Imagine a shopper in an electronics store. Look, there’s a Fitbit display, with its “activity bands” which measure your steps and show details. Or, more pricey, its Versa smartwatch. Perhaps to save money, just buy the activity band? But wait … just over there are some generic activity bands, and they’re cheaper. Maybe save some money with those.

Move along a bit, and there are GoPro cameras. But once again, there are some slightly cheaper models beside them; not well-known brands, but a camera is a camera, surely? Further along, there’s a Parrot drone. Next to those is a Sonos speaker, which works with Amazon’s Alexa. But beside it is a cheaper Amazon Echo, and a voice-controlled Google Home, and a Siri-enabled Apple HomePod. Why would you go with the smaller brand, faced with those offerings from tech’s behemoths? Or, at the previous displays, why not just buy the cheaper models?

Survival of the fittest

That’s the challenge for many consumer electronics firms. Not how to make things, or how to distribute them and get them in front of potential buyers. It’s how to make a profit. Out of Fitbit, GoPro, Parrot and Sonos – each operating in different parts of the consumer electronics business – only the latter made an operating profit in the last financial quarter, and all four have made a cumulative operating loss so far this year.

Making a profit in hardware has always been difficult. By contrast, in software, all the significant costs are in development; reproduction and distribution are trivial – a digital copy is perfect, and the internet will transport 0s and 1s anywhere, effectively for free. If your product is free and ad-supported, you don’t even need anti-piracy measures; you want people to copy it and use it. Software companies typically have gross margins of around 80%, and operating profits of 40% or so.

In hardware, though, the world now seems full of companies living by Amazon founder Jeff Bezos’s mantra that “your [profit] margin is my opportunity”. Indeed, Amazon is one of the reasons why long-term profit is more elusive: it provides a means for small startups to distribute products without formal warehousing arrangements, and compete with bigger businesses at lower cost.

That, together with the rise of a gigantic electronic manufacturing capability in the southern Chinese city of Shenzhen, about an hour’s drive north of Hong Kong, has made the modern hardware business one where only those with huge reserves of capital and brand recognition can hope to thrive. Apple, Amazon, Google, Microsoft, Samsung, and Sony can probably rely on their brand name; after that, it’s survival of the fittest.

So is it already game over for GoPro and the rest?

None is a newcomer. GoPro was founded in 2002 by Nick Woodman, who wanted to capture better pictures of a surfing trip to Australia; it came to market in June 2014. Sonos was also founded in 2002, focusing on multi-room high-quality sound, and came to the market earlier in 2018. Fitbit was set up in March 2007, and joined the stock market in June 2015. Parrot is the oldest of them all, founded in 1994 and has made many consumer electronics products, including a voice-recognition system (in 1995) and a Bluetooth-based hands-free kit for cars in 2000.

Parrot got into drones, both for consumers and business, in 2010 and early in 2018, its chief executive and co-founder, Henri Seydoux, confidently called the drone market “the emergence of a new industry with global strategic and economic stakes”. By November, though, he was contemplating a 40% year-on-year crash in revenues. The shares sank to an all-time low of €1.58 – down from €37 in 2015 – valuing Parrot at less than its cash reserves. Seydoux insists the consumer drone market is just “taking a break”.

Fitbit is struggling to move away from fitness bands – simple devices that record steps and calories burnt – where low-cost Chinese products are swamping the market. It is trying to shift into smartwatches, which are higher-priced, have more uses and generate higher customer loyalty. But it’s not easy; in the first nine months of the year it sold 8.4m fitness bands – and 2.8m smartwatches. The opportunity is there: Fitbit has 25m users who pay a subscription to its services, and could be future smartwatch buyers. But in the most recent quarter it made a $200m operating loss on sales of $940m and over the past eight quarters it has made a net loss of $624m. Its shares, which hit $47 soon after its IPO in 2015, are now $4.97.

Photo: Shutterstock. Illustration photo shows a Gopro camera mounted on a drone

GoPro has managed to stabilise its unit sales, at around 1m per quarter, but profitability has remained elusive. So it is trying to encourage owners onto a subscription offering, at $5 per month; so far 185,000 have signed up, generating about $11.1m a year. That’s about the same revenue as selling an extra 44,000 cameras – but the profit on subscriptions, as with software, is far higher than on the hardware. Its shares are currently at $4.24, down from $87 in 2014.

Niche segments

“It’s harder for any company that focuses mainly on hardware to survive in the long term,” says Francisco Jeronimo, a smartphone analyst for the research group IDC. “But the big problem for many of these companies is that there isn’t a strong incentive to keep buying them. I might buy a GoPro, but I don’t need it on a daily basis if I have a smartphone. Same with Parrot – it’s a very niche segment. These companies were so eager to get to an IPO that they took advantage of the hype around their category, but haven’t been able to reinvent themselves, and they need to do that to keep alive.”

The risk for such companies is that they are consigned to the virtual, or real, cupboard under the stairs to gather dust, while smartphone capability expands to take on functions that once needed a separate device.

Yet it’s never been easier to make and sell hardware. Crowdfunding sites such as Kickstarter and Indiegogo provide easy ways to find early adopters who will stake money on entrepreneurs with unproven designs, which can then be realised in Shenzhen. The Pebble smartwatch raised $10.3m as a Kickstarter project in 2012, then its biggest-ever fundraising; it topped that in 2015, raising $20.3m for a newer model. Yet in December 2016 it announced it would close, citing financial trouble. (Fitbit bought its intellectual property – essentially, the smartwatch software – for $23m.) “Crowdfunding sites are great for attracting early adopters, but the majority of consumers don’t go there,” says Jeronimo. “It misleads companies into thinking their category is going to explode.”

Even while it tried to expand beyond those early adopters, Pebble’s problem (which is now also Fitbit’s problem) was that Apple launched its own smartwatch in 2015, and quickly became the largest smartwatch maker. Sonos, similarly, found that a market it once had to itself – multi-room speakers streaming music and radio from the internet – turned into a jostling match with Amazon in 2014, followed by Google and most recently, Apple. Suddenly, everyone is making a “smart speaker”, and Sonos’s hardware-only model has come into sharp focus because it doesn’t have a native voice assistant (it is adding Amazon’s Alexa and Google’s ‘OK Google’).

The ability for the big players to squash smaller players isn’t unique to hardware; Facebook has tried to do it to rivals such as Snapchat. But in hardware, firms such as Sonos find themselves assaulted by both the big brands and the unheard-of ones leveraging Shenzhen and Amazon’s distribution.

Moving upmarket

Sonos’s response has been to insist that people will move upmarket, to its better sound quality. It is also looking for collaborations, most notably with Ikea, whose fruits are promised in 2019. Patrick Spence, the Sonos CEO, is confident he can rely on the existing Sonos user base of 20m devices across 7.4m households.

“We have a strong base of existing customers that we can tap into and have a good relationship with,” he said in November. “And so, I think that puts us at an advantage, [compared to rivals] quite frankly.” But Amazon is coming up fast: it is reckoned to have 35m of its Echo devices installed in the US alone.

The squeeze on smaller hardware players has played out before, in PCs and smartphones. In the mid-1990s, the PC market was dominated by American companies such as IBM, Hewlett-Packard, Dell, Gateway, Apple, Compaq, NCR, Packard Bell and Zenith. As manufacturing costs in the US rose, they shifted production to Taiwan, South Korea and, gradually China – only to be usurped by local rivals using that manufacturing expertise and building international distribution networks. Now, only Dell, HP and Apple remain; the three other biggest PC makers are Acer and Asus, of Taiwan, and China’s Lenovo.

Similarly in smartphones, the early advantage that American companies such as BlackBerry and Motorola had in 2009 was quickly eroded as the market expanded. Now there are hundreds of Chinese companies offering smartphones. But profits are thin: Counterpoint Research estimated recently that the top five smartphone companies grab 99% of the profits – leaving 600 others to scrap for the remaining 1%.

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