When reviewing HP’s 2009 results, I discussed three universal laws impacting technology markets:
- There is an Inverse relationship between Moore’s Law and product margins.
- As technology markets mature, revenues and margins become services-centric.
- Product-centric companies contract in mature markets.
There are plenty of technology companies that serve as reference points to the validity of these three laws. Yet, Intel just announced a seven point improvement in margins. And Apple, as product-centric as they come, continues its march from roughly $8B of revenues in 2000 to over $36B revenues today. Are these two industry icons immune to the above laws? Hardly.
Intel’s Operational Efficiency
There is an inverse relationship between Moore’s law and product margins. Look at the graph below mapping the average price of a PC.
From over $2Kto under $500. And that $500 netbook has more storage, processing power, and capabilities than that $2k PC in 1996 ever had. How much can Intel charge for a processor when the entire netbook sells for less $500? Yet, Intel just reported a huge jump in gross margins. Is the company defying gravity as the law kicks in? Reading the comments of CEO Paul Otellini and CFO Stacy Smith, I don’t think so:
“The fourth quarter was a strong finish to what turned out to be a good year,” Intel CFO Stacy Smith said on a conference call discussing the company’s December quarter results yesterday afternoon. The improvements made to our cost structure and efficiency levels have led to exceptional financial results in the fourth quarter and served as a strong foundation on which we can build in 2010 as we refresh our product line and ramp 32-nm process technology.”
CEO Otellini breaks down how Intel improved margins into the following activities:
In essence, Intel is increasing volume and operational efficiency to improve company margins. Stronger prices coming out of the 2008 global downturn seem to be a small part of the improvement story. Intel can continue to generate decent product margins. However, they will need to achieve that feat by dominating markets, building chips cheaper than anyone else, and providing more capabilities for the same or less price. The first law is clearly in play for Intel. The only question is how laws #2 and #3 will impact Intel in the long run.
Apple’s Change Market Run
The second company that recently seems immune to these three laws is Apple. Their revenues stay product-centric and they continue to grow. Apple seems to be flawlessly executing what we call a “change market” strategy. Just when one product market begins to mature and commoditize (law #1 starts kicking), Apple latches into a new product market and avoids having to face laws #2 and #3. But is all what it seems to be?
First of all, the success of the ipod was as much a function of product design as it was service offering. Itunes is a service and it solidified Apple’s position in the MP3 player market. Secondly, look how quickly product margins are commoditizing for Apple products. The initial Ipod with 5 gigabytes of storage cost went $499 in 2000. Today, I can buy and 8 gigabyte ipod that plays music and video for $133. The Iphone went from $599 in June of 2007 to $399 four months later. The first generation of the Ipad is being offered for $499. And look at everything they are cramming into that gadget! How long before e-readers like the Ipad are below $200? At this rate, to keep growing, Apple will need to offer new revolutionary products every 6 months at smaller and smaller price points. Or Apple will need to start “changing mix.” To be a $50B or $100B technology company, Apple will need to look at exploring service revenue streams that augment product revenues.
I don’t believe Intel and Apple are exceptions to the three universal laws outlined at the beginning of the post. They are executing well and dominating their target product markets. This excellence dampens the impact of these three laws, but does not make them moot. Watch. If Ipad sales falter, I may be updating this thread sooner than later.