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Hot Stock What Drives the Hardware Industry
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The forces that make it difficult for companies to create economic moats are magnified many times over in the hardware sector. Although other areas of the economy are also subject to product cycles, price competition, and technological advances, these factors are particularly intense in industries such as semiconductors, PCs, and telecom equipment. In fact, the environment in the hardware sector makes it fiendishly difficult to build a sustainable competitive advantage because technological advances and price competition mean that the lion's share of hardware's benefits are passed to consumers, not the company creating the products.

Investors often spend a great amount of time delving into the vast trove of technical minutiae for hardware companies. But we don't believe the hard­ware sector behaves by its own special rules. Rather, the sector's dynamics simply elevate the importance of the factors we look for in every area: solid management, a focused economic model, and an economic moat.

Even the casual computer user has experienced the factors that drive the technology hardware sector. If you've ever bought a PC, you already know that it won't take long before one twice as fast is on sale for less money. While the average PC cost more than $1,500 in 1998 (perhaps with a Pentium II chip), you could buy a much more powerful PC for less than $1,000 in 2OO2.

But It's "worth remembering that even goods that deliver a big benefit to society—either through increased productivity or leisure—won't necessarily make their producers a cent, much less make money for investors. In the next section, we'll examine how the most successful companies in the industry manage to keep their heads above water and how you can identify them.

The hardware sector's central driver is its ability to innovate so that computing power Increases while costs of that computing power rapidly decrease. The basis for this driver is Moore 's Law, which was initially observed by Intel founder Gordon Moore in 1965. ( Moore 's Law basically states that the number of transistors that can be crammed on to a given piece of semiconductor real estate doubles every couple of years.) Conversely, chip industry economics means that the price per transistor also tends to plummet at an inverse rate. In other "words, although technology innovation happens at a rapid pace, most of the benefits of that innovation are passed on to the end user.

Moore 's Law helps spread the productivity and leisure benefits of informa­tion technology (IT) to an ever-wider range of activities. Decades ago, IT processing power (software plus hardware) was economically feasible for only a few large military, communications, and financial applications. Today, however, the average person can afford a very powerful computer, and IT has countless applications in everyday life—whether in snapping photos with dig­ital cameras or scribbling notes in a Palm Pilot.

A second driver is that advanced economies are progressively shifting their focus away from manufacturing and toward services. Most manufacturing can be performed in countries with lower costs, but services are much more difficult to import. By the very nature of their activity, services require a much larger investment in IT (directly or indirectly) than manufacturing. Both Moore 's Law and the changing structure of advanced economies suggest that demand for hardware should grow faster than the economy as a whole.

A third, driver is the symbiotic relationship between technology hardware and software. After all, if a person didn't have software applications to run on his or her PC, what good would it be? Advances in hardware allow software to do more in less time, whereas new software applications help create de­mand for more capable hardware.

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