Hard Drive Makers Resist Price War

But there are signs -- albeit tentative ones -- that the scene is changing. Rising demand is helping hard drive companies resist sacrificing margins for market share.

That has made for a blockbuster quarter for the two remaining U.S.-based hard drive makers, Seagate Technology (NYSE: - ) and Western Digital (NYSE: - ), which are known for being efficient and profitable industry players. And analysts expect the good times to continue -- welcome news for one of the technology sector's most commoditized industries.

"A lot of discipline has come back, and, added to that, demand has perked up," said Krishna Chander, an analyst with iSuppli.

Hard drive makers have seen a broad surge in demand -- from large corporations needing more units to store digital records to consumers looking to store more media files on their PCs and iPods.

Brian Dexheimer, chief sales and marketing officer at Seagate, says demand also is being driven by Web 2.0 sites such as MySpace that need mountains of hard drives to store the ever-rising tide of new members and the content they create on their Web pages.

"It's really driven at both ends of what's going on in the home," Dexheimer said.

Double-Digit Sales Growth

Shipments of hard drives jumped 17% in the third quarter from a year ago, to more than 133 million units, according to John Monroe, an analyst at Gartner. The figure represented a 21% jump from the second quarter.

Seagate recently reported that sales increased 18% to $3.3 billion for its first quarter ended Sep. 29 vs. the year-ago period. Adjusted earnings rose more than 300% to 69 cents per share, topping views.

Western Digital, the smaller of the two hard drive titans, reported sales growth of 40% to $1.8 billion in the quarter ending Sep. 28. Adjusted earnings rose 72%, crushing analysts' expectations.

Western Digital has seen its stock climb about 40% in the past three months while the Nasdaq was flat. Seagate has climbed about 15% over that period.

"It's a combination of better overall pricing and seasonal demand," said Matthew Kather, a W.R. Hambrecht analyst who has a buy rating on both stocks. "Seagate and Western Digital are likely taking share."

Other players in the industry include Hitachi (NYSE: - ), Toshiba and Samsung.

Chander says a price war broke out in the early part of the year, driving down prices and making investors nervous.

In the first five months of the year, Western Digital shares slid about 10% and Seagate was off 20%. Seagate blamed a decline in earnings on a price war over desktop disk drives, while Western Digital cited soft pricing for flat earnings.

But that began to change during the summer.

Gartner's Monroe says demand picked up, balancing out supply. As of November, worldwide sales channels had less than three weeks' worth of hard drive inventory in various stages of the supply chain, an ideal level. Normally even four weeks' worth of inventory is a bit tight.

And the future is looking brighter, thanks to seasonally strong demand for the second half of the year.

Unlike previous years, hard drive makers aren't rushing to pump up production to try to cash in on the holiday selling season. They don't plan to add capacity until at least the second quarter of 2008, Monroe says. That should keep production in line with generally rising demand while keeping prices from cratering, he says.

"We're seeing more and more (players) manage for profits, not share," he said. "There's just more mature management."

Samsung Changes Philosophy

For example, Monroe says Samsung has shifted its focus away from basic desktop-type hard drives toward higher-end drives that pack more storage and super-compact drives for digital music players. That's kept supply more in balance with demand.

"Samsung just changed their philosophy," he said.

Another help: Fewer companies cuts the chances that one of them will resort to a price war. Industry consolidation over the last three years has shrunk the number of significant hard drive makers from 10 to six, Monroe says.

Asian firms at times get the blame for starting price wars. But Monroe says everyone -- including the U.S. hard drive makers -- are guilty.

"It doesn't matter who fired the first or second shot. It's who fired the third or fourth shot," he said. "It takes more than one or two bad apples to spoil the whole group."

Seagate and Western Digital tend to do well when the industry is healthy. Kather says they distinguish themselves with better reliability -- not with products necessarily, but with more dependable deliveries to distributors and retailers.

"There's been multiple cases where the Asian vendors have completely fallen down on that front in the past two quarters," Kather said.

Monroe says Seagate set itself apart five years ago with more flexible manufacturing and Western Digital did the same two years ago. The changeover has given both companies the ability to make more than one type of drive on the same production line, something the others still can't do, he says.

"Manufacturing flexibility," he said, "is going to be a key differentiation."