The 2014 Global Consumer Electronics Outlook
It is the best of times (for a few) and the worst of times (for everyone else). The global consumer electronics industry is suffering.1 Fifty-six percent of companies in this technology sector—representing a full 88% of overall sector revenue (excluding Samsung and Apple) —have already fallen into financial stress or are at high risk of doing so, according to AlixPartners’ 2014 Global Consumer Electronics Outlook.2 A winner-takes-all situation has emerged, with two giants—Samsung and Apple—grabbing the lion’s share of revenue growth and profit share in an otherwise stagnant and even declining market. The two behemoths have achieved this by skillfully blending innovation focused on the consumer experience with savvy marketing and brand management, augmented by mastery of the sector’s value chain and distribution channels.
Yet so far in 2013, even Samsung and Apple are finding it difficult to sustain the momentum they built in 2011-2012. That is largely due to the twin pressures of softening global demand for consumer electronics paired with ever-shortening product and technology lifecycles. Indeed, over the 12-month period ending in June 2013, Apple’s revenue growth cooled to an annualized rate of 14% (one-third of its growth rate over 2011-2012), and its operating earnings dropped at an annualized rate of 3%. Meanwhile, over the same period Samsung’s revenue grew by 18% (after rising 30% over 2011-2012), although its operating earnings continued strong growth at 68% (after rising 67% over 2011-2012).
If even these two global giants may be beginning to stumble, how can other players in this troubled sector survive, never mind thrive? Underperforming companies must take steps now to strengthen their operations, or else continue their descent into financial distress. Those that implement targeted and sustainable improvements in four key areas –portfolio optimization and rationalization, outsourcing of non-core activities, overhead cost reduction, and strategic partnerships – will be best positioned for survival and, over time, success.
A Winner-Takes-All Environment
At a high-level, the consumer electronics sector breaks down into two main tiers based on EBITDA and revenue performance. The first of these we will call “The Top Two”—Samsung and Apple—and the second tier we will call “The Rest.” The Rest can be further divided into two sub-tiers: “The Next Four” (Panasonic, Sony, LG, and Sharp) and “Everybody Else” (a set of about 50 companies). Mapping players against these categories reveals just how much of a winner-takes-all scenario has arisen across this sector (figure 1).
"The Top Two"
Taken together, The Top Two, Apple and Samsung, generate nearly as much revenue as does the rest of the consumer electronics industry combined. In 2012, revenues for The TopTwo grew considerably—45% for Apple and 22% for Samsung. Together, they recorded more than four times more profit (as measured by EBITDA) than the rest of the players in the sector combined. Apple, for instance, generated $58.5 billion in EBITDA—more than 2.5 times the rest of the sector’s companies combined (excluding Samsung). And Samsung recorded $41.8 billion in EBITDA—nearly 2 times the rest of the players combined (excluding Apple).
From 2012 to 2013, companies making up The Rest of the consumer electronics sector saw their revenues drop by 7% ($388 billion to $364 billion) and their profits contract by 28% ($31.5 billion to $22.6 billion). Within this tier, The Next Four are suffering acutely: Their revenues fell by 8% and their combined profits by 36% over 2012-2013 (figure 2). Their profit margins are just 20-35% of those of The Top Two. And all four companies in this sub-tier are in financial distress or are at risk of being so.3 The Next Four generated 70% of The Rest’s revenues during 2012—but just 50% of the sector’s profits.
The Everybody Else sub-tier fared better, but not by much (figure 3). Revenues in 2012 remained nearly flat, and EBITDA declined by 16%, reaching an average of 9.7% in the sub-tier. Within this sub-tier, gaming companies are largely profitable and enjoying some growth. But other companies (such as those making audio components and equipment, as well as businesses focused on home entertainment and appliances) are fighting hard to sustain even meager profits and are experiencing modest to declining growth.
While The Top Two are still in the pink of financial health, 56% of companies in The Rest tier—representing a full 88% of that tier’s revenue—are in financial stress or at risk of being so, due to declining revenues, weak margins, and ongoing capital needs.
Our analysis of companies in the Everybody Else sub-tier shows that players based in North America and Europe constitute the least profitable group, recording an average EBITDA of less than 9.7% and the highest sales, general, and administrative (SG&A) costs in 2012 (figure 4). Companies based in the Asia Pacific region, which account for 75% of revenues for this sub-tier, have an average EBITDA of just 5.5%.
In addition to geographic trends, we see trends within the sub-sectors. For instance, in the Everybody Else sub-tier, companies that draw revenue primarily from sales of home appliances, set-top boxes, games, and electronic components and equipment have the lowest profitability. Enterprises focused on selling classroom/online education, games, and products for diversified consumers have the highest SG&A costs.
Innovation Is No Longer Enough
Product innovation has driven much of the success enjoyed by winners in the consumer electronics sector. But with consumers’ attention spans shrinking, brand loyalty eroding, and product and technology lifecycles shortening, even the best company can lose the hearts and minds of ﬁckle consumers in just one or two innovation cycles. Market dominance and market shares are shifting faster than ever. Moreover, competitors have captured valuable lessons from the giants’ success stories. And they’re using what they have learned to close the gap between themselves and the biggest players.
The consequences haven’t been pretty. Consider:
- Palm, once the dominant player in the personal digital assistant space, became no more than an operating system. It was then sold to Hewlett-Packard for a fraction of its former value.
- Research in Motion, which once deﬁned the portable messaging space with its Blackberry, is struggling to determine its next steps and implementing a major downsizing.
- Apple’s share of the smartphone market fell 25% from the second quarter of 2012 to the second quarter of 2013.4
- Nokia, once the leading global mobile handset manufacturer, has formed a close alliance with Microsoft and divested its smartphone business.
- Motorola decided to exit the mobile handset sector and divest its mobile handset business to Google.
A Roadmap for Action
In the face of so¬ening consumer demand, ever-shorter development cycles, and eroding revenues and profits, no company in the consumer products sector—even the largest, most successful ones—can afford to sit idle. Management must take action now. Winners need to launch strategies aimed at maintaining their marketposition, given that the innovation prowess that has helped them in the past will no longer be enough to sustain their success. Everyone else who is struggling will have to develop strategies for staying in the game. We believe four groups of actions are particularly critical for these companies:
- Pursue product profitability. Underperforming companies often support too many brands, product lines, and SKUs without a solid understanding of which of these are—and are not—making money. An unsentimental review of product portfolios can reveal which product lines are unprofitable and have limited or no brand equity. Dropping those products enables companies to reduce costs and focus on a more profitable core. We have seen portfolio rationalizations generate 20-35% or more of EBITDA improvement.
- Seek lowest-cost providers. Companies that haven’t already sought out the lowest-cost providers should begin to aggressively outsource production. This can reduce many of the high legacy costs in manuf acturing operations that can limit a company’s ability to compete. We have seen aggressive use of low-cost country sourcing reduce costs by as much as 20-30%, or more.
- Rein in overhead costs. Our analysis shows a high correlation between gross profit and overhead (SG&A) costs. Companies often appear to be spending as much on overhead as they can afford. Indeed, some spend more than all of their gross profit on overhead costs (figure 6). Underperformers—especially those with higher overhead costs than their competitors—have no choice but to find less expensive ways of managing their operations. We have seen that companies with high initial SG&A costs can achieve cost reductions of up to 10-25% after a careful review of overhead staffing and spending and the implementation of comprehensive measures.
- Partner strategically. We are seeing a number of strategic partnerships (Honhai’s prospective 10% investment in Sharp, for example) and acquisitions (Microso¬-Nokia, T-Mobile-MetroPCS, for example), and given the sheer number of companies now in precarious financial positions, we expect to see more activity in both financial restructurings and consolidation in this sector. In particular, we expect to see contract manufacturers seeking to move down the value chain through acquisitions, as well as several Asian companies looking to gain or improve their access to the large North American and European consumer markets.
Around the globe, companies in the consumer electronics sector face a brutal, winner-takes-all competitive environment. Continuing challenges, including relentlessly shrinking product and technology lifecycles and waning consumer loyalty, are delivering harsh blows to traditionally dominant sector players in the forms of declining revenues and shrinking profit margins. Even the biggest and financially healthiest companies are struggling to sustain their impressive growth rates. Meanwhile, the specter of financial stress and distress hangs over the most troubled enterprises in this sector, and many have already succumbed.
Only significant, swift, and immediate action—in the form of targeted operational changes—can help companies maintain their market positions and enable the underperformers to chart a more productive course for survival.
1For the purpose of this report, we define companies in the consumer electronics sector as those generating revenues primarily from the following major product categories: home entertainment and appliances; audio components and equipment; gaming devices, software, and online services; diversified consumer products; professional and office accessories; electronic components and equipment; education; and security systems and miscellaneous accessories. This definition excludes companies that generate revenues primarily from the following major product categories: personal computers and laptops (except as noted with Apple and Samsung); servers and mainframe equipment; wireless handsets and related services (except as noted with Apple and Samsung); and online retail and commerce (except online gaming services).
2The Consumer Electronics Outlook assesses past and future industry performance through an analysis of publically available industry and company financials. All references, facts, and opinions contained in the article can be found in the Outlook.
3Altman Z-Scores and AlixPartners analysis