Trade Talk: Cheap PCs part 2: falling prices, rising expectations

By Joseph Rydholm | April 1, 1998

Reading time: 8 minutes

Abstract

An overview of the current and future state of the PC industry.

Research Topics:: Data Analysis
Industry/Market Focus:: Computer-Hardware | Computers | Information Technology (IT) | Retailing
Content Type: Magazine Article | Trade Talk

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Last month we ran the first of a two-part look at the impact of sub-$1,000 computers compiled from several reports provided by Forrester Research, a Cambridge, Mass., firm specializing in the computer and high-tech industry. Forrester interviewed executives from a number of computer industry firms for these reports to get their thoughts on the near-term and long-term effects of cheap PCs, which Forrester defines as home computers costing $999 or less and including a Penfium-class processor, CDROM drive, sound card, and a minimum 16MB of memory, 1GB hard drive, and 33.6Kbps modem. A monitor is not
included. Part I explained how the sub-S1,000 price-point cam about and looked at who’s buying the inexpensive PCs. This month we look at the implications for the computer industry and Intemet marketing.

-Joseph Rydholm

Will advances in technology make fools of consumers who buy $999 computers? After all, an outdated PC that can’t run next holiday season’s software is no bargain. But these new systems will be worthwhile investments. They easily:

Handle the basics. Low-end systems already sport speedy CDROM drives, large hard disks, and fast processors required for contemporary software. Only high-end 3-D games do not run their best on these platforms, but in many cases the games can be played with lower image quality.
Access the Internet as fast as possible. Modem speeds determine consumer satisfaction with Web surfing. Every low-end system now comes with at least a 33.6 Kbps modem. Consequently, an entry-level Compaq Presario will download E-mail and display Web sites just as quickly as a fully loaded Dell Dimension. Next year, all models will ship with 56Kbps modems.
Escape multimedia obsolescence. Despite the push from industry leaders like Intel, most consumers will not pay an extra $1,000 for CPU-intensive multimedia capabilities like DVD playback and digital imaging. DVD software will not reach critical mass until at least 1999. Mainstream consumers will not spend the time or money on tasks like photo editing.

Prices will keep falling

The sub-$1,000 PC is just the start. Forrester believes that by the end of 1998, entry-level systems from name-brand manufacturers will retail for as little as $599. Cheap PCs will build momentum, as:

Processor clones drive chip prices down. AMD ships CPUs with Pentium performance but only charges 75 percent of Intel’s price. National Semiconductor will reduce prices by integrating graphics and peripheral control into the silicon. With Compaq, IBM, and Acer already shipping clone-based CPUs, Intel will continue to cut its own prices - even on its high-end Pentium II line - to retain market share.
Build-to-order (BTO) and in-store brands proliferate. Consumers willing to buy BTO systems from second-tier vendors like Proteva and CTX can save hundreds of dollars. Computer retailer MicroCenter currently offers its own entry-level configuration for $499. Mainstream vendors like HP will hone manufacturing capabilities to create viable products at comparable price points.
Excess capacity pushes component cost lower. The costs of memory, CD-ROM drives and motherboards continue to drop as an overload of suppliers in the U.S. and Asia try to stay afloat by dropping prices. By next year, all but the cheapest PCs will offer 32MB of memory, 32x CD-ROM drives, and 56Kbps modems.

Cheap computers will change the market

Forrester predicted in October 1996 that PC penetration would reach 53 percent of U.S. households by 2001, but this forecast was based on the belief that sub-$1,000 systems would not shake up the market until 2001. Forrester now believes the market for cheap PCs will blossom during the next five years. The company estimate that by 2002, 17.5 million new systems will be sold to U.S. consumers. High-income consumers will buy an extra machine for the kids, while low-income families will finally take the plunge. The effect of this sales acceleration in low-cost systems will be:

A faster increase in household penetration. Forrester estimates that 43 percent of U.S. households currently own a personal computer. By year-end 2002, it expects almost 60 percent of U.S. households to own one or more PCs.
A closing of the information gap. Close to 40 percent of low-income homes and 62 percent of households earning from $25,000 to $49,999 per year will be equipped with a PC by 2002. The reduction in prices will unleash demand in cash-strapped institutions like schools, libraries and senior centers.
A resurgence in first-time buyers. During the next five years, Forrester estimates that 21 million first-time buyers will come into the market, accounting for close to 30 percent of new purchases. This onslaught of first-time users will place new demands on PC makers, content providers, and software companies.
Multiple-PC households gain ground. Forrester predicts that one-fifth of U.S. households will have more than one computer by 2002. Parents will reserve one system for Quicken and holiday card creation, while the kids will use a machine for games and educational purposes. By this time, almost 40 percent of PC households will have more than one computer.

Far-reaching consequences

The ascendancy of cheap PCs will have far-reaching consequences for consumers, content and e-commerce players and PC manufacturers. As new buyers and multiple computer purchases dominate the PC market, the demands and buying habits of consumers will shift. Here’s how:

Consumers stop overbuying. People historically have bought high-end PCs to guard against premature obsolescence. But cheap PCs will run next year’s software just fine. High-end models sporting fast processors and gargantuan drives will gather dust on retail shelves. Consumers won’t need to replace systems every two years - PC lifespans will stretch to five years or more. Meanwhile, households will divert their PC savings to fund space-saving flatscreen monitors, photo-quality color printers, photo scanners and additional software.
Buying cycles shorten. As word of mouth and mainstream press reassure the public of the viability of cheap PCs, consumers will purchase more quickly. Instead of agonizing for weeks over possible price drops or impending obsolescence, consumers will buy on impulse for graduations or other family events.
Brand loyalty dissipates. For PC vendors, getting top ratings in Consumer Reports’ annual PC buying guide will be much more important in 1999 than being the first to offer a 300MHz CPU. Consumer choices will narrow to price and features, with a final decision determined by ease of setup, device ergonomics, service and support.
High-bandwidth demands grow. As the PC becomes affordable for almost all households, speedy Internet access will be the new defining line between the haves and have-nots. Households with more disposable income will pour money into second and third phone lines, cable modems and digital telephone lines.

Online content and commerce expand

Online content and transaction sites will benefit from the boost in penetration and diversification of PC households. For online business, this means:

Mass-market vendors find an audience. Last fall, Forrester found that 72 percent of online shoppers lived in households with an annual income that exceeds $40,000. But giant merchants like K-Mart, Wal-Mart and QVC will find that cheap PCs bring more of their patrons online. Retailers should partner with PC vendors to include special links, incentives and one-button access to their online stores.
Tools for frugal shoppers take off. Convenience is the reason current online purchasers buy over the Web. But an increasing proportion of lower-income shoppers will look for opportunities to save money, opening up the market for services like Web coupons from the Interactive Coupon Network or SuperMarkets Online.
Free online access opportunities heat up. Many lower-income families will balk at $20 per month pricing for unlimited online access. Free e-mail services like Juno will be joined by subsidized Web access opportunities from online shopping services like Peapod, which will provide Web access in return for guaranteed monthly minimum purchases.
Home banking gets a boost. The jump in household penetration will benefit all online financial services sites, but the largest opportunity for growth lies in home banking. Families making $45,000 may not invest no matter how low commissions go but they do need to know the status of their checking and savings accounts.
Internet advertising jumps. The rise in PC shipments - especially the three million to four million per year by first-time buyers - will increase the number of eyeballs on the Web. America Online should benefit as its ease-of-use continues to attract online newcomers. As penetration climbs to over 50 percent of households in 2000, companies will pour more money into online marketing campaigns.

PC industry shakeout

The good news for the PC industry is that shipments will increase. Unfortunately for vendors and computer retailers, these systems will sell for under $1,000, leaving very little room for profit. The major effects of this change will be:

Big problems for Intel. The giant still commands 80 percent of the cheap PC processor market, but PC vendors will only buy Intel when the price point competes with AMD and National Semiconductor. The heart of lntel’s power - the x86 instruction set that runs all PCs - will become generic as new vendors like IDT enter the fray. To fight market share erosion, Intel must drop its price and quickly push high-end technology down to the low-end PC market. Profit margin will erode, forcing Intel to spin off investments in non-core technology like videoconferencing hardware and desktop management tools. The company will be forced to reinvest in Pentium-class technology as its expensive, next-generation processors are ignored by the booming consumer market.
Big gains for Microsoft. Just as "IBM-compatible" became the term for all PCs in the mid-1980s, "Windows-compatible" will become the term for any Pentium-class processor that runs PC software. The "lntel Inside" campaign will lose steam as Microsoft and its Windows logo provides the guarantee that any new computer can run off-the-shelf software. Future innovations - whether enhanced graphics or voice input -will come from Redmond and top PC manufacturers. During Microsoft announcements, Intel will be forced to share the stage with AMD and National Semiconductor.
Premium-priced vendors must sell at $999 or leave the market. Companies like Dell and Sony must ante up and begin selling $999 systems by the end of 1998 or lose ground. Companies like Apple and Toshiba that can’t learn how to play profitably in the sub-$1,000 space will be forced from the market. By 2000, Forrester expects more PC casualties as companies like Gateway struggle to make ends meet.
The network computer (NC) crowd must regroup. Consumer NCs won’t be able to compete in price with PCs - why pay a hundred dollars less for a system that can’t run Disney’s Ready to Read with Pooh? NC players like Oracle should stop competing with PCs and focus instead on enhancing existing devices like phones. A simple, cheap screen phone that seamlessly links to the white pages and Cybermeal’s take-out service will beat out PCs for kitchen space.
The interface opportunity. The PC platform has reached maturity as stable processors and operating systems slow down technology innovation. But one glaring hole remains - the interface. The basic windows metaphor is over 25 years old, and Microsoft is failing to advance the user interface. Vendors like Apple, MetaCreations, or America Online have the opportunity to graft distinct and consumer-focused interfaces on top of Windows.