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Invasion of the Netbooks

Some consumers are opting for the inexpensive, small, Web-connected computers in place of laptops that can cost three times as much

As Brian Pelowski shopped for a new computer for his wife, who's working on her doctorate in developmental psychology, he wanted a machine that was lightweight and low-priced. So he opted for a Lenovo IdeaPad S10 netbook instead of a higher-end laptop. "She walks to school and can stick this in her big sidebag without it taking up a lot of room or killing her shoulder," Pelowski explains. "We also didn't want to spend a ton of money."

Neither do the millions of other people who this year are expected to buy netbooks, a relatively new family of inexpensive, pint-sized, Web-connected computers. Rising demand for any tech gear is welcome at a time when recession is forcing consumers to refrain from all but the most essential purchases, but the enthusiasm is tempered at the computer manufacturers whose sales will be pinched as buyers opt for a netbook in place of a full-featured laptop that can cost more than three times as much.

It wasn't supposed to be like this. PC makers surmised that netbooks would complement bigger PCs. They would appeal to weary business travelers, for example, who wanted to get online and send e-mail from a hotel room. But in many cases, consumers are opting for netbooks in place of laptops, PC manufacturers say. Jackie Hsu, president of the Americas division of laptop and netbook maker Asus, estimates that 10% to 20% of netbook buyers would have bought a more expensive laptop or desktop if netbooks weren't available.

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Sumit Agnihotry, director of notebook product marketing for Acer America, places cannibalization at 8% to 10%. And since netbooks are generally less profitable than their bigger cousins, manufacturers will have to make up much of the sales difference through higher volume sales of netbooks. Users are expected to purchase 11 million netbooks this year, from 182,000 in 2007, according to market researcher IDC.

Analysts expect the popularity of netbooks to continue to rise. Mobile-phone service providers, which have an interest in promoting wireless Web-enabled machines, are likely to step up in-store netbook marketing in the coming months. Vendors including Acer and Dell (DELL) are expected to unveil models richer in features such as longer battery life, larger screens, and better wireless-network compatibility. Researchers at iSuppli expect that netbooks will account for 18% of portable computer sales in 2012, up from about 8% this year. "Netbooks are cheaper, and the concern is they could account for a greater proportion of the business," says Matthew Wilkins, a principal analyst at iSuppli.

Amid the worst economic crisis since the Great Depression, computer makers and retailers reckon it's better to sell a cheaper product than none at all. And many netbooks are sold to consumers who've never bought a PC. Still, the industry may have to cope with lower sales in cases where a netbook substitutes for a laptop. What's more, as more consumers buy netbooks, they may replace more expensive laptops less frequently, say, every 36 months instead of every two years, Agnihotry says.

Putting Pressure on PC Prices

With their lower price tags, netbooks could also pressure overall PC prices. "In a down economy, you've got a new category at a low end of the price spectrum, and that requires price adjustments," says IDC analyst Loren Loverde. Next year the average selling price on a PC will drop 12%, partly due to netbooks, posting the largest price decline since 2001, Loverde estimates.

PC makers aren't the only players in the computer industry that could lose out as netbooks become more popular. The devices tend to feature cheaper processors, graphics chips, and displays, and they use less memory and older software. In a Nov. 13 presentation for clients, Citigroup (C) analyst Brent Thill called netbooks a "troublesome trend" for Microsoft (MSFT). The reason? PC makers get the Windows operating system for netbooks for $15 to $25 per device—that's less than half of what the company charges for its lowest-priced Windows XP software, according to estimates by David Daoud, research manager at IDC.

During an October conference call discussing quarterly results, Microsoft Chief Financial Officer Chris Liddell blamed netbooks in part for missing quarterly revenue growth forecasts by four percentage points. "At this stage, it is too early to determine the extent to which the new netbooks segment is cannibalizing the traditional consumer PC market sales, or simply capturing a new market opportunity, though we believe that there are likely aspects of both," Liddell said.

Bad News for Chipmakers

Growth could suffer for vendors of computer components as well. Intel's (INTC) Atom processor, which powers many netbooks, sells for $35 to $40, vs. $150 for a traditional notebook chip, iSuppli's Wilkins figures. And while percentage margins on the semiconductors are similar, Intel's dollar margins on Atom are three to four times lower, estimates David Wu, an analyst at Global Crown Capital.

"We've not seen widespread [cannibalization] yet," says Bill Calder, an Intel spokesman. "It's something we are mindful of, and we are watching it closely." On Nov. 12, Intel lowered its fourth-quarter outlook, and projected lower revenue and gross margins on weaker-than-expected demand. Netbooks use about half the memory of a typical laptop computer. That could be troublesome for memory vendors such as Samsung, Intel, Sandisk (SNDK), and Micron (MU).

For more on netbooks, see's slide show.

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