Tech groups wrestle with hardware offload; Ending up as a second-rate Apple is not an attractive proposition

February 13, 2014 2:26 pm

Tech groups wrestle with hardware offload

By Richard Waters

Ending up as a second-rate Apple is not an attractive proposition

Suddenly, jettisoning hardware is all the rage.

From IBM shedding part of its server business to Google abandoning smartphones andSony backing out of PCs and hiving off its television division, the household names of tech have started a spring clean.

This feeds a popular belief that making stuff is an arduous, low-profit pursuit best left to companies that do not care about their profit margins. There may be a risk in seeding new competitors who will one day claw their way up the tech value chain, but that is the kind of long-term risk that can easily be set aside for the exigencies of the present.

The paradox, of course, is that the most valuable company in the world is a hardware business that rings up its profits one iPod, iPhone or Mac at a time.

For the tech companies wrestling with whether to stay in the hardware business, this conflict prompts two interrelated questions. The first is whether they can find a way to reorganise the hardware business model to make the returns more respectable. The second is whether hardware sales can be a means to capturing a higher margin from other activities that have nothing to do with making physical objects.

IBM has just faced up to the first of these questions with a decision to reconsider its involvement in the semiconductor industry.

Making chips looks like the opposite of producing PCs or TVs. It involves a mastery of one of the most difficult manufacturing challenges on earth. So what happens when this fails to produce a return?

Simply dumping the division may not be an option. For IBM – let alone its customers, some of whom probably have important national security remits – giving up control of the component that represents the “brains” of an IT system looks like a big strategic gamble.

For Apple, selling a device is the moment it captures revenue. But the people who buy its products are drawn by everything from the design of its iOS operating system to the apps in its mobile store

The likely result is a reorganisation that would leave IBM doing what it does best – pushing forward the research and keeping control of its semiconductor IP – while handing its physical plant over to one of the specialised chip foundries.

Yet this may not be enough. Ultimately, IBM’s customers do not want better chips, they want better solutions to their business problems. If IBM’s silicon doesn’t produce that outcome – if, for instance, its advanced Watson question-and-answer machine could work just as well on Intel’s x86 chips as it does on IBM’s Power architecture – then there is not much point staying in the chip business.

That outcome leads to the second question faced by the tech companies reconsidering their place in hardware: whether it can be turned into an integral part of a high-margin sale that draws much of its value from other things.

For Apple, selling a device is the moment it captures revenue. But the people who buy its products are drawn by everything from the design of its iOS operating system to the apps in its mobile store, its iCloud device syncing systems and the Siri voice search feature (a kind of consumer version of Watson).

For companies trying to develop rival tech ecosystems of hardware, software and services, this presents a dilemma. Ending up as a second-rate Apple is not an attractive proposition – which is why Google just agreed to sell its Motorola handset division.

But abandoning hardware means losing an opportunity to capture new customers and revenue. And it also means risking handing customers to a rival ecosystem player. By getting out of handsets, Google, for all its might, has admitted that it is dependent on acloser alliance with Samsung to reach its users.

That partnership might look like a case of mutual self-interest for now, but such tech industry alliances have a way of fraying as their participants’ ambitions evolve.

Abandoninghardware means losing an opportunity to capture new customers and revenue. And it also means risking handing customers to a rival ecosystem player

It is tempting to look at PCs and TVs – hardware markets where margins have been largely competed away – as inherently bad businesses. But even here, things may change as the new tech ecosystems consolidate their power. Sony may be abandoning its Vaio laptops, but Apple’s Macs and Google’s Chromebooks are following the tablet model, with app stores of their own. In this world, all screens end up serving the function of assuring a user’s loyalty to a given ecosystem.

Rumours that Apple is about to revive its TV ambitions are once again rife. It would be ironic if, just as Sony splits off the business that established its technology leadership in consumer electronics, Apple stepped in. It would also be fitting proof that hardware is still a key battleground in the tech wars.

 

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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