SanDisk Plays Its Cards Right Eli Harari isn't wary of ever-plunging prices. He's used them to build his billion-dollar flash memory empire even faster.
By Owen Thomas

(Business 2.0) – There was a point in 2000 when SanDisk seemed to have it made. The company's flash memory chips were a favorite in the endlessly expanding telecom industry, and digital-camera manufacturers couldn't get enough of its CompactFlash memory cards as the medium for storing images. Month after month, sales were doubling 1999 levels.

Then came the recession of 2001 and, with it, the long arm of both Moore's Law and the law of supply and demand. First, Samsung Electronics flooded the camera and telecom market with its own flash memory--interchangeable with SanDisk's product--driving prices down 68 percent. Next, the telecom market collapsed. After making $300 million in 2000, SanDisk lost almost the same sum in 2001. It laid off 40 percent of its workers, cut salaries as much as 20 percent, and closed plants in Virginia and California in favor of production in Japan and Taiwan. "We've got all the scars," says co-founder and CEO Eli Harari.

Harari took an important lesson away from that unpleasantness. Like it or not, he realized, SanDisk operates in a market where prices are not just competitive--they're continually cascading. The company had no choice but to cut its costs just as fast. Moreover, if it wanted to avoid the boom-and-bust cycles of, say, the telecom industry, it would have to cease being mostly a supplier to manufacturers and rely on selling its memory to consumers.

Retail to the Rescue

As it turned out, Harari succeeded on both counts. Since 2001 he has cut prices 30 to 40 percent every year and has seized an ever-growing share of the market. "We're driving the bejeezus out of costs," he says. SanDisk has also broken the retail market wide open: Once accounting for only a sliver of SanDisk's business, consumers supplied fully 64 percent of the $982 million that the company pulled in from product sales last year. Making cards compatible with virtually all cameras, phones, and PDAs on the market--xD, SD, Memory Stick, what have you--as well as USB flash drives, SanDisk hit a record $1 billion in revenue in 2003 and earned $168 million in profit, more than four times what it made in 2002. The company now commands a third of the worldwide memory-card market, up from 25 percent in 2001.

The hard facts of life in the flash memory business are a direct result of Moore's Law. The amount of storage that a manufacturer can squeeze onto a card doubles almost every 18 months, which means that the supply of megabytes on the market rises exponentially and the price per megabyte inevitably plunges. For Harari, then, increasing sales and growing profits is a bit like running up a down escalator.

Before the crash, the upward momentum came in large part from the growing volume of demand from the makers of cell phones and digital cameras. But telecom buyers all but vanished in the crash, and while digital cameras continued to sell, camera makers tended to buy SanDisk's lowest-capacity cards or those of its cheapest competitor. Because of Moore's Law, that meant an inevitable decline in SanDisk's revenue per camera. Harari decided to expand by selling additional backup memory directly to digital-camera owners. Though SanDisk had been selling branded cards at retail since 1998, they were a small part of the business. SanDisk needed to get into more outlets, particularly high-volume chains like Best Buy and Circuit City and the office-supply superstores.

Of course, the retail market obeys its own laws of supply and demand, which are quite different from those that rule original-equipment manufacturing. For one thing, Harari's team quickly realized, each category of retail outlet has its own pricing sweet spot and product mix. The company sells an $849 2-gigabyte card, which holds about 3,000 photos, exclusively at camera shops, while its best-selling card in electronics stores is a $65 256MB card. Electronics retailers, where customers typically buy their first digital cameras, tend to carry larger-capacity cards than office-supply stores, where people more typically pick up a second card that matches what they already have.

But if the retail market requires more nuance than the OEM market, it has one major compensation: Consumers are willing to buy higher-capacity chips--as long as they're priced right. Individuals don't think in terms of megabytes, explains Nelson Chan, SanDisk's general manager of retail. "With a retail customer, it's a question of how much budget they have," he says. "They're going to buy to that budget." If consumers are willing to drop $300 on a digital camera, they'll spend $60 to $80 on an accessory, and they'll pick the best one they can get at that price. So rather than trying to maintain volume on last year's hottest chips by slashing prices, SanDisk simply packs more memory onto the card it sells at the magic price point for each kind of retail outlet. That new card becomes the volume leader, and revenue per card holds steady. Sure, customers may eventually see no point in buying ever more capacious memory cards. But as long as each new generation of cameras keeps snapping bigger photo files, Chan figures demand won't fade away.

Of course, flash memory customers are hardly brand-loyal, so the name of the game is to sell everywhere. During the past five years, SanDisk has expanded its brand presence from 7,000 outlets, mainly specialty camera stores, to more than 60,000, including all the big-box electronics and office-supply chains. Harari says he can triple that number by breaking into mass retailers--drugstores, convenience stores, and supermarkets--with 32MB cards. The marketers have repackaged these products as novice-friendly Shoot & Store cards. Instead of pushing megabytes, the packaging touts the 50 pictures you can take with the card. Hitting shelves now, each costs about $15, but the goal is to get the price down to $8 in three or four years, to the point where, as Chan puts it, "the card is truly a consumable product" that customers can take out of the camera when it's full and store--like a shoe box full of snapshots. Getting consumers to treat memory cards like canisters of film isn't just a tactic for moving more megabytes--it's a long-term strategy for the inevitable day when consumers decide that they are through buying more memory for the camera. By then, Harari hopes, they will be buying gigabytes of memory cards as virtual photo albums.

Laying Down the Law

They'll buy more, of course, only if SanDisk continues to drive down prices for cards of a given capacity (or to increase the capacity of cards of a given price)--because if it doesn't, competitors like Samsung and Sony will. SanDisk has some advantages on the cost front, including a big plant in Japan scheduled to open in 2005 (to be operated in partnership with Toshiba) that will more than double the company's capacity.

Chip-design and meticulous packaging improvements helped SanDisk slash production costs on its popular 256MB cards by 42 percent in the past 12 months. But that's not enough for Harari, who is constantly pressuring his engineers to figure out clever ways to cut costs. "In the past we've had engineers who say, 'No, I want to work on a 64-bit processor that zooms around.' And I say, 'I'm sorry.' This is not about gratifying engineering egos. It's about making money. And you make money when you give value." Call it Harari's Law.

Owen Thomas (othomas@business2.com) is a senior reporter at Business 2.0.