A year ago, eMachines (EEEE) was a highflying startup. The maker of low-cost computers had rocketed in a single year from zero sales to No. 7 in PCs shipped in North America, according to International Data Corp.
But now the company is feeling the squeeze. On one side, lower-priced offerings from bigger brand-name PC companies such as Dell (DELL) and Compaq (CPQ) have cut into eMachines' and other second-tier manufacturers' sales. On the other side, eMachines faces a rising tide of Internet appliances that, for as little as $200, offer basic functions such as e-mail and Web surfing. As if this weren't bad enough, eMachines also faces a slowdown in demand for computers.
The result: eMachines expects to have dismal fourth-quarter earnings, and its shares have dropped into the penny-stock range. But eMachines is hardly alone. While the big five computer companies -- Dell, Compaq, Hewlett-Packard (HWP), Gateway (GTW), and IBM
-- can hunker down behind their brand names and huge corporate clients, the second-tier PC makers are flailing as their core of small-business customers drastically cuts back on info-tech purchases. Thus, eMachines and its ilk have received "a disproportionate amount of pain," says Roger Kay, research manager for technology consulting at IDC.
CLOSINGS AND CONSOLIDATION. How much pain? Fountain Technologies, the parent of two prominent second-tier players, CyberMax and Quantex, filed for bankruptcy protection in August, leaving thousands of disgruntled customers in a lurch (Internet message boards are still full of rants against the two companies). The sales of non-branded PCs in North America, typically sold by lesser-known makers, dropped from 7.3 million in 1999 to 5.4 million last year, according to IT analysts Reality Research & Consulting.
Acer, Micron (MU), and NEC all have been slammed after lame revenue reports in the last quarter. And eMachines could face a delisting from Nasdaq this March. Experts agree that the likely outcome for the industry will be closings and consolidation. The second-tier PC makers don't "have a defensible value proposition," says Kay.
Declining demand for PCs, motherboard shortages, and markedly increased price competition during 2000 left their mark on nearly all PC players. Market leader Dell, with 19% of PC shipments in North America, has watched its stock drop from a 52-week high of 59 11/16 to just under 20 as the economy has slowed down. And the Goldman Sachs Computer Hardware Index, weighted heavily toward the larger players, has plummeted from a 52-week high of 690 in December to less than 400 on Jan. 9.
LANGUISHING. But market-share leaders Dell and Compaq clearly have the financial stamina and brand recognition to make it through what looks to be a rough year. But it could be considerably rougher for the likes of Micron, No. 11 in terms of PC shipments to North America. The company posted third-quarter earnings of 58 cents, missing Wall Street's expectations by two cents. Its stock has languished in the $30 to $40 range since mid-October, a far cry from its mid-July high of $97.
Fat profit margins have lured the top companies into the lower-price market
Taiwanese computer manufacturer Acer Inc. is likewise losing ground (see BW, 1/15/00, "For Acer, a Bad Year Turns Brutal"). The company posted revenues of $2.52 billion for the first nine months of 2000, a 13.2% decline from the same period a year earlier. eMachines also missed its fourth-quarter estimates by a wide margin and is expecting to post losses of 19 cents to 23 per share.
Tough times for the second tier began last year when they faced component shortages and found themselves frozen out while Intel took care of the bigger brand-name makers first. Meanwhile, the fatter profit margins enjoyed by white-box computer makers lured brand names into the lower-price market. While a top-name desktop computer typically has a 10% profit margin, a lesser-name machine could allow for a 17% profit margin, explains Richard March, senior director at Reality.
In response, Compaq began manufacturing some of its computers in Asia, selling them online worldwide to compete with smaller retailers. PC giants like Compaq and Dell are now using lower-price machines coupled with superior customer service to lure away the small businesses that had been the second-tier companies' bread-and butter, says March.
SIMPLER RIVALS. "The first-tier companies recognize that there's less room for differentiation in terms of features and performance. IBM held high position and lost market share," says Keith LeFebvre, director of desktop and workstation product marketing at Compaq's Commercial PC Group.
Acer, Micron, and other low-cost sellers are suffering as Internet appliances gain ground, says March. With some models going for as little as $200 and offering Web access and e-mail, which often are all a small business needs, these new devices could be a more attractive buy than even a non-branded PC.
Other problems are plaguing the second-tier PC makers as well. Some of the brand-name companies for which Acer makes machines claim that Acer is competing too closely with them. Micron has been dragged down by its memory-chip business as chip prices have slumped for more than three months.
While some second-tier PC makers can weather the tough times -- for example, Sony and Toshiba both have backing from massive parent companies as well as defined niches in the higher end of the market -- companies in the category are nevertheless struggling to keep up. Adding to the pressures are the stepped-up offerings from surviving local and regional PC companies that formerly sold hardware but now emphasize personal service.
A LOSING BATTLE? "If all they're doing is selling a desktop computer that's going to sit on somebody's desk -- that's not enough," says Calvin Lam, president and founder of PC company Avus. Lam's company makes only 2,000 computers a month but emphasizes enhanced customer support and network-management services.
Alas, that's not an option for most second-tier makers, which have streamlined manufacturing operations. And they may be fighting a losing battle as profit margins in the already brutal sector continue to shrink. Of the bunch, eMachines, which has never posted a profit, appears to be in the most precarious position. The company declined to comment for this story.
Analysts expect other second-tier companies either to consolidate or sell off their PC manufacturing arms if the slowdown in computer sales persists. In the long run, only a few large PC companies and some specialized outfits will dominate the market, says Kay. The question is who will survive a year that in the second week of January is already shaping up as a real pressure cooker. By Olga Kharif in New York