Low Margin Versus High Margin

Let's say that Nikon is correct about future camera buying, what does that imply for the entire industry?

Let's first recap what Nikon said last week: (1) the entire market for interchangeable lens cameras will be only about 4.5m units in four years; and (2) 66% of that market will be mid- and high-end models for pros and hobbyists. 

Nikon two years ago began diverging from their old market-share strategy. Canon is still trying hard to win 50% of the market (in terms of units), so is still using the old market-share strategy. Sony and Fujifilm have unclear strategies, though it appears that Sony is beginning to opt for Nikon's approach. 

So let's look at Canon first. With the current market between 5-6m units, Canon still retains half. At 6m units, that's 3m cameras sold. But at least half of those are entry-level models. If Nikon's correct—and they've been consistently good forecasters in terms of market direction—then four years from now Canon will be selling 2.2m cameras, and if Canon continues to pursue market share, half of those are going to be entry-level models. Canon would likely lose market share in the mid- and high-end model lines. Indeed, both Nikon and Sony need to succeed at mid- and high-end in order to stay in the camera business under Nikon's forecast. Thus, Nikon and Sony are going to be aggressive in the high-margin products. 

You can already see that with the Z9. By cutting a significant cost (shutter) Nikon has placed a flagship model well below the typical flagship model price. I expect Nikon to continue that trend down line, while raising the bottom end of the lineup they sell (done by eliminating the true consumer DX products). Nikon's pretty darned good at meeting clear targets, and it seems they have a clear target: sell as many units in four years as they do today (700K), with all of those being higher-margin, higher-end cameras. If they're successful at that—and I believe they will be—that leaves 2.3m high-end units for Canon, Fujifilm, and Sony to share (OMDS and Panasonic will take a small piece, too, but the real high-end battle will be between four makers (Canon, Fujifilm, Nikon, and Sony). 

Here's an approximation of what the low-end/high-end share splits might look like four years out if Nikon is right and Canon pursues their current strategy:


Note how distorted that looks when you think about low-margin (low-end) products versus high-margin (high-end) products.

Nikon already adjusted their overhead and manufacturing to allow them to keep unit sales flat, move all those units to the high end, and to retain clear, solid profit margins. Nikon is the lean player now, but powerfully lean. Think marathon runner, not football lineman. 

If Canon pursues the 50% overall market share strategy they've been on (forever), that means they'll likely produce nearly 1.5m low-end consumer cameras and perhaps fewer than 1m high-end, high margin cameras. Yes, they'd outsell Nikon overall in unit volume, but the low margins they'd get on all those true consumer cameras wouldn't make them much more profitable than Nikon, if at all. Or more profitable than Sony. Canon hasn't really written off production capacity, and it's currently spreading R&D over three mounts and four lines of products in pursuit of their "dominate via market share" strategy. Because Canon uses only their own image sensors for interchangeable lens cameras, they're also constrained by what they can do at their own semiconductor fab. All the new fabs coming on line don't help them. 

I believe Canon's still trying to pay back their huge fab investment via market share: the more cameras they can amortize their recent semiconductor factory investments over, the better. I'd say there's high risk to Canon that the market actually falls below Nikon's 4.5m projection, at which point Canon's economics simply won't make sense and they'll have to write off facilities and investments. Note that virtually every other camera manufacturer other than Fujifilm and Canon has already had to do that, though some have been sneakily doing so in dabs hidden by other related products as opposed to the big write downs Nikon and Olympus made. 

One of the things that made the Japanese camera companies so hardy when it came to basic economics is the stagflation that ran rampant in Japan for decades. Banks found that it was better to loan money at 1% to big companies with a strong chance of paying them back than it was to do anything else with that money, as interest rates sat at near 0% for a long, long time, and the banks could just borrow more. One has to wonder whether stagflation will continue, though. Last month Japan's consumer price index went up above the 2% target that the Bank of Japan set many years ago but seems to never achieve. 

Unfortunately, I think the Bank of Japan is dreaming. They're trying to keep monetary policy intact as Japanese consumers—and that means all those folk working for the camera companies in Japan—are not getting raises to keep up with even that modest inflation rate. Something has to give under the current scenario, and that could get ugly in the rapidly declining camera market. The only good news on the macroeconomic front is that the yen has fallen against the dollar recently. Where you could get 114 yen for a dollar at the start of the year, today you'll get 128. That makes exports that were cost in yen look better overseas, and one reason why you're seeing companies move more inventory recently into the US for sale.

Of course, any economic forecast is going to be wrong. Mine, Canon's, and Nikon's included. Generally economics is really good at seeing and forecasting trends, but not in being able to predict specific numbers. A good economic forecast of any type would be any that falls within +/-4% points of what actually happens.

But that brings me back to product margins. There's simply not a lot of margin in a US$500 camera. Dealers take 15-20%. Wholesale takes 25-30%. Sales and marketing take at least another 10%. So you have to make a profit by producing that US$500 camera for an out-of-the-factory cost of US$225. Things look so much better for a US$2000 camera, even though some of your parts costs will be higher (but not high enough so that you can't get far better profit margins). Which is why Nikon and Sony are targeting cameras at that level, mostly. And why Canon and Fujifilm will likely eventually have to do the same. 

Which brings me to this: I've written for some time that Canon's M line is a dead-end. No amount of juggling by Canon could keep that from not being the case, particularly when they made the wrong mount decision in 2012 when they first came out with it. (Note that Nikon also made the wrong mount decision with their CX line in 2011, but also look at how fast they realized that and discontinued it.) The problem today is that Canon can't afford to put any additional R&D money into M, as the overall trend for consumer cameras like that is down. Spending more money on low-margin products that are being squeezed out of the market is not shareholder-friendly. I expect Canon will try to milk the M for as long as they can, but that's going to look more and more problematic on their bottom line.

Notice that the new R10 is basically US$1000 and the R7 is US$1500. The M50 is US$600, and the M200 even less. The M6 Mark II, the highest camera in the M lineup is US$850. Do the math. Take 20% off for the big dealers. Take another 30% off for the wholesale (subsidiary costs). Take another 10% off for marketing and sales costs. Now what do you have to make the M50 for? US$270. And I'll bet you that it's actually far worse than that (once higher internal costs are fully accounted for, including that fab, R&D, and more). No, I don't think that's sustainable for Canon. If their volume becomes more than 50% low-end products like the M's and the chart I show above, it will just eat away at their bottom line as camera sales continue to decline. Meanwhile, Nikon and Sony will be posting higher profit margins. 

Let's face it, cameras are becoming niche. More and more niche every year. The things I'd pull a dedicated camera out for over my highly competent smartphone keep declining. And I'm more demanding in those niches over time, wanting faster frame rates, better focus, additional specialty lenses, and more. 

No, Nikon has made the right call. Sony seems to be making the right call. Fujifilm's mostly been adding higher-end gear to their lineup (GFX models, upcoming X-H2 models), so I think they've figured it out, too. The only Japanese camera company still racing down the wrong track is Canon. My advice to them? Bite the bullet and quickly amputate their market share strategy. Yeah, that'll end up with a big, one-time write down, but Canon really needs to go all in with RF (both stills and cinema), and they need to concentrate 100% of their energy in US$1000+ cameras now. Anything else simply dilutes their earnings, which will eventually generate the usual shareholder revolt that forces them to do what I suggest, anyway. 

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