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Will Flash Bring Cash for Gateway?

By Sarah Lacy You have to give Wayne Inouye credit so far: He's had quite a year atop struggling Gateway Computer (GTW). The computer maker's president and CEO slashed the work force to just under 2,000 people, or a quarter of its former size, shuttered the entire cow-themed chain of Gateway Country Stores, and slipped its products into nearly 8,000 retail shops, including several big chains overseas.

As a result, market share for the Gateway line is up 55% year over year in retail stores, according to the NPD Group. He also pulled back on low-margin consumer-electronics gear, such as flat-panel TV sets and digital cameras, and refreshed the entire line of notebooks and PCs with sleeker designs and more features.

LANGUISHING STOCK. The moves have helped the company narrow its losses quarter by quarter. When Gateway announces second-quarter earnings on Aug. 15, analysts are predicting the first profitable three-month period since the end of 2001 -- if only just by two cents per share. Sales are expected to be $895 million.

The move into the black has put some attention on this quarter, and Gateway officials want to make sure they get it right. The company has delayed filing twice while it waits on a ruling from the Securities & Exchange Commission on how to account for a $150 million settlement with Microsoft.

While Inouye has proven he has a knack for streamlining costs and elbowing Gateway's products into retailers, he hasn't managed to move the needle on the outfit's stock -- at least in the right direction. The Irvine (Calif.) company's stock price has barely budged, trading at $3.81 a share on Aug. 12 -- down about 30% since Inouye took the reins in March, 2004. The Gateway chief, formerly the head of eMachines, came aboard when Gateway acquired eMachines for $262 million in cash and stock. (Gateway adopted eMachines' management team almost wholesale.)

LESS FOLKSY. But Wall Street worries about Inouye's ability to avoid getting stuck in the profitless game of low-margin, low-cost products. The open question on Inouye: Does he have the chops to remake Gateway as a premium brand? "He did very little marketing at eMachines other than, 'We're cheap,'" says Roger Kay, president of market researcher Endpoint Technologies Associates.

The company wouldn't comment for this article. But in past interviews and discussions with analysts, it's clear that Inouye's next steps are focused on beefing up Gateway's marketing and design skills. The company needs to create an identity, aside from the cow theme it has been known for in the past. Analysts say the PC maker realizes it needs laptops that someone can spot as a Gateway laptop (like Apple laptops), and they need to have some wow factor if they're going to steal attention on the retail shelf.

So far, the new line of products, introduced from February to June of this year, is a big improvement. New laptops, for example, have a sleeker and sharper look -- they're a quarter-inch thinner, with contrasting black and silver. What's more, the Gateway black-and-white cow spots are gone -- but not completely. The Gateway logo is the same but less folksy because it's monochromatic and on a brushed-steel background.

MARKETING HELP NEEDED. That's just the start. Inouye is committed to using design to differentiate the Gateway brand. He convinced John Loudenslager, owner of design firm Duo, to close his doors and come work exclusively for Gateway. Loudenslager was the director of design for Compaq in the mid-1990s before striking out on his own. Although hiring Loudenslager was less expensive than acquiring Duo outright, it's a dramatic departure from the way eMachines was run -- a virtual company with nearly everything outsourced.

It's not all about design. Analysts say Gateway's PCs perform better, too. Gateway was the first to use the Intel designed BTX Chassis, which rearranges the guts of the computer so you need fewer fans to cool the machine. That helps batteries last longer and makes the machine quieter. But analysts note that the outfit still needs some standout products. "They had silver things that were not attractive and not comfortable, and now their notebooks are similar to Toshiba's," Enderle says. "They need a couple of flagship products."

Next on Inouye's to-do list: Marketing. Gateway has lost Kathy Stauffer, an electronics-marketing guru from Good Guys who was hired by Inouye as vice-president of marketing about a year ago. According to Endpoint Technologies' Kay, she tired of the commute from San Francisco to Irvine. "She left with Wayne's blessing, but it's a shame because she was really quite good," Kay says. "Only Apple really does good marketing, and they [Gateway] need someone to help them."

"BIG OBSTACLES." Even with better marketing and design, Inouye faces an uphill battle. The big growth and fatter profit margins are in notebooks, but the competition is fierce between Dell (DELL), Hewlett Packard (HPQ), Toshiba, Sony (SNE), and others.

And in desktops, it could be hard to wean consumers off the expectations of cheap machines. Even the mighty Dell -- one of the lone consistently growing companies in recent years -- missed sales expectations when it announced earnings Aug. 11, in part because of missteps pricing its PC too low (see BW Online, 8/15/05, "Dell's Shortfall, Dell's Challenge").

To grow, Gateway will have to steal share from HP, which has been entrenched in retail chains longer. "They've got big obstacles in their way," says Steven Baker of the NPD Group. "I don't know that anything has been missing, [but] you just can't take over the world in one day."

WILL COSTS REBOUND? Inouye also needs to start closing large deals with big businesses -- a tough market to crack because it's dominated by Dell. There's a set list of vendors companies are approved to buy from, according to analysts, and Gateway has never been on it. With Dell's strong products and low prices, corporations will be loathe to try out a new player, especially one that's a shadow of its former self. In past interviews, Gateway executives have noted this is a long-term strategy.

Short term, Inouye will likely focus on consumers, schools -- where Gateway has made great strides in the last year -- in addition to small and midsize businesses. Trouble is, these are tough markets to sell to because they are so fragmented. It's much easier to ring up $80,000 in sales by calling on one big corporate customer than peddling one computer at a time to college kids and mom-and-pop operations. And even though Gateway now has an enviable retail presence, getting buzz in these markets will require some slick, Apple-like marketing.

But creating marketing buzz could add to the costs Inouye has spent so much time and effort wringing out of the company. Gateway is finally at the point where its margins rival superefficient Dell's. And its marketing, sales, and administration costs are down from 23% to 9% -- on par with Dell. That means it can compete in the low-price trenches and still make a nice profit.

"It's a very complex problem for a company whose primary advantage is keeping things simple," says Rob Enderle of market researcher the Enderle Group. "They'll have to staff up to do it right. That makes them less attractive to Wall Street." It's all new territory for Inouye -- eMachines' computers sold well, but the low price tag was all the advertising they needed. Lacy is a reporter for BusinessWeek Online in Silicon Valley

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