Emachines: Fast, Cheap, And Ahead Of The Pack

emachines' sub-$600 computers are flying off the shelves

Why are personal-computer stocks getting pummeled? Janet Hassan may be partly to blame. For years, she longed for a new personal computer to replace her five-year-old clunker--but memories of its $1,600 price tag kept her from looking. "That's a lot of money to me, since I consider it a luxury to have a PC at home," says the single mother of two in Baldwin, N.Y. But then she saw an online ad for emachines Inc., whose priciest PC sells for $599. Days later, she gave in to temptation. "I just love it--and at those prices, how could I say no?" says Hassan, who picked up a 300 MHz PC along with speakers, printer, and 17-inch monitor for just $815.

Turns out she's not alone. In one of the fastest takeoffs in high-tech history, emachines has sold 480,000 PCs since last November. As of February, the Irvine (Calif.) company had shot to No. 4 among U.S. home-PC makers in terms of shipments--with a 9.9% market share, less than a point behind IBM, according to PC Data Inc. At the current clip, emachines is on track to sell 1.7 million PCs and take in $1.1 billion in its first year, says Chief Executive Stephen A. Dukker. Even more remarkable, emachines has been profitable since mid-February, he claims, despite prices that average roughly half those of top home-PC brands. "Everything is going exactly to plan," says 46-year-old Dukker. "I pinch myself every morning."

Rivals may want to do more than pinch Dukker. Just when they were learning to live with sub-$1,000 machines, Dukker & Co. lowered the bar, putting even more profit pressure on Compaq Computer, Hewlett-Packard, and IBM. So far, the biggest victim may be NEC Packard Bell, which once was the low-price leader. Its parent recently laid off 15,000 employees, and the computer unit scaled back its product line.

SUMMER SIZZLERS? That's just the first sign of how much impact the sub-$600 category (that's sans monitor) is having. Sales of such models--mostly by emachines--have exploded, from 5% of the U.S. home-PC market in November to 16% in January, and could be 25% by yearend, according to PC Data. "They're going to force the big boys to get into this market sooner than they would have liked," says PC Data's Stephen Baker. Baker now expects $400 models from top-tier players this summer, rather than by Christmas.

By then, Dukker expects to have broadened his assault. Emachines is preparing a jazzy new model similar in look to Apple Computer Inc.'s $1,200 iMac that will sell for $799 (monitor included). And he's in talks with investment bankers about a public offering to finance increased capacity, because the $200 million provided by emachines' co-owners, monitor maker Korea Data Systems and contract manufacturer TriGem Computer Inc., hasn't been enough to keep up with demand. Production is sold out through June, Dukker says. "This is the fastest quarter-mile ever run in the history of the PC industry," says James D. Poyner Jr., an analyst with CIBC Oppenheimer.

A 16-year PC-retailing veteran who worked at CompUSA and Computer City, Dukker test-marketed sub-$500 PCs at Computer City in 1997. "The demand was unbelievable," he says. "We sold more than 10,000 in two days." Emachines was born last summer when the two Korean parents agreed to provide the working capital and good terms on monitors and contract manufacturing.

Now, Dukker's challenge will be to build a company that can keep up with the runaway marketing hit he created. While emachines' product quality has been good so far, retailers worry about its scrawny customer support system. And given its razor-thin margins, it could find itself only a recall or inventory miscue away from trouble. "The PC landscape is littered with people who thought they could make it up on volume," warns Compaq Senior Vice-President Rod Schrock. Counters Dukker: "Right now, the big guys are scratching their heads about what to do about us. The more we sell, the harder we become to catch."

MINI-MARGINS. Dukker's ultimate advantage may be his cost of operations. The company has just 20 employees and it uses slightly trailing-edge parts, which still lets it sell machines with mass appeal, even if more sophisticated buyers demand more pizzazz. Emachines, for instance, has no plans yet to use the new Intel Corp. Pentium III chip, which by itself costs $450. Instead, emachines uses Intel's older Celeron chip, which sells for about $60. A new model with a 400-MHz Celeron will sell for $599. Dukker is also willing to live on less--a 10% gross margin vs. the 15% or so that top-tier rivals earn on $1,000-plus computers.

With prices so low, emachines are flying off the shelves--sometimes before they've even been advertised. This keeps emachines' inventory costs low, which makes a big difference in its margins. Analysts say that slower-moving, higher-priced PCs typically cost their producers 10% of revenues because manufacturers reimburse retailers for price cuts needed to keep product moving.

And once they're out the door, fewer machines are coming back. In fact, fewer than 5% of emachines' units have been returned so far, claims Dukker, roughly half the industry average. That's important because product returns are another area that saps profits from PC makers. But at under $600, emachines has discovered that customers are less likely to experience buyer's remorse. PC returns typically cost manufacturers $100 per machine.

Dukker has hit the PC market at just the right time--and with just the right prices. The Internet has finally given the masses a reason to want a PC, and basic surfing doesn't require a $2,500 high-end screamer. As such, emachines is appealing to a vast market of people who might not otherwise buy a PC. Roughly half its customers are newbies, most of whom make less than $45,000 a year. The other customers are largely PC veterans who want extra machines for family members. "There are lots of people who see a $399 PC as a viable way to end the civil war in the house," says CIBC Oppenheimer analyst Poyner.

But it's the newbies that could turn out to be the most lucrative market for emachines. Given its high percentage of first-time buyers, the company has more chances to sign revenue-sharing deals with Internet service providers (ISP) that are trying to lock up new customers. Rather than a onetime "bounty" of $20 for each new customer it delivers to an ISP, Dukker is negotiating with ISPs for a slice of monthly fees, arguing that his company delivers a higher mix of newbies anxious to get on the Net than any other PC maker, say some analysts. Additional revenue from ISPs could boost emachines' net profit margin to 8%, say analysts. That's roughly in line with highflier Dell Computer Corp.

So far, Dukker is shipping enough PCs to suggest that his formula is working. Says Mark Copman, managing director of investment banking for US Bancorp Piper Jaffray, a potential underwriter: "It looks like emachines' [business] model has legs." That may be good news for consumers--and Dukker--but for rivals, it's a long-term headache.

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