Are Laptops The Next Desktops?

With a price war raging, notebooks are headed fast toward commodity status

When Intel Corp. (INTC ) launched its Centrino chip for wireless notebook computers last year, General Managers David "Dadi" Perlmutter and Anand Chandrasekher made a bet with the sales team: Beat the sales targets, and we'll shave our heads. On Feb. 3, after sales topped forecasts by 10%, they took the stage at a sales summit, doffed wigs, and unveiled new chrome domes.

Perlmutter and Chandrasekher may have shaved too soon. The notebook boom that Intel helped set in motion looks to be running into some difficulty. For one thing, a price war that has raged for three years in desktops is shifting to notebooks, threatening to turn them, too, into commodities. And it looks like the industry over-estimated first-quarter demand -- meaning some PC makers may have big inventories to work off even as new rivals are rushing in. Finally, supplies of such key parts as liquid-crystal displays are tight, pushing up costs. With most PC profits now derived from notebooks, the combination could spell bad news for the industry. "The safe haven is disappearing," says IDC analyst Roger L. Kay.

PC makers insist their inventories are in good shape. But there are signs of trouble further down the supply chain. Analysts were taken aback to learn that the Taiwan companies that make the guts of notebooks for mar-ket leaders Hewlett-Packard Co. (HPQ ) and Dell Inc. (DELL ) saw February sales plunge 10% to 15%.

What's going on? PC makers, encouraged by robust 35% growth in third-quarter notebook unit sales and signs of even stronger holiday demand, ramped up their orders from Taiwan by a staggering 68%, according to the Taipei-based Market Intelligence Center. But while the sales surge kept going through the fourth quarter, analysts fear that the sudden drop in supplier orders means that the pace has slipped in the first quarter of this year. Analysts add that PC makers incorrectly assumed that laptops were so hot that they were immune from the post-Christmas sales slump that has traditionally afflicted desktops. The manufacturers insist notebook unit sales remain strong, but Merrill Lynch & Co. (MER ) expects growth to slow to about 20%, from 27.2% in 2003.

Making matters worse, falling prices could cut into revenues and profits. The average selling price of a notebook is expected to fall 8.5%, to $1,409, this year from last year, says Merrill. That would be the steepest drop in three years, hurting everyone from HP to IBM (IBM ) to Dell. Indeed, Merrill technology strategist Steven Milunovich says falling prices mean industry revenues will grow just 10% this year, vs. 18% in 2003.

PARTS BOTTLENECK. Rising prices for key components could also put a further squeeze on notebook margins. Prices for LCDs are at their highest point since 2002 because popular sizes are in short supply. While capacity is expected to grow 35% this year, much of it will be diverted to more profitable LCD TVs and flat-panel desktop monitors. All told, supply will exceed demand by a slim 1.8% in 2004, according to research house iSuppli Corp. The market is so tight that HP, expecting more bottlenecks, stockpiled $150 million worth of laptop parts recently.

Making matters worse, cheaper rivals are gaining ground. Irvine (Calif.)-based eMachines Inc., which launched its first notebook last year, says it has grabbed 9% of retail market share. Several contract manufacturers who build laptops for the major PC makers are also looking to enter the market with their own labels. "Everybody wants to be in this space," says Greg Memo, eMachines' executive vice-president.

All this has left PC makers scrambling for new customers. The firms hope corporate buyers -- who typically buy higher-margin products -- will get off the sidelines. Some are also counting on fancy features for an edge. In February, IBM introduced its new ThinkPad, a 3.5-pound model that sports the equivalent of an air bag to protect the hard drive. With a little luck, it will help cushion the coming blow to notebook sales.

By Andrew Park, with Cliff Edwards, in San Mateo, Calif.

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