PC Feature Wars: Differentiation in a Commodity Market
Issue 14
Welcome to Bill Gurley Notes. Together, we’re taking a step back in time to the early days of the internet and into the writings of Bill Gurley, the famed 6’9 venture capitalist and author of his aptly titled blog Above the Crowd. We started with his maiden issue and are working forward in chronological order. To follow along with the un-notated versions, check out my friend KG’s comprehensive collection of Gurley’s writings here.
PC Feature Wars: Differentiation in a Commodity Market
5/30/1995
“Differentiation is the act of designing a set of meaningful differences to distinguish the company's offer from competitor's offers.”
—Kotler
While vacationing down South over the recent holiday weekend, we decided to wander into one of those huge computer superstores to study the now-famous consumer PC buyer in action. Unfortunately, the pleasant weather outside limited the number of shoppers inside. So rather than make this a wasted trip, we decided to take a look at the products rather than the purchasers. After taking a long hard look at several multimedia PCs from several different vendors, we have arrived at two conclusions. First, we are in the midst of an intense feature war in the PC industry, which could have some interesting side effects. Second, and perhaps more important, the Christmas of 1995 will likely be much different than last year.
Feature War Theory
Intel's aggressive participation in the motherboard business continues to lower the barriers to entry in the PC business and simultaneously to reduce industry-wide spending on research and development. Consequently, PC makers are searching high and low for new ways to differentiate their products. The result of this effort, in our opinion, is a feature war. PC ads read like laundry lists, and woe is the PC maker that fails to include the latest bell or whistle. The ironic thing is that for all their effort, the feature lists for the PCs we looked at were surprisingly similar. In other words, the bells and whistles that are included are not proprietary. As a result, participation in the feature war becomes merely a requirement for staying in the consideration set and not a useful way to differentiate one's product.
Seems like a good role for branding here. In commoditized industries, branding, manufacturing, and distribution edges are essential.
Consider the recent 4X CD-ROM shortage at Gateway 2000. Likely as a result of its focus on more experienced users, Gateway 2000 accurately predicted the move from double-speed CD- ROMs to quad-speed CD -ROMs and positioned its product line accordingly. Since well over 50% of Gateway's PCs include a CD-ROM, Gateway's early move to quad-speed drives made it one of the largest, if not the largest, consumer of such drives in the world. Unfortunately, Gateway is not a member of a CD-ROM cartel, and as such, several other PC makers switched to quad-speed drives seemingly overnight. Now it is quite likely that Gateway is still the world's largest purchaser of quad-speed drives, but with more buyers now on the market, CD-ROM manufacturers probably feel it is more prudent to balance their allocation across several customers, limiting the product availability to Gateway.
As with many things, feature perception can be more important than feature reality. Take for instance the combination of EDO (Extended Data Output) DRAM and burst-SRAM. These two components supposedly offer performance advantages over their predecessors' generic DRAM and SRAM, and individually this has proven to be true. However, performance tests indicate that the combination of both of these features is somewhat redundant. The performance advantage gained from adding the second memory feature is negligible. Nonetheless, many PC makers include both in their systems and advertise both in their feature lists.
What are the implications of a feature war? Well the easy answer is that it drives consolidation in the industry. The spot market for the "hot" components will likely dry up, reducing availability to smaller players. Keep in mind, however, that there is a balancing effect to component availability as a driver of consolidation (as Gateway recently discovered). In an effort to increase their own strategic positioning, component vendors will likely allocate products in short supply across several vendors so as to avoid dependence on any one customer. Therefore, feature wars may lead more to sticky market shares rather than quickened consolidation.
Another likely result of the now-infamous feature wars will be continued and excessive parts shortages for "hot" components. It is unclear how this will affect PC makers. Will prices rise on backlogged products? Will companies have trouble selling limited-feature-list PCs? Will investors accept component shortages as an excuse for expected revenue shortfall over several quarters? Unfortunately, we cannot think of a good historical analogy to help answer these questions (your input is welcomed). Nevertheless, the biggest beneficiary of the PC feature wars will be the small peripheral company with some unique bell or whistle that can help create the perception in the marketplace that this particular item is a "must have" for any PC maker's feature list.
Christmas of 1995, a.k.a. Battle Royal
It is typically stated that certain PC vendors "understand the consumer," whereas others do not. We would argue that this simply means that certain PC vendors have the right feature lists at the right price points at the right time. When product development cycles were much longer, this was a particularly important issue. Feature sets had to be determined well in advance of the important Christmas selling season. However, with Intel's "piece-part" strategy, PC assemblers can remove and add features in a matter of weeks, lessening the advantage of foresight.
I couldn’t find exactly what the “piece-part” strategy Gurley refers to here was. My guess is that it has something to do with Intel’s motherboard strategy.
Last Christmas, few PC vendors "understood the consumer." While Packard Bell and Acer were clearly on the ball with low-priced Pentium multi-media machines, these vendors were the exception rather than the rule. Compaq insisted on an all 486 line-up, and IBM drastically underestimated demand for its new Aptiva line. AST's presence was also limited by design and manufacturing problems. Therefore, last Christmas there were two well-positioned Intel-based PC companies, or three if you count IBM and Compaq as two halves.
Consumers care about multimedia-rich feature lists. Makes sense.
This year should look dramatically different, as we would argue that there will by potentially nine or ten Intel-based PC vendors in the retail PC market that all "understand the consumer." As a point of clarity the list is as follows: Packard Bell, Acer, Compaq, IBM, AST, DEC, Hewlett- Packard, NEC, AT&T; GIS, and possibly Leading Edge (its future is unclear at this time). The big difference comes from the aggressive participation of the traditional big box companies. These legacy computer vendors have concluded that competing in the consumer PC market is of critical strategic importance. Moreover, keep in mind that this list ignores the consumer presence of the larger direct PC vendors Dell, Gateway, and Micron Electronics.
Leading Edge became defunct in 1997.
What are the implications of a Battle Royal this Christmas? Well, it would be naive to ignore the importance of a three-to-one increase in the number of correctly positioned consumer PC companies. Unless the losers are compassionate players that enjoy eating inventory, we would assume that pricing pressures could intensify. Another likely consequence will be the increasing importance of shelf space. PC vendors that have invested time and effort in developing retail channel relationships should begin to see a return on that investment. Also, we could see an increase in sales and marketing dollars being spent on the channel. Which brings us back to our recent visit to the computer superstore. Guess which brand had the most shelf space? The in- house label. Go figure.
Takeaway
Gurley identifies two major trends here—which interact with each other. On the one hand, we have an intensifying feature war as Intel’s motherboard strategy lowers barriers to entry to the PC industry and PCs become further commodified as a result. His closing anecdote is a great illustration of this.
The same dynamic, he says, will drive a battle royale over the holiday 1995 season to win consumers—a battle for price, features, and shelf space, he predicts.
Was he right?
Here’s the opening of the New York Times’ December 4, 1995 report on the PC industry: “There may have never been a better Christmas to buy a computer. There may have never been a Christmas when it was such a bruising battle to sell one.”
It was an absolute pricing frenzy that year—a Packard Bell priced at $2,500 in 1994 was marked at $1,600 in 1995. Gurley missed that Apple, the subject of yesterday’s post, would enter the competition as well, lowering prices its prices to be more competitive—and no doubt further eroding its niche strategy in the process.
The trend Gurley doesn’t mention: the growth of consumer internet. Whereas in 1994, multimedia was king, by 1995, consumers cared more about internet access and capabilities. Another quote from The Times:
"Anything that has to do with the Internet is selling," said Abe Brown, spokesman for J & R Computer World of New York, one of the largest independent computer superstores in the nation. "More and more people are flocking to buy computers to get on it."
There were not part shortages.
Until tomorrow,
DS