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Sony's Picture Looks Brighter


It was once the crown jewel of the Sony empire. But for years now the Japanese company's consumer-electronics division -- responsible for everything from TVs to Walkmans to DVD players -- has been a disaster. Since the halcyon days of the late '90s, when the division was the profit leader for the company, Sony Corp. (SNE) has seen its electronics unit fall deep into the red, losing $300 million in the 12 months ended March, 2004. Investors long hoped the company might do the heavy restructuring needed to revive profits and compete with new rivals. But Sony just wasn't tough enough.

Finally, though, the company is showing results. In the quarter ended in June, the electronics division reported $65 million in profits. Earnings for the September quarter, scheduled to be announced on Oct. 28, were expected to confirm the trend. Brokerage Merrill Lynch & Co. (MER) predicts the electronics business will book sales of $45.4 billion and profits of $375 million this fiscal year. Not a bad recovery, although it pales next to the $2.3 billion the division earned in 2000 and remains well below the combined $1 billion Merrill expects Sony's far-smaller games, music, and movie units to earn this year.

Much of the turnaround stems from some painful rethinking of the way Sony does business. By 2006 the company expects to trim $2.8 billion in annual costs from the electronics division, in large part through layoffs and early retirements that will reduce the company's overall payroll by 13%, or 20,000 workers. After shuttering 17 of its 70 factories from 1999 to 2003, Sony closed an additional four in the past 18 months. At the same time, the company plans to pare its offerings in about 15 of its 137 product categories.

And Sony is cutting the number of parts it uses. In TVs, for instance, it's trimming the various chassis -- or basic platforms -- in its TV sets. A year ago, Sony had 30 chassis. Today it has 15, and the target is six by 2006. "When we use common chassis, production gets much easier, so our production costs drop" by 30% or more, says Makoto Kogure, head of the television unit. All told, Sony hopes to cut its parts list from 840,000 a year ago to 100,000 by March, 2006.

But Sony insists its electronics recovery isn't simply a cost-cutting story. Instead, the company is trying for greater vertical integration, buying the bulk of key parts for its most profitable products from divisions inside the company rather than from outsiders. This technique has been tried off and on by many companies over the years, but Sony sees it as a big new strategic advantage. The TV unit, for instance, next year will start getting its LCD panels from a Sony-Samsung joint venture. And while Sony today buys many of its TV chassis from outsiders, once it reaches the half-dozen platforms Kogure wants, most will be made in-house.

THE SOURCE IS WITHIN

Sony has made similar progress in digital cameras. A year ago, Sony's camera division bought just 30% of the parts for its still cameras from other company units. But in its ultra-slim, 5.1 megapixel T1 -- the No. 2-selling digital camera at U.S. retailers last summer, according to market researcher NPD Group -- Sony boosted that share to 60%. One key component is the camera's tiny lens, developed in cooperation with Germany's Carl Zeiss. More important, Sony now makes the computer processor at the heart of the T1 and its successor, the T3, introduced this fall. That's cheaper than buying chips from outsiders, but it also lets Sony customize the parts, says Hideto Jimbo, who heads product planning for digital cameras. "A manufacturer who's purchasing all of these components from outside could never achieve such a thin body," Jimbo says, turning the 1.8-cm-thick camera over in his hands.

That's not to say all of Sony's problems are behind it. For decades, Sony dominated portable music, with kids from Sapporo to Stuttgart bopping to the beat of their Walkman cassette and CD players. But Sony was slow to jump into MP3 players and was left behind when Apple Computer Inc. (AAPL) launched the oh-so-cool iPod. Last summer, Sony finally introduced the Network Walkman, a hard-drive-based player similar to the iPod. But it remains far behind Apple's offering. Today margins for Sony's audio business are continuing to collapse, falling from 6.7% in the year ended in March to just 3% in this fiscal year, according to Merrill Lynch estimates.

In TVs, too, Sony isn't the powerhouse it once was. The company has long milked profits from televisions via technologies such as its so-called WEGA Engine, which processes TV signals to enhance picture quality. But now, Sony faces strong challenges from the likes of Samsung, Panasonic, Sharp, and a host of Chinese upstarts. This year, Sony is in the red in LCD and plasma TVs, and is seeing its margins fall in DVD players and traditional TVs, according to brokerage Deutsche Bank Securities Inc. (DB). "Sony's problem is that it's losing money in its star products, and the margins on its older products are declining too quickly," says Deutsche Bank analyst Yasuo Nakane.

Sony, though, says it has a slew of hits up its sleeve that will help the company get its groove back. This year, execs say, the company will increase research and development spending in electronics by 33%, to $1.9 billion. That money is being spent on developing new games, boosting sound quality, and creating high-definition TVs that display bright, supersharp images on screens the size of Texas. There's the Qualia 006, a 70-inch rear-projection model that will cost around $10,000 when it's introduced in the U.S. in time for next year's American football Super Bowl. There's a high-definition camcorder that will retail for about $3,700. And there's Blu-ray, a new DVD format that records two hours of high-definition programming on a single disc.

Will the new products be enough to boost Sony's electronics profits? Reviewers are generally impressed with the new gear, and analysts say the vertical-integration scheme makes sense. The verdict will soon come via stores around the world. "This Christmas season is extremely important," says Merrill Lynch analyst Hitoshi Kuriyama. "If their new products are a hit, investors and consumers will believe in Sony again. If not, it will look like a no-growth company" and may never get back to the fat margins of the 1990s. For its part, Sony is downplaying the importance of Christmas sales -- as long its new products get noticed. "This year my target is to show the kind of quality we're aiming for," says Kogure. "Next year we will pursue quantity." Coming from behind? That used to be someone else's problem, not Sony's.

By David Rocks in Tokyo


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