Tuesday, January 07, 2003

Globalisation and the New Economy

This piece in the Los Angeles Times on the fact that consumer electronics companies and retailers are not making any money on DVD players, tells us more than anything how much the world has changed. The big Japanese companies have been waiting 20 years for another "blockbuster" product, the last being the VCR and the CD player in the late 1970s and early 1980s. This is The gist of the article is that DVD players are now really cheap: selling for $59 or less. That such a complicated technological product could sell for so little, astonishes some of the people quoted in the article, and it certainly also astonishes me.

"The joke is you're going to get a free DVD player with the purchase of a DVD [movie] pretty soon," said Noah Herschman, vice president for video at Tweeter Home Entertainment Group of Canton, Mass.

"You can buy a DVD player that has a laser and all sorts of advanced technology ... for less money than it costs to buy a necktie," he added. "It doesn't make any sense."

When you think it through, it does make sense, and for two main reasons. One is economies of scale. The size of the market for consumer electronics products has expanded extraordinarily over the last decade. Go almost anywhere in the world, certainly anywhere throughout asia, no matter how poor the country, and there is now a market for this stuff. Virtually the whole world now watches television, and the whole world is a market for stuff like DVD or VCD players and satellite dishes. These are products where the costs of development are high, and the costs of setting up factories to make the products are perhaps high too, but the marginal costs of making individual products are very low to negligible. And the marginal costs are dropping. The article alludes to a reason for this

Even worse for consumer electronics makers and retailers, the DVD experience may be a harbinger of things to come. Competition at the market's low end is intensifying for all sorts of digital gear, fueled in part by low-wage assembly plants sprouting up across China.

Yes, it is our friends the industrialists of the Pearl River estuary in action. They can use low cost labour to produce products much more cheaply than can anyone else. The PC revolution and the internet have led to a logistics revolution, so components can be sourced much more cheaply and easily in the past, so setting up a DVD player factory is suddenly much cheaper. All this means that there are more DVD player manufacturers, and that markets for new technological products get commoditised much faster than before, and once this happens, prices collapse. With low transport costs due to container shipping and superior logistics in Wal-Mart's distribution and retail system, the product ends up on a shop shelf in the US costing $59.

It isn't just DVD players: such things as printers and scanners, low end digital cameras and the like from no name manufacturers are now incredibly cheap, even compared to three or four years ago, but the DVD player market was particularly vulnerable to be captured in this way for a couple of reasons. For one thing, traditional consumer electronics companies attempt to segment the market. They produce a variety of models, some low end, some high end and some in the middle, with varying features, and for reasons of economies of scale many of these are often made on the same production line together for about the same cost. (Genuine high end products are often made separately to higher standards and sold to people who genuinely care, but the low end product is usually just the middle product with some features disabled. The middle product does not cost any more to make than the low end product).

Although segmenting your market in this way is how the electronics companies have traditionally operated, it still involves duplication of some costs and costs money. The cheap Chinese companies generally don't bother, and go for a one size fits all approach. As the additional features of the mid-level product cost very little for the manufacturer to add, cheap players often have more features than low end products from Sony or Panasonic. Thus, a customer may be faced with a choice of $59 for a Chinese no-name product, $100 for a low end Panasonic with fewer features than the Chinese player, or $150-200 for a mid level Panasonic with the same features as the Chinese no-name. This makes Panasonic's market segmentation strategy look obvious and silly.

Plus there is one other thing about the DVD player that made it vulnerable, which is the deliberate crippling of the product by the consumer electronics industry to make the movie studios happy. DVDs and players are region coded, so that DVDs sold in one part of the world will not play in players purchased elsewhere. It is quite easy to produce a DVD player that will play any DVD. It is also in most places perfectly legal. However, electronics companies are prevented from doing this by the nature of their contracts with the consortium that devised the standards for DVD players. If, however, you are making DVD players in Dongguang, the nature of your contract with the DVD consortium is somewhat nebulous, and in any event, you can only be sued through the Chinese courts, which means you are safe, at least you are if you are well connected. Therefore, Chinese DVD players almost always come out of the box without any regional coding. (A small industry has sprung up to disable regional coding for brand name players, but this adds hassle and cost). Therefore, if you want to watch discs you have bought from Amazon.com and you are in London or Sydney, then a Chinese no-name player may well be better. Hopefully, this result will discourage companies to deliberately cripple products in future. (That said, when the crippling comes from pressure from the MPAA, this message will not get through for a while. The MPAA is not known for learning things quickly).

All this means that customers are better off, which is surely good. However, it also means that life is hard for the large Japanese consumer electronics companies. However, there is a good side of this too. To quote the article once again

"You survive by making new technologies," explained Andy Parsons, a senior vice president at Pioneer Electronics Inc. in Long Beach.

One area with potential is DVD recorders. Mike Mohan, director of audio-video merchandising for Good Guys Inc. of Alameda, predicts that more DVD recorders than players will be on the market within two years. And he expects them to sell for $200 to $300 per unit.

That is, if you have ferocious competitors snapping at your heels, you innovate faster and faster to try to stay ahead of them. Sounds good to me.

Aside: Of course, there have actually been other successful consumer electronics products since the CD player. As far as I can see, there have been three of them. Firstly, there is the mobile phone, which has been dominated by non-Japanese companies (Nokia, Ericsson, Motorola, and maybe now Samsung). Secondly, the video game console (which has benefited one of the traditional Japanese consumber electronics companies, Sony, enormously, but which has not been the sort of commodity product that all the Japanese producers could produce and earn fat margins on. Thirdly, of course, the personal computer. This was, of course, a product like no other. Microsoft got control of the software market, and the hardware market turned into the combination of one or two very high value parts (microprocessors, mainly, dominated by Intel) and a mass of low value components came ultimately from Taiwanese, Korean and Chinese manufacturers rather than the Japanese. Sony, Panasonic etc were not playing in this particular market in a big way, but the way that PC hardware became commoditised was the precursor to what we have seen with DVD players, and they really should have been watching.

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