Is Creative Technology Stuffed?
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Creative Technology manufacturer of the Zen MP3 player is bleeding profits. Its shares have slumped 55% as they desperatly try to compete with the Apple iPod. How long can they last before they bail out of the MP3 Player market?

The fast growing MP3 market has gone pear shaped for several vendors with the likes of BenQ and JNC set to exit the Australian market. Also on the skids is Creative Technology who in a desperate attempt to emulate Apples success with the iPod is now staring down the barrel of mounting losses? The issue for many is lack of margin and the high cost of R&D.

Creative Labs as the Company is known in Australia is in deep trouble with resellers starting to drop the products from their shelves in favour of new offerings from the likes of Sony, Toshiba and Samsung. The latest Creative MP3 offerings have been described as 2003 MP3 technology re designed in 2005 covers. This is despite the fact that their product has won awards around the world. The message to Apple from a lot of vendors is enjoy it while it lasts with almost every other company in the digital music space vying for consumer attention after several years of domination by the iPod and iTunes. The MP3 market has become a margin call business with Apple already sucking out the biggest margins. However the arrogance of Apple could well work against them as the going gets tough going forward.

Riding off the back of the iPod market is a massive accessories and home integration market with many organisations now delivering systems that use the iPod as a base storage system that integrates into a home entertainment or car audio system.

Apple’s successful combination of sexy design and elegant usability has propelled the iPod to the top of the digital music market as the undisputed king. Every move Apple makes these days results in victory. As the rest of the flash-player market floundered, Apple took over the category in a day with the release of the iPod Shuffle. It turned pod casting from a cool-sounding technology that nobody used to a legitimate format by adding it to the new version of iTunes — and generating 2 million subscriptions in less than a week.

Today, Apple commands 80 percent of the MP3 player market and 75 percent of online music sales. But even as analysts predict another massive holiday sales season for the company this year, many believe Apple’s reign will last only another 12-18 months before the playing field levels out. After that the top players are tipped to be Samsung, Sony and Toshiba. Both Samsung and Toshiba have the best of both worlds. Samsung produces processors for the iPod and Toshiba the drives. Creative Technology will not even be in this market as the cost of developing new and better MP3 devices is going to spiral into the billions of dollars.

“It’s inevitable that over time their market share declines,” Piper Jaffray senior research analyst at Gene Munster said. “It’s safe to say that nobody can sustain an 80 percent market share in a consumer electronics business for more than two or three years. It’s pretty much impossible.”

Privately, record company executives say they can’t wait. Not because they want to see Apple stumble, but because a less dominant Apple means a more robust market for digital music. The company by itself cannot bring digital music to account for 25 percent of all music sales, as labels hope it will by 2009.

Apple points to the 500 million tracks downloaded on iTunes to date as a milestone. But dividing that figure by the more than 20 million iPods sold indicates that each iPod owner has bought an average of fewer than 30 songs from iTunes. Piper Jaffray estimates that only nine tracks are bought per month per iPod user.

“The mass market still is entrenched in a non-MP3 world,” Munster says. “Until those changes, there’s just too few iPods out there to move the needle for the overall music industry.”
“There’s a whole lot of green field out there,” Gartner G2 analyst Mike McGuire adds. “Some people at labels are acting like all this is over because Apple has it. Guys, 98 percent of music purchases (are) still coming from somewhere other than online.”

Label sources say Apple stubbornly disregards their suggestions for drawing in new digital music customers. They say they would like more flexibility on track pricing and promotions. But more than anything, labels want to see the iPod become interoperable with music services other than iTunes.
“It’s a monologue with them,” one label executive who asked not to be identified says. “They pretty much say, ‘This is what we want to do,’ and if you disagree with them you’re an idiot. It’s like dealing with a cult.”

The first step to chipping away at Apple’s dominance is for a competitor to introduce a device that can capture the public’s imagination as the iPod has. The story of the digital music revolution so far has been monopolised by the MP3 player, and the iPod outsells all others by a ratio of 3-to-1.
Creative The Singapore-based manufacturer has brought to market a full range of critically digital music players, capped most recently by the Zen Vision, which includes support for digital video files. But its market share remains about 9 percent and it is losing money hand over fist. Industry observers instead look to the much larger consumer electronics powerhouses Sony Toshiba and Samsung to lead the next round of battle against the iPod juggernaut. Unlike Creative, these two companies are supported by revenue from their other consumer electronics products and have strong global brand identity.

Although late to the market, both are taking aggressive steps to challenge Apple and target the many consumers who do not yet own a digital music device.

“Only 11 percent of the U.S. population owns an MP3 player. In Australia it is less than 8%” says Peter Weedfald, senior VP of consumer electronics sales and marketing for Samsung. “There is plenty of opportunity to capture market share.”
Samsung has stated its intention to take 10 percent of the MP3 market this year, and aims to become the global leader by 2007. That is a tall order. Even a company representative, speaking on condition of anonymity, calls such success unlikely.

But Samsung has a history of successfully challenging seemingly invincible market leaders and succeeding. Ten years ago, the company brashly took on Sony in the broad field of consumer electronics, and has since surpassed Sony on InterBrand’s top 100 recognizable global brands list at No. 20 — a 19 percent gain. Sony is No. 28.
Samsung made an equally aggressive push into the mobile phone market in 2002 with the advent of a camera phone, catapulting past industry stalwarts Ericsson and Motorola to briefly capture the No. 2 market position behind Nokia. Samsung today is No. 3 in market share at 13 percent, behind Nokia and Motorola, according to Strategy Analytics.

Sony is also making moves. Having shamefully ceded its dominant portable-music market share to Apple by dropping the digital ball, the company had exactly one MP3 device on the market last year. Today it has more than 10 and already is No. 1 in MP3 player sales in Japan, ahead of Apple.
The real battle is expected once Sony relaunches its failed Connect digital music store. In Australia Sony is considering its options. Sony is one of the few companies in the position to offer an integrated device and retail service with the same brand, similar to Apple’s iPod/iTunes combo.

If Apple indeed has only 12-18 months of market dominance left, the next two months will show exactly how its competitors plan to mount their attack.

No one assumes Apple will go without a fight. It is expected to introduce a video-capable iPod in September and finally unveil its iTunes-compatible mobile phone with Motorola. It is also rumoured to be working on a subscription service with the help of a former Xbox Live executive.
“They have shown, based on prior performance, that they have the capability to remake themselves,” McGuire says. “They have the flexibility to seize opportunities as they’re presented.”

For Creative it could be the end of the line in the MP3 market unless they get a massive injection of capitol. One white knight was tipped to be Microsoft but they said no thank you.  Creative Technology sank into the red in the fourth quarter to June with a net loss of US$31.9 million as a bruising battle with Apple’s iconic iPod took its toll, the company. A bright star on the horizon for the company is MP4 Video players however in this market Creative could also face the same problems.Sales in the June quarter totalled US$305.4 million, up 51 percent from US$201.8 million in the same period a year ago, the Singapore-based digital entertainment products maker said in a statement. In the same quarter last year, the company had turned in a profit of US$6.63 million.
The fourth-quarter loss was worse than expected.

The June quarter’s dismal performance was a drag on earnings for the full fiscal year to June 2005 with net profit amounting to just US$588,000, down sharply from US$134.25 million in the previous full-year period.

Craig McHugh, president of subsidiary Creative Labs, said sales of MP3 music players in the June quarter jumped more than 260 percent year-on-year but this was still far short of the target the company had set. Falling prices also hurt the bottom line. “We had set our targets higher for unit volume and average selling prices for our MP3 players than we achieved in the period,” McHugh said. “Missing our targets caused us to miss our revenue goals and we were not able to reduce our inventory levels as rapidly and as much as we had expected,” he said.

Inventory write-downs during the fourth quarter also severely affected the company, Creative said.
“During the quarter, there was a decline in the value of certain components in our inventory, including flash memory and hard drives, so we needed to take an inventory write down,” McHugh said. “Even though we increased overall revenues 50 percent year-over-year, the lower-than-expected selling prices for MP3 players and the inventory write-downs negatively impacted gross margins in the period,” he said.

Creative, which found global fame with the SoundBlaster cards that turned personal computers into entertainment machines, branched out into the digital entertainment segment in a bid to grow its portfolio.