Personal computers are not commodities

People in the computer business are fond of declaring that the "PC is a commodity," as an excuse for why the final equipment manufacturers (Dell, Lenovo, Acer, etc.) make such low margins.  The average operating income is about 2%.   Let’s define a commodity as a product with little opportunity for differentiation and with plenty of providers.   Or, said another way, a commodity is a category of product where people don’t care which brand they buy, because they perceive that they are all the same.   I can appreciate the challenge of making money in such a category, as suppliers will naturally compete on price.  But are certain product categories inherently commodities, or is commoditization a function of the behavior of the players in those categories?

If commoditization were sufficient cause for low margin, why does a cup of coffee deliver 90% gross margin, along with anything in the cold beverage case at Spiffy Mart?  Why does the corn flake with the rooster on it make 80%+ GM and retain high market share , when, I assure you, anyone can make a yummy corn flake?  At the same time, it seems like any device with an on/off button earns only subsistence level profit:  DVD players, TVs, mobile phones, printers, personal computers.

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Perhaps it is a function of category.   Maybe electronics are rational purchases where the price/function ratios can be easily compared between offerings, and therefore margins quickly fall to just above zero:  a continuation of the lowest-MIPS-per-dollar approach from the early days of mainframes.    But observe, Apple personal computers generate something around 30% GM and 10% OI – this gleaming exception undermines the rational category theory (a Mac does the same things a Windows computer does).  Oh, and I remember that Sony has consistently commanded a premium in TVs (something you buy on specs like size and contrast ratio) and A/V equipment.  So not all electronics offerings generate "commodity" level margins.

The difference, I submit, is brand value, and a related item, marketing investment.   The top PC makers spend less than 1.5% of sales on marketing, while consumer packaged goods are supported with 10%+.   Apple spends 3X per computer sold on marketing activity vs. the Windows PC competition .  Higher marketing spend is correlated with higher margin, and the additional gross margin is greater than the cost of marketing, so net profit benefits.  So simple, a cave man could do it…

Even I, a brand weenie, will admit that there are other factors.  Take the tacit price collusion in certain categories, like breakfast cereal or beverages.  Occasionally, some cereal factory owner observes that he could charge 50% less and still make money, so ValueCrunch arrives for $2 per box, and they pick up some share.  Does the rooster follow the price down to protect share?  Nope.  They run promos, in-store taste tests, and NASCAR driver appearances so the next time a person walks in the store, he doesn’t even see ValueCrunch.  Starbucks competes with Caribou for share, not by lowering price, but by promoting Gingerbread Delight and playing custom collections of cool music in the store (and by being everywhere).  When SuperPop shows up at $0.30 per bottle, the other $1.25 brands ignore it like the new kid at school.  The uncool libation dies of social stigma.

k3c5s

These are examples of Being Smart that apparently the computer and consumer electronics (CE) makers don’t get.  Another factor is the customer /product experience, but I suggest this is a contributor to brand value, the real driver of margin.  Many superior products have failed due to poor brand value.

How did CE and computer companies miss the gravy train?  I have not made an academic study of it, but since this is a blog, I will opine…There are two reasons:  1) poor marketing capability, and 2) slippery slopes.

First, electronics companies are not very good marketers.  They copy each other, they commoditize their own categories through spec/price selling, they do not make an emotional connection, and they abuse us with terms like megapixels, discrete graphics, and front side bus.  One cause may be staffing:  a majority of marketing positions in CE and computer companies are held by former engineers.  Engineering (job) leads to product management, leads to product "marketing," leads to marketing (leads to being thought of as stupid by fellow engineers).  Before I offend some friends who have followed this path, let me hasten to add that I know people in these positions who are very smart, and who leverage their technical backgrounds along with learned marketing skill to do a great job.  BUT, there is a good reason that P&G has been the talent source for every other industry looking to upgrade its marketing capability over the last two decades.  P&G builds businesses from the brand up, and orients its decision making around marketing.   Observe that PC companies apply most of their marketing funds to communicating a special deal (i.e., a price reduction).  They are spending money to emphasize that you should only buy if you can get a great rebate or a free printer (you know, when the margins are lower).  Apple never advertises deals – they invest in creating desire, which keeps prices high.

The second issue is Slippery Slopes.  I’m referring to competitive patterns that take hold in a category.  When Compaq entered the PC business with a lower priced equivalent to the IBM PC, followed by Dell, IBM unfortunately followed the path of competing on lower price for share.  Thus the slippery slope emerged, helped by Microsoft and Intel’s subsidization of marketing which presents PCs as assemblies of standard parts.  Thus, the prospective customer was trained to compare specs and price, and inertia makes it very difficult to reverse this.  Similarly, the CE companies are in a continual race to the bottom.  I recently saw a DVD player at HH Gregg for $19.99.  I remember when they were $1000.  Yes, the internal components get cheaper over time, but properly managed prices will reflect the value of the product to the customer.  Starbucks can get $4 for lovely coffee experience, while the prices of PCs, which have transformed the world and provide astonishing enablement to their users, have fallen 50% in 5 years and continue to decline at double digit rates.  Bad marketing, and a slippery slope.

Regardless of how we got to this point, the VALUE to the user of a personal computer is immense.  One billion are in use.  They deliver email, Skype video (how I saw my baby roll over for the first time), Excel, Flickr, BBC.com, e-business, Pandora, Facebook, PayPal, Craigslist, Wikipedia, Kiva.org.  Your new one does a lot more than your old one.  If you take my hard drive and backups, I’ll pay $20,000 to get them back.  The fact that the benefit delivered is rising rapidly, while the prices are falling rapidly, is proof that PC prices are not aligned with value.  This is an opportunity.

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The PC is not inherently a commodity, in spite of the fact that most have the same Intel chips and Microsoft OS.   This is the essential barrier for a PC maker that wants to rebuild margin:  cheap, readily available substitutes with no perceived difference  (this is probably a better definition of a commoditized market than I offered above).  I don’t care which salt I buy;  they are all salty.  But I buy Morton without comparing prices.  This is brand value.  Could a PC brand not achieve the same thing?

Coming soon:  how PC companies, and other purveyors of "commodities" can fix their margins.

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7 Responses to “Personal computers are not commodities”


  1. 1 David Churbuck February 21, 2009 at 8:08 am

    Allow me to fence your arguments.
    Electronics are commodities at their essence. Silicon, capacitors, transitors, NAND logic …. all the discrete components are, at their essence, commodities.

    They are not commodities like corn or pork bellies in that a certain thing called Moore’s Law applies – a law, variously defined, that calls for a doubling of capacity and a halving of cost every 18 months or sooner.

    Like corn or pork bellies, electronic components do have a shelf life, and “rot” over time. This is the obsolescence cycle that makes your VCR useless and your DVD player about to be made useless by Blu-Ray.

    So, take a perpetual cycle of creative destruction, where one generation is rapidly made obsolete by the next, and add in the fundamental issue of standards and you find your self in the commodity business very quickly.

    Standards level distinction. Trains need to run on 4′ 8″ gauge. IBM got its butt handed to it in the late 80s when it decided to regain a proprietary definition of the PC with the MicroChannel bus, only to get pilloried by customers who took their business to Dell and Compaq where the “ISA” was still supported.

    Poke your head above the fray in the PC industry and you either get it chopped off or you get imitated. Customers cherish backwards compatibility in a package that makes them feel sexy, hip, etc. Nothing more, nothing less.

    • 2 Craig Merrigan February 21, 2009 at 8:44 pm

      Thanks for the additional perspective.

      Moore’s Law is, to me, the thing that makes it most tragic that the PC space is one of low margin. We can deliver better functionality while incurring less cost, so margins should rise over time. Instead, when customers upgrade functionality, they pay less. This represents missed opportunity to capture value in price (note: Microsoft doesn’t miss the opportunity, and they are part of the equation). Standardization is the double-edged sword: it generates much greater product acceptance, but it creates the key barrier to any one PC vendor improving margin through differentiation, as they risk getting their heads lopped off, per your point. But I submit, it is worth the risk, as the possibility of multiplying the bottom line is there.

      In A/V equipment, the prices plummet well before the next technology is known (see flat TVs). Manufacturers set price using cost-plus formulas that solve for minimally acceptable margin.

  2. 3 benjamin lipman March 18, 2009 at 6:49 pm

    David’s right that most of your examples remain consistent. The corn flakes don’t have a faster, smaller, newer model — perhaps only a slightly smaller box for the same price.

    Apple has become adept at milking product life cycles. It’s unlike all the other companies. Yes, they have OS differentiation, but they keep the same product at the same price for months. The iMac line was only recently refreshed after more than 12 months. We know margins in months 6-12 were much better than 1-6. Customers paid the same price.

    I also can figure out what 1% milk is. The XJ1200 model doesn’t say a damn thing to me. Apple has done well here too. It’s the iMac. The faithful may refer to it as the “early 2009” but consumers don’t see that in the ads. Just iMac. Or Macbook. Sometimes the 2.0 — as in iPhone.

    Electronics have no such consistency. DVD players, TVs, they may have a 2009 line but the models are a mix and mash of letters and numbers.

    Consumers may have some brand connection (Apple, Thinkpad, etc) but rarely model connection. The Mini Cooper will be called the Mini in 2014. New model, same name. The X, R, etc series from Lenovo was good like that. The new Ideapad, whatever stuff? I’ve lost track.

    The consumer brands go for both “Kellog’s Corn Flakes.”

    Just a thought

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    Your style is unique compared to other folks I’ve read stuff from. I appreciate you for posting when you’ve got the opportunity, Guess I will just book mark this web site.


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