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My first assignment to cover a major story in the glitzy world of consumer electronics should have been a warning signal. It was January 1997 when the Lufthansa plane hit the tarmac in Nuernberg (Nuremberg) in southern Germany, on my way to nearby Fuerth to write about the demise of the once mighty electronics firm Grundig.
It was one of those miserable weeks that define the depressing north-western European winter, with temperatures around zero and ashen skies that could not decide between being clouds or mist. In a tired Mercedes cab with peeling leather upholstery and the smell of old cigarettes, we ploughed through the sleet on the autobahn. It did not feel very glitzy to me.
This was the home of Grundig, and the weather chart symbolised the crisis that was facing a company which only three decades earlier was synonymous with the German Wirtschaftswunder of post-war economic recovery. The first TV many Germans could afford was made by the company founded by Max Grundig.
At its heyday, Grundig employed over 40,000 staff, but that number had dropped to less than 7,000 in 1997 when I arrived in the Bavarian town. Standing at a vast and desolate car park, a security guard pretended to flatten two office blocks and several manufacturing sites with a sweeping gesture. Those had been sold. I had just been inside one of those grey buildings dating back to the 1950s and 1960s. The design furniture was the same age as the buildings and had once been ultrachic. Now, though, it was faded and worn.
At one the sites where Grundig was still producing video recorders and TV sets, the car park was nearly empty at 2:30 in the afternoon. “Working hours have been cut by two hours. We need to produce less, because we cannot sell enough of our TVs,” said Robert Schmidt, a 37-year veteran on the production lines. Within a year, he told me, he would lose his job. By the end of that year, Grundig would employ only 6,100 staff.
The unions, which have powerful positions in post-war German enterprise and take seats on the board, were “stinksauer”. They blamed the downfall on Philips Electronics, the big rival from the smaller neighbouring country of the Netherlands which had taken a 32 percent stake in the company in 1984 plus an obligation to buy the rest 20 years later.
Philips’s consumer electronics chief Joop van Tilburg had indeed accelerated the problems at Grundig. Instead of reading the tea leaves of the global economy and the transition to low cost production sites, Van Tilburg had decided to augment production capacity in Germany at the end of the 1980s and early 1990s. Enthused by the political whirlwinds after the collapse of the Berlin Wall, he was one of many who expected an economic boom period for Germany, eastern Europe and Russia. Eastern Europe was soon going to be Europe’s own Asia. His mistake had dramatic consequences.
“When that eastern European growth did not come through as fast as expected, we had to wind down capacity again,” recalls Han van Splunter in 2005, a Dutchman who was on the four-person strong Grundig management board for six years. He helped to shut factories in Barcelona (Spain), Italy and France, and move production to eastern Europe while creating a base of contract manufacturers in China. But the most important manufacturing base, Germany, was much harder to restructure. “It was extremely difficult to do that in Germany.”
In an attempt to stem the tide with an aggressive move to increase its size, Grundig wanted to take over the television set activities of Nokia from Finland. Nokia’s TV operations were in a similar tight spot, and the new CEO Jorma Ollila was ditching everything unrelated to mobile phones. (in 1992/1993 just when Jorma Ollila had taken over as CEO of Nokia) The takeover failed, because Nokia refused to shut a loss-making TV tube factory in Esslingen, Germany, which was a condition for the acquisition. “Grundig didn’t want another bad running factory,” said one person close to the companies. Ollila declined to comment, but sources at Nokia confirmed the talks.
Grundig’s CEO in 1997, Pieter van der Wal, a giant fair-headed Dutchman who went by the nickname ‘the killer whale’, took the blame. “In hindsight, Grundig was too focused on Europe, and within Europe too much on Germany. In addition, we wanted to make too many products by ourselves.”
Under the terms of the 1984 purchase, Philips had been obliged to cover all of Grundig’s losses, and pay an annual dividend of 45 million euros to the heirs of Max Grundig regardless the earnings. It had already spent more than 3 billion guilders (1.4 billion euros in today’s money) on the German company when reporters filed into a conference room on that miserable Friday in 1997. A few moments later Philips announced it would cut all ties with Grundig. The German consumer electronics group was a sinking vessel that would need to find another partner to keep it afloat, said Philips, hardly trying to conceal its bitter contempt.
Dieder Dornberger, another assembly line employee who I met a few hours later, was deeply saddened when I asked him about the decision. He too would lose his job that year.
Grundig relied heavily on one product, TV, and TVs were no longer special enough to guarantee fat profits. Three quarters of Grundig’s annual sales of 3 billion marks (1.5 billion euros) was generated by TVs and VCRs, with remaining activities in car radios and HiFi equipment. TV-making, in the mid-1990s, had become a cut-throat industry. The technology to make a TV was no longer a well-kept secret and this had led to a host of new Chinese rivals which were producing important components such as the tubes and benefited from their lower cost base. Lower prices and oversupply caused sharp price drops. Every year, VCRs became 10 percent cheaper and TVs dropped 5 percent in price. Only very large players were able to reduce their costs enough to stay marginally profitable. Grundig, with its factories in high-wage Germany, and its reliance on Philips chips and tubes, was not one of them.
The very thing that was killing Grundig in the 1990s had once been its birthright. Benefiting from low cost labour in war-destroyed Germany, it had carved out its place in the market by leading the price war. In 1952 it had introduced the Zauberspiegel (The Magic Mirror), which was the first TV priced under 1,000 marks. Max Grundig had opened the TV era for Germany.
The company was an early adopter of new technologies, either purchased or developed in-house, with products such as a mini-radio in 1947 and a portable radio in 1949. It launched a dictation device in 1954 and a tape recorder in 1955. But by 1997, all of these products were at the end of their development. The consumer markets, in particular Grundig’s German home market, had become saturated.
There was one big hope: high definition television. It was a technological leap ahead that would leave the low-cost Chinese biting the dust, and it would force consumers to replace their existing sets long before the end of the normal life cycle. But the technology was not ready yet and the revolution took another decade to take off. Instead, TV makers tried to lure consumers into buying sets with wider screens (16:9, instead of 3:4). These were also harder to make for the Chinese upstarts. The mass market, however, did not bite. A new consumer electronics product needs to be “10 times better” in order to convince consumers to upgrade, according to former Intel CEO Andy Grove, and a few centimetres of extra TV screen added to the side was not a compelling reason for consumers to flesh out a 500 to a 1,000 euros.
An emblematic tale
Grundig’s fate was emblematic for the German processing industry. In eight short years, the German economy had gone from 32.2 percent of GDP generated by manufacturing industries in 1986 to 24.5 percent in 1994. Grundig was not the first “Traditionsunternehmen” (traditional enterprise) that collapsed under the pressure of high wages. Another example was the Allgemeine Elektrizitäts-Gesellschaft, better known as AEG, wich dated back to the 1800s. Parent company Daimler-Benz, was fed up with the losses of its white goods and electronics unit and had shut it down in 1996. Only the brand survived, and landed in the hands of the world’s biggest white goods producer Electrolux in 2004.
Grundig awaited a similar future. No strategic partner was prepared to pick up the pieces left by Philips, and the firm ended up in the hands of a Bavarian consortium led by several regional banks. The losses kept mounting and the firm had to seek creditor protection in 2003 when employee numbers had dropped to 3,500. Grundig’s consumer electronics activities, effectively the brand name and some sales staff, were sold for 80 million euros to the Turkish firm Beko Electronics which has large production facilities outside Istanbul, and Britain-based Alba Radio Ltd. Car systems were later sold to United States-based car parts giant Delphi – which in its turn collapsed in 2005.
Nazi Landmark
I left Fuerth and Nuernberg (Nuremberg) with the image of two symbols of bygone eras. At a stone’sstone’s throw away from the soon-to-be derelict Grundig production facilities, I passed the stadium designed by Nazi architect Albert Speer for the NSDAP party rally. In the same city where World War Two criminals had been sentenced to death, the 1930s symbol of their megalomania still lay there. I was stunned. Somehow I had always assumed that this dubious site, the scene for Leni Riefenstahl’s 1934 film Triumph des Willens, had been demolished. I realised the Grundig name would probably be erased from the Nuernberg (Nuremberg) landscape long before Speer’s landmark.
Grundig not alone
Grundig’s story was no isolated case. There had been many Grundigs before Grundig, and there would be many more after it.
Aristona, RCA (Thomson) and Nokia are no longer TV makers. Well known American brands like Zenith, Emerson, Magnavox, Sylvania, Philco, Admiral, GE, Sears (Warwick), Quasar (Motorola) have exited the business. In Europe, Saba (Thomson), AEG, Thomson have all disappeared. In Italy, dozens of smaller names have vanished.
They all struggled to deal with a new world of ferocious competition, mainly from Asian rivals whose names they could not pronounce, In the early 1990s, many of the new Chinese rivals did not even exist five years earlier.
Let’s take a closer look at Nokia, which is now the world’s best known maker of mobile phones, but which in the 1980s was an industrial conglomerate looking for a future. It had decided it wanted to be a top consumer electronics name and had started buying troubled TV producers Nokia had acquired Salora from Finland and state-owned Luxor from Sweden in 1983, as well as Oceanic from France in 1987 and the associated companies Sonolor and Televisso which was from Electrolux of Sweden. Nokia also bought Standard Electrik Lorenz (SEL) from Alcatel in late 1987. It produced TVs under Finlux and Guestlink.
All this consolidation had given Nokia a larger presence, but it was still not big enough to compete with cheap Asian imports and its production base was in expensive Europe. Soon after it turned down Grundig to merge because it did not want to shut down its Esslingen plant, it was forced to close it anyway. Nokia’s capacity was 2 million tubes a year, and it needed 3 million to be profitable.
Its TV production activities collapsed in 1996 after it failed to find a partner. It had to shut down most of its operations. Cumulative losses from TV manufacturing had been 1,3 billion euros. Without the profits from Nokia Mobile Phones and Networks, Nokia may very well have collapsed. Thomson, in its turn, booked billions of euros of aggregate losses in the 1990s.
Consumer electronics has transformed our lives
Why is it so hard to make a profit with a TV? After all, TVs are important to our lives. We dwell a staggering number of hours in front of TV screens. An average person in North America watches four hours and 32 minutes of TV at home every day. (Nielsen, in 2004/2005 TV season). Europeans tend to lag behind, but still watch an average 3 to 4 hours a day.
But there is more time we spend in front of screens. Young people between 8 and 18 years spend eight and a half hours of recreational (non-school) use of TV and videos, music, video games, computers, movies, and print. This total amount of media content consumed by young people has increased by more than an hour over the past five years (from 7:29 to 8:33), with most of the increase coming from video games (up from 0:26 to 0:49) and computers (up from 0:27 to 1:02, excluding school-work). (A March 2005 survey of 8 to 18 year-olds by the Kaiser Family Foundation)
Because children multitask, they pack that content into an average of six and a half hours a day, (44.5 hours a week) including three hours watching television, two hours listening to music, more than an hour on the computer outside of homework, and just under an hour playing video games.
Adults may spend less time in front of a PC at home, but most office workers spend hours every day in front of a PC monitor.
The time we spend in cars dwarfs by comparison. The people in Basel, Switzerland spend only 27 minutes per day in a car, but even in car-intensive Perth in Australia it is not more than an average 47 minutes a day (study Werner Brög, Nicola Mense, Socialdata GmbH, Hans-Grässel-Weg 1, 81375 Munich, Germany; Broeg has been a lecturer at the Massachusetts Institute of Technology (MIT) and at the Technical University of Graz (Austria).
One would expect that the companies who gave us the Walkman, the compact disc, the DVD player and plasma TV are handsomely rewarded for their accomplishments to change our lives so dramatically over the course of the last 50 to 60 years. Who would have thought 10 years ago that we could play all of Beethoven’s symphonies from a gum-sized MP3 player of just a few grammes worn around our neck? It’s nothing short of magical.
Profits are tiny
For all the importance of consumer electronics, almost all manufacturers of our daily high-tech diet struggle to make a profit.
For the last nine years, the world’s top consumer electronics companies -- Sony, Panasonic-owner Matsushita, Samsung Electronics, Philips and LG Electronics – have generated disappointing profits from their operations. Profits have averaged well below 5 percent of sales of TVs, DVDs, camcorders, digital cameras, stereo sets and other consumer gadgets. (graph 1). For every dollar of equipment those multinational behemoths sold to retail stores like Best Buy, Circuit City and Media Markt, they have only been able to keep a few cents of profit after deduction of all their costs.
Sony, the best known consumer electronics brand in the world and a fountain of innovation, has not generated earnings from its consumer electronics operations in the last four years. Even when the profits from its highly successful games console PlayStation are thrown in, the company’s profit margin has not exceeded 2.5 percent.
Sony is no isolated case. The top 10 electronics companies in Japan, including top names such as Fujitsu, Toshiba and Canon managed to earn an operating profit of just 2.8 yen on every 100 yen of sales (excluding Sharp which did 5.9 percent)
Samsung, the big challenger which has stormed into the global top 3 during the last decade, has very little to brag about either. Its record profits are entirely generated by its electronic component divisions and its mobile phone unit. The large digital media group which makes PCs, TVs, hard disk video recorders, MP3 music players, camcorders and still cameras has been barely profitable.
The same gloomy story goes for personal computers, which have also come to fit into the consumer electronics space as roughly half of sales are to consumers, students and home offices. Averaged out over the last nine years, Hewlett-Packard earned next to nothing with its PC unit. And IBM, the company which set the world standard for the personal computer in 1981, piled up $973 million of losses in the 3.5 years before it decided to sell that division for all but $1.25 billion to Lenovo from China in late 2004 – it has annual sales of close to $10 billion.
(For a full Excel spreadsheet and graphic of the long-term financial performance of consumer electronics companies, click on the Excel attachment at the end of this Prologue)
“The PC business has a history of recurring losses, negative working capital and accumulated deficit. The ability to settle obligations as they come due is dependent on IBM funding the operations on an ongoing basis,” IBM said in a regulatory filing published on Dec 2004.
David Katz, chief investment officer at New York-based Matrix Asset Advisors, sold millions of shares in Hewlett-Packard after that company took over Compaq and, briefly, became the world’s biggest PC and computer maker. Investors who buy shares in H-P only pay for the printer business. The balance of the computer business they get for free, he says. In other words, H-P’s personal computer business which generated staggering revenues of almost $25 billion in 2004, is deemed worthless by investors. (operating profit margin hovered between 0 and 1)
A small profit is the same as no profit
It is a misunderstanding that a company is secure as long as it is making a profit, no matter how tiny. Normal companies need capital to conduct their business, to invest in factories, to finance their inventories and give credit to customers – there are examples of abnormal ones and I’ll talk about those later.
Most companies have to borrow that money, either from banks or investors, and they pay roughly 7 percent of interest for a year. Even if they do not have to borrow that money, for instance because they have been able to save some cash, the money they invest still has a price because it can be productive elsewhere. Suppose that a company has a billion euros or dollars in the bank. It can use that money to build a new factory, but it can also invest the money in a mix of bonds, equity, commodities and real estate, and achieve a reasonably secure return of around 7 percent, depending on how much risk it is willing to take. This opportunity cost determines the price of the money that is needed by a company, also known as the "cost of capital". And so a company must always be confident its investments will generate more money than the capital markets. Why else would would anyone -- including you -- invest in your company in the first place?
Sometimes a company does not need any money, even when it makes a loss. If such a company does not have to invest a lot of money in its factories, it may still generate cash. The mirror image of this example is a very profitable company which consumes cash -- for instance a fast-growing company which is investing a lot of money. Over the long run such a profitable company is doomed if it's not able to cut its spending or boost sales and start generating cash. Surely if that's the case, then the marginally profitable consumer electronics companies may not be in such dire straits after all? Suppose they have very modest investment needs? In that case it's almost irrelevant how small their profit is.
While that may be the case -- and we will see that this is indeed the strategy pursued by some of the electronics firms, -- investors still expect the company to generate a long-term return on its assets. Investors have many options for their nest egg. If a bank offers a safe interest rate that is higher than a company's share price increase annual dividends, they may sell the shares of that company. If many people sell shares, that leaves a company vulnerable for a takeover, or the management may get the boot.
Indeed, a nest egg is often better off at a local bank branch where a savings account yields a safe albeit meager 4 percent interest, than invested in an electronics company. Investors know it, too. The stock market tells that tale in very clear numbers. Shares of Philips, in June 2005, were at the same level where they were in 1998. Sony’s stock was at levels of mid-1997. Hewlett-Packard, the company which almost single-handedly created Silicon Valley, saw its shares hover around 1996 levels. And by mid-2005, Motorola and Matshushita shares were back where they were in 1995.
Compare that with the tech-heavy Nasdaq stock index in New York which has more or less doubled early 1997 and mid-2005, on the back of phenomenal price performances of software and Internet companies such as Oracle, Microsoft, eBay, Yahoo, and, as of late, Google. The main Dow Jones Industrial went up 64 percent over the same period.
In general, the software and Internet companies have done remarkably better than the hardware firms. Yet, without the hardwired boxes produced by the likes of Motorola, Sony and Hewlett-Packard, there would be no software or Internet to use. You need a computer and a display to search on Yahoo or run a word processor.
Why is it that many hardware companies pulled the short straw in the past decade? More importantly, why do these tech giants continue to throw valuable resources such as money and talented people at an industry that is so clearly unable to deliver results? And what does the next decade have in store for those struggling companies?
These questions surface every three months with another string of disappointing quarterly results, like an endless strain of un-kept promises of improvement only occasionally freshened up with a rare windfall that will not last.
If there had been an investor at Kitty Hawk on December 17th 1903, he might have shot down the Wright brothers’ contraption of tent poles and cloth, multibillionaire Wall Street investor Warren Buffet from Omaha once said. That smart investor would have saved the world from billions of dollars of capital destruction by the airline industry in the following century.
You may wonder what would have happened, had that same investor been present at the New York Bell Labs in December 1947 when John Bardeen, Walter Brattain, with support of their supervisor William Shockley, discovered the transistor. And what would have happened in Philo Farnsworth’s lab in 1927 if that same investor had witnessed the transmission of the first television image comprised of 60 horizontal lines? Or even earlier, in 1884, would that investor have also stopped Paul Gottlieb Nipkow proposing and patenting the first electromechanical television system?
Without these geniuses, there would not be no $2.5 trillion a year technology industry, or the Internet, or the fifth season of the West Wing. But neither would there be the value destruction as applied by so many of the companies who sell us personal computers, microwaves, digital cameras, car radios, TVs and electronic toothbrushes that have come to define our modern lives.
Gadgets have helped the greater good
It would of course be a tad short-sighted to land a hammer on the first transistor only because Sony failed to make a profit 58 years later. Billions of dollars have been burned by the airline industry, but its planes have enabled global trade. Similarly, technology products have made us more productive, they have made our lives more comfortable, and they also have borne the radio, TV and Internet media industries.
The fact that Hewlett-Packard, IBM and pretty much all of their competitors cannot make a profit from PCs does not make the invention itself a failure. Without the PC, we would be without email or spreadsheets at work. It’s only a few decades ago, before the introduction of the fax, that we would wait a day or two to receive our mail. With our cell phones and Blackberries we now have instant access to people and email wherever they are. At home, without a PC there would be no song swapping, no CD burning, no free Internet calls.
“It’s such a fast-paced industry. It has the potential to be very cool and emotional,” says David Steel, Vice President Marketing Team Samsung’s Digital Media Business. Perhaps we should just be grateful that the PC producers go through the trouble of delivering computers to us at cost price, and move on.
Still, it is puzzling why it is so hard to make money with such essential products as PCs of which over 200 million units are sold every year. Equally disturbing perhaps is that the similarly sized TV market, another 190 million units every year, is an almost identical trench war. Why do we not award the producers according to the value they provide us?
It is not as if computers and televisions are easy to make. You need big factories, expensive equipment, lots of trained engineers and a library of books on physics, chemistry and electronics.
How unfair is it that some companies only need fresh water, wheat, barley, hops and yeast to brew up profit margins that are a lot higher. Beer brewer Heineken generated an operating margin between 10 and 15 percent for the past 10 years. Anheuser-Busch, the producer of Budweiser, squeezed out an operating margin of more than 22 percent in 2004, 2003 and 2002. How do they manage to achieve such results, considering that it is hardly a sophisticated production process? After all, even the ancient Egyptians already knew how to brew a pint.
And so the question is why? Why is Sony still in this industry? Why is life so bad for LG? And what are they going to do about it?
You liked the Prologue? Continue with Part 1 here
It was one of those miserable weeks that define the depressing north-western European winter, with temperatures around zero and ashen skies that could not decide between being clouds or mist. In a tired Mercedes cab with peeling leather upholstery and the smell of old cigarettes, we ploughed through the sleet on the autobahn. It did not feel very glitzy to me.
This was the home of Grundig, and the weather chart symbolised the crisis that was facing a company which only three decades earlier was synonymous with the German Wirtschaftswunder of post-war economic recovery. The first TV many Germans could afford was made by the company founded by Max Grundig.
At its heyday, Grundig employed over 40,000 staff, but that number had dropped to less than 7,000 in 1997 when I arrived in the Bavarian town. Standing at a vast and desolate car park, a security guard pretended to flatten two office blocks and several manufacturing sites with a sweeping gesture. Those had been sold. I had just been inside one of those grey buildings dating back to the 1950s and 1960s. The design furniture was the same age as the buildings and had once been ultrachic. Now, though, it was faded and worn. At one the sites where Grundig was still producing video recorders and TV sets, the car park was nearly empty at 2:30 in the afternoon. “Working hours have been cut by two hours. We need to produce less, because we cannot sell enough of our TVs,” said Robert Schmidt, a 37-year veteran on the production lines. Within a year, he told me, he would lose his job. By the end of that year, Grundig would employ only 6,100 staff.
The unions, which have powerful positions in post-war German enterprise and take seats on the board, were “stinksauer”. They blamed the downfall on Philips Electronics, the big rival from the smaller neighbouring country of the Netherlands which had taken a 32 percent stake in the company in 1984 plus an obligation to buy the rest 20 years later.
Philips’s consumer electronics chief Joop van Tilburg had indeed accelerated the problems at Grundig. Instead of reading the tea leaves of the global economy and the transition to low cost production sites, Van Tilburg had decided to augment production capacity in Germany at the end of the 1980s and early 1990s. Enthused by the political whirlwinds after the collapse of the Berlin Wall, he was one of many who expected an economic boom period for Germany, eastern Europe and Russia. Eastern Europe was soon going to be Europe’s own Asia. His mistake had dramatic consequences.
“When that eastern European growth did not come through as fast as expected, we had to wind down capacity again,” recalls Han van Splunter in 2005, a Dutchman who was on the four-person strong Grundig management board for six years. He helped to shut factories in Barcelona (Spain), Italy and France, and move production to eastern Europe while creating a base of contract manufacturers in China. But the most important manufacturing base, Germany, was much harder to restructure. “It was extremely difficult to do that in Germany.”
In an attempt to stem the tide with an aggressive move to increase its size, Grundig wanted to take over the television set activities of Nokia from Finland. Nokia’s TV operations were in a similar tight spot, and the new CEO Jorma Ollila was ditching everything unrelated to mobile phones. (in 1992/1993 just when Jorma Ollila had taken over as CEO of Nokia) The takeover failed, because Nokia refused to shut a loss-making TV tube factory in Esslingen, Germany, which was a condition for the acquisition. “Grundig didn’t want another bad running factory,” said one person close to the companies. Ollila declined to comment, but sources at Nokia confirmed the talks.
Grundig’s CEO in 1997, Pieter van der Wal, a giant fair-headed Dutchman who went by the nickname ‘the killer whale’, took the blame. “In hindsight, Grundig was too focused on Europe, and within Europe too much on Germany. In addition, we wanted to make too many products by ourselves.”
Under the terms of the 1984 purchase, Philips had been obliged to cover all of Grundig’s losses, and pay an annual dividend of 45 million euros to the heirs of Max Grundig regardless the earnings. It had already spent more than 3 billion guilders (1.4 billion euros in today’s money) on the German company when reporters filed into a conference room on that miserable Friday in 1997. A few moments later Philips announced it would cut all ties with Grundig. The German consumer electronics group was a sinking vessel that would need to find another partner to keep it afloat, said Philips, hardly trying to conceal its bitter contempt.
Dieder Dornberger, another assembly line employee who I met a few hours later, was deeply saddened when I asked him about the decision. He too would lose his job that year.
Grundig relied heavily on one product, TV, and TVs were no longer special enough to guarantee fat profits. Three quarters of Grundig’s annual sales of 3 billion marks (1.5 billion euros) was generated by TVs and VCRs, with remaining activities in car radios and HiFi equipment. TV-making, in the mid-1990s, had become a cut-throat industry. The technology to make a TV was no longer a well-kept secret and this had led to a host of new Chinese rivals which were producing important components such as the tubes and benefited from their lower cost base. Lower prices and oversupply caused sharp price drops. Every year, VCRs became 10 percent cheaper and TVs dropped 5 percent in price. Only very large players were able to reduce their costs enough to stay marginally profitable. Grundig, with its factories in high-wage Germany, and its reliance on Philips chips and tubes, was not one of them.
The very thing that was killing Grundig in the 1990s had once been its birthright. Benefiting from low cost labour in war-destroyed Germany, it had carved out its place in the market by leading the price war. In 1952 it had introduced the Zauberspiegel (The Magic Mirror), which was the first TV priced under 1,000 marks. Max Grundig had opened the TV era for Germany.
The company was an early adopter of new technologies, either purchased or developed in-house, with products such as a mini-radio in 1947 and a portable radio in 1949. It launched a dictation device in 1954 and a tape recorder in 1955. But by 1997, all of these products were at the end of their development. The consumer markets, in particular Grundig’s German home market, had become saturated.
There was one big hope: high definition television. It was a technological leap ahead that would leave the low-cost Chinese biting the dust, and it would force consumers to replace their existing sets long before the end of the normal life cycle. But the technology was not ready yet and the revolution took another decade to take off. Instead, TV makers tried to lure consumers into buying sets with wider screens (16:9, instead of 3:4). These were also harder to make for the Chinese upstarts. The mass market, however, did not bite. A new consumer electronics product needs to be “10 times better” in order to convince consumers to upgrade, according to former Intel CEO Andy Grove, and a few centimetres of extra TV screen added to the side was not a compelling reason for consumers to flesh out a 500 to a 1,000 euros.
An emblematic tale
Grundig’s fate was emblematic for the German processing industry. In eight short years, the German economy had gone from 32.2 percent of GDP generated by manufacturing industries in 1986 to 24.5 percent in 1994. Grundig was not the first “Traditionsunternehmen” (traditional enterprise) that collapsed under the pressure of high wages. Another example was the Allgemeine Elektrizitäts-Gesellschaft, better known as AEG, wich dated back to the 1800s. Parent company Daimler-Benz, was fed up with the losses of its white goods and electronics unit and had shut it down in 1996. Only the brand survived, and landed in the hands of the world’s biggest white goods producer Electrolux in 2004.
Grundig awaited a similar future. No strategic partner was prepared to pick up the pieces left by Philips, and the firm ended up in the hands of a Bavarian consortium led by several regional banks. The losses kept mounting and the firm had to seek creditor protection in 2003 when employee numbers had dropped to 3,500. Grundig’s consumer electronics activities, effectively the brand name and some sales staff, were sold for 80 million euros to the Turkish firm Beko Electronics which has large production facilities outside Istanbul, and Britain-based Alba Radio Ltd. Car systems were later sold to United States-based car parts giant Delphi – which in its turn collapsed in 2005.
Nazi Landmark
I left Fuerth and Nuernberg (Nuremberg) with the image of two symbols of bygone eras. At a stone’sstone’s throw away from the soon-to-be derelict Grundig production facilities, I passed the stadium designed by Nazi architect Albert Speer for the NSDAP party rally. In the same city where World War Two criminals had been sentenced to death, the 1930s symbol of their megalomania still lay there. I was stunned. Somehow I had always assumed that this dubious site, the scene for Leni Riefenstahl’s 1934 film Triumph des Willens, had been demolished. I realised the Grundig name would probably be erased from the Nuernberg (Nuremberg) landscape long before Speer’s landmark.
Grundig not alone
Grundig’s story was no isolated case. There had been many Grundigs before Grundig, and there would be many more after it.
Aristona, RCA (Thomson) and Nokia are no longer TV makers. Well known American brands like Zenith, Emerson, Magnavox, Sylvania, Philco, Admiral, GE, Sears (Warwick), Quasar (Motorola) have exited the business. In Europe, Saba (Thomson), AEG, Thomson have all disappeared. In Italy, dozens of smaller names have vanished.
They all struggled to deal with a new world of ferocious competition, mainly from Asian rivals whose names they could not pronounce, In the early 1990s, many of the new Chinese rivals did not even exist five years earlier.
Let’s take a closer look at Nokia, which is now the world’s best known maker of mobile phones, but which in the 1980s was an industrial conglomerate looking for a future. It had decided it wanted to be a top consumer electronics name and had started buying troubled TV producers Nokia had acquired Salora from Finland and state-owned Luxor from Sweden in 1983, as well as Oceanic from France in 1987 and the associated companies Sonolor and Televisso which was from Electrolux of Sweden. Nokia also bought Standard Electrik Lorenz (SEL) from Alcatel in late 1987. It produced TVs under Finlux and Guestlink.
All this consolidation had given Nokia a larger presence, but it was still not big enough to compete with cheap Asian imports and its production base was in expensive Europe. Soon after it turned down Grundig to merge because it did not want to shut down its Esslingen plant, it was forced to close it anyway. Nokia’s capacity was 2 million tubes a year, and it needed 3 million to be profitable.
Its TV production activities collapsed in 1996 after it failed to find a partner. It had to shut down most of its operations. Cumulative losses from TV manufacturing had been 1,3 billion euros. Without the profits from Nokia Mobile Phones and Networks, Nokia may very well have collapsed. Thomson, in its turn, booked billions of euros of aggregate losses in the 1990s.
Consumer electronics has transformed our lives
Why is it so hard to make a profit with a TV? After all, TVs are important to our lives. We dwell a staggering number of hours in front of TV screens. An average person in North America watches four hours and 32 minutes of TV at home every day. (Nielsen, in 2004/2005 TV season). Europeans tend to lag behind, but still watch an average 3 to 4 hours a day.
But there is more time we spend in front of screens. Young people between 8 and 18 years spend eight and a half hours of recreational (non-school) use of TV and videos, music, video games, computers, movies, and print. This total amount of media content consumed by young people has increased by more than an hour over the past five years (from 7:29 to 8:33), with most of the increase coming from video games (up from 0:26 to 0:49) and computers (up from 0:27 to 1:02, excluding school-work). (A March 2005 survey of 8 to 18 year-olds by the Kaiser Family Foundation)
Because children multitask, they pack that content into an average of six and a half hours a day, (44.5 hours a week) including three hours watching television, two hours listening to music, more than an hour on the computer outside of homework, and just under an hour playing video games.
Adults may spend less time in front of a PC at home, but most office workers spend hours every day in front of a PC monitor.
The time we spend in cars dwarfs by comparison. The people in Basel, Switzerland spend only 27 minutes per day in a car, but even in car-intensive Perth in Australia it is not more than an average 47 minutes a day (study Werner Brög, Nicola Mense, Socialdata GmbH, Hans-Grässel-Weg 1, 81375 Munich, Germany; Broeg has been a lecturer at the Massachusetts Institute of Technology (MIT) and at the Technical University of Graz (Austria).
One would expect that the companies who gave us the Walkman, the compact disc, the DVD player and plasma TV are handsomely rewarded for their accomplishments to change our lives so dramatically over the course of the last 50 to 60 years. Who would have thought 10 years ago that we could play all of Beethoven’s symphonies from a gum-sized MP3 player of just a few grammes worn around our neck? It’s nothing short of magical.
Profits are tiny
For all the importance of consumer electronics, almost all manufacturers of our daily high-tech diet struggle to make a profit.
For the last nine years, the world’s top consumer electronics companies -- Sony, Panasonic-owner Matsushita, Samsung Electronics, Philips and LG Electronics – have generated disappointing profits from their operations. Profits have averaged well below 5 percent of sales of TVs, DVDs, camcorders, digital cameras, stereo sets and other consumer gadgets. (graph 1). For every dollar of equipment those multinational behemoths sold to retail stores like Best Buy, Circuit City and Media Markt, they have only been able to keep a few cents of profit after deduction of all their costs.
Sony, the best known consumer electronics brand in the world and a fountain of innovation, has not generated earnings from its consumer electronics operations in the last four years. Even when the profits from its highly successful games console PlayStation are thrown in, the company’s profit margin has not exceeded 2.5 percent.
Sony is no isolated case. The top 10 electronics companies in Japan, including top names such as Fujitsu, Toshiba and Canon managed to earn an operating profit of just 2.8 yen on every 100 yen of sales (excluding Sharp which did 5.9 percent)
Samsung, the big challenger which has stormed into the global top 3 during the last decade, has very little to brag about either. Its record profits are entirely generated by its electronic component divisions and its mobile phone unit. The large digital media group which makes PCs, TVs, hard disk video recorders, MP3 music players, camcorders and still cameras has been barely profitable.
The same gloomy story goes for personal computers, which have also come to fit into the consumer electronics space as roughly half of sales are to consumers, students and home offices. Averaged out over the last nine years, Hewlett-Packard earned next to nothing with its PC unit. And IBM, the company which set the world standard for the personal computer in 1981, piled up $973 million of losses in the 3.5 years before it decided to sell that division for all but $1.25 billion to Lenovo from China in late 2004 – it has annual sales of close to $10 billion.
(For a full Excel spreadsheet and graphic of the long-term financial performance of consumer electronics companies, click on the Excel attachment at the end of this Prologue)
“The PC business has a history of recurring losses, negative working capital and accumulated deficit. The ability to settle obligations as they come due is dependent on IBM funding the operations on an ongoing basis,” IBM said in a regulatory filing published on Dec 2004.
David Katz, chief investment officer at New York-based Matrix Asset Advisors, sold millions of shares in Hewlett-Packard after that company took over Compaq and, briefly, became the world’s biggest PC and computer maker. Investors who buy shares in H-P only pay for the printer business. The balance of the computer business they get for free, he says. In other words, H-P’s personal computer business which generated staggering revenues of almost $25 billion in 2004, is deemed worthless by investors. (operating profit margin hovered between 0 and 1)
A small profit is the same as no profit
It is a misunderstanding that a company is secure as long as it is making a profit, no matter how tiny. Normal companies need capital to conduct their business, to invest in factories, to finance their inventories and give credit to customers – there are examples of abnormal ones and I’ll talk about those later.
Most companies have to borrow that money, either from banks or investors, and they pay roughly 7 percent of interest for a year. Even if they do not have to borrow that money, for instance because they have been able to save some cash, the money they invest still has a price because it can be productive elsewhere. Suppose that a company has a billion euros or dollars in the bank. It can use that money to build a new factory, but it can also invest the money in a mix of bonds, equity, commodities and real estate, and achieve a reasonably secure return of around 7 percent, depending on how much risk it is willing to take. This opportunity cost determines the price of the money that is needed by a company, also known as the "cost of capital". And so a company must always be confident its investments will generate more money than the capital markets. Why else would would anyone -- including you -- invest in your company in the first place?
Sometimes a company does not need any money, even when it makes a loss. If such a company does not have to invest a lot of money in its factories, it may still generate cash. The mirror image of this example is a very profitable company which consumes cash -- for instance a fast-growing company which is investing a lot of money. Over the long run such a profitable company is doomed if it's not able to cut its spending or boost sales and start generating cash. Surely if that's the case, then the marginally profitable consumer electronics companies may not be in such dire straits after all? Suppose they have very modest investment needs? In that case it's almost irrelevant how small their profit is.
While that may be the case -- and we will see that this is indeed the strategy pursued by some of the electronics firms, -- investors still expect the company to generate a long-term return on its assets. Investors have many options for their nest egg. If a bank offers a safe interest rate that is higher than a company's share price increase annual dividends, they may sell the shares of that company. If many people sell shares, that leaves a company vulnerable for a takeover, or the management may get the boot.
Indeed, a nest egg is often better off at a local bank branch where a savings account yields a safe albeit meager 4 percent interest, than invested in an electronics company. Investors know it, too. The stock market tells that tale in very clear numbers. Shares of Philips, in June 2005, were at the same level where they were in 1998. Sony’s stock was at levels of mid-1997. Hewlett-Packard, the company which almost single-handedly created Silicon Valley, saw its shares hover around 1996 levels. And by mid-2005, Motorola and Matshushita shares were back where they were in 1995.
Compare that with the tech-heavy Nasdaq stock index in New York which has more or less doubled early 1997 and mid-2005, on the back of phenomenal price performances of software and Internet companies such as Oracle, Microsoft, eBay, Yahoo, and, as of late, Google. The main Dow Jones Industrial went up 64 percent over the same period.
In general, the software and Internet companies have done remarkably better than the hardware firms. Yet, without the hardwired boxes produced by the likes of Motorola, Sony and Hewlett-Packard, there would be no software or Internet to use. You need a computer and a display to search on Yahoo or run a word processor.
Why is it that many hardware companies pulled the short straw in the past decade? More importantly, why do these tech giants continue to throw valuable resources such as money and talented people at an industry that is so clearly unable to deliver results? And what does the next decade have in store for those struggling companies?
These questions surface every three months with another string of disappointing quarterly results, like an endless strain of un-kept promises of improvement only occasionally freshened up with a rare windfall that will not last.
If there had been an investor at Kitty Hawk on December 17th 1903, he might have shot down the Wright brothers’ contraption of tent poles and cloth, multibillionaire Wall Street investor Warren Buffet from Omaha once said. That smart investor would have saved the world from billions of dollars of capital destruction by the airline industry in the following century.
You may wonder what would have happened, had that same investor been present at the New York Bell Labs in December 1947 when John Bardeen, Walter Brattain, with support of their supervisor William Shockley, discovered the transistor. And what would have happened in Philo Farnsworth’s lab in 1927 if that same investor had witnessed the transmission of the first television image comprised of 60 horizontal lines? Or even earlier, in 1884, would that investor have also stopped Paul Gottlieb Nipkow proposing and patenting the first electromechanical television system?
Without these geniuses, there would not be no $2.5 trillion a year technology industry, or the Internet, or the fifth season of the West Wing. But neither would there be the value destruction as applied by so many of the companies who sell us personal computers, microwaves, digital cameras, car radios, TVs and electronic toothbrushes that have come to define our modern lives.
Gadgets have helped the greater good
It would of course be a tad short-sighted to land a hammer on the first transistor only because Sony failed to make a profit 58 years later. Billions of dollars have been burned by the airline industry, but its planes have enabled global trade. Similarly, technology products have made us more productive, they have made our lives more comfortable, and they also have borne the radio, TV and Internet media industries.
The fact that Hewlett-Packard, IBM and pretty much all of their competitors cannot make a profit from PCs does not make the invention itself a failure. Without the PC, we would be without email or spreadsheets at work. It’s only a few decades ago, before the introduction of the fax, that we would wait a day or two to receive our mail. With our cell phones and Blackberries we now have instant access to people and email wherever they are. At home, without a PC there would be no song swapping, no CD burning, no free Internet calls.
“It’s such a fast-paced industry. It has the potential to be very cool and emotional,” says David Steel, Vice President Marketing Team Samsung’s Digital Media Business. Perhaps we should just be grateful that the PC producers go through the trouble of delivering computers to us at cost price, and move on.
Still, it is puzzling why it is so hard to make money with such essential products as PCs of which over 200 million units are sold every year. Equally disturbing perhaps is that the similarly sized TV market, another 190 million units every year, is an almost identical trench war. Why do we not award the producers according to the value they provide us?
It is not as if computers and televisions are easy to make. You need big factories, expensive equipment, lots of trained engineers and a library of books on physics, chemistry and electronics.
How unfair is it that some companies only need fresh water, wheat, barley, hops and yeast to brew up profit margins that are a lot higher. Beer brewer Heineken generated an operating margin between 10 and 15 percent for the past 10 years. Anheuser-Busch, the producer of Budweiser, squeezed out an operating margin of more than 22 percent in 2004, 2003 and 2002. How do they manage to achieve such results, considering that it is hardly a sophisticated production process? After all, even the ancient Egyptians already knew how to brew a pint.
And so the question is why? Why is Sony still in this industry? Why is life so bad for LG? And what are they going to do about it?
You liked the Prologue? Continue with Part 1 here
