Bleak Christmas for PC Makers, except DELL
Business Week: October 25, 1999
News: Analysis & Commentary: Computers
The Vise Trapping PC Makers
Caught between rising chip prices and stingy consumers
It was beginning to look like another blockbuster Christmas for PC makers. With slick new products, low prices, and Internet service rebates that promised ``free' PCs, record sales seemed certain. Until Sept. 21. That's when Taiwan was rocked by a horrific earthquake that disrupted America's big PC makers and other electronics firms from vital sources of supply. ``This was going to be a huge Christmas, but suddenly there's a wet blanket on things,' says Merrill Lynch analyst Steven Fortuna.
The disruptions in supply lines helped to tighten the vise in which the PC industry finds itself. On one side, consumers expect lower prices and can't remember the last PC price hike. On the other, suppliers are suddenly commanding higher prices for key components such as memory chips. A worldwide shortage of computer parts, from 3 cents capacitors to $400 flat-panel displays, has been driving parts costs up for months. The price of a 64-megabit DRAM chip has skyrocketed from less than $5 to almost $20 since July.
Complicating matters are delays by Intel Corp. on components needed for new designs--the models that command the highest prices. Several PC makers have had to put off the introduction of PCs for the Christmas season as a result. Intel itself reported disappointing earnings for the third quarter, citing, among other factors, more sales of cheaper chips than it had anticipated. On Oct. 13, the chip giant's earnings report sent its stock tumbling by 10% and helped take down the rest of the market.
Now, with the Taiwan disaster tying up supplies, PC makers are scrambling to secure the motherboards, chipsets, and other parts they need to meet demand--even if it means paying a lot more to get them. And that undoes the formula that allowed PC makers to thrive, despite falling prices. Before, they could use dropping component costs to help underwrite price cuts and make up for shrinking margins with higher volumes. Today, the options are less attractive: eat the rising costs and sacrifice earnings, or try to up their prices and risk losing sales. The latter seems risky, considering that the driving force behind surging PC volume--gains have run as high as 30% a month lately--is falling prices that bring new shoppers into the market.
Unless the supply situation clears up quickly, PC makers may be hard-pressed to crank out enough computers to meet demand, no matter what the price. Notebooks are already in short supply, and the earthquake could choke off supplies of graphics chips. Danny K. Lam, a semiconductor analyst with market researcher Fisher-Holstein Inc. figures supplies will be 5% to 20% below fourth-quarter levels. ``And you can't build a PC without a graphics chip,' he notes.
Already, Hewlett-Packard Co. has warned that its sales growth will be pinched, coming in at 7% to 10%, not 10% to 13% for the quarter ending Oct. 31. On Oct. 8, IBM, which lost $1 billion on PCs last year, announced plans to cut costs by laying off 10% of the workers in its consumer PC group. And on Oct. 13, Apple Computer Inc. reported earnings of just $90 million after one-time gains--25% below what analysts has been predicting before the company warned on Sept. 20 that a shortage of key chips would slow sales.
The situation, if it persists, could dull the luster of Wall St. darlings such as Dell, Gateway, and Apple. All have been rewarded by investors for their streamlined, just-in-time manufacturing setups, which enable them to quickly benefit from falling parts prices. But with fewer parts in inventory, they're more exposed to rising prices and shortages.
Dell Computer Corp., by virtue of its size, might minimize the damage: Few suppliers will risk losing its business to take advantage of what may be short-term pricing power, say analysts.
Apple and Gateway may not fare so well. Apple's decision to double the memory in its new iMacs, to 64 megabytes, could cost the company $50 million in the fourth quarter, say analysts--equal to 20% of anticipated profits. ``If you're Dell, it's no big deal. If you're Apple, it's a big problem,' says Brown Brothers Harriman & Co. analyst William J. Milton Jr.
Hardest hit will be the second-tier brands. Not only will they be hard-pressed to secure parts, but they will face daunting margin pressures. Companies such as emachines earn just $40 or so on their cheaper models--just a few dollars more than the rise in the price of memory since July. ``The rise in memory prices alone marks the difference between making money and not making money,' says Andrew Watson, president of PC maker Monorail Computer Corp.
There is good news. For starters, demand shows no sign of abating. ``Our PC customers continue to be bullish,' says Guerrino De Luca, CEO of mouse-maker Logitech Inc. And what's more, few believe parts prices will remain high for long. Continued price drops on some parts, such as disk drives, continue apace. And many analysts think the high memory prices may be short-lived. As long-suffering Asian chipmakers ramp up capacity to profit from the higher prices, ``I'm guessing spot prices could fall back to $6 by November,' from $18 today, says Dataquest analyst James Handy.
Still, relief isn't likely to come by Christmas. To ease the pressure, some top players are contemplating something unheard of in PCs for most of the '90s: price increases. Already, Dell has raised prices in Japan on its Dimension J model, from $870 two weeks ago to $1,000. And if significant parts shortages crop up, these companies hint they'll build more profitable, higher-end machines. ``[Consumers] may not see as many low-end units available,' says Michael J. Larson, head of Compaq Computer Corp.'s consumer division.
Getting customers to pay more may be wishful thinking, however. Since 1997, the average price of a home PC has dropped from $1,642 to around $800, according to Ziff-Davis InfoBeads, and that's not counting the $400 rebates that Internet Service Providers such as America Online Inc. are offering to customers who sign up for three-year contracts. So if PC makers stuff shelves with fancy models with who-cares features, sales could suffer even more. ``Consumers may not have a very wide range of models to choose from this Christmas, and I think unit sales will drop dramatically as a result,' says analyst Allison Boswell.
That's a worst-case scenario, to be sure. But having trained customers to expect perpetual price drops, PC makers may have little wiggle room. Ask Julio Meran, 43, a tax accountant in Lawrence, Mass. He recently put off buying a high-end machine in favor of an emachines model that cost $199 after a rebate. That's not to say he doesn't want a screamer, but he'll only buy one if the price falls by a few hundred bucks. For PC makers, making that happen is looking tougher all the time.
By Peter Burrows in San Mateo, Calif., with bureau reports |
