and a retailer before hitting customers. Gateway sells direct and can absorb, or retain, some of these transaction costs.

As a result, Milne said, the company's profit margin on TVs, digital cameras, MP3 music players and other consumer electronics is "well over 20 points and on some products it is way higher than that." One-third of Gateway's revenue now comes from consumer products.


News.commentary
Video loses its chains
At CES 2004, the notion of unshackled
video took a big step forward. But
widespread adoption of new devices
is still a long way off.


Yet consumer electronics will not likely be any long-term panacea for PC companies. Gateway has reported some initial success since introducing its first plasma TV in late 2002, but the company's overall financial health has continued to suffer. And as evidenced in the DVD player market, the relatively high profit margins on the flat TVs can disappear seemingly overnight.

"I think all hardware ends up commoditizing over time--look at DVD players," said Frank Barbieri, group product manager for Microsoft's Embedded Devices Group. "But I think you're going to see manufacturers continue to find ways to innovate."

Peter Weedfald, senior vice president of strategic marketing at Samsung Electronics, added that many electronics makers let products linger on the shelves instead of introducing models with new features. Samsung, by contrast, might put out fewer models but upgrade them more rapidly.

Consumer electronics veterans counter that such strategies won't be so easy in today's hypercompetitive environment. "The time to enjoy the premiums of an innovative or higher quality product is shrinking," said Mark Viken, senior vice president of marketing at Sony Electronics.

Riddhi Patel, analyst with iSuppli/Stanford Resources, also believes that computer companies face significant challenges of brand acceptance in the LCD TV business. "I don't think they are going to take over 40 percent of the market or 30 percent of the market," she said. "I think the consumers are still pretty brand-conscious when it comes to their television."

Back to the future
This is not the first time that the computer industry has targeted the electronics market. More than a decade ago, Silicon Valley companies were working on rudimentary forms of interactive TV technologies that would allow viewers to communicate online and participate in certain types of programming, but those efforts proved to be premature.

The industry took more concrete steps toward electronics in the mid-1990s, when the computing and television industries appeared headed for a much-anticipated "convergence" of technologies and markets. Some PC makers, such as Gateway and Compaq Computer, designed combination PC-TVs intended to eclipse any rival technologies from the consumer electronics industry. Microsoft made the boldest move of all, purchasing start-up WebTV and its Internet-surfing set-top box for $425 million.

Yet the computer industry largely retreated from TV when it found little consumer interest at the time while the PC market was still growing. Since then, however, some important developments have sparked consumer interest in bringing more digital computing technologies into the living room.

One was the so-called Napster phenomenon of sharing digital music files across the Internet and creating custom CDs for pennies. Another was the rise of wireless networking in the home, which has created new opportunities for technologies coming from the PC industry.

This increasingly "connected home" has sparked consumer interest in products never before seen in the living room, said Peter Labe, analyst at Nutmeg Securities. "I think you're going to see a revolution in the TV business where it's going to be a growth business again," he said.

The direct connection
PC companies say the move from computers to electronics is part of a natural evolution. Dell, for instance, believes that people will buy consumer electronics online just as they began to do with PCs in the 1990s.

John Hamlin, senior vice president and general manager of Dell's consumer unit, said his company has succeeded by applying its manufacturing efficiency to markets where technology has matured and become standardized. Under this "Dell effect," as he called it, "the first thing that happens is prices drop and things get easier for consumers, even in a market where prices are already dropping."

Others aren't as confident that tactics from the PC industry can work as easily in the television business. "People will buy PCs sight unseen. They will not buy TVs sight unseen," IDC analyst Bob O'Donnell said. "Dell has a particular challenge because people want to see and touch these things."

Either way, consumer electronics veterans say such concerns are only the beginning for any outsiders trying to break into their business. Many believe that computing companies underestimate the complexities of their business.

"Success for the PC makers comes from improving the productivity of its users, but home entertainment is different. It involves understanding emotions and user experiences, and we spend a lot on R&D figuring out what consumers want," Sony's Komiyama said. "Can Dell re-create that sort of environment or understand that kind of experience? I don't know."

CNET News.com's Michael Kanellos and David Becker contributed to this report.

 

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