`This Is Not A Fun Business To Be In Right Now'Catherine Arnst
Long ago, the personal-computer industry changed from a freewheeling world of garage-shop entrepreneurs to a complex, $ 80 billion-a-year industry. But one holdover from the early days was an ever-present zone under what executives called the price umbrella. This umbrella, set up by IBM, Compaq, and Apple, was the relatively high prices charged by the major players that allowed upstart, low-overhead vendors to sell computers for 20% to 30% less.
Now, the umbrella is collapsing, and computer makers are bracing for the aftermath. Instead of just following the clone makers' moves, the top players are prepared to take the lead in cutting prices. The result: an industrywide shakeout that could eliminate hundreds of clone makers. "There are 500 suppliers -- and 450 shouldn't exist," says Intel Corp. President Andrew S. Grove.
As Bear, Stearns & Co. analyst Andrew Neff puts it: "This is not a fun business to be in right now." Like other analysts, Neff has scaled back earnings projections for PC makers. He has also launched a regular report called Shakeout Watch that lists the already departed and those on deathwatch.
Shakeout fears have been building for a year. With too many players seeking a slice of the slowing PC market, price-cutting had already more than doubled from the normal 15% annual rate. But the fears became more vivid on June 15, when Compaq Computer Corp. decided to outdo clone makers with a new line of PCs priced from $899. Wall Street reacted swiftly: Compaq shares dropped 10%, to $25. Shares of Dell Computer Corp. -- a prime target of Compaq -- plunged 25%, to $15.75, three days later, when it warned analysts that price cuts might jeopardize its usual 6% net profit margins. Dell also joined a half-dozen computer makers, including Toshiba, NEC, Hyundai, and Acer, in cutting prices in reaction to Compaq's move.
CASUALTIES. The squeeze may be just beginning. Chief Executive Eckhard Pfeiffer warns that "in a month or two, we'll be calling you back" for more price cuts. IBM is also joining the fray, hawking PCs on 800-number phone lines in the U.S., selling an Asian-built clone in Europe, and promising a new line of low-priced PS/2s this fall. Meanwhile, Apple Computer Inc., which hiked its market share to 19% last year from 11% in 1990 after slashing prices, plans new sub-$ 1,000 Macintoshes this fall.
Who will survive? Only companies with lots of cash, low operating costs, and the guts to live through a protracted price war. With prices dropping as much as 40% a year and shipments inching up only 8%, revenue growth will be flat at best, according to International Data Corp. Already, Philips subsidiary Magnavox, KLH Electronics, and Goldstar have exited the U.S. market this year. Money-losing Northgate Computer is selling out to Everex Systems for just $ 4.5 million, and mail-order supplier Zeos International Ltd. lost money in the first quarter. And Packard Bell Electronics Inc. nixed an initial public offering because it couldn't get its asking price. The most vulnerable companies are the hundreds of no-name clone makers with less than 1% market share.
If this sounds like deja vu, that's because it is, sort of. In 1985, the PC industry went through a similar shakeout after IBM decided to stop clone makers -- particularly Compaq -- from grabbing market share. IBM slashed prices and expanded its dealer network. Within a year, dozens of companies were gone. "Back then, it was IBM on one hand and a bunch of very small companies on the other," says Marc Schulman, an analyst with UBS Securities Inc. "This time, the competition is much better financed, so the war could last a lot longer."
DIRECT APPROACH. Indeed. AST Research Inc. co-founder Thomas C. Yuen says his company is bracing for a three-year upheaval. He ticks off the factors: overcapacity, many strong players with lots of money, a determination to sacrifice margins for market share, and a perpetual pool of newcomers from Taiwan and South Korea. "The significant players are not going to have a total failure, like bankruptcy. We also won't see anyone give up major market share," says Yuen. "We have come to the conclusion that no one is willing to concede."
So, if no one will concede, what will it take to play? Low prices are a given. After that, there are a lot of theories. Compaq says its brand name will again give it clout. After all, if PCs cost the same, why buy Brand X? Tandy Corp. says there's already a shift to brand names at its Computer City superstores. "It happens in every other commodity business, including soap," says Vice-President Howard Elias. "There's no reason why it shouldn't in the computer business."
That PCs are now a commodity is abundantly clear. A big reason is that most of the innovation is done at the chip or software level, leaving little room for PC makers to be both creative and price-competitive. As a result, "the companies that count on technology alone will be in the most trouble," says IDC analyst Aaron Goldberg. Instead, marketing will be a critical factor. To attract the customer's attention, PC makers must throw in more features and jump into new distribution channels, such as mail order, warehouse stores, or mass-merchandise chains.
That's why so many PC makers are getting into direct sales, the marketing method that made Dell an $ 890 million company in just six years. Dell made mail order respectable in the eyes of major corporations, which put the squeeze on Compaq. Now that Compaq is squeezing back, founder Michael S. Dell says he's not rattled. "They've come into our ring to play our game," says Dell, "and we think we know the game much better than they do."
As Compaq meets it on price, Dell is upping the ante in marketing by adding more customer-support services. At the same time, it's bringing out new models that it says will sell for less than the wholesale prices Compaq charges dealers. And Dell can afford to keep fighting: It has a strong balance sheet, including $175 million in cash.
The other way to separate winners from losers may be in manufacturing, IBM's strong suit. Because it makes most of its own components, IBM has the opportunity to control costs and quality. Compaq also has invested heavily in manufacturing. Dell claims highly efficient assembly plants, although it makes few of its own components.
PUBLIC PAIN. Packard Bell has already discovered the problems that can crop up when a company depends too heavily on subcontractors. In the prospectus for its aborted IPO in January, the company disclosed that although gross sales grew 35% in 1991, to $ 820 million, net sales were 17.5% lower because so many machines had been returned -- an ominous indication of possible quality problems.
Packard Bell may be better off staying private, says Ted Waitt, president ef Gateway 2000 Inc., a mail-order supplier. In a price war, it's an advantage not to have to answer to Wall Street. Says Waitt: "You can't have all these public companies losing money continuously."
That may be true. But even Wall Street understands that, in a lengthy price war, no pain, no gain. So it could be a long time before the PC business is fun again.