Rebooting Toshiba

Its edge in notebooks has shrunk. Now it aims to restore the glory

When it comes to technology leadership, few PC companies top Toshiba Corp.'s (TOSBF ) record. The Japanese giant practically invented the notebook computer in the 1980s, and throughout the '90s it dominated the business with innovations such as tiny hard drives, thin CD-ROM drives, and long-lasting batteries that make ultraportable computers possible. So while makers of desktops got trapped in margin-crunching price wars, Toshiba raked in cash based on its No. 1 position in more profitable notebooks. By 2000, one out of every seven notebook PCs sold in the world was a Toshiba.

That makes the sorry condition of the company's PC unit today all the more distressing for Toshiba. The company has fallen to No. 3 in notebooks as rivals Dell Inc. (DELL ) and Hewlett-Packard Co. (HPQ ) have beefed up their laptop businesses and outsourced manufacturing to Taiwan and China. Today, once-costly notebooks have become nearly as commoditized as their desktop cousins -- and Toshiba's technology edge is no longer a big advantage. For the year ended Mar. 31, Toshiba's $253 million profit, on sales of $49 billion, was dragged down by the PC arm's $193 million loss. "We could not adapt," concedes President Tadashi Okamura. "We were proud of our quality, so it was difficult for us [to change]. That was our mistake."

Now, Okamura aims to restore Toshiba to its former glory. His plan: Focus on higher-growth businesses such as top-end memory chips and consumer electronics, while shifting most PC production to cheaper locales. And this time around, Toshiba will cooperate more often with partners -- sometimes even rivals -- to develop new products. The consumer-electronics group developed a new flat-panel TV technology with Canon (CAJ ), for instance, while the semiconductor unit is working with IBM and Sony Corp. (SNE ) on a chip for gizmos such as game consoles. "We have become a little bit smarter," says semiconductor President Shigeo Koguchi.

Toshiba is also cooperating with NEC to make a new generation of DVD players that can read and store the massive amounts of data needed for high-definition television. While the new machines probably won't reach broad distribution for three years, Toshiba execs are making monthly trips to Hollywood to try to convince studios that Toshiba's standard is better than an alternative developed by a Sony-led group. The winner will likely reap rich rewards in licensing fees as the players gain acceptance. Once consumers see HDTV pictures, "standard DVD won't satisfy them," says Hisashi Yamada, a top Toshiba engineer who is working on the new player.

RUSH TO OUTSOURCE. The success of Okamura's plan, though, will depend on whether he can fix the PC business. So he's planning to outsource at least half of Toshiba's PC production to Taiwanese manufacturers, up from about 30% today. Most of the rest of Toshiba's computers will be made at its factory in Hangzhou, China, while production at Japanese plants will be cut by 75%, to 20,000 computers a month -- just 4% of Toshiba's total. Toshiba will command a premium, says Okamura, because its PCs will be more sophisticated than those of competitors, with features such as TV tuners, stronger batteries, and superior sound. Rivals "are concentrating on commodity products," he says. "They don't have any new technology."

Okamura is already enjoying success from the remake of the semiconductor division. In 2002, Toshiba decided to get out of low-margin PC-memory chips and focus instead on more profitable flash chips used in products such as digital cameras. The company has shut down a third of its memory capacity in Japan, and last year sold a PC-memory factory in Virginia. Now, it's building a $2.4 billion flash memory plant, although that may not be enough to meet Toshiba's needs. So by 2010 it expects to outsource 30% of chip production, compared with 5% today. The chip division last year earned $1 billion, up 85% from 2002.

Toshiba is hoping the semiconductor group will help it establish a beachhead in China. There, Toshiba has taken a small stake in Shanghai's Semiconductor Manufacturing International Corp. (SMI ) It has opened a Beijing research center focusing on technologies such as voice recognition. The company also owns 2% of TCL Corp., one of China's top producers of TVs and cell phones. That connection should help Toshiba increase chip sales in China from the current $1.3 billion to a projected $5.3 billion by 2010, helping fuel 15% annual sales growth in China, execs say.

Skeptics, though, wonder whether Okamura's plan will cure what ails Toshiba. Rivals Thomson Corp. (TOC ) and Alcatel (ALA ), for instance, have signed their own deals with TCL, which could limit the scope of Toshiba's cooperation with its most important Chinese partner. The TV business is getting more crowded as Samsung Electronics Co. and Acer Inc. jump into the fray along with established players from Japan and the U.S. And PCs are tougher than ever, as Dell and HP wage a brutal price war. Unless Toshiba outsources more of its production, it won't be able to compete because it will pay more for components than the hypercompetitive Taiwanese manufacturers do.

TIME TO LOG OUT? Some say Toshiba hasn't been bold enough in its outsourcing plans. "Toshiba doesn't understand that PCs are a commodity business," says Noriya Nishi, an analyst at Credit Suisse First Boston in Tokyo who says Toshiba should unload its computer division. Others want Toshiba to spin off its semiconductor division so that, as a separate business, the unit can more easily raise the funds it needs to build new chip factories without being weighed down by the more troubled PC and consumer electronics groups. And some doubt whether selling higher-end TVs will work. "Every major consumer electronics company is positioning TV as its major product," says Ikuo Matsuhashi, an analyst at Goldman Sachs (GS ) in Tokyo. "It's hard to see how Toshiba can gain there."

Toshiba execs have resisted calls to spin off major units. Koguchi, head of the chip arm, says the semiconductor business is better served by staying part of the bigger company, where it has greater resources and more cooperation with engineers who actually make finished products. Likewise, Okamura insists there's no reason to shed the PC division. "PCs will remain a key pillar of our future growth," he says. Some analysts think he's on the right track. The restructuring marks "a very big change in direction," says Yoshiharu Izumi, an analyst at J.P. Morgan (JPM ) in Tokyo. That's what Okamura likes to hear. He's betting that strengths in semiconductors, PCs, and televisions will position Toshiba as a key player in the electronics industry at a time when digital video and audio machines are converging with PCs as the entertainment devices of the future. And he's determined to prove he can save the big tech powerhouse he runs without tearing it apart.

By Bruce Einhorn in Tokyo

    Before it's here, it's on the Bloomberg Terminal.