by George West, CEO & Senior Analyst

Zensys is a company in direct competition with the members of the ZigBee Alliance. The company, according to one of their customers, received $30M from Intel Capital this year. At first glance Zensys appears to be a strong competitor in the Wireless Control Network market. The first sign of evidence to the contrary emerges with the company’s assertion that it does not compete with their customers. Industry history is rife with counter examples that suggest technology companies either need to consider competing with their customers or need to have an exit strategy that involves selling themselves before the venture capital runs dry. Intel and Microsoft are two companies that have done pretty well for both themselves and their stockholders while competing with their customers. 

It is possible to purchase Intel processors as chips, as part of a chipset or as a motherboard. For motherboard vendors is Intel the competition or a supplier? There are similar examples from Microsoft and software applications. 

One argument is that by competing with their customers, Microsoft and Intel have been able to thrive and survive and as a consequence are continuing to provide the basic technology that enables a multiple hundreds of billion-dollar per year industry eco-system. It may just be that for a technology company that plans to stay around for the long haul – and not just for an equity event in the next eighteen months – that competing with their customers may be a good idea. One of the consequences of competing with your customers is the opportunity to take advantage of the higher sales margins that result from selling a higher value differentiated product. 

Let’s take an example from the often discussed Audio Video sector of the Wireless Control Network market and focus on Logitech and the Harmony 890 remote control in particular. Logitech reports the revenue from the Harmony products in the ‘Other Retail’ category of the income statement. 

This income category contains other items besides the Harmony remotes and if we simplify and say that all the revenue derives from the remotes it provides a quick and dirty method of bounding both the revenue as well as the unit volumes. 

For the quarter ending June 31, 2006 Logitech reported roughly $22M in sales in the category ‘Other Retail’. The Logitech annual report from March 2006 reported yearly sales in this category of $80M and that year over year sales growth is on the order of 100%. This is a very nice business for Logitech. Logitech’s RF-enabled remote control product is the Harmony 890 remote control. This device uses an RF controller in the handset and another in a remote RF-IR repeater which would be located inside a media cabinet or closet, possibly in a separate room from the television screen. Today the RF controller is a Z-Wave component manufactured by Zensys. WTRS estimates for the unit volumes of the H890 are between 40,000 and 400,000 units per year. To get to 400,000 units we need to attribute 100% of the Other Retail sales to the H890. At the retail end of the channel, this represents sales between $16M and $160M per year. For Logitech, this represents sales between $8M and $80M per year. 

What does this mean for the technology provider that doesn’t compete with their customer? 

There are two RF chips for each remote so the unit volumes are roughly 80,000 to 800,000 per year. Revenue from the sales of RF chips is roughly $240K to $2.4M per year. 

Let’s get wildly optimistic and assume that revenue is $2.4M per year. What does that mean from a business standpoint? We will use the Cambridge Silicon Radio gross margin of 47% for the purposes of the calculation. Using various press releases, Zensys’ company headcount is 40 people and we will assume a burdened rate of $200K/person/year. This equates to estimated earnings for Zensys, created by the Logitech relationship, of ($6.9M). That is nearly a loss of $7M. 

The WTRS estimate for break even sales is roughly 6M chips if the ASP is $3/chip, a shipment volume not achievable, according to WTRS analysis and forecasts, until 2008. 

Luckily for Zensys, they appear to have other customers, among them lighting manufacturers. Unfortunately for Zensys every one of its large announced customers have slipped their production schedules in 6 month increments and in unison. 

Thus WTRS is certain that at this point the fable circulating the industry of a below-$1 Z-Wave chip is just that – a fable. 

Estimate of Company Z’s Earnings

Revenue	$2.4 M
Gross Margin, CSR is 47%
Operating Earnings	$1.1 M
Est. Combined R&D and SGA for 40 people	($8 M)
Estimated Earnings	($6.9 M)

– George West
Senior Analyst, WTRS