Profitless Prosperity?

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The much awaited CES show is finally coming to an end, and as expected it created a lot of hype, buzz and some distorted form of reality. Michael Dell, Bill Gates, Carly Fiorina – all those who normally attended the computer shows came and hawked their wares, and what I call the start of yet another chapter in technology industry’s profitless prosperity.

I will get into this a bit later, but here is a tiny background. In March 2003, I wrote a piece called, The Death of a Cheerleader for Salon magazine. At the very end of the article, here is what I had to say..

> And instead of being all about the investor, the tech boom has now become all about the consumer. Cisco, which for years has provided the plumbing for the Internet, recently spent $500 million to buy a company that sells WiFi products to consumers. After all, how many more Internet routers can it sell? Cisco now advertises its wares on prime-time television, while Intel hawks its goods in Vanity Fair. Blokes get their MP3 player tips from Maxim, and girls buy Sony Clie’s because they are cute.

(It is a whole different story that most of the business press is writing about it, but never mind.) Since then a lot of Silicon Valley companies have realized that there is money to be made, if they can harness the power of commoditization, a trend I have labeled, Moore’s Claw. I said so as much in my recent Business 2.0 story, The Rise of The Instant Company. In this piece I outlined why small companies could get into new product business and if done smartly, could make a decent living by combining smarts and commodity products. Silicon Valley giants are following that road map, but in the opposite direction. Which is where I come back to the concept of Profitless Prosperity.

Lets start with HP and Gateway. These folks are trying to sell LCD televisions, Plasma screens, DVD players, and Media Center computers. Blah! Blah! Blah! One small problem – they cannot do this and make money. These two companies, for instance have failed to make a profit on their core personal computer businesses, where they have inherent advantages over rivals like say Japanese consumer electronics companies.

In the consumer electronics marketplace, they (which I mean computer-based companies) have little or no brand presence. After all why would I choose Planar over JVC or Sony Plasma screen TV (considering that they get their raw components from one or two sources which are shared by all). The consumer electronics companies have a better track record of selling televisions, CD players and DVD players.

They know how to support these products, have a business model which is based on single digit profit margins, and have the inbuilt advantage: consumers know that Panasonic would not change its mind about TVs, but Gateway might. (Anyone remember their 30-inch TV from the late 1990s?) Dell, however is a slightly different story. It has a consistent record, does not start selling new products to bail out a month or two later, has great service/support arm, and knows how to live with single digit margins.

I am going to take this argument a little bit further. Okay now if you everyone from HP to Dell to Planar to Viewsonic selling the same products say televisions, media centers, and personal movie players based on commodity components, there is very little differentiation. I have seen it again, whenever there is little differentiation, and there are too many players, prices collapse. And that leads to profitless prosperity.

One man who seems to agree with my outlook is Pip Coburn, the erudite technology strategist at UBS. “There’s tremendous hype. The IT companies, with no growth in their current market, are pretending there’s a digital consumer revolution. But it’s very early, and a small part of the whole pie,” he told Barron’s. (Actually this is a great round-up of CES.)

But as Bill gates noted in his key note at CES, this is going to be a great time to be a consumer. Investors, however are screwed.

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Om, I have always enjoyed your commentary… and have been doing some bit of thinking about the ‘revolution’ in the digital home that is underway, at least if one were to believe the surge in press coverage.

You are right about hardware – Apex is the best example. A four year old company, roughly 100 people, $1.5 billion in revenues. More importantly, it is the largest seller of DVD players in US. As prices for hardware continue to shrink, hardware companies will have to learn to live with single digit margins, perhaps even less.

However, in the past few years the gap between houeshold electronic devices and desktop computers, in terms of processing power/memory/storage, has shrunk. Just look at the evolution of Palm, from that bulky equipment w/ monochrome display to the sizzling Wi-Fi-enabled Tungsten C, and you will have an idea of what I mean. This processing power is now finding its way into the consumer electronic devices; there are HDTVs that run on linux! The short of it all is that the digital home of tomorrow will be populated with devices that 1) have enough processing power and storage to host more-than-rudimentary software applications, 2) are part of the home network, and 3) the network is wireless. Thus, the digital home will be made up of numerous devices that are not only intelligent as stand-alone entities, but can also talk to each other through a wireless network.

And the innovation will be in using software to integrate such devices to make my life at home easier. If some one is going to integrate all my consumer electronics into one ‘home media network,’ why not let the individual control other household devices – airconditioners, lights – through the same interface. For example, just before retiring for the night, I don’t want to be walking througout the house shutting off lights; why can’t I use my handheld to access the ‘home server’ and tell it to do that. As there is a SAP for the enterprise network, there will be a SAP for the home network.

I agree that it will take a lot – software will have to extremely reliable (which it will be, as I will no longer install third-party applications on any of the devices; it is usually the third-party apps which are the source of unknown conflicts and render a PC unstable); prices for hardware will have to drop, which they will etc; houses undergo rennovation once in fifteen to twenty years, much longer than the three/five-year cycle for corporate IT purchases. But I do see all of that happening, if gradually.

In such a case, the consumer will start paying for software, not hardware. Hardware has been commoditized(?), but software is still years, if not decades, away from it. To give you an example of that, both Rio and iPod depend on a system-on-chip from Portal Player, but it is the software that Apple has written for that hardware that lets them charge me more. As long as Apple keeps improving its software, a task made all the more easier by the commoditization (I am sorry, I could never spell that word correctly without a spell checker) of hardware, I will keep upgrading myself and adding to that company’s bottomline.

In my view, we have just begun an extremely interesting phase where automation / computing spreads into an individual’s life. It is not entirely impossible that sometime in the next two decades, the ‘digital home’ that Bill Gates built for himself in 1990s will be sold as a commodity item.

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