THREAD ---The Wall Street Journal -- August 12, 1998
Computers:
PC Makers Hunt for Gold in Internet Hookups
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By Evan Ramstad
Staff Reporter of The Wall Street Journal
Faced with sinking prices and slowing demand, the makers of personal computers are preparing to do something radical: make money from Internet services.
Compaq Computer Corp., the biggest maker of consumer PCs, has reached separate agreements with a range of on-line service providers, including America Online Inc. and GTE Corp., and electronic retailers including Amazon.com Inc. Hewlett-Packard Co. has cut its own deal with GTE. In each case, the Internet company has agreed to share with the hardware maker a slice of the revenue on-line customers generate using Compaq or Hewlett machines.
In exchange, the PC makers have redesigned their keyboards to add "quick-access" Internet features -- and, naturally, give prominent placement to the Web sites and services of their partners. Compaq's 1998 consumer desktop PCs, for example, have four new Internet buttons -- for connecting, searching, electronic mail and shopping -- with automatic links to America Online, GTE.net, Amazon.com and Walt Disney Co.'s on-line store. Every time a customer orders, say, a book from Amazon.com using his Compaq Presario, Compaq gets a portion of the sale. The companies won't disclose how much.
The companies' quick-access features could make the Internet easier to use. They also would shift some of the control over how consumers use the Internet into the hands of PC makers and their on-line partners. The PC industry is hoping the new features also could reinvigorate the economics of making and selling computers.
"These are the first steps to a dramatic new world for the PC and companies like us," contends Rod Schrock, chief of Compaq's consumer division. Three other hardware concerns -- Packard Bell NEC Inc., International Business Machines Corp. and Gateway Inc. -- have forged similar on-line pacts, while also trying to tap Internet revenue by creating their own services.
If the on-line service business becomes as lucrative as expected, then the entire economic model of PCs could someday move in the direction of pagers and cellular phones: Customers would pay a minimal amount for the hardware but would agree to pay for the service over a fixed period.
Selling PCs that way isn't all that far-fetched. In France, people have accessed the Minitel on-line service via "free" computer terminals for 15 years. The cost of the hardware is hidden in the monthly fee.
"You could envision something like the cellular-phone business model here," says Phil Hester, chief technology officer for IBM's personal-systems division. "With prices coming down and margins coming down, that day is probably not too far ahead of us."
It may take more than a simple point and click to get customers to accept the new Internet features. Compaq has already found out how easy it is to annoy users by herding them into preselected Internet sites. In response to early complaints from testers, the company had to modify its software to make it easier to reprogram settings on the Net buttons.
Then there are all the problems and uncertainties of the Internet itself. Even though they are called "quick-access" buttons, the new Internet features don't shave any time off the long wait endured while most home PCs get on the Net. And over the long term, the PC may still be supplanted by the television set as the way most households go on-line.
Still, PC makers are salivating at the thought that the Internet could restore their battered profit margins. If they can cut the right deals, PC executives think, Internet and related services could provide 15% to 25% of their consumer revenue in just a few years.
Today, hardware provides about 95% of that revenue. Compaq, with 1997 consumer PC sales of $3.8 billion, is aiming to have consumer PCs generate $1 billion in Internet-related revenue by 2001. Mr. Schrock says he believes one million Compaq buyers will have tried either GTE's or AOL's services by next July.
On-line executives say they hope the new agreements with hardware makers can help keep customers signed up to Internet services. "There's skin in the game for both parties," says Alex Coleman, a vice president at GTE Internetworking Services. Barry Schuler, president of America Online's interactive-services unit, says PC prices are nearing the point where a monthly Internet service could conceivably come with a "free" PC. The critical point, he says, may be when the price of a PC and monitor falls below $500 -- down from a low of about $800 today.
"If we could put the service out for something like $35 a month and you got the hardware with it, we think that's a great price," Mr. Schuler says. AOL, the nation's largest on-line service, currently charges $21.95 a month for unlimited access.
Compaq's Internet plans emerged last year. Executives were reviewing a deal with America Online that was about to expire. In it, AOL, like other on-line service companies, was paying Compaq a fee for installing AOL access software on consumer PCs.
Compaq had just conducted research showing that on-line services were now consumers' No. 1 reason for buying PCs. Compaq decided to help encourage Internet use and push for speedier connections by investing in a cable-TV venture and joining a consortium of phone companies working on fast phone-line technology.
Mr. Schrock set out to shift Compaq's Internet strategy into even higher gear. He directed engineers to make it simpler to connect to the Internet from Compaq PCs. In addition, Compaq decided to offer GTE's Internet service in addition to AOL and negotiated with both services to share revenue from customers' monthly fees. It also offered a $100 rebate to customers who signed up for GTE's service
Compaq made signing up for an on-line service one of the steps in the start-up program that runs the first time users turn on their computers. Previously, several on-line services appeared as logos on the PC desktop every time. Now, once users make their initial on-line selections, they are connected via preset links directly to the services and home pages of Compaq's partners -- with just one push of a Net button.
Other companies have similar on-line arrangements in the works. AOL says it is sharing revenue with IBM and Packard Bell NEC as well as with Compaq. Meanwhile, GTE is working with Compaq and Hewlett-Packard, which countered Compaq's rebate offer with its own offer of 50 hours of free Internet access and maintenance of a personal Web site.
Gateway is taking a different route. Since May, it says, the number of subscribers to its on-line service, Gateway.net, has surged, following the start of a financing program called "YourWare." Customers choose a computer, software and Internet service and pay for all three in 48 monthly payments starting at $29, for a total of $1,392. The computer alone would cost about $1,000.
Partly because of the bundling and financing effort, Gateway's gross profit margin jumped to 20.6% in the second quarter from 19.5% in the first quarter. Gateway says the number of subscribers is approaching 100,000. "I'll think you'll see more of this from the industry," says Bart Brown, Gateway's marketing chief.
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