PC Makers: More Sales, Fewer Profits
If anybody in Taiwan should be happy with the computer business, it's Quanta Computer Inc. Chairman Barry Lam. Since he founded Quanta in 1988, it has become one of the world's biggest designers and manufacturers of notebook PCs. Quanta makes one-quarter of all notebooks sold in the world and counts Dell Inc. (DELL ) and Hewlett-Packard Co. (HPQ ) among its major customers. And in this year's second quarter, Quanta's sales nearly doubled.
So why isn't Lam crowing? Because it's getting tougher to make big profits on computers. In two years, Quanta's gross margins have shrunk from 15% to just 5% as notebook PCs have started to become low-cost commodities. Taiwan Ratings Corp., an affiliate of Standard & Poor's (MHP ) in Taipei, predicts that Quanta's profits this year will be up no more than 10%, to $350 million, even as sales jump 70%, to $7.1 billion. As a result, Lam is looking to reduce his reliance on notebooks by diversifying into servers and digital TVs. "We have to go beyond the PC," says Lam. "If we don't, our margins will keep dropping." Next year, Lam even plans to drop the word "computer" from the company's name.
Other Taiwanese computer makers face the same paradox of rising sales but shrinking margins. In this year's first half, Taiwan's notebook shipments jumped 23%, to 10.7 million units, thanks to more outsourcing by top U.S. and Japanese brands. But the price manufacturers get fell 10%, to $666, says IT researcher Market Information Center in Taiwan. True, relentless price deflation has long been a fact of life in electronics. But lately, the downward spiral has accelerated. In the first quarter, Lite-On Electronics Inc. says selling prices for its color monitors, keyboards, and other PC products have dropped as much as 20%, double last year's pace. "It's a micro-profit era," says Lite-On CEO David Lin. Analysts also expect earnings growth to slow at blue-chip electronics makers such as Hon Hai Precision Industry Co. and BenQ Corp.
A big culprit, Taiwanese suppliers say, is consolidation in the global computer industry. Second-tier players such as Gateway (GTW ), Fujitsu Siemens Computers, and NEC (NIPNY ) are steadily losing share. and last year, Hewlett-Packard swallowed PC giant Compaq Computer Corp. Now, Dell and HP together control 50.1% of the U.S. PC market, up from 45.9% a year ago. But while PC demand is rising, pricing power remains weak. So the Big Two have even more leverage to squeeze contractors. "There's been a significant landscape shift," says Morgan Stanley tech investment banker Julian Snelder. "That puts tremendous pressure on suppliers."
To compensate, PC contract manufacturers such as Quanta and MiTAC International Corp. are scrambling to diversify. Others hope to ease their reliance on no-name outsourcing and are launching their own brands. Both strategies are risky since the Taiwanese must go against established players.
Of all the post-PC options, the TV business is especially intriguing to some Taiwanese. Most upmarket TVs are still assembled by the companies whose brands appear on them, such as Panasonic, (MC ) Sony, and Samsung. But because many of the key parts also are used in PCs, the Taiwanese figure they can move in. "All the components of digital TV will be very familiar to us," says MiTAC Chairman Matthew F.C. Miau. He predicts "a reshuffling" of the industry. "It may be that the IT people will be the ones manufacturing TVs," Miau says. What's more, digital-TV margins remain strong.
Thus, the Taiwanese are betting they can either make TVs for traditional consumer electronics companies or for PC companies looking to enter a new market. "Most of the IT guys want to go into home entertainment," says Quanta's Lam, who thinks computer makers will compete well because they're accustomed to the cutthroat nature of the PC business. Later this year, Quanta will start producing 23-inch and 26-inch LCD TVs that will retail for up to $1,500 -- for a brand he won't name. By entering such market niches, Lam predicts that Quanta's dependence on notebook PCs will drop from 95% of sales in 2002 to 50% four years from now. Still, the Taiwanese have little experience in high-end consumer electronics. And competition from Chinese producers is likely to be fierce at the low end.
But TVs may be less risky than the strategy of other Taiwanese computer specialists to launch their own brands. ASUSTeK Computer Inc., a maker of notebook PCs, game consoles, and motherboards, has launched a handheld PC under the MyPal name. Inventec Corp., another notebook producer, has a line of cell phones and PDAs under the name OKWAP. Earlier this summer, motherboard maker Giga-Byte Technology Co. launched its own notebook PC in Taiwan and China. Executive Vice-President Richard Ma says he hopes the move will make Giga-Byte less vulnerable to the whims of U.S. giants. As a contractor, "you can have a good business," Ma says. "But next year everything changes because some competitor lowers his price by 50 cents and you lose business."
True, but Taiwan's electronics industry has tried the branding tactic before. During previous waves of brutal competition in the 1980s and 1990s, companies such as MiTAC and Acer Inc. marketed their own PCs with mixed results. Leading computer companies didn't want to outsource to suppliers who were morphing into potential competitors. MiTAC exited the business in the early '90s. Acer enjoyed some success in the U.S. but eventually proved no match for the marketing and distribution muscle of bigger American rivals. Switching from contract manufacturing is not easy. "It's a totally different culture," warns Acer Chairman Stan Shih, who recently jettisoned Acer's manufacturing division. Can other Taiwanese companies succeed? "No way," he scoffs.
Another drawback is that Taiwanese electronics companies seem incapable of growing big enough to compete globally on their own. "A lot of times, the Taiwanese have had a shot at the title but have underplayed the necessity of critical mass to be successful," says Tien Yu Sieh, director of Asian technology research at Merrill Lynch & Co. "In manufacturing, you can focus on cutting costs, cutting costs, and cutting costs. But when trying to sell something, it's much harder to cut expenses without hurting your brand."
So why are the Taiwanese trying the same tactic? One reason is opportunity. No single company now dominates world markets for smart phones or wireless-enabled PDAs. And the world's largest cellular-phone market is in neighboring China. "With phones, it's a different story," says Sarina Lin, an associate at consultant McKinsey & Co. in Taipei. "The biggest market is actually right here."
That's why BenQ, an Acer spin-off that is trying to sell its own MP3 players, digital cameras, and plasma TVs, is looking for markets close to home. Chairman K.Y. Lee says he has learned something from Acer's frustrations in North America. For BenQ, "the U.S. is not a major focus," he says. North America accounts for just 10% of its sales, compared with 40% for Greater China. MiTAC, which spent years quietly making PCs for others, is focused on Asia, too. In June, it started selling its Mio brand smart phones in Taiwan. "Dell's not in the phone business, and HP's not in the phone business," he says. For now, that's reason enough to venture into uncharted waters.
By Bruce Einhorn in Taipei