Lenovo Faces PC Margin Pressure in China

The top selling PC brand still has a big market share on the Mainland, but critics think it's reaching the saturation point

Lenovo still leads in the China market with a huge margin, but is the top-selling PC brand unshakeable at home?

For the quarter ended Dec. 31, excluding minority interests, Lenovo's net income grew 23 percent year on year with a profit jump from US$46.8 million a year earlier to US$57.7 million. Sales grew 0.4 percent to just over US$4 billion.

According to a company statement, Lenovo's PC shipments to Greater China increased 17 percent. Consolidated revenue for the quarter totaled US$1.6 billion, or 40 percent of the company's total revenue, including its mobile handset business which is conducted primarily in China.

But despite the higher-than-expected profit growth, several factors will make it difficult for Lenovo to remain profitable and stay on its positive growth trajectory, according to a Technology Business Research (TBR) report.

Analyst Martin Kariithi wrote: "Given the competitive dynamics and aggressive attempts by top-tier vendors like HP (Hewlett-Packard) and Dell [Computer] to increase market share in the region, TBR believes Lenovo's market share in China is close to reaching a saturation point.

"TBR expects the company's market share gains to taper off as Lenovo approaches the 39 percent market share level," he said. Lenovo's market share in China stands at 36.2 percent for the fourth quarter.

In its report, TBR said Lenovo's China operations continue to face margin pressure. The company posted a 5.1 percent operating margin during fourth-quarter 2006, representing a 140-point decline from 65 percent during the same quarter the year before, and a 60-point drop from third-quarter 2006.

Kariithi wrote: "Lenovo attributed this operating margin decline to strong price competition, indicating that the company is relying on cutting prices to drive revenue and unit growth. We believe it will be very difficult for Lenovo to reverse the trend toward declining operating margins in China."

Struggling in America, where its PC shipments fell 4 percent in the latest quarter, Lenovo will need to strengthen its position at home, he said.

"Given that China is Lenovo's most profitable region--the only one earning an operating margin above 1.6 percent during the quarter--the company needs to maintain high margins in China to buoy its less profitable operations in North America and Europe," Kariithi noted.

Bryan Ma, director of personal systems research at IDC Asia-Pacific, was more upbeat about Lenovo's prospects. He told ZDNet Asia in a phone interview that the Chinese giant will be able to hold its lead in its home turf.

"Lenovo is strengthening," Ma said. "And look at the distance between the No. 1 and No. 2 vendors--it's vast."

According to IDC, China's PC vendor rankings for the third quarter saw Lenovo at top position with a commanding 36 percent market share. It was followed by Founder at 13 percent, Dell (9 percent), HP (8 percent) and Tong Fang (6 percent). IDC has not released the rankings for the fourth quarter.

Ma said Lenovo has several things going for it in China, including its longstanding market experience, huge distribution channel and ties with the government.

But TBR said that Lenovo will need to do better in other areas to keep its rivals at bay. In order for the PC giant to effectively compete against the likes of HP, it needs to develop a more diversified services, software and peripherals portfolio.

Kariithi noted: "Doing so will help stimulate revenue growth while boosting the company's margins, as software and services are higher margin products."

Asked whether Lenovo's fortunes could improve if it launched its mobile handsets outside of China, Ma said the vendor should focus on what it knows best. "Their core strength is in the PC business, while the phone business is a different beast," he noted.

According to IDC's fourth-quarter vendor ranking for the Asia-Pacific region, excluding Japan, there were no changes to the top five positions. Lenovo maintained its lead with 21.6 percent market share. Trailing behind were HP (13.2 percent), Dell (8.4 percent), Founder (6.3 percent) and Acer (6.1 percent).

Lenovo's share grew slightly from 20.7 percent in the third quarter as it continued to expand in China and India. HP, fueled by a successful run in notebook sales, recorded its strongest year-on-year growth among the top 5 players, IDC said.