Notebook Price Erosion Challenges Leading Manufacturers in U.S. Retail Market

by Nicole D’Onofrio
Mobile Computing Analyst
January 18, 2006

It was a happy holiday for notebook consumers this year, as retailers advertised notebook computers for as little as $149 on the front covers of their circulars. In November, the average selling prices (ASP) for notebook PCs in the U.S. retail market hit a new all time low of $980. These unprecedented sale prices and ASPs not only boosted holiday notebook sales by 44% compared to the previous year, but they also shattered the perception that notebook PCs are luxury purchases. Consumers no longer have to trade portability for affordability.

While notebook consumers may look back at the year of 2005 with a smile, notebook manufacturers are more likely to review the year with concern. Although manufacturers were blessed with strong retail sales, the constant price wars dragged revenues down. In 2005, the U.S. retail notebook market experienced a year-over-year increase in unit sales of 46%. However, as retail notebook ASPs declined by 17% year over year (Dec 04 to Dec 05), manufacturers and retailers could only celebrate a year-over-year retail notebook revenue sales increase of 20% in 2005. The disproportionate growth of unit and revenue sales only fuel notebook manufacturers’ fears of market commoditization. While Current Analysis predicts the U.S. retail notebook market will experience continued growth in 2006, price erosion and profitability will continue to be a growing concern for manufacturers.

Catch-22

The rapid ASP decline over the last year was driven by an increase of competition on retail shelves. Low-price players, such as Gateway and Acer, stepped up their retail presence in 2005 with feature-rich products that offer consumers a good bang for their buck. By the second half 2005, Gateway and Acer accounted for a combined 23% of unit share and 19% of revenue share of the U.S. retail notebook market. In an effort to compete against the influx of systems from these value manufacturers, Toshiba, HP and Sony each were forced to reevaluate their pricing strategy.

The following table lists the average retail selling price of systems by manufacturer for the months of 2005.

Gateway and Acer’s pricing pressure and subsequent success in the market forced the top three retail players, HP, Toshiba, and Sony into a Catch-22 situation. The top retail players could either maintain higher price points and continue to lose market share or lower their prices and face potential revenue and profit losses. The manufacturers adjusted their pricing strategies in the second half of 2005 to defend themselves against the new competitors, but they took different pricing approaches. Toshiba focused its marketing efforts on the entry-level and high-end ($1,250+) portions of the market. HP took a divide-and-conquer approach, using its Compaq brand to target the entry-level market while positioning its HP Pavilion products in mid-market ($750 to $1,249) price band. Sony continued to target the premium market segment.

The top manufacturers’ results reflect their marketing efforts. In H2 2005, sub-$1,000 products comprised 54% of Toshiba’s unit sales, systems within the $750-$1,249 price band accounted for 60% of HPQ’s (HP + Compaq) sales, and systems over $1,250 made up 85% of Sony’s total sales.

Below is a graph of the top manufacturers’ unit shares by price band in the second half of 2005.

HP Triumphed

As competition and price erosion drastically increased in the second half of 2005, HP withstood the challenge by utilizing a dual-brand strategy to maintain sales and revenue. This initiative was evident in March of 2005, when HP dropped the ASP of its Compaq-branded systems to $1016, which was over $200 less than the industry’s ASP to compete against price lows from Gateway and Acer. Meanwhile, HP positioned its Tier 1 HP brand to target the mid-tier consumer. With the Compaq brand defending the entry-level market, HP was able to maintain higher ASPs with its Pavilion brand. This strategy gave HP a balanced approach to target the market in H2 2005 and allowed HP to realize year-over-year unit sales and revenue growth of 44% and 20% respectively (see graph below).

While HP’s product strategy focused on the mid-tier market segments, Toshiba’s market strategy was centered on the high and low ends of the market. In November, Toshiba offered two blockbuster promotions featuring sub-$500 systems, which enabled Toshiba to capture a large percentage of entry-level sales. However, it did so at its own expense. In the second half of 2005, over half of Toshiba’s unit sales were composed from systems in the sub-$1,000 market, which drove 40% of its retail revenue share. Toshiba struggled to defend its share within the $1,000-$1,249 price band because its competitors, particularly HP, utilized AMD’s Turion-64 and Athlon-64 processors to provide strong price/performance propositions.

Sony, which is infamous for carrying a price premium, dropped its ASP by 14% in H2 2005 compared to H2 2004. However, the retail notebook ASPs throughout the industry dropped by 20% during the same time period, further distancing Sony from the market’s equilibrium. Sony’s H2 2005 price premium ranged from $345 to $580 depending on the month. While Sony’s notebook systems have always carried a price premium over other systems, the retail market place no longer allows for it. Due to the drastic price erosion in this channel, Sony’s premium target market base is shrinking. The result, in 2H05, Sony’s unit sales grew by 8% compared the same period last year and its revenue sales declined by 7% year over year. To add salt to the wound, Acer stole Sony’s fourth place ranking for top-selling notebook manufacturers in U.S. retail for the month of November.

Of these three manufacturers, HP, Toshiba and Sony, HP’s 2H05 results rank the highest proving that its balanced product mix approach could effectively defend against the value players while maintaining strong revenue growth. In the second half of 2005, HP captured 39% of the market, while Toshiba captured 27% and Sony grabbed 9%. However, not only did HP surpass Toshiba and Sony in market share, but it also experienced the highest year-over-year sales revenue and unit share growth.

Below is a graph comparing HP’s, Toshiba’s, and Sony’s second-half 2005 revenue and sales growth with that of H2 2004.

Show Me the Money

As price erosion and market commoditization will continue to be a reality for PC manufacturers in 2006, manufacturers looking to make money in retail need to target the appropriate market segments with the proper product mix. In order to achieve this product balance, manufacturers need to focus on price bands that generate the largest amounts of revenue, offer products with strong price/performance equations, and increase consumers’ perceived value of their products.

Current Analysis forecasts that the $1,000-$1,249 price band will offer the strongest potential for sales and revenue growth in 2006. However, in order to capture significant portions of this price class, manufacturers will need to promote systems with strong price/performance solutions, such as HP did by utilizing AMD processors. There are a number of ways manufacturers can enhance their price/performance equations within a particular price band. They should enhance their machines’ speeds and feeds with larger hard drives and memories, and build systems with longer battery lives and lighter weights. Another way manufacturers can increase sales and revenue share in particular price bands is by increasing consumers’ perceived value of the systems. Current Analysis recommends a few options to build a system’s perceived value:

1. Wow Them with Warranty. Manufacturers should offer a two-year warranty on consumer systems to trump the usual one-year warranty. This will convince consumers that the system is a quality product and increases the system’s value equation at a minimal cost to the manufacturer.

2. Bundle Up. Manufacturers should look within their own company to find creative and fun bundle opportunities. For example, Sony recently promoted a notebook and digital camera at CompUSA. Toshiba could do a similar offering with its Gigabeat MP3 player. By bundling a notebook and CE device under one price, consumers are given the perception that they are receiving more for less.

3. Emphasize the Efficiencies. Add technologies that can save consumers time and market the convenience of the technology, not the technological aspects. For example, include a biometric fingerprint reader in a consumer system. Instead of highlighting the security feature, market the convenience of having to remember fewer passwords.

4. Media Madness. Current Analysis anticipates that we will see more Media Center systems like Dell’s 14W XPS M140 product, which sells for $999. PC consumers have shown an interest in Media Center systems sans TV tuner, hinting that they are more interested in sharing and organizing their media than recording TV shows. Media Center capabilities are an attractive addition to notebook systems that fall within the $1,000-$1,249 price range.

With the threats of price erosion, market commoditization, and increased competition looming over the 2006 U.S. retail notebook market, manufacturers will need to execute flawlessly to win share. HP ended 2005 with momentum, and it will look to continue its strong performance in the first half of 2006. However, PC manufacturers can expect Acer and Gateway to continue to make noise, especially after gaining share during the holiday season. Although Toshiba and Sony need to realign their product mixes and pricing strategies to regain lost market share, they should not be dismissed; both have strong brand names and retail relationships.

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