Thursday, February 14, 2013

High-end Only STB Vendor? Is this Possible?

 It is understandable that a dominant vendor such as Cisco would be skittish when it comes to slugging it out in the low end of the settop box market.  The gross margins on these devices are much lower than a CRS-1 or ASR-9K.  (OK, big understatement) Yet, is a high-end only strategy sustainable?  Let’s look at an historical example that would argue it is not. 

In the heyday of the “IBM PC” market, as it was known, there were dozens of manufactures of PC “compatibles”.  At the same time the Win-Tel (Windows and x86 Intel) franchise was moving rapidly up market eating away at the mini-computer and UNIX server markets.  The marketing messages from the mini and server vendors was as expected; Lower performance, not purpose built, not robust, etc. etc.

Yet, large system vendors such as DEC, AT&T, Unisys and Wang felt the need to offer their own manufactured PCs and Win-Tel servers to be able to offer the total system solution.  There are numerous interesting lessons from these dynamics, but let’s focus only on the PC for now. 

At this time Dell and Compaq were thriving selling the full range of PCs and were starting to compete in the server market.  These servers were priced around $80-100K.  DEC and the other began to see the low margin PCs, especially the consumer market, as a nuisance.  DEC publically stated that they were abandoning the “low end” PC market and were going to focus only on the high-end office PC and server markets.  Sounding familiar Cisco?   What happened was the Win-Tel architecture dominated the server market and cut harshly in to the UNIX server market.  Compaq and Dell were the winners.  Why?

If you looked at the hardware components of a low end consumer PC and a Win-Tel server they used many of the same components.  Same memory chips, same processor family, same disk drive family, etc.  Compaq participated in the high volume consumer PC market with volumes measured in 10’s of millions.  In this market gross margins were 5% on a good day.  However, they were buying these common components in 10 million unit quantities from the manufacturer. 

DEC on the other hand was selling these $100K servers in the 10’s of thousands and “high end office” PCs in the low 100’s of thousands.   Therefore, they were buying these common components based on 100k unit pricing.  When Compaq sold a $100K server in 10K volumes they had component pricing in the 10 million unit range.  Thus, by participating in the low end high volume market they had a tremendous cost advantage in the lower volume higher price market segment.  In the end, Compaq bought DEC arguably for the professional service business.

Will history repeat itself in the STB market?   The “low-end” and the “high-end” STBs share many common components.  The argument that STB are commodities anyway at the HW level makes sense in the short term.  The SW equivalent of Moore's Law, i.e., SW gets better with every release, will mitigate any software advantage over time.  Regardless of a perceived short term software advantage,  in the end, since STB are roughly 50% of an SP CapEx, low price will always win. Adding the move to virtualizing the STB and the high end only STB strategy is doomed to fail. 

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