What Will Santa Bring Us?

Key Thoughtz

• AMLCD producers are making smaller panels than they expected while planning recent fab investments.
• Commodity trends constrain demand for premium products.
• Producers will use any rationale to raise prices this year.
• Brands may find themselves squeezed between panel producers and retailers this holiday season.

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Panel demand is growing fastest in BRIC markets. This is particularly true in LCD TV set market segments, which leads to a smaller average AMLCD panel size being used than many producers expected. The effect is similar in richer countries as consumers seek bargain products. Demand for LCD TV sets is elastic relative to price and offering 24” or 26” panels is one way to increase the number of households able to buy LCD TV sets. In addition, new TFT fabrication plants coming on-line this year can make 26” or 32” displays with nearly the same efficiency as they can make 52” displays. Eighth-generation TFT fabs can produce three times more 32” panels and four times more 26” panels than 52” ones, however. That enables panel makers to meet demand for entry-level TV sets in emerging markets. Consequently, the average panel size is decreasing for some producers.

Panel producers are obtaining diminishing returns to scale. As the market matures, the typical profit margin approaches zero. It is rational for producers to invest in more capacity until they reach that point, so they tend to do so. Public disclosures by LG Display demonstrate this tendency. The following chart plots the average sales per square meter of display from Q1’02 through Q2’09. It also charts the average cash cost, which is the cost of product reduced by depreciation and amortization charges. Plotted over thirty quarters, exponential curve fits show that the average area price falls 23% a year while the average cash cost falls more slowly at 18% a year. That squeezes the producer’s cash profit margin over time: it has declined 12% a year since 2002. At that rate, the trend lines would intersect a few years from now. If they do, that implies that leading panel makers would be unable to sustain their business.

Display Area Sales and Cash Cost for LG Display (USD/m²)

Source: author estimates for 2002–2003; LG Display disclosures, 2004–2009.

How High Can Prices Rise?

Under such conditions, producers will seize any opportunity to use material shortages or other factors as reasons for raising prices. Sudden reductions in TFT capacity utilization in 2H’08 hurt some material suppliers deeply. Even glass suppliers responded by turning some furnaces off, though they remained profitable overall. As TFT-LCD producers bring capacity back on-line, some experience shortages. Others claim shortages. In any case, constraints on production cause buyers to bid panel prices higher as they struggle to keep or sustain their market shares. Such dynamics led to an average area sales revenue increase of 8% Q/Q for LG Display even though the average price decreased 38% Y/Y in Q2’09. Put another way, square meters of display sold increased 53% Y/Y while the cash operating margin/m² decreased 68% Y/Y in Q2’09.

Will Brands Be Squeezed?

How much higher can panel producers raise prices without reducing consumer demand for LCD TV sets? The good news is that producer interest in higher prices and government interest in greater consumer spending may support prices of larger LCD TV sets. Constraints on production, especially by Taiwanese panel makers, and demands for entry-level products in BRIC regions may sustain prices for smaller LCD TV sets through the year. Brands and retailers may use such support to limit discounts on larger sets because there is a natural relationship based on price per square inch. Without doubt, brands and retailers will position LED-backlit TV sets and internet-compatible sets as premium products this holiday season.

The bad news is that consumer spending in rich countries may constrain demand for larger, premium LCD TV sets. The cumulative loss of non-government (private) employment in the USA since December 2007 exceeded 6.6 million jobs in June. The official unemployment rate reached 9.5% and the total number of hours worked decreased. Consumers in the USA are saving more and spending less. For many years, they and consumers in Western Europe were the primary market for larger LCD TV sets. Even if employment rises or housing prices stabilize, they are unlikely to resume spending at levels considered normal before 2008.

The social shift from spend to save can be seen in the change in how people shop. Advance retail numbers for June show spending at US electronics stores decreased 9% in the first-half of 2009 compared to 2H’08. The following chart plots the increase or decrease each month relative to the prior year. It shows that electronics and appliance stores enjoyed rising receipts Y/Y until August 2008.

Cumulative Change (YoY) in U.S. Electronics Sales Since December 2007

Source: US Census Bureau, unadjusted retail sales by electronics and appliance stores (NAICS #433).

Strategic Implications

Panel makers may expect (or even deserve) price support but they may find less demand for larger, premium displays that they expected when they invested in next-gen fabrication capacity. If so, they may allocate more of such capacity to serve entry-level market segments. The number of TV panels would rise because the next-gen glass substrates yield three or four times more sub-40” panels than they yield 52” panels. Rising output would lead to falling prices, unless demand in BRIC regions can rise to the occasion. If this occurs, we may find bargain-basement TV sets under our Christmas trees.