Does Compaq's Formula Still Compute?Mark Ivey
Compaq Chief Executive Joseph R. Canion has always run his company with a simple ideal in mind: that its IBM-compatible personal computers were in a class by themselves. More than mere clones, Compaq Computer Corp. PCs featured the latest technology and incorporated advances others didn't have. They also carried higher prices and delivered fatter profits to Compaq and its dealers. The strategy worked like a charm. Compaq's machines gained a huge following in big corporations, and the nine-year-old company grew into one of the most successful startups ever. Its soaring profits--1990 net income reached $455 million on $3.6 billion in sales--made Compaq's stock a winner on Wall Street.
Lately, though, Canion's formula is showing signs of wear. Some computer buyers have begun to question whether it's still worth paying up to 30% more for a Compaq PC than for a clone from companies such as Dell Computer Corp. and AST Research Corp. These companies, as well as IBM, have been closing the technology gap that Compaq worked so hard to create. The week of Apr. 22, for example, all three--as well as such clonemakers as Advanced Logic Research, Acer, and Everex Systems--announced that they had already designed machines using Intel Corp.'s brand-new microprocessor, the 486SX. Compaq's is still in the stall, and the company won't say when it's coming. "We're ahead in technology overall," says Canion. But, says Roger D. Bender, president of the Microcomputer Manager's Assn., "customers realize they don't need to buy Compaq to get a good machine."
DAVID AND GOLIATH. That attitude could put Compaq's entire premium-brand strategy in jeopardy. Already, it has the computer maker on the defensive. To clear out bloated inventories and to stop a slide in its U. S. market share--from 8.7% in 1989 to 7.8% last year, according to market researcher InfoCorp--Compaq slashed list prices by as much as 34% in April. The company has also tried to mute its critics. It filed suit in U. S. District Court in Houston seeking to ban Dell advertisements that ridicule Compaq's high prices. Dell, based in Austin, Tex., is gleefully promoting the suit as a David-and-Goliath contest. "We've been running ads comparing ourselves to Compaq since 1987," says Chief Executive Michael S. Dell. "It wasn't until Dell became a threat to their business that they sued." Says Canion: "We're just trying to keep them from misleading the public."
Compaq has already gotten a glimpse of what life might be like without its premium image. Even though its price cuts came after the first quarter ended, they cost Compaq about $23 million, since the computer maker refunds to dealers the difference between the old and new wholesale prices on their inventories. So, on Apr. 25, the company reported net income of $114 million for the quarter--about 7% below what analysts had anticipated. And Compaq warned that slimmer margins will likely produce second-quarter earnings below last year's. The company's stock took a nosedive on the double whammy, tumbling 15% that day, to 52 1/2.
Even with the cuts, Compaq's prices remain relatively high. Now, for instance, Compaq asks $4,799 for a notebook computer based on the 80386SX chip, down from $6,999 before the cuts. But a similar machine from AST sells for $3,795 (table). While dealers normally discount Compaq's list price, they won't be doing as much of that now: To try to protect its 41% gross margins, Compaq cut the wholesale discounts it gives to computer stores from about 40% to 30% for the highest-volume stores.
Longer-term, Compaq has a plan to restore its technological luster. In early April, the company said it will supplement its PCs with office workstations based on the RISC (reduced instruction-set computing) technology now used in engineering workstations. For help in building the machines, Compaq invested $185 million in Silicon Graphics Inc., a Mountain View (Calif.) maker of three-dimensional graphics workstations. Then, to try to build a market for the machines, Compaq formed a consortium of 20 companies, including Digital Equipment Corp. and software giant Microsoft Corp. They have agreed to focus on the same basic workstation design. If the Compaq consortium succeeds, the company can shake off its clonemaker image and grab the lion's share of credit for establishing a new industry standard. At the very least, the effort will move Compaq into one of the fastest-growing computer markets. While growth in the $34 billion U. S. personal-computer market has slowed to less than 5% or so annually, sales of RISC workstations are growing at 24% a year. Indeed, while Compaq was disappointing Wall Street, workstation maker Sun Microsystems Inc. turned in a strong report for its third quarter, which ended on Mar. 29: Revenues grew 34%, to $848.3 million, and income rose 60%, to $58.7 million.
But Compaq won't be able to bring a workstation of its own to market until 1992. And it could be later--owing to continuing disagreements over product details among the diverse participants in the consortium, insiders say.
FOREIGN PROSPECTS. In the meantime, Compaq faces a price war at home and slowing growth abroad. For more than a year, Compaq has been able to compensate for a slowdown in U. S. sales with strong international growth, primarily in Europe. Last year, overseas sales soared 49%, to $1.9 billion, or 54% of total sales. But much of that growth was exaggerated by a weak dollar. Now, between slower demand for computers in Europe and a stronger dollar, Compaq's foreign prospects aren't as good. Overseas sales rose just 16% in the first quarter--and only 6% after currency benefits were factored out. That has analysts slashing their earnings estimates. Soundview Financial Group analyst James W. Weil figures the company will earn $431 million in 1991, down from last year's $455 million, on sales of $4 billion, up 12%.
Canion insists that he's not worried and that Wall Street is overreacting. "We still have the best machines," he says. "The perception had evolved that we were overpriced, so we're repositioning." But critics say it's more than that. Says one consultant who has worked closely with Compaq: "They prospered by creating a premier image and commanding more than everybody else and by selling PCs only through loyal retail dealers. Now, they're seeing it doesn't work as well."
It's too soon to tell whether or not Compaq's price cuts and image-building campaign will pull defecting customers back into its camp. Once buyers get a taste of the competition's machines, "they're not going to be hotfooting it back to Compaq the minute it cuts prices," says Jim Poyner, an analyst at William K. Woodruff & Co. If Poyner is right, Compaq's Canion may have to come up with a new ideal.
Mark Ivey in Houston, with bureau reports