Compaq: All Things To All Networks?

It was in early 1992 that CEO Eckhard Pfeiffer began telling analysts of his goal for Compaq Computer Corp.: to overtake IBM as the world's No.1 supplier of PCs by 1996. Compaq breezed past Pfeiffer's goal two years early. Along the way, the Houston PC maker also stomped IBM and other old-line outfits in the server market by selling inexpensive--but highly profitable--machines to help companies control networks of desktop computers. Thanks to corporate buyers who continue to favor Compaq's PCs and servers, earnings for the second quarter, ended June 30, are expected to rise 19%, to $250 million, on a 38% sales jump, to $3.4 billion.

Heady results for sure. But to achieve Pfeiffer's new goal--grab twice the market share of Compaq's nearest rival by 2000--he must take the $11 billion giant well beyond its PC roots. So, on June 26, Pfeiffer cut a deal with Cisco Systems Inc. that leapfrogs it into the fastest-growing computer hardware market: networking. Compaq is poised to buy its way into the market and buy share once it gets there. In June, the company was outbid in its effort to acquire a computer networking company, tiny Applied Network Technologies Inc. in Westford, Mass. But don't rule out another target: Compaq won shareholder approval in May to more than triple its shares outstanding--staking it to, at current stock prices, a $34 billion acquisition kitty.

ROUGH EDGES. Meanwhile, Compaq has quietly built up a network engineering and marketing staff. It's all in preparation for a jump into the $4 billion market for the digital modems, routers, and switches favored by small businesses and corporate departments. With the manufacturing might to churn out 3 million PCs a year and with more than 38,000 dealers, a determined Compaq could quickly become a networking giant. Says Robert W. Stearns, vice-president for corporate development: "It's strategically very important to us."

For the companies already in the networking business, the arrival of this 800-pound gorilla could reshape the entire industry. As in the early years of the PC business, the networking market today consists of hundreds of specialized hardware makers. With all that variety, customers are desperate for a way to smooth the rough edges that come with setting up and operating networks. First Interstate National Bank in Phoenix, for example, uses Compaq servers and PCs throughout its main office network, but high costs and difficult installation problems have kept it from installing networks in its remote offices and replacing old terminals. As Timothy E. Sullivan, a senior vice-president for technology planning at First Interstate, says: "The world is looking for anyone who can lower complexity."

In which case the world may well beat a path to Compaq's door. In PCs, the company has long championed standard designs that reduce the complexity quotient. That same adherence to standards also makes it a lot cheaper to build products. Where existing manufacturers of specialized network hardware need 50% gross margins to be successful, Compaq is thriving now on 25% gross margins, says Todd Dagres, a communications technology analyst at Montgomery Securities. Says Compaq's Stearns: "Nobody can make a part cheaper than we can."

If his boast holds, Compaq stands to make plenty of money: The market for each network segment has phenomenal prospects. Demand for workgroup-oriented network switches, for instance, will rise to $2.9 billion in 1999, up from $77 million this year, estimates Dell'Oro Group, a market researcher. Compaq won't disclose its revenue goals, but marketing manager Ed Reynolds says: "I have high expectations for this business."

Compaq's plan is to ease into networking with the customers it knows best: the small and midsize businesses that are its biggest PC buyers. Many of these long ago installed local-area networks, but Compaq is anticipating that those loops are just now requiring upgrades such as routers, which direct messages among groups of PCs, and network switches, to boost performance. Compaq is counting on these businesses to want network capabilities eventually built into the server.

Still, some customers and analysts believe the company is split over how aggressively it should pursue the network market. Where Compaq once projected a market entry in 1994, it now won't bring out its first product until 1996. Says Francis X. Dzubeck, CEO of network consultants Communications Network Architects Inc.: "Compaq is taking too much time to decide what to do."

LASER BURN. Compaq's Stearns says that there's no dispute over the approach and that the business launch is "on schedule." The company is well into developing a series of networking products that will be released over the next two years. It has already completed development with Texas Instruments Inc. of a new networking chip to be built into some of its computers. And, says Stearns, rather than try to build a stand-alone network business, Compaq's idea is to use networks to push sales of servers and portable computers.

To make a lasting mark in networking, analysts say Compaq will have to take a strong tack. Last year, it quit the laser printer business after deciding it could not unseat Hewlett-Packard Co.'s hold on customers and dealers. Now, HP and leading network maker 3Com Corp. are slashing prices on their networking products to preempt Compaq from using price to make its move. "I don't believe Compaq could build or distribute our products better or at a lower price than we can," says Eric A. Benhamou, CEO of 3Com. "They will have to spend a lot more on R&D in networking than building a PC."

There are signs that Compaq will spend more on an acquisition as a fast way to build momentum in the network business. Working with consultants McKinsey & Co., the company tried last month to acquire Applied Network Technologies, a privately held developer of small-group network switches, for an undisclosed amount. Fore Systems Inc. outbid it, spending $35 million to buy the company, according to Charles Federman, a managing director at merger specialists Broadview Associates. Now, with some 700 million new shares at its disposal, Compaq may be thinking of bigger deals. Especially if Pfeiffer wants to keep hitting his goals ahead of schedule.


The niches where Compaq hopes to strike gold

NETWORK ROUTING Long favored by large corporations, this technology is moving into smaller enterprises as a way to streamline the delivery of E-mail messages. Demand is expected to rise 17%, to $1.6 billion, in 1996.

DIGITAL MODEMS Booming portable sales, a more mobile workforce, and Internet wanderlust are pushing remote-access technologies such as digital modems into hypergrowth. Researchers see a $1 billion market by 1998.

NETWORK SWITCHING As smaller networks and video-intensive applications proliferate, advanced switching technology is in demand to take advantage of the full bandwidth of the network. The PC portion of the market is enjoying 50%-plus growth rates and should hit $3 billion by 1999.


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