News: Analysis & Commentary: HIGH TECHNOLOGY
HIGH TECH: `THERE'S SOMETHING WRONG OUT THERE'
Computer-industry overcapacity is taking a toll
What's bugging high tech? From every corner of the industry--modems to microchips to database software--companies have stunned Wall Street in recent weeks with warnings of disappointing earnings. In most cases, companies have cited special circumstances--currency-hedging mishaps or production snafus--and assured investors that the high-tech engine behind so many capital gains is not slowing.
But some industry veterans fear that a slowdown could be coming. "There's just something wrong out there," says Stephen Luczo, president of Seagate Technology Inc., which in December said it would shutter one plant in Ireland and postpone expansion of another. "My sense is that things are slowing down, but all our big customers are saying demand is great. Someone isn't telling the truth."
For now, Luczo is part of a gloomy minority in the perennially upbeat high-tech community. Even factoring in the effects of the crisis in Asia, market researchers, Wall Street analysts, and company executives still predict double-digit growth for 1998. International Data Corp. lowered its prediction for 1998 personal-computer sales growth by a mere two points, to 13%, as a result of the Asian troubles. Analysts tracked by First Call expect computer makers to post 22% earnings growth in 1998, up from a weak 12% this quarter.
Still, the pieces are falling into place that could create a very painful decline if, for whatever reason, demand falters. Around the world, there is already excess capacity in the businesses that supply components for computers. At the same time, computer makers are pushing harder than ever for lower prices--in part to preserve their own profits as they crank out sub-$1,000 PCs. In coming weeks, Hewlett-Packard Co. and Compaq Computer Corp. are expected to announce new home PCs with price tags below $800--which will set the bar even lower for partsmakers.
So, even as demand remains strong, many companies are living through the weird experience of a profitless prosperity. Disk-drive leader Seagate lost $240 million in its first quarter, ended Oct. 3. Rival Western Digital Corp. expects only to break even in its second quarter, ending Dec. 27, and Quantum Corp. on Dec. 10 announced that quarterly earnings would fall by about half, to around $50 million, despite record sales. On Dec. 15, chipmaker Micron Technology Inc. announced that quarterly earnings had fallen 53%, to $9.6 million, despite 31% revenue growth, while Cypress Semiconductor Corp. lowered expectations from a slight profit to breakeven. Network equipment maker Cabletron Systems Inc. has announced plans to lay off 600 workers following disappointing earnings.
"WE'VE GOTTEN DRUNK." These companies have unique problems, but all share a common ailment: excess capacity. Makers of everything from $2 memory chips to sophisticated $1 million networking switches for the Internet have spent the past year cranking up production in an all-out battle for market share. "For the last few years, we've all gotten drunk on technology spending," says Luis F. Machuca, head of NEC's corporate-PC unit. And, in a euphoric mood, they have spent liberally on new plants.
All that new capacity has led to price wars. Even before Asia's woes, the industry was seeing troubling declines in prices for disk drives, memory chips, software, printers, and PCs. Rather than the usual 25%-a-year price cuts, disk-drive prices have dropped over 10% this quarter alone, says Quantum Chief Executive Michael Brown. After falling 75% from mid-1996 to mid-1997, prices on memory chips fell an additional 25% last quarter.
That puts more and more companies close to the edge. If Asian economies fall further or if the U.S. economy slows markedly in 1998, losses among high-tech companies could mount. On Dec. 9, Oracle Corp. shook the market by announcing disappointing sales and earnings--thanks in part to a slowdown in sales to Asia and overall sluggish demand for its core database product.
Now, for the first time, there's talk that the slower growth could hit some of the industry's strongest computer makers, too. Citing the prospect of a tough 1998 because of the Asian crisis, analyst Daniel T. Niles of BancAmerica Robertson Stephens downgraded Compaq, Hewlett-Packard, and Dell Computer on Dec. 15. "Anyone who says `It won't affect me' doesn't get it," says Niles. "If NEC can't sell anything in Japan, they're going to come here." Niles's choice of companies is especially disturbing: HP has become a bellwether for the tech sector and Compaq and Dell have long seemed immune to market gyrations.
What could bring down such highfliers? Beyond an overall economic downturn, analysts now worry about how upcoming technology will sell. The industry depends on a periodic injection of new features to get customers excited. The next thing on the horizon is Windows 98, which has been scheduled to ship by mid-year. Many industry executives have been questioning whether the new Microsoft Corp. operating system can drive new sales the way Windows 95 did. Now, with Microsoft embroiled in litigation that might apply to Win98, delivery could slip (page 40). At the same time, many corporations are focusing their computer budgets not on new gear but on fixing their software to work beyond 1999 (page 41). Already, analysts have cited spending on the Year 2000 bug as a reason for slower spending on some of Oracle's products.
SHAKEOUT. Even if the economic picture doesn't deteriorate, high tech is in for more consolidation. For instance, there are 15 disk-drive makers chasing the 20% of the market not dominated by Seagate and a handful of other market leaders. One of them, Micropolis, filed for bankruptcy on Nov. 19. In desktop PCs, the top players hiked their market share from 50% to 60% in the past year, hurting second-tier companies such as AST, Acer, and Apple Computer. And in memory chips, Japanese and Taiwanese companies are preparing to wrestle market share back from cash-strapped Korean giants such as Samsung and Hyundai.
At the same time, Asian companies such as Fujitsu Ltd. and Samsung Group are expected to make a bigger push into the U.S. Their home markets are drying up, and their falling currencies give them a pricing edge in the West. Western Digital and Micron Technology have already complained of Asian rivals selling below cost. In notebook PCs, some U.S. suppliers say they have sacrificed margins to keep up with Toshiba's aggressive pricing. In printers, Canon and NEC are producing sub-$100 printers that are often given away free by retailers to move slow-selling PCs.
Another factor in the profit equation is the move to "build-to-order" manufacturing by computer makers. Hoping to match the efficiencies of direct-mail leader Dell, companies such as Compaq, Hewlett-Packard, and IBM are starting to rejigger their plants to build systems to customer specifications--and avoid a buildup of costly inventory. But the changeover to that system is causing major dislocations among parts suppliers, who are getting stuck with excess inventory. According to estimates by Michael K. Kwatinetz, an analyst at DMG Technology Group, the shift to build-to-order will lead to a one-time 7% hit on PC component sales this year.
To be sure, global demand for high-tech products is still brisk. A survey by SoundView Financial suggests that corporate spending on information technology will rise 9.5% in 1998, compared with a 10% increase in 1997. "The appetite to deploy technology is nothing short of voracious," says Dennis J. O'Leary, chief information officer for Chase Manhattan Bank, which will spend nearly $2 billion in 1997, roughly the same as in 1996.
But there are still those in the high-tech crowd who are beginning to--ever so quietly--question whether the neverending tech boom might just be getting a bit tired.By Peter Burrows in San Mateo, Calif., with Gary McWilliams in Houston, Paul C. Judge in Boston, Roger O. Crockett in Chicago, and bureau reportsReturn to top