consumer electronics: a new front on the online/bricks-and-mortar battlefield

I’d been planning to write this post before the announcement yesterday that the CEO of Best Buy is resigning.  Maybe it’s a bit more topical today.

trying to end discounts on consumer electronics

Early in the month, Korean and Japanese consumer electronics firms–among them, Samsung, LG, Sony and Panasonic–announced new rules for sales of their high-end products in the US.

Previously, the device manufacturers had at least threatened to, and perhaps actually withheld sales incentive payments to retailers who aggressively discounted the recommended selling prices set by the brands.  That didn’t stop internet retailers from undercutting their bricks-and-mortar rivals, however.  The manufacturers are now taking a new tack.

From April 1st, the consumer electronics companies say they won’t just not pay marketing money to discounters.  They won’t ship “hot” products to them at all.  To get the latest and greatest, buyers will have to go to full-price outlets.

Sounds crazy. 

Why would they do this?

Two reasons occur to me:

1.  The manufacturers want to preserve the bricks-and-mortar distribution channel.  In particular, they want to preserve the big-box strip mall retailers like Best Buy.

This would be somewhat like what the book publishers did a year ago, when they forced Amazon–by withholding newly-published “best seller” e-books from the internet retailer–to charge higher prices.  That provided a pricing umbrella under which independent bookstores could a least continue to limp along and under which Barnes and Noble could complete development of its own e-reader, the Nook.

2.  As far as I’m aware, the consumer electronics companies aren’t going to raise wholesale prices.  So they won’t initially make more money.  They may think, however, that if all retailers become more profitable, then they’ll be less likely to resist future increases in wholesale quotes–or future reductions in sales incentives.

the new plan won’t work

My guess is that this new plan will do more harm than good.  Four reasons:

1.  When prices go up, consumers buy less.  If the price of, say, high-end HDTVs rises by the $800 a unit that some are suggesting, sales volumes will doubtless contract.  Pre-Great Recession, a customer might think of a new HDTV as being like a new car–and finance it.  Not today.  Absent easy availability of cheap credit–and customer willingness to use it–the falloff in unit volume that higher prices brings might be surprisingly large.  And not every manufacturer is in rude financial health, so profit contraction could be painful.

2.  There’s no reason to think that loss in unit volume will be distributed equally across all competitors.  In an environment of smaller price differentials, competition won’t disappear.  It will just take a new form.  My candidate is perceived product quality.  If so, I think this means the market will gravitate toward Samsung and away from Sony.   In any event, market share losers would be under enormous pressure to go back to the old system, before the new competitive game causes irreparable damage to their businesses.

3.  The umbrella of higher prices will potentially allow competitors who don’t adopt the new system–or new market entrants, for that matter–to compete successfully by discounting aggressively.

4.  The move won’t fix what ails Best Buy, in my opinion.

Thirty years ago, suburban big box retailers were an evolutionary advance over urban department stores and local mom and pop shops.  They still are, but the latter, like the dodo, aren’t the competition anymore (actually, the dodo never were).

Today’s competition takes two forms:

–internet retailers, and

–Wal-Mart/Target/Costco, the discount retailers who are the modern successors to the department store.

Compared with the latter group, Best Buy stores are too big and too seasonal (think:  Toys R Us). Best Buy has to lease, light, heat/cool and staff its retail space for the full twelve months of the year, even though 60% of its profits come from sales that happen between the year-end holidays and the Super Bowl.  The others just expand and contract their seasonal departments, depending on the time of year.

Tilting the playing field away from internet retailers and to the benefit of bricks-and-mortar will, it seems to me, just intensify the battle between Best Buy and Wal-Mart et al.  I think we all know who’s going to win that struggle.

there is a better solution for consumer electronics

By the way, this all shows how prescient Apple was in opening its Apple Stores.

Smartphones: haves, hads and have-nots

new cellphone data

A bunch of cellphone industry researchers–Gartner, Nielson, Canalys–have all released data for the June quarter of 2010.  this post is an attempt to put the information into a coherent framework.  Here goes:

almost all the market growth is in smartphones

1.  The global cellphone market continues to grow, by about 14% year over year in the second quarter.  That’s driven almost completely by smartphones, however.  According to Gartner, Inc. sales of smartphones were about 50% higher in 2Q10 than in 2Q09.  Older “feature” phones, which still make up 80% of all units purchased, showed only a 4.5% increase.

Being able to offer an attractive smartphone is the real dividing line between haves and have-nots.  In the case of Korean cellphone company, LG, which has no signature smartphone, average selling prices fell by 27% in the second quarter and its cellphone division lost money.

market share

2.  Market share shifts are the second differentiating factor.

global

On a worldwide basis (Gartner, Inc. figures) the players look like this:

Nokia     41.2%, loss of 9.8 percentage points

RIMM     18.2%, loss of .8 percentage points

Android     17.2%, gain of 15.4 percentage points

AAPL     14.2%, gain of 1.2 percentage points

Others     9.2%, loss of 5.9 percentage points.

The really stunning figures here are highlighted–the emergence of Android and the precipitous drop in Nokia’s share of the market.

Two other things to note:

–shortages of components, particularly high-end active-matrix OLED screens, may have affected sales a bit

–AAPL ran down inventories of older iPhones during the quarter in preparation for launch of the new iPhone4.  The company estimates that it could have sold an extra 250,000 smartphones, were it not doing so.  That would have only nudged its market share up by about .3%, however, not enough to make a significant difference.

the US

3.  The Neilson Company data for the US show a similar story, with the significant exception that Nokia, with a 2% market share, is a non-factor is the domestic smartphone market.  The market share figures:

RIMM     35%, loss of 2 percentage points

AAPL     28%, gain of 7 percentage points

MSFT     15%, loss of 12 percentage points

Android     13%, gain of 11 percentage points

Others     9%, loss of 4 percentage points

MSFT has announced that it is, at least temporarily, exiting the smartphone market, hoping to reenter before yearend.  While it seems reasonable to assume that some market share loss comes from the announcement, I think the causality goes the other way.  MSFT had been steadily losing market share over the past year, long before it decided to regroup.

Neilson also provides data on the most recent quarterly trends on domestic smartphone purchases.  These data paint a somewhat different picture of the market from the installed base figures above:

RIMM     33%, down 3 percentage points

Android     27%, up 10 percentage points

AAPL     23%, down 4 percentage points

MSFT     11%, down 3 percentage points

Others     6%, down 1 percentage point.

Unlike the earlier data, which show the strong taking share away from the weak, these suggest that Android is taking share from all the others.  The timing of the introduction of iPhone4 may have something to do with this.  If so, 3Q10 data should show an unusual jump in AAPL market share in the US.   Nevertheless, this is something to watch closely.

brand loyalty

4.  These are Neilson figures for the US.

Asked what kind of phone they wanted next,

–89% of iPhone users said they wanted to stick with their brand.

–71% of Android owners want to stay with GOG, with 21% thinking of switching to AAPL.

Only 42% of Blackberry owners, however, intend to be repeat purchasers.  Of the rest, 29% said they’ll switch to iPhone; 21% intend to make a move to Android.

investment implications

have-nots

I don’t see a good investment case for the have-nots.   Value investors may disagree, however.  And it’s true the LG has been extraordinarily resilient in the past.

hads

Of the “hads”, cellphones are too small to be relevant to MSFT’s profits.  It might be a psychological boost for the stock if the company can demonstrate it can make money at any diversification away from the operating system and office productivity software businesses, though (not something I’d bet the form on).

I was a very large holder of NOK in the Eighties and into the Nineties.  I don’t know the company well any more (that I’m not compelled to make the effort to stay current is a statement in itself).  Despite its early entry, as far as I can see, the company doesn’t seem to be able to get the smartphone market right.  It’s competitive strengths seem to lie in other areas–low-cost manufacturing and established distribution networks in emerging markets.  My big worry is that it still has an awful lot of market share left to lose.  Again, value investors will likely disagree.

RIMM is an interesting case.  Its claim to fame is its secure mobile network for business users.  Recent  public demands from India and Saudia Arabia that RIMM give those governments access to its encripted data streams are a made-in-heaven third-party endorsement of RIMM’s security (remember, too, that the major leagues for the espionage business is corporate spying).  By implication, they say those countries have no trouble hacking into other cellphone networks.

So far RIMM is refusing. There may be an innovative solution to this problem.  At some point, however, RIMM may be forced to choose between its corporate core customers and having access to fast-growing emerging markets.

haves

It’s easy to get tied up in knots about AAPL.  It’s up about 25x from the lows of a half-decade ago and is now a cellphone company that happens to make PCs and other consumer devices.

I feel confident that the 25x is not going to recur.  But the company has only one significant rival, Android, in the smartphone market.  That market is growing by leaps and bounds.  One can easily imagine that smartphones end up being 60% of the overall cellphone market, which would mean a tripling in its current size.  Whether AAPL ends up being #1 or #2, it could at least double its share of the smartphone market over the next four or five years.  In other words, AAPL’s cellphone revenue might well advance 6x over the next half-decade.  I don’t think anything like that is factored into today’s price.

I find GOOG harder to handicap.  I’m not concerned about the ORCL lawsuit over Java.  I also think Android will be very successful.  In baseball, if a manager says during spring training that he has four third basemen it really means that he has none.  Well, I have about four different opinions about GOOG.  I’ll leave it at that.