Are Netbooks Eating Into PC Sales?

In recent times, much of the debate in the PC industry has focused on whether netbooks are a complementary product or a substitute to more expensive PCs, which are normally high margin product.

Netbooks, which normally sells for less than $400, lacks the sophistication required for the heavy-duty applications, but are ideal for students and professionals who need perform basic functions such as internet browsing, e-mail, blogging etc. Industry players like PC makers, chip makers and software makers have rushed to enter the market segment as sales of netbook registered an astounding growth in 2008.

According to market research firm NPD, netbooks constituted less than 1% of laptop sales in the first half of 2008. Sales of the device remained lackluster till the third quarter of the year. In December, netbooks accounted for 12% of unit volume, their highest total of the year. About 50 percent of all netbook sales for 2008 occurred in December.

NPD also came up with few interesting numbers regarding average selling price (ASP). The impact on overall laptop ASPs was significant.  In January 2008, laptop ASPs were $861, by December they had fallen to $740.  Without netbooks price erosion in 2008 would have been much smaller as non-netbook ASPs were $795 in December compared to the $861 at the start of the year. Clearly, low profit notebooks have begun to take a heavy toll on industry players dependent upon PC sales.

Slowing PC sales and rising netbooks shipment has been adding to the woes of Microsoft (NASDAQ: MSFT). An estimated 30% of all netbooks sold come with free and open-source Linux operating system. Moreover, Microsoft has been selling its Windows operating system at a discount to get it installed in the machines, which in turn is hurting its software business. Last month, the Redmond, Washington based company reported a meager 1.6% rise in quarterly sales. While announcing 5,000 job cuts, the software giant blamed netbooks for a drop in Window sales. "Client revenue declined 8% as a result of PC market weakness and a continued shift to lower priced netbooks," the company said in a statement. Windows sales were down 8% in the latest quarter.

However, Hewlett Packard's (NYSE: HPQ) Chairman Mark Hurd would like to wait before arriving at any conclusion. "I've seen in print, from people who claim expertise, that 80 percent of netbooks is new [sales] and 20 percent is cannibalization of the bottom part of the notebook market. We have some time before I can give you a good metric and good consumer data back." Phil McKinney, chief technology officer for Hewlett-Packard Co's personal systems group, said the company continues to consider netbooks as a companion device. "We kind of look at the minis as what we call a tweener product," he said.

Paul S. Otellini, President and CEO of Intel Corporation (NASDAQ: INTC) rejects the notion that netbooks are hurting PC sales. "While there is some cannibalization, the data suggests that the vast majority of netbook sales are incremental, and by the time we get to the analyst meeting, we'll share that data with you," Otellini says.

Forrester analyst J.P. Gownder believes that the PC makers should view netbooks as a complementary product. According to him, netbooks constitute a "third form factor in the consumer PC space, in addition to laptops and desktops."

However, there are many analysts and industry officials who are of the opinion that netbooks are indeed eating into the sales of personal computers and that with time, the trend will only gain in momentum.

Mika Kitagawa, an analyst at technology research firm Gartner states "There's definitely some cannibalization going on. But we don't know the depth of it yet. Today's netbooks may still be a little underpowered, but it's only a matter of time before what's being offered ... is actually good enough."

Asustek Chairman Jonney Shih said he sees a netbook cannibalization rate of around 10 per cent, but said they are the key to his company's future: "Those kinds of products are the growth opportunity for us." Asustek, which also pioneered the development of netbooks, is hoping to grab the majority share of the market.

However, it appears that it's still too early to precisely determine the extent of damage on PC market. Stephen Baker of NPD group says that buyers are still quite confused about the capabilities of the device. "If consumers see netbooks as an alternative to a laptop instead of an additional PC we could see cannibalization occur very quickly. New features are already being introduced which may blur the line between netbooks and laptops even more. The netbook market is being redefined before it's been fine tuned and that may cause even more consumer confusion."

Disclosure: Author does not own any of the stocks discussed here.