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SanDisk Wants to Grow Its Gadget Arsenal

The flash memory maker aims to be the next hot consumer electronics company.

Investors showed no quarter on

SanDisk's

(SNDK)

stock after the company

warned of steep pricing declines in the flash chip business.

However, lost in the panic (which sent shares more than 6% lower on Wednesday) is another trend taking shape at SanDisk that may have a big effect in shaping the company's future.

Building on some of its early products such as MP3 players, SanDisk is now seeking to transform itself into a vertically integrated consumer electronics company.

"We should not be looked at as a component supplier, because we're really an end-to-end solutions provider," SanDisk President Sanjay Mehrotra said in a conference call with analysts after the company's fourth-quarter earnings report on Tuesday.

"We want to become a global consumer powerhouse, and we want to achieve that by bringing new products, new ideas that leverage our technology manufacturing and the vertical integration business model, including our worldwide retail sales footprint," he said.

Mehrotra pointed to a bevy of recently released gadgets, such as a wireless MP3 player and its USBTV flash-based TV recorder, and promised more to come.

With the recent success of companies such as

Apple

(AAPL) - Get Apple Inc. (AAPL) Report

in setting the pace of newfangled electronics devices, it's easy to see the appeal of stepping up consumer efforts.

For SanDisk, the move offers a chance to outrun commoditization in the flash chip business and to tap new revenue streams.

But it also distracts from SanDisk's important business of staying ahead in the chip race, and if the company isn't careful, it could ultimately hamper -- not boost -- the proliferation of flash-based gadgets.

NAND flash memory, which retains data even when an electronic device's power is switched off, is at the heart of many of the hottest new consumer electronics devices. As one of the world's largest NAND flash makers, SanDisk has benefited from this trend, with sales leaping by 41%, 30% and 64% in its past three fiscal years.

For the good times to keep rolling, though, flash memory needs to continuously get adopted in new types of devices, as it has in digital cameras and MP3 players in past years.

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In 2006, there wasn't any fundamentally new type of electronic device based on flash memory that came to market. Not coincidentally, prices for flash memory cratered in 2006, as demand couldn't soak up supply.

At SanDisk, the average price per megabyte sold crashed 58% year over year in 2006 -- very close to the 60% danger zone, a level of price erosion that SanDisk acknowledges is not sustainable yet couldn't rule out from happening in 2007.

SanDisk's answer is to create the demand itself: If the market isn't producing new hit products based on flash memory, SanDisk will do it for them.

"They see it as an opportunity to accelerate the adoption of products that are enabled by NAND flash technology," says American Technology Research analyst Doug Freedman.

New products such as SanDisk's portable video player and the USBTV, announced earlier this year at the Consumer Electronics Show, seek to turn mobile video browsing into the same mass-market phenomenon that MP3s have become.

And because SanDisk makes the entire product itself, it eliminates the middleman and the accompanying markup that ordinarily gets added to the retail price. This means SanDisk can sell the product for less money, increasing its chances of getting widely adopted by price-sensitive consumers.

SanDisk may not have the design and marketing DNA of a consumer electronics firm. But it has another asset: direct ties to 208,000 retail stores, ranging from consumer electronics chains to wireless phone carrier outlets.

"If they

SanDisk want to push a product, all they have to do is go to all the retailers they work with," says Gartner memory analyst Joseph Unsworth.

That's how the company built up its market share in USB flash drive and MP3 player businesses so quickly, says Unsworth. Today, SanDisk has the No.2 spot in the MP3 player market, according to industry research firm NPD Group. (Of course, SanDisk's current 11% share is still dwarfed by Apple's 72% share.)

But success in the consumer market could be a double-edged sword.

As SanDisk increases its consumer presence, it runs a risk of working against its own goal of fostering new markets for flash memory. The do-it-all advantage that SanDisk has of producing its own flash and selling the final product could cause other electronic companies to shun flash memory in their own products, since they can't compete with SanDisk on cost.

"The question is, do they create the technology, demonstrate the technology and then enable the larger food chain to adopt it? Or is their effort actually counter to their goal and

will it cause less of an adoption as

companies become hesitant to add NAND flash to their device, given that they will be at a disadvantage to a SanDisk product?" wonders Freedman.

The consumer foray has other risks, from weighing down SanDisk's profit margin to distracting the company.

"It's not like the semiconductor business is easy," says one hedge-fund investor.

For each new consumer product that SanDisk rolls out, the company could be adding a few more competitors to its universe.

Of course, if SanDisk somehow comes up with the next smash hit product, none of that may matter.