This time we dig into some industry dynamics to help explain what’s been going on with Sigma Design. We saw a big runup turning into an almost equally big fall from October 2007. The price seemed to have rebounded somewhat, we think there is every chance that will continue, general markets provided.
If you would ask us what the first thing is we look for in a company who’s shares we are following we would say: defensible competitive advantage. Sigma Design is a pretty good example of this importance.
What do we mean by defensible competitive advantage? Well, the company must be able to do something that other companies cannot match on equal terms, and that advantage has to last for some time to come to enable the company to cash in on it’s advantage.
We often see companies in new growth industries over-hyped with reasoning like: the market will grow at 20%, 30%, 40%, 50%+, the sky is the limit, the company is on it’s way to greatness.
It’s no doubt that for a company to operate in a new growth industries that’s about to take-off in a serious way is an extremely attractive place to be. But that says all about the industry and the markets, next to nothing about individual companies that operate in them. Drawing conclusions from this can be very dangerous.
Before we turn to Sigma Design’s specific situation we will provide a little typical industry dynamic explaining issues one typically finds in early industry development.
Dominant design
For a start, most new growth markets do not have what economist call a ‘dominant design’ yet, a set of technological features that, taken together, addresses market demands the best.
Early on in the growth cycle of an industry, there are competing technological solutions that address similar problems, and competition is mostly concentrated on those technological features, much less so on price.
It’s often difficult to say which technology (or ‘design’) will eventually win, that is, which technology will be the ‘dominant design’. It’s far from inevitable that the best solutions from a technological point of view necessarily win. It’s often a design that offers the best compromises between price, features, and main customer concerns.
Or, it might even be down to luck, for instance, first mover advantage is often quite powerful, setting customer expectations and perhaps creating a standard and/or a supporting ecosystem, powerful positions from which it is difficult to dislodge a company.
In the early stages of the video recorder market, many experts pointed out the advantages of Betamax (Sony) and Video 2000 (Phillips). However, the technologically inferior VHS managed to become the dominant design.
The same happened in other markets, a notorious example is the QUERTY keyboard, which was actually designed to slow typing down (as the early typewriters often jammed when typing too fast). Or in the PC market, where Microsoft became dominant while most observers touted the abilities of Apple and Atari (funny enough, the last has just been delisted from Nasdaq).
So, before one gets starry eyed about the growth prospects of the industry, one should wonder whether one is backing a company that is likely to have a ‘dominant design’ (or if not, if they can switch relatively easily).
To back a losing technology can be very costly, as Toshiba recently experienced when it’s HD-DVD technology lost out against Sony’s Blue Ray, that loss has been figured as amounting to a cool billion dollars.
When a dominant design emerges, markets can only really begin to grow, as competing technologies often slow down adoption considerably because of the uncertainty surrounding which technology will win, the HD-Blue Ray saga is a good example of that.
Defensible competitive advantage
Even for a company that is a winner in this stage, success is by no means guaranteed in the next stages. This is because competition will change in nature.
Before a dominant design has emerged, competition takes on many forms, different designs, technological features and concepts, and multiple combination of functions co-exist, and there are more often than not a lot of new companies each touting their own solutions.
However, once a dominant design emerges, competition shifts towards arena’s like economies of scale, access to marketing and distribution channels, supply chains, brand recognition, and the like. This is a different ball game altogether, and it’s by no means guaranteed that the winners in the first stage will be those that win the next.
Since in the particular industry that Sigma operates, these typical issues are not as important as usual, Sigma outsources production, and its relation with Microsoft and set-top box makers will guarantee the necessary marketing and distribution clout. The number of clients are limited, which makes the situation not too complicated.
Sigma Design
Now, not all of this matters for Sigma, but this description of a typical transition from the early stages of an industry does provide some insights as it is where Sigma is.
The market is in its early stages still, and used to be very fragmented, according to Junko Yoshida in the EETimes.
The IPTV market today is geographically fragmented by deployment type (cable, satellite or terrestrial) and by regional differences in digital-TV requirements. Available bandwidth and data rates also vary among DSL infrastructures. And there’s no standardization among requirements for conditional access and digital-rights management.
Many IPTV deployments today are still MPEG-2-based and are not using Microsoft’s TV IPTV Edition platform. “We need to be agnostic not only in terms of middleware, browser and conditional access but also in video servers and encoders,” said Pace Micro’s Delaney. That said, many IPTV deployments are shifting toward programming based on HD resolution. “The next wave of IPTV will be H.264-based HD implementations,”
However, there is no doubt about the fact that Microsoft’s Mediaroom software is emerging as the dominant standard in middleware (after having lost the interactive tv battle to OpenTV). This enabled Microsoft to set standards and requirements for chip designs. According to that same report:
Microsoft dictates IPTV chip design down to such details as the exact graphics features and video decoding processing capabilities. Microsoft-defined specs for IPTV chips include advanced features such as HD with picture-in-picture, higher security when connected to other devices, and mandatory support for Microsoft’s digital-rights management scheme, as well as support for the VC-1 superset of the Windows Media Video 9 codec.
According to Perich, Microsoft specifies that the HD decoder handle 16 percent more macroblocks per second than single-HD-stream processing, to support such advanced features as high-definition picture-in-picture.”There is definitely a sense of urgency on the part of telcos and Microsoft to add ‘wow’ factors to IPTV boxes” to enhance competitiveness with cable-based solutions, he said.
Sigma Designs was the first chip vendor to offer what Perich called “healthy working silicon” that allowed Microsoft to port its client software. Other vendors are now falling in line.
There are a number of companies offering IPTV chips, like : AMD, Broadcom, Conexant, Focus, LSI, National Semiconductor, NXP, Micronas, Pixelwork, Sunplus Technology, STMicro, Texas Instruments, VwebCorp.
However, until today, Sigma is the only certified Microsoft chip, but it’s likely that this advantage will not last, as argued above, Microsoft has spelled out the requirements and other chip designers will, sooner or later, meet these, if they have not already done so.
This is not all though. There are a series of steps involved before one can sell chips for MSTV.
- You must be named a partner.
- Your chip must be certified which will take a minimum of several months.
- Once certified, the chip maker can petition the telcos to use their chip in specific boxes.
Broadcom, which seems to offer the most serious threat until now, only announced that first step, the Microsoft partnership in January of this year.
Funny enough, originally, Broadcom was asked to participate in the Microsoft platform in early 2005. At that time the size or success of the IPTV market was widely unknown and Broadcom declined the request for proposal.
It does strike us (and not only us), that Jeff Schreiner, of American Technology Research, was quite premature when he cut Sigma to hold on competition worries (specifically from Broadcom) as early as 28 March 2007.
He had to take some of that back after Motorola placed another big order at Sigma on 29 Augustus 2007.So today, Sigma is still in a virtual monopoly as far as Microsoft’s MediaRoom middleware is concerned, and has a dominant position in the overall market.
It cannot have been such a surprise that new players are willing and able to enter the market. Reading up on even a little background in industry dynamics like we have just done would have pointed that out.
And even if one is too lazy for that, logic and a few other facts show the benefits of entering this market, which is about to take off in a serious fashion, and Sigma’s skyrocketing profits and share price (until last October) are further signs of the size of the booty.
Yes, competition can (and probably will) bring down margins and can eat into market share, but on the other hand, the market itself is about to embark on a serious sustained growth path, for us the selling seems overdone.
We know the market looks forward, but to price-in competition that hasn’t even arrived in such a comprehensive fashion seems overdone. Sooner or later, Sigma will face other Microsoft vetted players, but this was always going to happen sooner rather than later, and, as a matter of fact, it seems to happen later, rather than sooner.
Sigma already has a better chip up it’s sleeve, so it’s competitive advantage seems pretty sustainable still. This was never a likely industry for monopolies, Sigma still has a dominant position, and the competitive threat is, as of today, still unproven.
There is one unanswered question though. What are the capabilities of that Broadcom chip that sparked such fear and short-selling in the market? Is it much better (or cheaper, or both) than Sigma’s own new one? Only in that case do we foresee problems that are not already (more than) reflected in the current price.
After all, even super bear Jeff Schreiner, the one who set-off the drama, from the American Technology Research has $28 target. No wonder, it’s also pretty well placed in another market that is now taking off, that of Blue-ray players (yes, you guessed it, that emerged as a dominant design).