Industry Fragmentation Will Cause These 3 Companies to Surrender

Michael is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The fast food, headphone, and hard-drive industries are increasingly becoming more fragmented as new competitors continue to enter the market. Americans are estimated to spend nearly $200 billion this year on fast food. The U.S. market for headphones is expected to rise almost 25% to over $3 billion this year. Solid-state drive (SSD) shipments are predicted to at least double this year to 83 million units worldwide due to lower-cost laptops, tablets, and other portable devices.  Despite these positive trends within each of these sectors, industry fragmentation will eventually cause the following three companies to surrender sooner than later.

Fast food options favor the consumer

Year-to-date, Wendy’s (NASDAQ: WEN) is up over 55% and it currently is at a 52-week high. Last month, the old quick-service restaurant chain reported its third straight quarter of positive net income with $12.2 million as revenue passed $650 million for the second quarter. While Wendy’s appears to be making all the right moves, the fast food industry has changed a lot in the past 20 years.

Lower expectations have favored the chain recently. Of the 160,000+ fast food locations in America today, roughly 6,200 of those locations belong to Wendy’s. Back in 1990, Wendy’s had just 3,700 locations as it produced sales that exceeded $3 billion annually. With 2,500 more locations today, inflation, and an American population that grew by over 65 million, Wendy’s produced just $2.2 billion in sales for 2012. Comparing net income totals, 1990 resulted in $39.4 million whereas 2012 saw just $7.1 million.

More options have clearly benefited consumers over the years, and as quick casual restaurants like Chipotle and Panera Bread add to the mix of choices, not being a first choice among Americans when it comes to fast food will continue to hurt Wendy’s in the near future.

Wendy’s has been increasing the rate of closing its poorly performing locations annually up from just 43 in 2010 to 135 in 2012. It also recently announced the sale of 425 company-owned locations to franchises. Both decisions are expected to help boost profit margins and the bottom line. However, it may be too little too late as the restaurant industry, and fast food in particular, continue to become more fragmented.

Headphones are too trendy

It would be hard to find a more fragmented industry than the headphone business. Skullcandy (NASDAQ: SKUL) has seen its stock decline over 71% since its July 2011 IPO of $20/share.

Financially, the company has heard better news. The first- and second-quarter results for 2013 showed year over year net sale declines of 30.4% and 29.9%, respectively. Net sales in the first half of 2013 have been just $87.9 million, far from the pace of its 2012 total sales of $297.7 million.

The competition has greatly impacted Skullcandy. For example, Dr. Dre’s Beat Electronics entered the market five years after Skullcandy, but its annual sales hit $500 million just three years after entry. By comparison, Skullcandy has never produced TTM sales past $300 million. In addition, the $5 billion global headphone market is also the focus of larger electronics powerhouses like Sony, Panasonic, and Bose.

Skullcandy may already acknowledge defeat to some extent. In last year’s annual report, it mentioned about entering into the gaming peripheral market and it already has expanded into non-related headphone product lines like clothing and apparel.

In the end, the headphone market is too competitive and trendy because the human hearing range isn’t changing from the 20 to 20,000 Hz range. When you consider that there are no true competitive advantages in the headphone market, you realize that that trends and fads are the real margins and add to the bottom line.

Hard drives are driven by industry giants

Similar to Skullcandy, OCZ Technology (NASDAQ: OCZ) is a smaller contender in a highly fragmented and competitive market. A designer of primarily solid-state drives (SSDs), OCZ has faced financial difficultly and NASDAQ scrutiny as the company has failed to maintain listing and earnings submittal requirements.

The company appeared to fit right in with market trends a couple of years ago as SSDs have become more popular with more mobile options for consumers. It is hard to gauge where they are financially, however, since their last official quarterly report was July 10, 2012. Since then, there has been somewhat a cat-and-mouse game going on with shareholders, NASDAQ, and OCZ.

OCZ had made estimates in the $130 million-$140 million range for the August and November 2012 quarters, but gradually reduced expectations and skipped on submitting official earnings entirely. It later reported unofficially that revenue for those two quarters was in the $65 million-$85 million range. Preliminary results for the first quarter of this year were estimated to be $50 million-$55 million in revenue. Putting together the puzzle pieces with the fact that the previous five years of recorded quarterly earnings have all produced negative income but one quarter, it is likely that the business is in critical condition, and OCZ knows.

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WEN Total Return Price data by YCharts

Concluding thoughts

Industry fragmentation can be the worst enemy to a company. Wendy’s, Skullcandy, and OCZ all provide products that sell. However, Wendy’s faces the reality that the changing fast food landscape and time may have passed them by from their golden days. Skullcandy’s story shows that fads do indeed follow the definition of the word and styles are short-lived. OCZ presents how hard it is to compete in the tech industry when far larger companies with much larger market caps have the resources to slowly push smaller companies out entirely.

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Michael Carter has no position in any stocks mentioned. The Motley Fool owns shares of Skullcandy. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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