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Digital's Pc Pratfall

News: Analysis & Commentary: COMPUTERS


A bungled effort to grow ends in a big charge and layoffs

No.5 in '95. That was the market-share goal that Enrico Pesatori set for Digital Equipment Corp. when it entered the PC business on his watch in 1993. Pesatori, vice-president and general manager of DEC's computer systems division, had a personal goal, as well: He wanted the top job at Digital.

So much for those plans. Digital badly missed the mark on PCs, racking up an estimated $200 million loss for the division in the fiscal year ended June 30. Now, Pesatori is out. On July 1, CEO Robert B. Palmer issued a terse statement announcing that DEC's No.2 executive had resigned.

Bad news for Pesatori. But for Digital, the worst was yet to come. On July 2, Palmer said Digital would cut 7,000 jobs during the next year and take a restructuring charge of $475 million for the June 30 quarter, putting the full-year profits under pressure. The company's stock declined 12% on the news, to 40 3/8. Coming less than two years into a fragile turnaround for DEC, the drastic moves raise questions about Palmer's long-term strategy and Digital's staying power. "At some point, they are going to end up being forever a niche player," says Lynn Berg, an analyst with Gartner Group Inc.

PRICE WARS. Success in PCs had been an integral part of Palmer's plan. His theory: If Digital could successfully adapt to the falling prices and compressed product cycles of the PC industry, it could apply those lessons to its core computer systems business.

But under Pesatori's watch, Digital made a series of missteps. Last December, the company poured computers into the distribution channel in anticipation of sales that never developed. Then, with distributors holding 16 weeks of inventory, Digital was forced to take back large numbers of PCs and cut prices on the rest. At the same time, a fierce price war erupted. Digital's PC sales dropped 10% in the quarter that ended in March.

Pesatori, though, refused to alter his strategy of building market share through high-volume shipments, say former Digital PC executives. In a meeting with investors and analysts in March, Pesatori publicly locked horns with Digital Chief Financial Officer Vincent J. Mullarkey over the issue. Mullarkey argued that growth in market share had to come second to profitability.

Pesatori is the third high-ranking Digital executive in the past nine months to leave after profit shortfalls. To some insiders, it's a sign of the drive for accountability that Palmer brought when he became CEO in 1994. But others contend that Palmer's zero-tolerance policy leads managers to adopt unrealistic targets. "It's a good thing to hold managers accountable," says Berg. "It's another thing not to keep a handle on what's going on in the marketplace."

The PC fiasco raises questions about whether Digital can ever be a major player in PCs. Rival Compaq Computer Corp. has lowered prices by 20% this year, putting smaller players like Digital under enormous strain. "We are a relentless competitor," says Compaq Senior Vice-President Robert W. Stearns. "Only the strong will survive in this business."

Digital's problems aren't all in PCs. Sales of Digital products in Europe, which account for 40% of revenues, are running some $150 million below expectations. Meanwhile, a strengthening U.S. dollar means currency exchange rates are expected to hurt earnings. What's more, given Digital's anemic 4% revenue growth, some analysts wonder how flagship Alpha systems can be growing at the double-digit rates the company claims. "The company talks about how well it's doing with Alpha," says Merrill Lynch & Co. analyst George D. Elling, "yet the numbers don't hold up."

Services, long the company's cash cow, still account for half of Digital's revenues, but profit margins have fallen in the last two years, and analysts say Palmer could sell part of the business. Other units reportedly on the block include Digital's money-losing printer and computer memory divisions.

Palmer told Wall Street that Digital will be back on track in six months. He has taken charge of the computer systems division and plans to run it at least until fall. Says Datapro analyst Peter Lowber: "If they don't do well, Palmer is definitely on the hot seat."By Paul C. Judge in Boston, with Ira Sager in New YorkReturn to top

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