One common theme has emerged thus far in a variety of technology bellwether earnings – the race to zero.
Tech has always been about raising product functionality fast enough in order to combat the unrelenting pricing pressure that hits all tech products. So while 1 GB of storage costs a fraction today of what it did five years ago, we as consumers and enterprises tend to spend more on technology. When we purchased a PlayStation 3 we spent $600 or about twice as much as a PlayStation 2. When we upgraded from a cell phone to a smartphone we spent 5x more upfront + added a data plan. When we upgraded our 10 year old TV last year we spent about 25% more than we did in 2002.
But now, after years of high functionality more than offsetting cost pressure, the tables appear to be turning and the evidence is apparent throughout the tech earnings season. Google’s miss was prompted by growth in mobile ads, which have an 80% lower price than desktop ads. IBM’s software business saw the slowest growth since 2009, in our view at least partially driven by the shift from perpetual licenses to cloud subscriptions. Microsoft’s Server & Tools division saw healthy 20%+ bookings growth but only single digit revenue growth, again due to the cloud shift. Intel is languishing because its high end chipsets are not compatible with the move to mobile. Tablets are half the cost of notebooks and tablet minis will be about half the cost of full size tablets.
In what may be viewed as controversial contention, we argue that the race to zero has become most prominent in the enterprise. The enterprise, for tech vendors, has always been categorized as being defensive and margin-rich for incumbents and very hostile to new entrants. But the world has changed. New enterprise technology vendors are filling the voids left by Oracle, SAP and the rest of the incumbents with offerings that are free or maybe $20 per month. One of these young entrants, Box, is thriving while generating an average of $680 in revenue per corporate customer annually. This is about 140x below Oracle’s average annual revenue per customer of nearly $100,000.
What does all of this mean? It creates a broad overhang on virtually all established vendors in the tech sector, which includes the likes of Oracle, SAP, IBM and Open Text and CGI Group from our coverage list. Whether its mobility, cloud, or social, the prominent growth themes in technology all come with a dramatically lower price point. The incumbents will need to drive the functionality curve upwards or risk obsolescence whereas new market entrants are witnessing the largest and most fertile market opportunity in a generation.
This article is an excerpt from a research report from 4Front Capital Partners analyst Dushan Batrovic. To get access to the full piece contact 4Front here.
About the Author
Dushan Batrovic is a co-founder of 4Front Capital Partners and is a Vice-President of Equity Research. He is a well-regarded equity research analyst with over 7 years of experience covering Canadian and US technology stocks. He has earned a reputation for his independent and differentiated ideas.