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Small-scale innovation brings big profit

Electronics firms are pouring billions of dollars into factories for flat displays and memory chips, but some of their most profitable innovations are in items such as coffee machines and toothbrushes.
DYSON INTRODUCES THE DC 15 ANIMAL VACUUM
British industrial designer James Dyson showed the way back in 1986 when he re-invented the vacuum cleaner, turning it into a high-tech machine such as the recent model seen here.Dyson / PRN
/ Source: Reuters

Electronics firms are pouring billions of dollars into factories for flat displays and memory chips, but some of their most profitable innovations are in items such as coffee machines, fridges and toothbrushes.

In May, LG Electronics will launch steam washing machines on the European consumer market after a successful introduction in its home base of South Korea, rejuvenating a product category which has essentially remained unchanged since the first electric washer debuted in 1907.

The product, based on patented technology, helped LG improve its already dominant market share in South Korea and in Europe will be priced above 1,000 euros ($1,209), guaranteeing lucrative profit margins.

"This is key to our strategy to focus on premium products," LG's European President James Kim said in an interview. LG's operating profit margin at its digital appliances unit improved to 7 percent of sales in the third quarter from under 6 percent a year before.

In contrast, the volatile liquid crystal display company LG.Philips LCD generated an operating margin of 9 percent and just 1 percent in the third and second quarters respectively, despite huge investments in new factories.

The difference shows the profits that can be achieved with these new white good products outstrip those in consumer electronics, including fancy flat TVs and digital music players.

Throughout the white goods industry, electronics companies are investigating how they can turn tired old products into sexy new ones.

James Dyson, a British industrial designer, showed the way back in 1986 when he re-invented the vacuum cleaner, turning it into a high-tech, high-end machine coveted by rich consumers worldwide.

Since then, a wave of product innovation has led to closet-sized fridges and magnetically powered toothbrushes.

Philips Electronics of the Netherlands introduced a budget espresso machine called Senseo of which it sold 10 million in the first three years.

Low-cost followers from China, used to selling cheaper filter coffee machines, have had problems catching up, because they cannot easily copy the tight collaboration between Philips and Sara Lee's Douwe Egberts subsidiary which produces the coffee packets designed especially for the Senseo.

The coffee machines can be sold at competitive prices because Philips gets a cut from the coffee packet sales.

"The big retail chains like Aldi and Wal-Mart, when they see a product like this, they immediately go to China and ask for something similar. But that's not so easy, because you have to accompany it with a lot of marketing," Han van Splunter, chief executive of Philips's domestic appliances unit when Senseo was introduced, said in a recent interview.

"The coverage for that comes partly from coffee machines but mainly from coffee pads. It becomes unattainable for rivals which have to recoup that money from machines alone," he added.

Philips's domestic appliances unit generates an average operating profit margin of 15 percent, well above the average 2.8 percent at the top 10 electronics companies from Japan.

"The secret is that they have far less competition," said analyst Eric de Graaf at brokerage Petercam.

Not only is competition limited because products are protected by patents or by exclusive profit sharing partnerships, but also by advanced manufacturing.

LG's Kim stresses that the large fridges require more engineering expertise, while Philips dominates the global electric razor market together with rival Braun in part because of superior production processes.

"Producing the razor heads requires a level of sophistication that makes it practically impossible to copy," Philips appliances chief Andrea Ragnetti said in a recent presentation.

Profits in white goods and small appliances are also protected by the relatively small size of many markets, coupled with the huge marketing and technological expenses needed to enter.

"The TV market is huge as consumers often buy a new and more stylish TV before the old one has died," de Graaf said. "But who has ever bought a second or third washing machine?"