Can Logitech survive in a Post-PC world?

Yesterday I started a new series on the move towards Post-PC architectures, laying out what I believed a Post-PC device was. In essence its a low-cost, mobile device that acts as a window into a cloud ecosystem, has a more integrated hardware design and is often sold with an upfront subsidy. Oh and you'll probably be owning more than one of them.

I want to move on now to consider the implications for the various business models across the industry. Like any good bully I'm going to start by picking on the easy targets, the incumbent business models of PC manufacturers, and point out some of the obvious stress points.

Watch Out Wintel!

Great book - but can Intel practice
what they preach?

Well actually quite a lot, if you have any sort of economic interest in the current PC era. The current PC value chain is dominated by two companies - Microsoft and Intel. With their cool 40% operating margins they skim off the lions share of profits, leaving DRAM vendors, hard disk manufacturers and PC OEM's fighting it out for single-digit margins at the bottom of the pile. Note its a common fallacy that PCs are a low-or-no-margin business. They are actually a massively high margin business, but only if you name starts with "Microsof-" or ends with "-ntel".

These two profit pools (Microsoft's Windows and Office licences and Intel's CPU sales) are most directly threatened by the shift away from PCs. The move to post-PC devices removes one of their great competitive moats, which is that (apart from the limited OSX domain) there was no competing ecosystem users could play in other than the Windows Desktop. In essence buying an Intel CPU or a Windows licence was an obligatory tax you had to pay before you could use a computer. No longer.

Now this moat, which is one of the great economic monuments of our time, does not vanish overnight. As I said - the sluggards of the enterprise world are likely to remain a great bulwark supporting their profits for years to come.

Also Intel have moved frighteningly quickly with the mobile SOC development. Having been caught napping by ARM, Medfield is now not only feature but battery-life comparable to ARM. With their fearsome execution engine Intel will only move ahead from here.

But the problem is that an ARM SOC sells for $20-30 versus $100 for a full-fat Intel processor. Both are sufficient to power a single device - the problem is the post-PC device is a lot cheaper. And even in high-margin enterprise servers - the ultimate fortress for Intel's horsepower, ARM are starting to get a foot in the door.

For Microsoft the launch of Windows 8 becomes ever more critical. By all accounts they've done a good job of executing on what is essentially a compromise between two worlds. Actually MSFT's execution over the last few years has been great (Courier notwithstanding). But the problem is that slick new products like Kinect, or Windows Phone 7 can't outweight the ballast of Office + Windows in their revenue mix. That's doubly clear if you break out the profit contributions:

Of course as I said, most the enterprise world is barely getting its head around the idea that they can move to Windows 7, let along Windows 8 or - god forsake - some untried and un-enterprise-grade Post-PC gig. Just so long as you remember though that nothing lasts forever...

Look Out Logitech!

As I write this Logitech's shares are down 15% on the Nasdaq after a tricky H2 guidance cut. The issue is a sudden softening in PC demand in Q3 (funny how these things are always sudden!). Logitech are pointing to the slower macro, exacerbated by a pause ahead of Windows 8. But I have long suspected that the underlying issues are more structural.

I briefly touched on Logitech the other week as a potential loser in the war between platforms. I want to flesh that out a bit. In essence Logitech are overwhelming exposed to the existing PC platform.

This chart shows their revenue mix on a LTM basis. As you can see by far the most important contributors are keyboards and mice. Mice are the single biggest category - but where do they fit in a world that's moving towards touchscreen devices? Microsoft are clearly pushing Windows - even PC versions - towards a more Metro and touch-focused interface. The mouse may be becoming an endangered species.

In a Post-PC world keyboards also move from being essential to being an optional extra. Now to their credit keyboard sales do include some contribution from iPad keyboard accessories (I make iPad accessories about $17m this Q or 3% of group sales). However the truth is the attachment rates of keyboards in a Post-PC world is going to be far below the 100% rate Logitech currently enjoys.

But the exposure doesn't stop there though. Webcams - they are also linked to PCs (Post-PC devices generally have webcams built in, and are too small to mount an external one). Speakers, docks and headphones are also tilted towards speakers for PCs or iPod docks (another category that's on the way out after Apple's move to the Lightning Connector).

In short if the world moves hard towards the Post-PC architecture, three-quarters of Logitech's revenues are at risk.

This is exacerbated by the fact that Logitech are overwhelmingly a consumer-focused company. Remember if there is any area that will resist the most to Post-PC it will be slow-moving corporates. However what little exposure they have to these customers comes either from their low-margin OEM business (which is declining at a c20% rate) or their LifeSize video-conferencing unit (which is under-scale and loss-making). So little comfort there.

Of course Logitech will argue that the Post-PC world opens up new opportunities, and that peripherals such as their Ultrathin Keyboard Cover will allow them to drive renewed growth in Keyboards. However there are a number of challenges there which may prove too hard to overcome.

• The first is that the Post-PC peripheral market is brutally competitive. Like any growth market it attract any number of new entrants willing to have a go (the satnav market was very similar in the mid-2000s. Just look at the wide range of competitors Logitech faces in this group test. Now eventually there will be a shake-up as the market matures and Logitech will undoubtedly remain standing. However in the near term this means the market will suffer from pricing pressure and margins will remain capped.
• The second more fundamental issue is that Post-PC devices are, by nature, less amenable to peripherals. As I pointed out in yesterday's post, because they are smaller, cheaper and run on a very quick (6-12 month) product cycle, their design tends to be more integrated and appliance-like. This limits the scope for peripheral makers versus, say, PCs which were designed from the outset to be modular and peripheral friendly. Also if mobility is the hallmark of a Post-PC device, this again limits the scope for peripherals.
• Thirdly Post-PC devices are subject to significant platform risk. Apple's move to the Lightning Connector is a good example - at a stroke they've pretty much wiped out the market for iPhone docks and depreciated millions of dollars of current inventory. That doesn't mean you can't make good profits in the meantime, simply that you can never escape the risk you'll have a nasty shock further down the line. (e.g. what if Apple brings out the New iPad... With Keyboard Cover?)

The chart below show's Logitech's historic operating margin on a LTM basis. You can see clearly the fat, excess returns they earned in the 2000's when they had a dominant position in PC peripherals. Then you see the hit they took in the last recession, and their consequent recovery to 4% margins. The risk is that if the Post-PC world tips the desktop over the edge, even that may look generous.

PS And no, I don't have a position in Intel, Microsoft or Logitech shares. Just in case you were wondering.