SAN FRANCISCO (CNN/Money) -
Don't look now, but the PC industry is undergoing a metamorphosis that could change the way investors think of the sector.
Its leaders -- Hewlett-Packard (HPQ: Research, Estimates), Gateway (GTW: Research, Estimates), and Apple (AAPL: Research, Estimates), to name just three -- are steadily morphing from PC and peripheral manufacturers to consumer electronics companies, offering DVD players, MP3 players, TVs, and digital cameras alongside their core computer products.
The switch has many reasons. Companies want to capture consumers' increasing interest in using the PC as the "hub" of their "digital entertainment lifestyle."
For one thing, digital entertainment devices are a better business: DVD players, MP3 players, TVs, and digital cameras tend to be easier and cheaper to make -- and promise higher margins -- than the commoditized PC.
"[Computer] companies will continue to enter this space. It complements their business," says Michael Gartenberg, an analyst with Jupiter Research. "We've gone full circle from the mid-1990s, when Sony (SNE: Research, Estimates) and other consumer electronics companies got into the PC market."
Exhibit A: Digital cameras
To see how this is working for the PC makers, let's look at their forays into digital cameras. Few consumer electronics devices offered by PC companies have equaled the success of digital cameras. Research firm IDC estimates that 14 million of the devices will be sold in the United States this year, up 40 percent from last year.
For Gateway and HP (Apple doesn't make cameras, yet), they provide a dependable revenue stream, funding the companies' other excursions into consumer electronics. Gateway is the most recent to announce its entry into the market, and that comes just three weeks after HP launched a $300 million marketing campaign for its new fleet of consumer electronics products -- including a new line of digital cameras. The two companies appear to be on a collision course with their camera lines, but each brings unique advantages to the market.
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Gateway announced its intention to enter the digital camera market on Thursday, and Wall Street liked the news, sending the Poway, Calif.-based, company's stock up 5.6 percent to a new 52-week high.
Gateway has had a good run of late, almost tripling its stock price since February and seeing 13 of the 14 analysts that cover the company improve their rating calls in the last four weeks. This is a dramatic change from Gateway's performance last year, when it struggled to define itself in the downward-spiraling PC market.
Like Dell (DELL: Research, Estimates), Gateway sells directly to consumers and relies on phone and online ordering for most of its sales. Unlike Dell, however, Gateway owns and operates retail outlets that sell only Gateway goods. Eliminating the middleman allows Gateway to sell its digital cameras for less than the competition, including HP.
One natural reaction to a new competitor entering a market and undercutting prices is for other players to quickly drop their prices, eliminating the new entry's advantage. You've seen this tactic with PCs.
However, I don't believe HP will choose this strategy in addressing Gateway's digital camera debut, and here's why: Wall Street hammered HP after the company announced its latest quarter's results and admitted it cut its prices too far ahead of projected drops in component costs. You can be sure HP will think long and hard before announcing another price cut anytime soon.
This would seem to open a window of opportunity for Gateway. It can call attention to its low-cost cameras, selling them direct or through its own retail outlets, where it controls the displays. This is why Wall Street is reacting so favorably. (Another Gateway consumer product, its plasma-screen TV, is the best-selling unit in its category, according to the NPD Group.)
Don't weep for Carly Fiorina just yet. Even if Gateway chips away at established players' market share in digital cameras (HP currently has about an 8 percent share, according to IDC), HP stands to gain on the back end, regardless of what brand consumers choose.
That's because HP commands nearly 50 percent of the printer market, meaning anytime a consumer buys a digital camera and decides to print the photos, HP has a 50/50 chance of making money on that purchase.
"For HP, a camera is a camera is a camera," says Chris Chute, an analyst with IDC. "The goal for HP is to sell more printers."
A very special moment
So we're at a rare and fleeting moment for PC companies such as Gateway and HP, which are dabbling in consumer electronics -- one that investors will enjoy.
It's a moment when most entries into the market will almost certainly meet with a modicum of success. Gateway, with its direct-sales model and its focus on low cost, will likely enjoy short-term gains with its digital camera offerings. And HP, with its camera products and printer sales, will also experience short-term success from the general growth of the category.
Investors should tread cautiously, however, since erosion pretty quickly hits stakes pegged on pricing in the electronics industry. As such, Gateway will need to avoid "me-too pricing and me-too products," Chute says. That's easier said than done: Product innovation costs money.
And now that Dell is selling its own printers, HP's once rock-solid printer foundation is also showing signs of strain, meaning the company's agnostic approach to digital camera sales will likely fade. This is one reason for its recent marketing blitz.
While both companies should enjoy short-term gains from digital cameras, investors shouldn't expect these individual companies' electronics profits to grow similarly in the long term, as the market matures faster than an Instamatic.
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