Potential Risk Factors Ahead

As we enter the final months of 2009, we look toward what one hopes will amount to a brighter holiday season propelling the consumer tech industry into a better year ahead. By most accounts, 2009 was a dismal year. As we start Q4, we believe the worst is now behind us. It appears April - which experienced double digit revenue declines from the same period a year ago - will mark the low point for 2009 consumer tech sales and this recessionary cycle.

While the picture remains murky, the economy is beginning to recover. As this goes to press, we continue to believe the recession ended in July or August - concluding the longest recession in the post World War II period. Some economic indicators are already turning up. Consumer spending likely bottomed in early 2009. Other indicators are improving as well. While the industry and the economy continue to heal, there are important risk factors to watch.

As we move into the final quarter - an important one for tech spending - here are two risk factors worth watching:

1)      The Crowding Out of Consumer Tech Spending: During the past 18 months, consumers have cut back significantly on spending. Discretionary spending is down as consumers defer and delay purchases that can be pushed into the future. Typical of recessionary environments, consumers have cut back most significantly on durable goods purchases like major appliances, home furnishings, furniture and vehicles, because these purchases can most easily be delayed. As a percentage of overall durable goods purchases, consumer tech spending has held up incredibly well - and is now higher than it has ever been. In many ways, this suggests consumers are opting to spend on technology, while cutting back more severely elsewhere.

The risk comes when one looks at where those spending cuts have materialized that in turn have allowed tech spending to relatively outperform. New vehicle purchases are a great example.  Vehicle purchases have fallen to levels rarely seen. Another way to look at this data is to divide the number of registered vehicles by the number of vehicles sold. This tells us how long vehicles are currently projected to last before being replaced. As this graph illustrates, vehicles have on average lasted roughly 14 years. Current sales levels suggest the average vehicle today will last 26 years. Note that this trend changed abruptly as we moved into the recession - a clear indication of spending cuts rather than vehicles becoming significantly more durable. It is clear this trend is not sustainable in the near-term - vehicle sales will rise. Our current forecast suggests sales bottomed in the first quarter of 2009 and, while down on an annual basis in 2009, will increase by 18 percent in 2010. The money for these purchases will ultimately take away from spending on other categories, which could impact consumer tech spending.

2)      Restocking vs. Sales: As the economy unraveled and consumer sentiment deteriorated, manufacturers, distributors and retailers moved to quickly cut inventory levels. Headed into the fall of 2008, manufacturers, for example, were holding flat-panel TV inventories on the order of three times sales. The graph shows the inventory-to-sales ratio for flat-panel TVs, but the story is similar for most categories. A year later, as we move into the fall of 2009, manufacturers now are holding one-times sales. As we approach the final quarter of the year, there are indications that shipments into consumer channels are outpacing sales to consumers - suggesting there is some inventory rebuilding and restocking. Retailers, anticipating slightly more robust sales, do not want to be caught empty-handed. The biggest risk here is for a company's up-stream to perceive the uptick in orders as an indicator of end-market demand. If inventories are too quickly inflated without subsequent end-market demand, manufacturers and retailers further downstream might face potential price compression as players work to rein in inventory levels.

Certainly, there are other risk factors, but these two stand out as the biggest risk factors currently on the horizon and with the most potential to impact fourth quarter sales.