Portable Devices: Smartphones, and Tablets and Netbooks, Oh My!

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Paul Sagawa

203.901.1633

sagawa@sector-sovereign.com

August 24, 2010

Portable Devices: Smartphones, and Tablets and Netbooks, Oh My!

  • Market forecasters project dramatic growth in portable electronics. However, the combined expectations for smartphones, e-readers, tablets, netbooks and notebook PCs appear collectively rich, despite declines in other consumer electronics categories, and presuppose only modest market share shifts between these products. We believe that advances in wireless network speeds and availability, and the emergence of powerful cloud-based applications will obviate the need for a full PC platform for the large majority of users. At the same time, single-application devices will likely peak and begin to decline, as general purpose platforms achieve performance thresholds and absorb functionality. We see smartphones and tablets as the biggest beneficiaries – the large majority of consumer PC usage is spent in activities that do not require intensive keyboard input, with the fastest growth amongst social networking applications that gain significant benefit from the portability of those platforms. For users requiring full keyboards, we believe the rise of faster networks and better cloud application suites will boost netbooks over notebooks
  • Combining the forecasts for all of the various portable electronics categories paints a rosy picture – 12.6% annual unit growth – that may not take into account the cross-category cannibalization that we believe is inevitable. In particular, the gentle mix shifts that are implied seem unrealistic given the history of wrenching change – e.g. the rise and fall of paging, the sudden death of the walkman
  • To that end, we believe that PC based platforms will suffer from a mix shift toward non-pc smartphone, tablet and netbook categories. The emergence of effective cloud-based applications with access to seemingly unlimited storage and processing capability, enhanced by fast and available 3G networks and the pending launch of even faster 4G networks should render objections to lower-power non-PC platforms moot. Users conditioned to seek the big hard disks, copious memory and ever faster processors, will gradually place greater value on portability, battery life and cost, playing against the strengths of the Windows/x86 PC architecture
  • Single application devices, such as music players, point-n-shoot cameras, pocket camcorders, e-readers, or personal navigation devices, face relegation from mass markets to niche markets as their functionality is co-opted by increasingly capable multi-application platforms. The histories of pagers, PDAs, calculators, and word processors are cautionary tales for analysts predicting happy futures for their analogous antecedents. In some cases, stand alone devices will persist either for cutting edge aficionados, like professional-level SLR cameras, or embedded in long design cycle products, like automobile navigation systems. Otherwise, RIP
  • Consumer computer usage is trending strongly toward applications that do not require intensive keyboard input and can be effectively served via cloud platforms – i.e. social networking, streaming media, e-commerce, search, e-reading, image viewing and editing. Many of these applications gain added value from mobility, further fueling the market momentum of smartphones and the re-energized post-iPad-intro tablet market, vs. keyboard attached netbooks and notebooks
  • Recent market trends on netbooks have been discouraging, as consumer and enterprise users with data input needs continue to reach for an extra helping of hard-disk space, processor speed, and Microsoft Office along with their keyboards. We believe that this is due to a combination of inertia and the not quite yet adequate performance of cloud applications over current networks relative to traditional software suites. However, this is not a permanent condition – RescueTime reports leading edge users abandoning Office for the cloud-based Google Docs. Moreover, 4G networks will initially deliver a five-fold improvement in wireless speeds, with the promise of a further ten fold improvement over the next decade, dramatically improving the performance of cloud apps and thus, more portable and cheaper alternatives to the traditional notebook PC
  • We expect these trends to favor the champions of smartphones, tablets and to a lesser extent, netbooks – e.g. Apple, Google, Qualcomm, Broadcomm, ARM, HTC, Samsung, Motorola, etc.. Also advantaged will be providers of cloud based applications – e.g. Google, Apple, Netflix, Facebook, Twitter, Salesforce.com, Success Factors, NetSuite, Amazon, etc.. Meanwhile, the success of companies with exposure on both sides of this battle – e.g. HP, Dell, etc. – will depend on their ability to manage the transition to a new mobile paradigm. Finally, companies anchored in the traditional PC-centered model – e.g. Intel, Microsoft, Lenovo, Acer, Asus, Western Digital, Seagate, etc. – will need dramatic change to thrive in the future

The Device Menagerie

Personal electronic devices make up a healthy chunk of technology spending. Combining cell phones, smartphones, digital cameras, compact video camcorders, personal navigators, music players, e-readers, tablet computers, netbooks and notebook PCs into a single category yields a $180B global market on annual unit sales of 1.7 billion, projected to grow at 12.6% per year (Exhibit 1). In an era of economic uncertainty, these may be robust expectations.

Curiously, the mix of devices is only projected to shift gradually. At first blush, this may seem appropriate, but it is not consistent with a history where big categories like pagers or PDAs can disappear almost overnight, just as smartphones or MP3 players rise to prominence. In part, this arises because forecasts for the individual devices are generated by narrowly focused analysts, who may not fully account for cannibalization by devices outside of their domain. Single application device forecasts – e.g. e-readers, music players – may not fully account for absorption by general purpose platforms like tablets or smartphones, while big categories, such as mobile phones or PCs, may not address the impact that spending in one category may have in crowding out spending in the other.

These cross-industry effects are often difficult to assess. Motorola was the dominant maker of pagers during their mid ‘90’s heyday, with better than 80% market share (and reputedly, better than 80% gross margins). Despite also leading the global cell phone market, the company was caught flatfooted as text messaging decimated demand for the single application platform (Exhibit 2). Analysts of the day did not see it coming until shift was well under way.

Enter the iPad

The PC revolution brought power to the people. The magic of Moore’s law allowed generation after generation of PCs to grow ever more powerful – faster processors, bigger hard disks, more memory – even as the entry-level price point edged downward. This severed users’ reliance on big, centralized computers to accomplish processing tasks and ushered in an era of portable computing, as luggables gave way to laptops, which were slimmed into 5 pound notebooks able to run on batteries for most of a cross-country flight.

Of course, notebook PC ownership is not without its headaches. They are too big to carry in a handbag, much less a pocket. They are heavy and fragile. They require software downloads and upgrades. They crash and if not explicitly backed up, can lose valuable data. They are susceptible to viruses and vulnerable to security breaches. They are fairly expensive, particularly once software is factored in. They are not particularly user friendly. Despite all of this, sales of smaller, cheaper and less complicated tablet and netbook alternatives have been lackluster. Until now.

In the first 80 days of availability, Apple sold more than 3 million iPads, owing both to the ardor of its sizeable fanbase and to the thoughtfulness of its design. As a phenomenon, it is forcing PC makers and industry analysts alike to adjust their perceptions of the market (Exhibit 3). New tablet models are being announced on a near weekly basis, most based on Google’s Android operating system. While no one can argue that the iPad has not established staying power, observers are mixed in their views of the long range effect of the form factor on the global PC market. Will tablets take a big bite out of the notebook market or not?

Clouds + 4G + OS Alternatives = Pain for the PC

We are firmly in the camp that expects dramatic change. Future PC growth forecasts lean heavily on notebook growth and within that, growth in notebook sales to consumers (Exhibit 4). While pre-iPad tablets and netbooks were relative disappointments, there are key differences in market conditions that we believe will lubricate a paradigm shift. First, application usage on PCs has been shifting away from the legacy of self-contained document processing toward Internet hosted cloud applications that leverage seemingly unlimited processing and storage resources in web attached data centers. Social networking, a la Facebook, Twitter or Foursquare, is a prototypical cloud application. Streaming media, a la YouTube, is a cloud application. E-commerce is a cloud app. Search is a cloud app. E-mail is a cloud app. Blogging is a cloud app.

In the enterprise world, CRM is a cloud app. Even document processing, the application suite that launched the PC revolution, is becoming a cloud app. Google Docs, a cloud based application suite that allows users to generate, open and edit word processing, spreadsheet and graphics files compatible with the ubiquitous Microsoft office formats, is gaining traction with leading edge enterprise users.

The cloud solves a lot of problems. Data storage is essentially unlimited and automatically backed up. Files can be accessed from anywhere and from any compatible device. Security is managed professionally, leaving less room for malicious mischief or theft. The device itself can be eliminated as a security risk – lost or stolen devices will have little data resident and can be wiped remotely – and the costs of shifting to a different device can be de minimus as user profiles generated from the cloud remain safe and constant.

4G also solves a lot of problems. Relying on processing and storage in the cloud is dependent on the availability and performance of the network that connects the user to his or her data. WiFi is fast, but it does not provide wide area coverage and can be very expensive outside of the home. 3G is widely available and has come down dramatically in price, but it is not all that fast, at 1-2 Mbps. 4G wireless, available in its WiMAX variant from Sprint and Clearwire now and expected in its more widely adopted format LTE from AT&T and Verizon within short months, increases data speeds to 5-10Mbps – comparable to most public WiFi services. Regular upgrades could step speeds to more than 50Mbps before the end of the decade, with availability to more than 90% of US households. This is fast enough to support almost any application in the cloud without any noticeable loss of performance to users.

Choices

The emergence of Apple’s X OS and Google’s Android (and its coming launch of Chrome for netbooks and tablets) expands horizons for users previously limited to the Mac vs. PC debate. These new operating systems have established familiarity with users through Smartphone implementations and have earned reputations for ease of use that will be assets as consumers weigh abandoning their relationships with a PC architecture to which they have become accustomed over many years. These operating systems are designed to be efficient – they load and execute operations quickly – and intrinsically tie to cloud-based services. Rafts of compact applications are already available with thousands added by the week. The Google software has the further advantage of being available for free to any device maker that chooses to license it, a crucial cost advantage vs. the PC architecture.

For device makers, the same choice exists at the microprocessor level as well. The new software architectures are compatible with a range of processor choices from a variety of semiconductor vendors, most employing low cost, low power core designs licensed from ARM. Competition at the CPU level also spurs innovation, which shows in the variety of products coming to market.

Windows/x86 PCs and Other Declining Platforms

We have written about our gloomy prognosis for the PC platform (see our July 27 note “PCs: Raging at the Dying of the Light”). To sum up, we believe cloud computing, virtualization and fast mobile networks will catalyze an irreversible downturn in the PC market after 30 years of nearly uninterrupted growth. However, PCs will not be the only long term casualty of this mobile revolution. History is rife with examples of single purpose electronics platforms that boomed only to bust in an environment of relentless innovation. Transistor radios, word processors, calculators, “the walkman”, pagers, etc. – these are largely relics of a recent technology past. Other single function devices hang on as high-performance niche products for connoisseurs, but give up the mass market as their applications are absorbed into general purpose devices – stand-alone digital cameras and even wrist watches have headed down this path (Exhibit 5).

We believe that there are other dinosaur products still walking amongst us. In the hullaballoo about the iPhone, the phone-less iPod has headed into decline along with the morass of less than successful MP3 player rivals (Exhibit 6). While the glacial pace of innovation in the automobile industry assures that embedded navigation systems will be with us for many years to come, their handheld cousins appear ready for the endangered species list, save for specialized models targeted at hard core bushwackers and sailors. With Amazon and Barnes & Noble porting their e-reader software onto both Apple and Android platforms, and with forthcoming innovations likely to improve the readability of smartphone and tablet displays, the last chapter for Kindle and Nook devices may be within reading distance.

Do You Really Need a Keyboard?

The first killer application for the PC was document processing. In that era, the idea of a personal computing device without a keyboard would be a head scratcher. Today, few consumers use their personal devices for heavy duty word processing or spreadsheet editing. Rather, social networking, email, media streaming and downloads, e-shopping, search, reading/surfing, gaming, image/video editing and navigation have become the leading applications for most consumers (Exhibit 7). For these apps, a full keyboard is not a requirement and in some cases, a touch screen may be a superior input mechanism, particularly with steady improvements in on-screen virtual keyboards. Add in increasingly accurate speech recognition for text input and touch typing could eventually follow cursive script handwriting in the queue of antiquated skills. As such, we believe Apple was prescient in its rejection of the QWERTY keypad. Touch screen smartphones and tablets have the market momentum, and we expect it to persist.

Wither Netbooks

While many users, particularly consumers, do not really need keyboards, there are still those that do. Road warriors with reports to write, spreadsheet models to build or presentations to craft may not be satisfied with a tablet. For these users, the notebook has been the ticket. Of course, it would be a lot better if the device could be two pounds instead of five, and if it could cost less than half as much as it did…

We believe that cloud computing and 4G will revive the netbook and take a real bite out of the future of the notebook. These netbooks may run lean versions of Windows, but could be more likely to run Android or Chrome – simple, free operating systems optimized for portable cloud operation.

If You Had to Choose One…

Reality is that the vast majority of the world’s consumers cannot afford more than one device. For these users, the value of telephony and text messaging is not taken for granted and the mobile phone will continue to be device of choice (Exhibit 8). As more of the billion unit annual cell-phone market will come into play with ever lower price points, smartphone unit sales should dwarf those of any other personal device category. Here we believe that the early lead of Nokia’s Symbian platform and RIM’s Blackberry will be erased, with the closed iPhone architecture making the first charge, but the Android ecosystem poised to be the big winner. Microsoft’s Windows 7 and Nokia’s MeeGo are last chance Hail Mary passes that require a lot of things to break their way if they are to dent the momentum of Apple and Google.

For those of us lucky to afford a second device, we believe tablets will prove to be much more than a flash in the pan. As we believe Apple values margins even more than market share, we see Google powered tablets from a squadron of licensees following the same fast follower strategy to take market leadership. Like in smartphones, alternative tablet platforms – Windows, Linux, etc. – will have a lot of ground to make up if they are to challenge for leadership.

Winners and Losers

We believe that the mix of portable devices will shift decisively toward non-Windows/x86 smartphones, tablets and to a lesser extent, netbooks. Champions of these platforms will be likely winners. Examples include Apple, Google, Qualcomm, Broadcomm, ARM, HTC, Samsung, Motorola, etc. (Exhibit 9)

On the flip side, we expect PC architecture to suffer in the device market, leaving companies tethered to that model as likely losers – e.g. Intel, Microsoft, Lenovo, Acer, Asus, Western Digital, Seagate, etc.

Companies straddling the two paradigms will need to artfully adapt to changing market conditions. Those with the best execution could end up winners, but a stumble could yield a negative outcome. Companies in this category include HP, and Dell, amongst others.

Companies with exposure to single application platforms may offset declining sales in those categories by participating in the transition of those capabilities onto multipurpose platforms. For example, sluggish sales of Apple iPod’s are offset by the success of the iPhone, threats to e-reader sales by Amazon and Barnes & Noble can be exploited by selling e-books onto alternative platforms. Navigation vendors – e.g. Garmin, Tom Tom, etc. – and digital camera companies – e.g. Kodak, Canon, Fuji, etc. – have not been successful in levering their solutions into general purpose products and may have missed their window to transition to the new paradigm.

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