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Monday, 29 March 2010

The Pepsi Paradox

Right now, the hottest area of science is focused on the brain, understanding consciousness, perception and the sub-conscious mind.  Over the last decade interest in the field has been revolutionised by improvements in new scanning equipment, particular fMRI - functional magnetic resonance imaging - machines. The new tools allow scientists to monitor what is happening in the brain as it goes through certain tasks. In other words, we can see what is happening in the brain in real time.

Every breakthrough has a downside.Scientific revolutions usually start life as highly reductive. Remember the early days of genetic research, when we were told that a gene had been found for this or that, as though life was little more than a printed circuit board where components and transistors did specific tasks? The same is in danger of happening in brain research today. In particular, we should be wary of a new breed of neuro-economists who are recruiting the new research to support some of their own pet theories.

However, research into how the brain operates is beginning to reveal some surprising things about what drives us. There is an excellent survey of the latest research in a book called Mindfield, written by Lone Frank, a Danish neuroscientist. On reading her book I am tempted to say that we now live in the era of the medial prefrontal cortex and the mirror neurone.

Let’s take the medial pre-frontal cortex first. Decades of blind tastings have found that   when presented with Coke or Pepsi, most people prefer Pepsi. All the same, Pepsi has a market capitalisation of $104bn whereas Coke, plus its bottling businesses, which were spun off, has a combined capitalisation of more than $170bn.In marketing circles this is known as the Pepsi Paradox.

In 2004, Read Montegue of Houston’s Baylor College of Medicine, finally nailed what was going on in the brain when consumers taste the two colas.  Just under 70 volunteers were first asked to take part in a blind tasting. Just as so often before, Pepsi was the clear winner.  What the MRI machine saw was that Pepsi set off greater activity in the ventral putamen area of the brain, compared to Coca-Cola. The putamen is an area cradled deep within the brain in the striatum, which is, among other things, a component of the reward system. In other words, those who drank Pepsi felt just as you would expect them to when sipping sugared water.

In the next series of tests the subjects tasted colas with visible labels. This time round most of volunteers preferred Coca-Cola. This shift in attitude followed an important change in the brain - this time, the medial prefrontal cortex kicked into action. The cortex was the last area of the brain to develop, it houses our higher cognitive processes. When people tasted Coke this region of the brain overrode immediate feelings of reward evoked by the taste impression.  In particular, the medial prefrontal cortex is where elements of our awareness of self and identity are housed. Literally, when you say, “this is so me,” it is your  medial prefrontal cortex that is lighting up. Products, such as iPhones, BMWs, Prada bags, trophy wives and certain types of music, light up our medial prefrontal cortex like a pin ball machine. 

In the early stages of economic growth capitalism is focused on supplying our basic needs. This is why it makes sense to have a portfolio loaded up with consumer staples when investing in primitively developed economic markets. When you pass a certain point, which is probably when per capita income is close to $4000, capitalism enters its medial prefrontal cortex stage. In other words, it becomes increasingly concerned with satisfying our ever shifting sense of self. In a really poor country, very basic mobile phones will be what the market demands. Then, as incomes rise, we lust over an iPhone. At first all we can afford might be a cheap copycat iPhone from a Chinese white-box manufacturer but the goal will always be to buy the real article.

The Theatre of Envy

There is another force at work here and that is the recently discovered mirror neurone. Our brains are peppered with them. Humans and other animals are programmed to copy. The discovery of mirror neurones chimes with a theory long championed by Rene Girard, a famous literary critic. Twenty years ago, Girard published an highly influential book called, The Theatre of Envy. Girard’s big idea, made before the discovery of mirror neurones, is that our passions and desires are the result of mimicry. Girard identified Shakespeare as one of leading writers who recognised this basic human truth: if our friend falls hopelessly in love with a woman and starts regaling us with how marvellous she is, the chances are we will also fall in love with her too. There, in a nut shell, is the comedy of human relations and investment bubbles. The discovery of mirror neurones, and into which there is a considerable amount of research being directed, is revealing why the passions and dislikes of others have such an influence over us.

Within the next two or three years, around 3 billion of us - close to half the population of the world - will be connected to the internet. We will leave it to our readers to reflect on what will happen when passions, preferences and dislikes can be transmitted to millions of people at the speed of light. Now you know why Facebook has just overtaken Google as the most frequently visited web site on the internet. 

Friday, 19 March 2010

What's smart about IT

Some people always face the wrong way. Take the case of the average IT analyst. Many come from an industry background, and as a result they cannot but help see the world through the lens of desktop PCs, servers, outsourcing and enterprise software systems. This is unfortunate, because over the last decade corporate IT growth has been meager and the prospects do not look that much brighter.
In 2000, $371 billion was spent on PC hardware. By last year, this had shrunk to $326 billion, according to estimates from Gartner, a US based market researcher. This number includes the value of PCs, servers, printers and storage. For further confirmation, I suggests you examine the 10-year price charts for Microsoft (MSFT), Dell (DELL), or Intel (INTC). They are not quite flatlining, but the pulse is weak.
By contrast, where we have seen growth is in emerging markets, consumers and mobile telephony: A decade ago consumers represented 33% of desktop computer sales; by last year this had risen to 38% of the total. In the notebook segment, the contrast between business and consumer is even more striking: A decade ago consumers represented 32% of total sales; by last year this had risen to 56%.
Mobility and consumers are what drives the IT market. This trend is accelerating as smartphone shipments overtake computer hardware sales over the next two to three years. This is the single most important fact in technology investing. Missing it is rather like wandering past Mount Everest in the fog.
The catalyst for the long awaited pick-up in IT expenditure is said to be the PC replacement cycle. By 2011, it is estimated that 84% of desktop computers used by business will be five years old. In addition, corporate IT sales are expected to get a boost from Microsoft's recently released Windows 7 operating system. There is merit to this argument, just as there was merit to it during the last decade, but don’t hold your breath.
Most of the profits from the PC market go to Intel and Microsoft. Both companies have a better grip on the computer market than any analyst. When speaking in January, Paul Otellini, Intel’s chief, answered a question about a likely pick-up in enterprise spending by stating that growth would continue to be dominated by emerging markets and consumers. Both trends, as Otellini pointed out, lead to lower average selling prices.
Over at Microsoft, the picture was similar. Peter Klein, the company’s CFO said, that growth had been driven largely by strong consumer demand. He went on to say, “While consumer growth remained healthy, we have not seen a return of enterprise spending growth." The problem with IT is that the price of hardware tumbles each year. You can best see this by comparing unit shipments to sales: in 2000, 146 million PCs were shipped; by last year this had risen to 306m. Over that time revenues between the two data points had fallen 12%. Then, when you examine the trends that so enamour the average IT analyst, it looks suspiciously as though they will add to deflation. First, off, Windows 7 needs less memory and raw computing power than its predecessor, Vista; second, cloud computing itself requires less hardware.
My gripe with the whole PC upgrade cycle argument is that it has not worked for more than a decade. The reason it has not appeared in all that time is that corporate IT stopped being innovative sometime back in the 1990s. The truly last innovative piece of software that businesses needed to buy were enterprise resource planning (ERP) systems, which required the move to client server computing. This move, coincided with the launch of Windows 95 and the Unix/Linux operating systems and was the reason that stocks like Dell rose several thousand percent over the course of the 1990s. As if the move to client server were not enough, after 1995 the rise of the internet and the Y2K problem added momentum to what was already a strong trend.
Nothing like that exists anymore.
Where you do see a strong product cycle is, of course, in the area of mobility and the internet. Last year around 200m smart phones were sold. A new research report just out from ABI estimates that smartphone shipments increased 30% in Q4 over Q3. Our recent visit to Asia suggests that the smartphone trend has just taken hold there too, which may cause further surprises for analysts following this market.
At some point over the next two to three years these devices will outsell personal computers. Looked at in terms of revenue, last year the pure PC market, net of servers, printers and storage, was worth $224 billion, compared to $165 billion for the handset market. With smartphones now the fastest growing part of the mobile phone market, they will soon over take PCs in value as well as in unit terms.
This rise is the confirmation of the single biggest trend taking place in technology: mobile internet access. In turn this is generating colossal demand for content, as we can see from the rise in video traffic, which is more than doubling each year. Cisco (CSCO) estimates that by 2013, video traffic will represent 70% of the volume on mobile networks. YouTube has just announced that 24 hours of video is uploaded to its site each minute of the day, compared to 20 hours of video six months ago.
In a recent report from Chetan Sharma Consulting, it has been estimated that there were 7 billion software application and content downloads to mobile phones last year and that this will rise to 50 billion by 2012. By then the market for applications supplied to smartphones is expected to be of the order of $17 billion. This market barely existed a couple of years ago. This is a tsunami that will result in surprisingly strong profit growth and share price gains for a number of device and component makers and maybe some software companies, such as Sybase (SY). Google (GOOG) and Facebook will also win from this trend, as advertisers will pay more for mobile viewers.
The next place that this move to mobile computing will manifest itself is in the rise of the tablet computer. On this score, investors might like to monitor what is happening with estimates for Apple’s (AAPL) iPad computer. When first announced, most analysts seemed rather underwhelmed. The range was somewhere around 4 million units.
More recently, at least one major US investment bank has increased its estimate to 6 million units. Meanwhile, the buzz in Taiwan, among component suppliers, is that Apple is looking at 10 million units. If this device proves a success, it will be emulated by other device makers.
ARM (ARMH), the UK chip company, is the leading European beneficiary of this trend, as is Imagination Technologies (IGNMF.PK), which provides graphics chip intellectual property. CSR plc [LON:CSR], the Bluetooth and Wi-Fi chip maker, should also benefit. Infineon (IFNNY.PK) and STM (STM) in Germany and France, as providers of radio and baseband chips, will also see some impact. In Taiwan, outside of obvious names such as Hon Hai (HNHAF.PK) and Foxconn (FXCNY.PK), investors ought to look at touch screen makers, such as Wintek (WNTSF.PK). The LED supply chain, which will provide the backlighting for these devices, will also gain. In America, this would include Cypress Semiconductor (CY) and Synaptics (SYNA).
So, the next time an IT analyst tells you that the Windows 7 PC upgrade cycle or the move to Cloud computing are the main events in the IT market, hit him over the head with your smartphone.

Tuesday, 16 March 2010

Taiwanese component makers looking at 10m iPad sales

Some Taiwanese component makers who are supplying Apple say the company has ordered enough parts for  10m units of the iPad over the coming year.  If  correct, these numbers suggest that there is plenty of room for upside surprises in Apple's results. Over the last month estimates for  iPad shipments have been edging up. The initial estimate was for around 4m units, but more recently Goldman has published a 6m number and some other analysts are forecasting 8m units.

The other area where Apple could beat forecasts is with sales into Asia.  In the company's last reported numbers, Asian sales were remarkably strong. Sales to both Taiwan and Japan had increased several fold and more recently, sales of the iPhone into South Korea have exploded. Apple has always struggled in Asia, but by the fourth quarter last year the region was contributing 20% of profits - double what it represented a year earlier.

I have just returned from a 9 trip to Singapore and Hong Kong and iPhones can be seen everywhere. Only a year ago you seldom saw any Apple products across Asia.  In Hong Kong, I counted four Apple resellers in the Central region, compared to one 18 months ago when I last visited the island. A leading phone retailer in Singapore told me that smartphones now represent 70% of handset sales in the city state, with the iPhone being far and away the market leader.

Monday, 1 March 2010

The Revolution Will Be Televised

Demand for internet TV  continues to gain momentum in the US. The latest numbers from iSuppli, the market research firm, found that one fourth of TVs purchased by Americans in January were connected to the Web, either through integrated technology or an external device.
The researcher found that of the new sets purchased in January, 27.5% indicated their sets were connected to the internet. In December the number was 24.3%. Cisco estimates that video traffic is growing at 132% compound, making it the fastest growing type of data over the internet.
Latest numbers from DirecTV, a leading US pay TV service, with operations throughout South America, highlight the growing attraction of mobile connectivity. In the third quarter last year DirecTV saw twice as many connections to its service through the iPhone as in the entire year over personal computers. Since then DirecTV has signed up 2m mobile customers who schedule their DTVs from their iphones.  As well as internet and mobile enabled TV companies like DirecTV are also benefitting from increased interest in 3D television.
Speaking at the company’s most recent results, Mike White, DirecTV’s president and ceo said: “ I think it's fair to say that increasingly our consumers expect us to be even more of a full video provider and they also expect to access that content whenever and wherever they want.” 

He added that DirecTV, which has an alliance with AT&T, is working on ways to ensure that  its customers will be able to watch the same programs they currently view on their TV on their mobile phones and other devices, such as Apple’s forthcoming iPad. DirecTV noted that its coverage of the US National Football League -NFL- was particularly popular with iPhone and other mobile device owners. Sport will therefore form an integral part of the company’s plans to attract mobile users.
As we have pointed out in the last couple of issues of the Mash, interest in content companies is increasing, both because of rising advertising traffic, but also the growing awareness that content in an age of mobile devices, may have a higher value than many at first thought.
The pay TV business in the US is mature but a number of technological trends are now infusing the sector with new life. Besides mobile internet access, which has only just begun, the sector is seeing increased interest in Digital Video Recorders -DVR, high definition TV - HD and now 3D and internet enabled TV. The growth  in DirecTV’s subscribers who are taking HD and DVR has doubled over the last year. 
Later this year the company plans to launch a 3D film and program service. Interest in 3D is high following the unprecedented success of Avatar, which has become the biggest grossing movie of all time.  A number of other 3D film launches are expected this year.
Besides the technological angle to DirecTV the company a great deal of exposure to the rapidly growing Latin American market, where its sales rose by 47% over the year. DirecTV has operations in Mexico, Venezuela, Brazil and Argentina. 
Over the last quarter Tiger Global, a leading US hedge fund, in which the legendary money manager Julian Robertson has invested, emerged as the largest institutional investor in DirecTV, taking an 11.4% stake.
As we highlighted in Mash 35, Vizio, the American based flat screen TV maker is the leading supplier of LCD TVs in the US. Vizio - in which Amtran of Taiwan is one of the leading investors - saw shipments increase 92% over the year to 5.9m. 
iSupply found that nearly 42% of Web-surfing TVs in the US had integrated connectivity, which means that they can be accessed from other devices, such as PCs. Another 20% were connected through video-game consoles; 13% through Blu-ray players; PCs and stand alone boxes tied at around 12% each.

Message from Beijing

I have just had an interesting chat with someone I know who has just moved from Taipei to Beijing. He is English but has, after a ten year stint in Taiwan, learnt Mandarin Chinese. His overall impression of Beijing is that there isn't much for the wealthy Chinese to spend their money on.

In America the rich, and certainly the super rich, can buy a ranch in Wyoming, or a Condo in Florida; maybe a town house in New York, or San Fran. They can dabble in art, wine, private equity and of course, stocks and shares.

By contrast, the rich Chinese have limited options. The property market is tight and by common consent is a bubble and  most of the cities have little to commend them.  There are few opportunities for private equity. They can certainly buy local art, which is becoming popular in the West and the Chinese are developing a taste for expensive wines. They have a penchant for mixing their vintage cabinet sauvignon with coco cola. I'm sure the French growers don't mind, as long as they are paid.

The point is, from a western perspective Asia and other emerging markets look like the place to be. However, if you are rich and live there then the West, and in particular, America is still the place with the most opportunity.

Besides, the brutal truth is that much of Asia is pretty un pleasant. Hong Kong is a beautiful and vibrant city but there isn't much of interest culture wise. Like most of Asia, Hong Kong finance types with little interest in creating a rich culture. Seoul is awful and the locals can be difficult. However, you at least see some interesting experimentation in clothes and films, such as Old Boy, demonstrate a streak of brilliance you don't find elsewhere in Asia, with the exception of Japan.

Taipei is a bomb site - there has been very little investment over the years, though you can find great Sushi. Singapore is clean and works but it has as much get up and go as a supermarket check out. You would be hard pressed to find a more spookily soulless place on earth. The high point - fish head curry on Race Track road. There is an underlying atmosphere of hysteria in Singapore that is really quite unsettling.

Off to Singapore to night so best not say anymore. In Hong Kong over the week end.

Oh no, not more on the future of publishing

In 2009, 5 million e-readers had been sold worldwide.
In 2008, Amazon sold 1 m Kindles.
In the US, 50 million adults pay an average of $16 a month to get a daily newspaper delivered.
According to the Magazine Publishers Association 174.5m subscribed to magazines in 1970; by       2008 that number had risen to 324.8m.
US magazine advertising revenues fell 26% in 2009 alone.
When Kindle buys a newspaper or magazine e-book the publisher gets just 30% of the revenue.
According to the latest issue of Wired magazine, this year 60 tablet and e-reading devices will be launched.
“Where is the knowledge we have lost in information” TS Eliot.

At the end of 2009, there were 1.7bn internet connections in the world. An increasing proportion of internet access will come from mobile phones and other handheld devices. In a matter of two or three years, more than 3bn people come on line; within five, perhaps within three years, half the planet will be on line. By the end of the present decade, the majority of the planet will be connected to the internet. The number of people who feel swamped by digital data will increase. More of us are going to feel distracted, restless and unable to cope. Evolution has not equipped us to live in this way.

The human mind is the real bandwidth bottleneck that is choking internet access. As we saw last week, human conscious band width averages around 40 bits a second, which equates to one millionth of the data flowing into our conscious minds. The limitation of human bandwidth has profound consequences, both for our mental health, and also for the development of society.Any reader who wants to examine this further should start with the classic study, The User Illusion , which was published in 1999.

Apple, Google, Facebook and Twitter, are examples of companies that have cracked the human bandwidth problem. In other words, they have pulled off the most difficult engineering trick of all; they have buried complexity behind a facade of simplicity. This is the task now facing Asia’s hardware giants, such as Samsung. It is also the problem facing the global media industry.  People will not pay for content that they do not have the time to find or read.

An Age of Distraction
The signs are that with the help of Apple, media companies might be on the point of mastering the human bandwidth problem as well. Several weeks ago, we gave a link for a concept electronic magazine made by Bonnier, the Swedish media giant. Sports Illustrated, has also developed a exciting concept for an electronic magazine, which can be seen on Youtube. Finally, it seems the penny might have dropped: print media has to find a way to use new devices, like the iTab to compete with video, TV, computer games and social networking.

 This is what Bonnier’s Sara Ohrvall said of the concept magazine in an interview with Wired :  “People become more ‘rootless’ in their media behaviour. They consume media in places where they just happen to end up. This leaves consumers uncertain about whether they have read/listened to/viewed what’s relevant for them, or not.”

Ohrvall went on to explain that the fundamental problem is the absence of ‘closure’ in most experiences that people have with digital media.  On the web you always “link somewhere else; the story never ends. No sense of completion. For us, it was clear that there was something missing. We realised there must be other ways to tell a story in digital media, apart from millions of lookalike sites on the web.”

The touch screen interface of a device like the iPad is fundamental to what Ms Ohrvall is describing. Instead of viewing a crowded web page that is full of distractions in the form of ads and other links, the iPad allows the publisher to present a high quality graphic image, which the subscriber can then manipulate and navigate in an intuitive way. In other words, designers are grasping that they need to give their electronic readers a more complete, more immersive experience. As Ms Ohrvall explains, readers need a sense of closure and completion.

I would refer the reader to a fascinating book that scientifically examines the process of reading. Called Proust and the Squid, by Professor Maryanne Wolf, the book examines how reading leads to a rewiring of the human brain. Wolf’s central contention is that reading is not a natural act, it requires thousands of hours of training, which results in physically changing patterns of brain behaviour, which can be measured by scientific instruments. There is plentiful research that demonstrates that when we give our full attention to reading - remember how small human bandwidth is - we become less stressful because, quite literally, we are giving our brains a work out. In other words, instead of being focused purely on the conscious brain, literature works because it engages with memories and feelings that are not housed in the conscious mind. This is why a good book, a poem, or an interesting essay, really gets more neurones firing. Readers have richer mental lives than people who do most of their reading on a computer screen, hopping from blog, to web site to chat site; reading is brain food.

Since the foundation of Cyke our main area of focus has been the development of the mobile internet. We were among the first to highlight that the smartphone was the main product event in tech, while most were focusing on the PC upgrade cycle. As the world becomes populated by smart-phones and other handheld devices, such as `Apple’s forthcoming iPad, the very nature of the internet itself will change. It will be carved into empires, such as the Google, or the Apple empire.To sustain these empires content and applications are the key. Hardware innovation is becoming less important  in an age when people want to interact with other groups of people and experience applications and content, both socially and privately. We call this change the Fourth Wave, or the Smart Paradigm. In Asia the Smart Paradigm benefits Baidu, Shanda, NC Soft and Tencent more than it does Samsung, LG Electronics or Lenovo, in Asia.

As we suggested above, the trial facing hardware companies is to hide complexity behind simplicity. This is the most difficult task an engineering based company can face. The mastering of this skill was why Apple could, as an outsider,  invade the mobile phone industry and change it root and branch. RIM did it and now Google is trying. Notice that not one  and intuition that comes from being completely immersed in internet culture. No mobile handset maker or operator has yet managed to replicate this skill.

We cannot be certain, but it is probable that we are emerging from a period of transition. To sell devices and control their empires, Google, Facebook and Apple need content and applications because that is how you lock individuals to your service and product. We have arrived at a point where the technology exists that can make reading on an electronic device an immersive, rewarding experience. We also now have payment mechanisms, such as iTunes, which easily enable consumers to buy on-line. What is not yet known is whether media companies have the skills to capitalise on these developments? What we can be more certain of is that we as humans need to be able to read, there has to be more to life than endless digital distraction.