Strategies for Survival in PCs
By Monica Rivituso
January 25, 2001
BOY, IT'S TOUGH to turn
middle-aged. There are the aches and
pains, the things you just can't get
away with anymore, the growing
conviction that your glory days are
behind you. Just ask the
personal-computer makers.
Their once quintessentially adolescent
industry is starting to look awfully
creaky in the knees. Just about
everybody who wants a computer has
one, and one just about as powerful as
they could possibly need. PCs look
more and more like a commodity — a
Dell (DELL) computer seems about
the same as a Compaq (CPQ) as a
Gateway (GTW) — so their makers
are increasingly competing on price.
The economy is weakening, sales
growth has slowed sharply and these
stocks, onetime Wall Street darlings,
are deep in the dumps. Sigh. They
don't call it the maturing of an industry
for nothing.
But for companies as for people, it's all
about what you make of whatever life
hands you. And just as some of us
react to advancing years by hitting the
couch while others react by hitting the
gym, the responses of computer
makers to their industry's slump are
pretty varied. And some are more
promising than others. From the
launch of new consumer-electronics
devices that will attach to home PCs
to a push into corporate markets,
there will be a couple of key scenarios
for investors to watch this year.
The PC makers that are most closely
tied to the consumer market are the
ones facing the greatest challenges
right now. U.S. sales growth of
consumer PCs slowed to just 0.3% in
the fourth quarter, down from 17% the year before. And there's not much reason to
think things will pick up anytime soon. Roughly 60% of U.S. homes now have a
PC — which many say means the market is pretty much saturated. And these
days, people can generally accomplish what they want to with the system they
already have; few need to upgrade to a 1-gigahertz processor to crank out a Word
document or surf the Net. The advent of broadband Internet connections could
persuade more folks to trade up to zippier machines — but a widespread rollout is
still a ways off.
What has some PC makers more imminently excited, though, is the prospect that
computers could become the electronic hubs of homes. Some of the more
consumer-focused hardware makers could end up looking more like
consumer-electronics manufacturers, churning out PDAs, MP3 players, digital
cameras and the like for buyers to plug into their PC systems. Such electronic
gadgets, which electronically organize life's minutiae, download digital music or
take digital pictures, offer more immediate benefits to consumers than a new PC
with a slightly faster microprocessor. If computer makers can siphon off some of
those sales, they could effectively create some new revenue streams for
themselves.
"I think Hewlett-Packard (HWP), Compaq and Sony (SNE) are probably the
three best-positioned companies in the next few years in terms of providing a lot of
different kinds of products to people," says Stephen Baker, PC Data's vice
president of technology products research and analysis. How come? Compaq and
Hewlett-Packard already have their own branded Pocket PCs. In addition,
Compaq's product portfolio includes a personal digital music player and the
BlackBerry wireless email device. And it goes without saying that Sony, maker of
the popular Vaio notebook line, has a deep arsenal of consumer electronic
devices including everything from digital video camcorders to portable DVD players
to digital cameras.
But much of the benefit of broadband and gee-whiz consumer electronics is off in
the future. In the meantime, Dell appears to be the PC maker that's
best-positioned to cope with the grind of a sluggish market. Because of its low
costs, it has plenty of muscle to flex in a price war. And indeed, it's been
aggressively slashing prices lately in order to gain market share. According to
IDC's latest market research, Dell's world-wide PC shipments increased 30.9% in
the fourth quarter, while Compaq's increased only 4.2%.
"Dell has a low-cost manufacturing model and they have a history of success in
being able to grow market share when times get tough," says Eric Rothdeutsch,
an analyst at Robertson Stephens. "So, when the industry emerges on the other
side of the slowdown — which could happen as soon as the second half of this
year — I think Dell could be a stronger company."
That isn't to say that Dell doesn't have some areas that need work. U.S. Bancorp
Piper Jaffray analyst Ashok Kumar points out that it isn't particularly strong in the
higher-end corporate market, and it "has a lot of holes to fill" in services, an
increasingly important part of the business. As dependent as Dell remains on
selling PCs, then, it's little wonder the company warned on Monday that its
fourth-quarter sales and earnings would come in substantially lower than
expected. Still, says Rothdeutsch, the company is "the best performer in an
otherwise poorly performing industry."
The poor performance of that industry caught the other well-known direct seller of
PCs, Gateway, by surprise. Gateway had embarked on an innovative program to
set up retail storefronts so consumers could walk in, test drive a computer and
then order it. The strategy helped the company increase its "beyond-the-box"
revenues (sales of peripheral products like software and of services like training).
Leaner Times
PC Shipments
(millions of units)
1999
2000
2001*
World-wide
117.6
134.7
156.3
Annual Increase
26%
14.5%
16%
U.S.
44.8
49.4
55.3
Annual Increase
24.3%
10.3%
11.8%
* Forecast
Source: Gartner Dataquest (January 2001)
But when the consumer market soured so badly in the U.S. — where Gateway
has its greatest exposure — it felt the pinch. Its beyond-the-box sales weren't
enough to compensate for the falloff in PC sales, and fourth-quarter results fell far
short of already lowered expectations. Gateway had to scale back its aggressive
expansion of its Gateway Country Stores, saying it would open only 60 to 80 retail
outlets this year in the U.S., compared with previous plans for 80 to 100.
Management also announced it would cut 3,000 jobs. "They need to find some
ways to leverage their consumer focus into some new product lines that maybe
aren't quite as attached to computing as they've done in the past," says PC
Data's Baker.
As woeful as conditions are in the consumer market, it's little wonder that other
PC makers are betting more of their futures on the so-called enterprise market —
that's the world of big corporate customers to the likes of you and us. As large
companies increasingly tie their operations to the Internet, they're going to need
beefier servers, more capacious storage systems and more comprehensive
services. Besides being a growing market, such corporate sales carry far better
margins than PCs.
Trouble is, that tasty market already has a couple of well-entrenched competitors
— Sun Microsystems (SUNW) and IBM (IBM). U.S. Bancorp's Kumar says Sun
probably has the strongest enterprise strategy going. While the company's
hardware has never been "best of breed," he says, Sun has succeeded by
focusing on providing services and overall solutions to its customers. "The PC
vendors would do very well to take a page from Sun's book," says Kumar.
And as for IBM, its Street-beating fourth-quarter report last week offered solid
evidence of how well Big Blue is faring in the corporate market. With a new
mainframe product, solid Unix server sales and a strong showing in services,
analysts say IBM is looking stronger than ever.
None of that is stopping Compaq from increasingly focusing on high-end
enterprise products. Of course, with Dell grabbing PC market share, Compaq may
not have much choice. While its 13% world-wide market share means Compaq is
still the top seller of PCs in the world, Dell is close on its heels with 12%,
according to the latest data from IDC. So instead of focusing on a desktop war
with a cost-advantaged rival, many analysts think Compaq will focus on the higher
end of the corporate market, even if it means conceding some PC market share in
the process. "Their focus as a company is going to be on selling servers and
high-end solutions," says Wit SoundView analyst Mark Specker.
Compaq has already done a decent job of expanding this area of its business,
judging from the fourth-quarter results it reported on Tuesday. Sales in its
enterprise-computing division rose 20% from a year earlier while operating income
ballooned 64%. Still, there's concern among some on the Street that Compaq
hasn't managed to expand its corporate customer base enough. And, as Gerard
Klauer Mattison's David Bailey noted in a report Wednesday, that might mean
trouble as it tries to peddle its high-end servers against the likes of
more-established industry players like Sun, IBM or Hewlett-Packard.
And where does all the industry turmoil leave Apple Computer (AAPL), that
perennial turnaround story? As bad as the overall PC market has been, the
company only managed to make matters worse last year when it failed to expand
its customer base, overpriced its new products and flubbed a sales-force transition
in its important education division.
Since Apple has a relatively tiny footprint in the corporate marketplace, analysts
don't even mention its name when talk of enterprise offerings comes up. And with
its most recent missteps having led it to its first unprofitable quarter since
co-founder Steve Jobs regained the company's helm three years ago, critics are
quick to label the company as nothing more than a niche player. "Apple has
always been a marginal turnaround story, and that's about it," says U.S.
Bancorp's Kumar. Ouch. Tough verdict for any aging hipster to hear.
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