Editor’s note: Lenovo’s latest earnings report last week highlights the challenges the world’s No. 1 PC maker faces as inorganic growth disappears. So says Technology Business Research analyst Jack Narcotta.

HAMPTON, N.H. – Despite year-to-year corporate operating margin improvement, revenue growth in its Motorola and System x server segment, and nearly delivering on its promise to restore its Mobile segment to operating profitability, a stout challenge remains for Lenovo: halting revenue declines in its PC segment despite, per Lenovo, record-high global PC market share of 21.6%.

The upward trajectories of its Motorola and System x businesses speak to Lenovo’s ability to integrate, then reinvigorate slumping businesses. However, the incremental gains from these smaller business units are more than offset by the prolonged decline of its PC business.

Over the last year, Lenovo benefited from the addition of Motorola and IBM’s System x business, with corporate revenue and gross profit growing in excess of 15% and 30% year-to-year each quarter since calendar 4Q14. However, 4Q15 marked the end of Lenovo benefitting from inorganic growth. Lenovo’s overall revenue declined 8.4% year-to-year to $12.9 billion in 4Q15 despite Motorola’s and System x’s revenues rising 5% and 1% year-to-year to $2 billion and $1 billion, respectively; Motorola and System x combined for $3 billion in revenue in 4Q15, or approximately 23% of Lenovo’s total revenue.

While TBR is forecasting a narrower year-to-year revenue decline of 2% in 1Q16 to $11.1 billion, the scale of the PC business — and the impact of its declines — remains the most present threat to its long-term goals to reinvent itself in the post-PC era.

Challenges created by lower PC ASPs and fewer units shipped will persist for Lenovo

TBR believes that while Lenovo is protecting its PC margins by stabilizing the cost structure related to this business, it has yet to solve the problems the shrinking global PC market and lower PC ASPs present to revenue and profit growth. PC revenue tumbled 12.2% year-to-year to $8 billion, and PC ASPs declined 8.5% ($49) to $521. Typically, PCs account for more than 60% of Lenovo’s total revenue each quarter, amplifying the importance of restoring growth to this segment. Additionally, the impact of foreign exchange rates will follow Lenovo through 2016, especially with nearly 70% of its total revenue for any given quarter generated outside the U.S.

Additionally, lower PC revenue returns fewer gross profit dollars. While TBR believes Lenovo’s sales efficiency and manufacturing acumen helped keep PC gross margins steady year-to-year at approximately 14%, the smaller amount of PC gross profit — which TBR estimates accounts for about 65% of Lenovo’s total gross profit each quarter — complicates Lenovo’s intent to use its PC business to bankroll its mobile and enterprise initiatives.

Workforce reductions in its Mobile and Enterprise segments, as well as consolidating and streamlining its mobile device and server supply chains, have helped Lenovo rein in expenses related to those segments and move on from an uncharacteristic period of mismanaging inventory. However, the smaller pool of gross profit generated by PCs will hamper Lenovo’s desire to reach the aggressive goals it has set for its mobile and enterprise businesses as well as compel it to adapt its PC go-to-market strategy.

Macro trends affecting the PC market will have a pronounced effect on Lenovo’s go-to-market strategy in 2016

While achieving regional and global market share targets remains a component of its go-to-market strategy, thinner profits dictate a more selective, if not cautious, approach to pursuing opportunities in the global PC market.

Instead of implementing a volume-centric sales approach, which typically features lower-priced, less-profitable PCs that would prove costly to Lenovo’s margin-focused business model, TBR believes Lenovo will focus on increasing profit-per-unit to kick-start revenue and unit shipment growth, electing to focus on boosting sales of PCs that carry higher ASPs, such as its ThinkPad commercial PCs, and Yoga and Carbon consumer PCs.

While TBR believes this strategy has merits for a profit- and margin-centric company such as Lenovo, with commercial markets particularly overdue for a refresh of PCs, endeavoring to move PC users up the pricing ladder is a risky play in 2016. The allure of the Yoga and ThinkPad brands will garner additional growth and market share for Lenovo among premium consumer and enterprise segments, but the bulk of its PC business, and therefore its overall business, will remain under siege by customer sentiment shifting to favor lower-priced devices.

Lenovo’s global scale and brand strength ensure it will remain among the leading vendors in PC markets, but the proliferation of lower-priced, “good enough” PCs that boast similar features and specifications to their premium counterparts will be an obstacle in front of this go-to-market initiative.

(C) TBR