Reading, Writing, and Reflecting

Recently, there has been lots of coverage and discussion about netbooks.  Netbooks have been flying off the shelves, along with iPhones- perhaps the only consumer computing or communications device that is actually selling well.   It seems that everyone in the carrier, software, computer, and internet space is excited about netbooks.  But at a price point of less than $300, can everyone really be happy and make money?   Here are some recent news stories from a few of the major players.

Google- Google announced this week plans for a Google Chrome based Operating System to be targeted to Netbooks.   This is on top of previous plans to have Google Android based Netbooks available, a few of which are already available (Skytone (China based company) Alpha-680 Google Android Netbook).   Clearly, Google is targeting netbooks from multiple angles and ultimately wants to get more users on the Internet using non-Microsoft based devices and software to eventually view and click on Google based advertisements.

Microsoft– According to market research firm NPD, 96% of Netbooks currently are running Windows XP software– up from 2008 when OS was predominantly Linux based (only 10% MS).   Microsoft has stated they are excited about the Netbook trend as it allows them to enter new markets, even though the price point of their software has gone down and their Microsoft Office software is generally not an option on Netbooks.

Intel– Intel processors are powering 90% of Netbooks, according to GigaOm.  Intel was heavily involved initially in the development of the Linux based Moblin operating systems in 2007 and 2008 when netbooks began to emerge.  Also according to GigaOm, the netbook experience provides a solid entry way back into the mobile device for Intel architecture (besides flash memory), which they’ve tried before but ultimately failed.

Verizon- Verizon, in May, offered a promotion for a $199 HP Netbook with the requirement of a 2 year wireless broadband agreement from Verizon (starting at $40/month).    Following its typical playbook of offering subsidized phones to lock in longer term voice contracts, Verizon sees the Netbook as a similar vehicle to lock in more lucrative data contracts.

To understand the economics of netbooks better, I took a look at the article from Harvard Business Review written by Orit Gadiesh and James L. Gilbert more than 10 years ago titled Profit Pools: A Fresh Look at Strategy.  This article introduced the concept of industry profit pools—basically a framework to follow the money in the industry value chain.  One example they used to demonstrate their concept was the PC.  While the computing device they followed wasn’t necessarily a mobile laptop but rather a desktop,  I still think it is a useful framework in assessing what the netbook does to the computer industry.

Here is the profit pools as presented by Gadiesh and Gilbert 10 yeas ago.

PC Profit Pools- 1998

Operating

Margin

• Microprocessors and software have the highest operating margins at nearly 35% and 22% respectively.
• In terms of share of industry revenue, the actual PC manufacturer and the component manufacturers within the PC have the highest share of industry revenue at approximately 36% and 24% respectively
• The key takeaway was that while PC makers like Dell were extracting the most share of the industry revenue, Intel and Microsoft were clearly the most profitable.

Netbooks- 2009

Now, in 2009, netbooks have become a phenomenon.   Here are some typical configuration of Netbooks today.

As discussed in these articles on Techcrunch and CNet (The Fight for the Netbook Operating System and Google’s Chrome OS and Netbooks: Why Microsoft shouldn’t worry), options abound for the Operating System, some which include Microsoft and others that do not.   The typical processor as discussed is an Intel based processor, but AMD also has some options.   Application software is certainly stripped down; leveraging the cloud for robust productivity software or utilizing scaled down Microsoft Works software.   Also, carriers such as Verizon are using netbooks as a prominent vehicle to generate revenues for their wireless broadband services.

Given these dynamics, while not recreating a profit pools analysis for netbooks, I’ve thought through what I think directionally happens to the operating margin and share of revenue to each of the players in the value chain.

	Operating Margin	Share of Industry Revenue
Microprocessors
Other Components
Personal Computers
Software
Peripherals
Services

• Ultimately, with a shrinking price point, my conjecture is that the decline in per unit revenue is more than the decline in per unit costs for the majority of the value chain, shrinking the margin for all players, except services.
• Intel’s margins have to be be down given the overall decline in the price point of the netbook—a 35%-45% margin on desktops/laptops in the late nineties would most likely be lower than 30%, possibly near 25% in a netbook.
• Microsoft’s margins and share of industry revenue most certainly would be down—first off, netbooks generally don’t support high margin Office products and either support a lower margin scaled down MS Works or simply use the free cloud computing applications from openoffice or Google.   Additionally, not all netbooks even use MS operating systems and the one used is also a scaled down version.
• The PC maker like an HP certainly is losing a portion of its share of industry—the decline in the unit price of the computer has been at a greater rate than the processor’s change in price, increasing the processor’s share of revenue and decreasing the computer makers share.
• Services becomes a big winner with Netbooks if companies like Verizon can lock in 2 year wireless broadband data plans due to the distribution of netbooks—both their margin and share of industry revenue would likely have increased from ten years ago.