From Page One of Electronic News:October 27, 1997 Issue
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PC Profits: Hard For Some, Easy For Others
By Carol Haber
PC companies reported mixed earnings in the third quarter as the PC marketplace underwent drastic changes. Bigger profits were earned by companies that had targeted the consumer low end and/or had adopted their logistics to today's market demands. While consumers were going for the under $1,000 PC, the corporate market stalled as company MIS officers waited for the latest Pentium II technology. Suppliers to the PC companies were buffeted by the same phenomena.
Among the standout performers, Compaq recently reported worldwide sales grew 31 percent from 3Q96, with net income up 54 percent from a year ago. Unit volume vaulted 56 percent (EN, Oct. 20). Dell Computer revenues in its most recent quarter rose 67 percent quarter over quarter, and net income, 108 percent. Unit shipments grew "four times the industry rate."
Giants like IBM and HP did not fare as well. IBM reported overall gains, beating estimates (see story, page 48), but difficulties in PC operations tied to the low end of the consumer market. Hewlett-Packard, in its most recent quarter ended July, reported consolidated gains and "outstanding" increases in its PC business, but HP is expected to address the surge in low-end consumer business in the current quarter.
Still analysts think the changing nature of the industry make it likely that industry giants will eventually dominate the PC market, not necessarily those doing well now.
Among factors determining success in the PC marketplace today are: a broad product line to serve more sophisticated and entry-level consumers; degree of penetration into the corporate desktop market; scope of services and support: low production costs/economies of scale; distribution model; increasing value of brand names; and ability to stay on a rapid technology curve.
While companies like IBM and HP may not be so quick to respond to the whims of the consumer market, with their massive services and support infrastructures geared for the rich corporate desktop business, those companies, along with others, may stand the strongest chance to overpower rivals when consolidation occurs. This, as they utilize economies of scale and learn the ropes of new distribution models for lower-priced consumer offerings.
HP has been doing "very, very well" with PCs in the near term, according to Phil Rueppel of B.T. Alex. Brown, but like IBM has not been as quick to capitalize on the $1,000 PC. HP will address the low end in the fourth quarter, he said. HP's PC unit was one of its fastest growing large businesses, he added. About 20-25 percent of HP's business goes through the retail channel to consumers and small businesses, a ratio similar to Compaq's.
Today's Leaders In A Mixed Market
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But right now, "Two companies that seem to be distancing themselves from the pack are Compaq and Dell," said Mr. Rueppel. "Compaq in indirect sales and Dell in direct. IBM is not doing as well because it appears to have missed the low-end consumer buying cycle. Gateway appears to be having more difficulty than Dell because of its focus on the consumer and its loss of focus as it moves into retail, with ARL on the server side. It is a less focused company than Dell. They do have some low end but not very good penetration into mid and large businesses, where volumes are more consistent quarter to quarter."
Mr. Rueppel admires what Compaq has done. "Compaq is the number one market share vendor," he said, "and is leveraging that into further market share gains. I believe Compaq has the lowest cost of production of all and also has the broadest product line. When it was apparent that the $1,000 PC was going to be a big success, Compaq could ramp volumes much more quickly than any other vendor. That's what is driving Compaq's success in the near term."
Dell, he said, has perfected the direct sales business model by reducing the amount of overhead involved with middlemen. Dell's distribution allows it to offer more configured, lower cost computers.
Dell sells primarily to business (90 percent) rather than consumers, but is pushing into the consumer market. "Near term both Dell and Compaq are doing extremely well. Compaq just reported its September quarter with sales up 31 percent and units up over 50 percent. It's hard to imagine better execution."
Contending For The Long Term
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Nampa, Idaho-based direct marketer MEI, he said, makes a good product but "I don't see any clear trend near or long term that makes me think it will be one of the winners in a consolidation, which I expect over the next five years."
Contenders for long-term dominance are IBM, HP, Compaq and Dell, said Mr. Rueppel. "The top vendors still have less than 50 percent market share. I believe the market will evolve...into three or four large players and some smaller ones, but not the hundreds there are now. There are economies of scale which impact logistics and distribution, and the procurement of parts."
While the PC market is "fairly healthy" right now, one key concern, which "we are all trying to figure out" is: While the thousand-dollar PC is expected to have a lot of impact in the consumer space, "there is no impact or pressure yet for business users to move to a lower price point. We're watching that. We have seen relatively stable average selling prices (ASPs) in the corporate community. Expectations are that the corporate arena will be the first to embrace the Pentium II machines. This market segment of reasonably good power but inexpensive PCs...well, it is unclear how it will impact the players."
Joe Clabby at Aberdeen Group, Boston, also saw the industry giants hitting paydirt, but he is less sanguine about the futures of Compaq and Dell--even though they are booming today.
"Companies like Dell, Compaq and Gateway, companies that have no enterprise experience, are starting to try and build servers to push into the mid-range marketplace and up into the high end, primarily selling NT-based servers," he said. "I don't think they can do it. When you start playing in that market, you're in big trouble if you don't have services and support. They don't offer the services needed nor do they have the experience to help their customers deploy complex clustered solutions with distributed applications in multi-vendor environments."
He sees their broad product lines as a disadvantage. "The irony here is that they are making money right now because they've been selling at the workgroup level. They've been doing okay to date, but how long can they continue to do well if they're trying to defend their low-end markets while moving into the high end?" he asked.
On the other hand, "In the low-end market, the big players, IBM and HP, for example, have figured out how to do just-in-time inventory management and put together very potent channel programs for inventory management, and so now the ones with the experience at the high end have figured out how to pump product through the channels. Another squeeze for the Dell's and Gateway's.
"The big boys have finally figured out how to compete at the low end of the marketplace and how to appeal to indirect channel resellers...I don't see it long term for Compaq, Dell at all...."
Profits are in the NT marketplace, and the leader there, he said, is Compaq because it has done so well in desktop and workgroup. Second would be HP and third, IBM. "IBM--and especially HP--will start encroaching and potentially overtake Compaq in the next two years in the NT market space," he predicted.
Similar Problems For Suppliers
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Suppliers to PC manufacturers are also keeping on top of the trends.
Cirrus Logic, Fremont, Calif., is banking on integration in manufacturing and design and product definition to do the job of keeping costs low. It is also working very closely with customers to keep inventories just right. (See Breakfast in The Valley, page 1)
The company, which manufactures system-level ICs, draws about 25 percent or more of its revenues from the PC market.
Satish Gupta, VP, corporate marketing and business development, said that while building its stake in the commercial market ("where the growth is"), Cirrus Logic is taking steps to accommodate the low-end consumer trend by leveraging integration in manufacturing and product definition, which leads--not to classic cost-cutting--but to cost-reduction opportunities. He added, however, that often "What we gain in technology we lose in what we add in terms of operating systems and applications to give people what they want."
Mr. Gupta predicted that next year "We will probably see a really significant segment of the consumer market under $1,000."
Distribution also becomes more critical at Cirrus Logic as price points descend. "We work very closely with customers on inventory reduction programs. All of them want to cut inventory as close to zero as they can. We engage with them on all the advanced information systems as well as overall support to provide the inventory as late as they require it in the market. Basically we need to communicate a lot and understand each other's businesses a lot better."
Will the lower-end consumer trend make profitability harder to come by? Mr. Gupta commented: "It's plenty difficult to make money now in a market with Intel's dominance. There are very few dollars left for the others. However, we should have the opportunity to make appropriate profits as the technology allows us to get to the price point we want."
At Seagate Technology, in Scotts Valley, Calif., Jeff Burke, director of market research, is keeping track but counting on "a good cost structure that allows us to play where most of the volume is." For hard disk drives, this is in the $130-$170 range, the sweet spot for the under-$2,000 system market. "Seagate will argue you can get the best cost structure by being vertically integrated. Probably we're the most vertically integrated business besides IBM."
The low-end trend requires a greater variety of drives for consumers, who want more functionality on a cheaper machine. "It creates a lot of opportunities," he said.
Logistics grows as an issue. "Big companies like Compaq want to cut inventories down and do it just-in-time. The ability to have local inventory for drives is very important, and we're partnering with customers on the new logistics," Mr. Burke added.
In addition, Seagate product marketing manager Denise Lippert noted that the user base for PCs is more sophisticated. "That's one of the biggest changes. People are buying second and third PCs. You have a stronger technical knowledge base out there at the consumer and reseller level, and the PC has become more complex. A lot more devices are being installed in it; functionality has expanded. More users will be willing to try updating to extend existing PCs. At Seagate, we have enhanced the design by putting a device like SeaShield, a protective cover for the drive's printed circuit board which helps improve reliabiity and make installation easier," Seagate said. Also included is a label that includes installation instructions.
"This may make it easier for the reseller to integrate the drive, which can cut down on warranty costs and technical services."
Mixed Earning Reports Tell The Tale
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The PC picture was reflected in recent financial reports.
Last week Gateway posted a loss, including charges, of $107 million on a 25 percent revenue gain and 31 percent increase in units shipped, for its third quarter ended Sept. 30, 1997. Revenues totaled $1.5 billion, up 25 percent from $1.2 billion in 3Q96. "We continue to gain market share but our growth in the quarter wasn't what we expected," said CEO Ted Waitt. "We took aggressive action on our inventory issues and remain focused on reducing overhead costs."
Meanwhile, in Japan, consumer sales of PCs hit the skids after the consumption tax was raised 67 percent from 3 percent to 5 percent. Fortunately, most U.S. suppliers have only small participation in that business. But bad business in Japan is driving Japanese makers to target the U.S. market.
Mitusbishi Electric has started to export notebook PCs to the U.S. for the first time since 1990. Both Hitachi and Fujitsu have announced they will increase shipments of motherboards to their U.S. assembly plants so each can increase U.S. sales from 100,000 units per year to 200,000.
With consumer sales impacting earnings of PC makers to a greater extent, all eyes are again on the Christmas selling season when so much consumer business is transacted. |
