Downturn Has Silver Lining

Falling component prices and decreasing demand will benefit consumers.

The downturn in the economy has eroded demand for PCs and other high-tech gadgets. This erosion has hurt revenues and earnings at most semiconductor companies, but their pain will ultimately be your gain. Falling prices will spur demand for webpads, hard-disk video recorders, digital cameras, MP3 players and similar devices, many of which use Linux.

The chip industry has gone through several boom and bust cycles, and the current situation is just another down cycle. The problem is that building a new chip factory, or fab, costs upward of $1 billion and takes about two years from site selection to volume production.

During periods of high demand, such as last year, semiconductor companies can't add capacity quickly enough. This results in shortages and high component prices. With cash in hand, the companies madly invest in new capacity, but today we see that increasing capacity meeting falling demand.

Basic economics tells us that prices will fall. Indeed, DRAM prices have dropped by 50% over the past six months, as have the prices of flat-panel (LCD) displays. The prices of Flash memory and other components are also sagging. I wouldn't be surprised if, by the end of this year, some components cost a quarter of what they did last year.

These lower prices will benefit many emerging products. For example, webpads have yet to get off the ground. Only a few companies are selling them and generally at prices in excess of $1,000 US. The culprit is the cost of the flat-panel display, which has been several hundred dollars.

With display prices collapsing, vendors will be able to deploy webpads for much less than $1,000, perhaps as low as $500. I have no doubt an early-adopter market will spring up at these prices, and that market will grow as prices continue to drop. Most of the webpads announced to date combine Transmeta's Crusoe chip with Linux, delivering web compatibility without Windows.

TiVo's ground-breaking video recorder, which stores TV programs on a hard disk instead of videotape, has received critical acclaim but has only sold about 200,000 units. These low sales are due in part to the high cost of the unit, $500 or more (including the cost of the service). When TiVo launched last year, the price of a 30GB hard drive was about $300. Today, the same hard drive costs less than $100. The price of DRAM and other components in the system has fallen as well. Watch for TiVo to take advantage of these changes by dropping the price of its Linux-based recorder. With lower prices, more people will buy the TiVo system to take control of when they watch their favorite TV shows.

Like the TiVo system, an MP3 jukebox is primarily a simple computer wrapped around a large hard drive. These jukeboxes connect directly to home stereo systems and are just becoming available. But prices, such as $799 for the AudioReQuest, have inhibited demand. Falling component prices, however, should make these systems more popular. SonicBlue (which produces the Rio line of MP3 systems), Kerbango and others all use Linux to power their MP3 jukeboxes.

The bulk of the cost of a portable MP3 player is its Flash memory. The 64MB of Flash found in a $250 player cost about $120 at last year's prices. Even that amount of memory holds only 1-2 hours of music (depending on the quality and file type), barely enough to be useful. With lower Flash prices, we'll see low-end players approaching $100 and players with 128MB or more of memory selling for less than $300.

These MP3 systems will continue to grow in popularity despite the demise of Napster because they allow users to digitize their music collection and take it with them wherever they go. Users can easily find favorite songs, delete unwanted songs and create custom playlists. Linux can play a key role in networking a user's MP3 systems to enable seamless music portability.

Unfortunately, falling chip prices won't help PC sales. At $399, PCs are already as inexpensive as they can be without removing key components. Therefore, PC makers will take advantage of lower chip costs to offer faster processors, more DRAM and more disk capacity at the same price.

Some people may be attracted to better PCs at the same price, but a bigger problem will be convincing most PC users they need a better system. Most current PCs are fine for e-mail, web browsing and word processing. But the increasing popularity of digital video, digital photos and digital audio will drive the next PC upgrade cycle.

Despite the gloom in the industry, technology has not suddenly become a bad idea. The Internet continues to fundamentally change everything we do, and the trend toward digital media is revolutionizing personal entertainment. With chip prices down 50% to 75%, these trends will pick up speed.

Linley Gwennap (linleyg@linleygroup.com) is the founder and principal analyst of The Linley Group (http://www.linleygroup.com/), a technology analysis firm in Mt. View, California.

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