What happens when technology is good enough?

There are some areas in technology that have reached maturity and are at the point of being good enough.  Take JPEG image compression for example.  This old technology is used on websites everywhere to compress images.  There is a newer JPEG2000 format which is technically superior.  However, this superior technology has seen very little adoption on websites.  Internet speeds are so fast that the benefits (webpages loading slightly faster) aren’t important enough for webmasters to switch.

For some shareholders, there may be a disappointing future ahead.  Once the demand for more computing power stops, there is no longer room to create value with newer technology.  Often what happens is that mainstream consumer demand goes away first.  This can devastate the business model of companies developing new technology as it can only be sold on a smaller scale to niche markets.

Intel

Intel has seen its revenues and operating income shrink since 2011.  The decline in operating income is partially self-inflicted.  Intel has arguably made dumb acquisitions and spent too much money on its new fabs.  However, the decline in revenues has a lot to do with consumer demand.  The only tasks that really push the current generation of consumer CPUs are computer games and video editing.  Because not all consumers play cutting-edge video games or edit video with their computers, old Windows XP-era computers are good enough for their uses.  It looks like the mainstream consumer market will be a melting ice cube for Intel.

Smartphones and tablets are creating new consumer markets for Intel.  However, the chips that power these devices are significantly less powerful than a desktop or laptop CPU.  If you judge the chips based on the number of total transistors, then the typical smartphone or tablet SoC might have half the transistor count of a desktop CPU (or less).  The chips that power smartphones are generally lower-margin products that might sell for half what a desktop/laptop CPU would.  These new markets can somewhat offset Intel’s losses in desktop and laptop CPUs.  However, Intel has had terrible execution.  For whatever reason, Intel insisted on using an Infineon design (Intel acquired Infineon in 2010) rather than licensing a third-party design.  Unfortunately, Infineon was very slow in coming to market with a 4G wireless design.  Because of this, Intel has gained very little market share in smartphones.  Intel also chose not to manufacture third-party SoCs.  In my opinion, Intel hurt itself because it insisted on doing too many things in-house.  Only after its designs fail horribly in the marketplace will Intel warm up to the idea of using third-party semiconductor designs (e.g. Intel now makes FPGAs designed by other companies).

So far, Intel’s revenues have been shrinking.  If their markets continue to shrink, then Intel will have limited upside at best and possibly a lot of downside.  The stock will not generate unusual returns for shareholders.  As well, Intel’s future is not as attractive given how much money the company has spent on new fabs.  In 2010 and the years before it, Intel spent roughly five billion dollars a year on capex.  Since 2011, Intel has been spending a little over ten billion dollars on capex.  I don’t see the wisdom in spending so much on capex when the market is shrinking.

Other technology companies

  • Semiconductor manufacturers:  TSMC, UMC, FSL, etc.
  • Flash memory manufacturers:  MU, SNDK, etc.
  • RAM manufacturers: Hynix, etc.
  • Hard drive manufacturers:  STX, WDC, HTCH, etc.
  • PC manufacturers: Asustek, etc.

Eventually the other elements that go into a consumer desktop/laptop/tablet/smartphone will reach the point of ‘good enough’.  I would be very hesitant about investing in related technology stocks if it requires the company sustain its cash flows over one or two decades.

Resolution

In movies theatres, we have reached the limit.  Currently, there are some movies displayed at 4K resolution and some at 2K resolution.  Many digital Imax theatres are somewhere between 2K and 4K.  Movie exhibitors quickly figured out that audiences do not notice the advantages of 4K.

In other viewing situations, there may be an advantage to 4K.  If the viewing angle is greater, then the advantages of 4k are greater.  This may matter in the home if the user has a giant television or is watching on a computer monitor.  In the home, image resolution will top out at either 2K or 4K.    This has implications for some publicly-traded companies.

(From an investing point of view, 2K = HD and 4K = ultra HD.  From a technical standpoint there is a difference but viewers don’t care about the tiny increase in total pixels.)

Cable

Currently, cable enjoys a technological advantage over DSL.  Cable can deliver more bandwidth in a cost-effective manner, which means that cable can have more channels and faster Internet.

The main service that consumes a lot of bandwidth is video, whether it is video delivered over the Internet (download, streaming, etc.) or as traditional television.  Suppose that either HD or 4K is good enough.  Once we have reached the good enough point, cable’s technological advantage will become less of an advantage.  Over time, the capex required for telephone companies to deliver ‘good enough’ bandwidth will come down.  Cable’s advantage over telcos will diminish.  They will likely lose market share in video and Internet while gaining some share in voice.

In my opinion, we are in the last innings of higher television resolution.  4K will start off as a niche and may take one or two decades to become the standard.  When the prices of giant TVs come down, 4K will see wider adoption.

As far as cable companies go, they will still have decent economics.  I think that cable and telcos will become natural duopolies in most areas.  There will be increased demand for on-demand viewing because it gives consumers convenient access to a vast universe of content.  This will make satellite and over-the-air broadcasting less attractive.

The dream for cable companies is if there is significant demand for ultra HD/4K, even (or especially) if such content is delivered over high-speed Internet.  This will provide cable with a big advantage over satellite television and extend cable’s technological edge over telcos.

A historical perspective

To find examples of ‘good enough’, you can look at all of the chips that are being amalgamated onto a single piece of silicon.  Nowadays, manufacturers combine multiple chips onto a single chip to reduce the cost of manufacturing: networking, audio, storage controllers, etc.

In the past, many people would buy a better sound card to install into their PC.  Nowadays, the sound that is integrated onto modern CPUs/SoCs (or the associated chipset) is so good that there is little improvement from adding a sound card.  Publicly-traded sound card manufacturers such as Creative Technology (ADR symbol is CREAF) and Turtle Beach (HEAR) have delivered poor shareholder returns.

The chipset market used to be a major revenue stream for Intel and Nvidia.  Older Nvidia 10-Ks would break out this business into its own segment (e.g. under “MCP business” in the YE2007 10-K).  Nowadays, the chipset has moved onto the same piece of silicon as the CPU.  The chipset business is no longer a large market.

*Disclosure:  No position in INTC, NVDA, CREAF, HEAR, etc.  I am exposed to cable via LMCA.  Short IMAX.

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4 thoughts on “What happens when technology is good enough?

  1. Glenn, there’s an awful lot of prognostication in this post. While I’m mostly in agreement with you about your thoughts on the future of the PC chip market, I would be very careful about making judgments about what the future demands for bandwidth will be and when they will taper off…

    • It’s mostly video that is pushing the demand for more bandwidth. Once the whole household can do multiple streams of 4K, I don’t know what else is left. What can somebody use all that bandwidth for?

      I’ve seen NHK’s “8K” at NAB several years ago. It’s doable but I don’t think consumers will care.

      • So… This is a little challenging to discuss via online messages (and via a phone nonetheless), but the demand for bandwidth (not CPU power) has grown pretty much at the rate that the demand for storage has. In other words, if manufacturers can supply it, the demand will come.

        Don’t get me wrong, I think 4K is mostly a non-issue as far as bandwidth demand goes. However, I think there will be other things, things that we can’t even think of at this point probably, that will keep bandwidth demand growing like storage space demand has historically (and less like CPU power demand has).

        If you wish to discuss this more (my background is, to a certain degree, in writing software for network storage devices), send me an email. (I think you know what it is?) Again, it’s kind of hard discussing things via a phone keyboard 🙂

  2. Pingback: The future of advertising | Glenn Chan's Random Notes on Investing

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