Are Dell and HP Tech Enough to Succeed in Emerging Markets?


There is an important theme among PC-industry companies in recent earnings reports: the growing influence of emerging markets. While China's size and growth are well known, Intel (NAS: INTC) surprised many investors when it stated on its earnings call that Brazil is soon to become the third-largest PC market.

Intel cited emerging markets as a key reason for its better-than-expected earnings and outlook. According to the company, market researchers such as IDC and Gartner are undercounting PC sales in emerging markets. That's understandable: "white box" -- i.e., unbranded -- PCs do have a greater share outside developed markets.

White boxes do not affect all players equally
That's especially bad news for PC makers such as Dell (NAS: DELL) and Hewlett-Packard (NYS: HPQ) . PC makers add little to no intellectual property to PCs, especially when it comes to what cost-conscious buyers will pay for. Indeed, Dell got its start when founder Michael Dell assembled other companies' products in his college dorm. It was other companies that provided the intellectual property. Dell's initial strategy was to sell locally and compete on price.

Nowadays, Dell and HP outsource PC manufacturing to -- you guessed it -- companies in emerging markets. How do HP and Dell compete with companies that have the home-field advantage ... companies that sell locally and compete on price? In HP's case, not always very well. Missteps handling a product problem in China last year resulted in a rapid loss of market share. Dell was a big beneficiary of HP's missteps. But China-based Lenovo, which purchased IBM's PC business in 2005, was the biggest beneficiary.

How high-tech is your tech?
White-box makers need parts that cannot be made in a dorm room or garage. Parts that rely on sophisticated technology and big budgets. Parts that break out the "high-technology" companies from mere technology companies.

Semiconductor design and manufacturing are incredibly complex. The manufacturing requires huge economies of scale. That's why all but the largest semiconductor companies outsource manufacturing to foundries such as Taiwan Semi (NYS: TSM) , UMC, Chartered, GlobalFoundries and SMIC. Intel's threat in emerging markets is not that a small, unbranded outfit with nothing more than a dorm room or garage will start designing and making microprocessors. It is that price-conscious buyers will trade down to lower-cost, less profitable offerings, be they PCs powered by Intel or Advanced Micro Devices (NYS: AMD) , or netbooks, tablets, or smartphones, where ARM Holdings rather than Intel is the dominant processor provider.

Hard-drive makers such as Western Digital (NYS: WDC) and Seagate (NAS: STX) are in a similar situation. The level of technology needed to design and make a hard drive creates a huge barrier to entry. Every PC needs a processor and storage. In price-sensitive emerging markets, the storage is likely to be a hard drive rather than more expensive but uncommon (in PCs, anyway) flash memory. Thus, Intel, AMD, Seagate, and Western Digital are well positioned to benefit from PC sales in emerging markets.

But the PC businesses at HP and Dell will have a tougher time capturing that business. Fortunately for HP, PCs accounted for only 13% of its operating income over the past 12 months, mitigating the impact on the company's overall financials. Dell doesn't break out the portion of its revenue or profit from PCs, but it is widely believed to be a much larger share than HP's. It's a big enough number that management is doing its best to emphasize that it is moving beyond PCs.

Foolish takeaway
For years, the PC business was a rising tide that lifted all boats. With growth shifting to emerging markets, multinational PC industry companies need barriers to entry to successfully compete with local companies. Sophisticated technology and manufacturing are barriers to entry that position Intel, AMD, Seagate, Western Digital, and their competitors to capture a piece of almost every emerging-market PC sale. However, for the PC businesses at HP and Dell, which report earnings in August, emerging markets could be a tide that sinks a ship rather than lifts the boat.

What do you think? Are the PC businesses at HP and Dell tech enough to succeed in emerging markets? To help you keep an eye on the situation, The Motley Fool recently introduced a free My Watchlist feature. You can get up-to-date news and analysis by adding these companies to your Watchlist now:

At the time thisarticle was published Fool contributorCindy Johnsonowns no shares in any security in this story. The Motley Fool owns shares of Western Digital and Intel and has bought calls on Intel. Motley Fool newsletter services have recommended buying shares of and creating a diagonal call position in Intel. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Originally published