The surging popularity of computers priced under $1,000 is squeezing one supplier after another -- but not Compaq Computer Corp.
Compaq (CPQ) yesterday rang up a 54% jump in profit and a 31% increase in revenue for the third quarter, and reported that its unit sales jumped 56%. That's nearly three times the growth rate of the industry as a whole. More than half the quarter's sales of consumer PCs -- a small but crucial piece of its business -- came from two systems that cost less than $1,000. And thanks to adroit planning, the machines made money despite after-tax profit margins of just 2% to 3%.
Compaq's stock price fell sharply yesterday, amid a broad market downturn and jitters about technology stocks in general. But the company's third-quarter performance was so strong that directors voted to pay a three-cents-a-share quarterly cash dividend, the first cash dividend in the company's 14-year history.
Just this week International Business Machines Corp. became the latest casualty of the rush to buy cheaper PCs. Blindsided by the trend, and without a model below $1,000, it's expected to fold its home PC division into the IBM (IBM) operation that makes business PCs, slashing hundreds of jobs.
Meanwhile, Gateway 2000 Inc. (GTW) warned last month that its third-quarter performance wouldn't meet expectations because of a buildup of higher-priced machines. Circuit City Stores Inc. (CC), the biggest electronics retailer, attributed slower PC sales in September to a shortage of models below $1,000.
But Compaq decided a year ago that consumers really would buy leaner computers if they could get them much cheaper, and it began offering the lower-priced machines last February. Even so, its executives concede they didn't expect the systems to fly off the shelves. "Back-to-school reaction was a lot higher than any of us ever thought," says Earl Mason, Compaq's chief financial officer.
How has Compaq managed to stay profitable in this extraordinarily cutthroat marketplace?
To begin with, it picked a Cyrix microprocessor to power its first system. The chip, which was specifically designed for less-expensive computers, combines functions like sound and graphics into the main processor, cutting the manufacturer's cost per chip by about $100.
The move gave credibility to Cyrix Corp. (CYRX) and other Intel Corp. rivals and pressured Intel (INTC) to slash prices. As a result, Compaq can now sell a $799 system based on Cyrix's Media GX chip ($999 with a monitor) and a $999 model powered by an Intel Pentium chip.
Both of Compaq's cheaper systems have limited expansion capacity, use less powerful components and are smaller than more expensive models, all of which helps make them cheaper to produce. Compaq designed its tower-shaped $999 unit to look almost exactly like its $1,500 and $2,000 models from the front, which is how consumers see them on store shelves.
But the system is seven inches shallower in the back, which lets Compaq use less plastic and smaller packaging and lets the company stuff more units on each of its trucks.
To keep other costs down, Compaq hired Taiwan-based First International Computer Inc. to assemble the Cyrix-based systems at a plant in Austin, Texas. Doing that let Compaq keep the inventory off its balance sheet until the computers were actually completed.
To promote the systems, Compaq was willing to pay more for cooperative advertising than it pays for its other more expensive models. In August, according to Computer Intelligence, a La Jolla, Calif.-based market-research firm, Compaq sold 76,000 of the sub-$1,000 machines, more than two-thirds of all the machines it sold that month. Overall, stores sold 112,000 PCs priced under $1,000.
The company also tracks sales better than it used to. By Tuesday each week, Compaq managers know how much of each model was sold the previous week in 85% of the U.S. retail stores where its machines are sold. When sales of the $999 Presario 4505 started soaring in July, Compaq was able to increase its manufacturing capacity for the machines by 25% to keep stores supplied in August.
"We're getting better at ramping the lines faster," says Michael Heil, senior vice president of Compaq's consumer products group. "This is all basic blocking and tackling."
Others have been less successful. Packard Bell NEC Inc., the longtime leader in PCs sold through retailers, introduced a Pentium-based sub-$1,000 system in January, more than a month ahead of Compaq. Almost immediately, though, it had trouble keeping up with demand. By keeping stores stocked with its systems, Compaq, already the world's biggest PC maker, pushed past Packard Bell in retail sales this summer.
When Compaq started selling the cheaper machines, it didn't know whether their availablity would expand the computer market or change it. But evidence is mounting that consumers are shifting their purchases to low-priced computers from the fully loaded, $2,000 models they used to buy.
Further, a study by Computer Intelligence showed that buyers of sub-$1,000 machines and higher-priced computers had similar household incomes, signaling that cheap computers are attracting sophisticated, repeat buyers.
Investors felt the impact this week when Intel reported third-quarter profit below Wall Street's expectations and projected only slight revenue growth in the fourth quarter. The chip maker, based in Santa Clara, Calif., has been slashing prices to keep rivals Advanced Micro Devices Inc. (AMD) and Cyrix from winning business supplying makers of low-end PCs, and to push the market to new chips that offer computer users new advantages. Intel executives say they are perfectly willing to reduce high profit margins to keep market share and stimulate unit demand.
In the third quarter, Compaq earned $562 million, or 71 cents a share, before a $44 million, or six cents a share, charge related to the acquisition of Tandem Computers Inc.
Revenue was $6.5 billion, up from $4.9 billion a year earlier. Compaq adjusted its prior-year results to include Tandem.
Profit and sales were chiefly lifted by higher-margin workstations and servers, but the volume increase resulted from the sub-$1,000 systems. In the consumer business alone, Compaq's third-quarter unit sales more than doubled.
The higher margins associated with Tandem's specialized advanced computers bolstered Compaq's gross margin to 27.4% from 25% in the second quarter. With Tandem factored in, Compaq's gross margin would have been 26.4% a year ago.
Buoyed by such momentum, Compaq's directors also recommended a 2-for-1 stock split. Shareholders of record on Oct. 31 will be asked to vote on the split, the second of the year. Assuming it is approved, a holder who purchased 100 shares in 1991 and held on would own 1,500 shares after the split.
Copyright (c) 1997 Dow Jones & Company, Inc.
All Rights Reserved.
-------------------
Try The Wall Street Journal Interactive Edition at wsj.com for concise company briefing books and detailed stock quotes.
Transmitted: 10/17/97 09:38 (L100ZS2t)
SO WHY IS THE PRICE TAKING SUCH A HIT???????????? |
