Compaq's Rockin' Boss

New CEO Michael Capellas has his act together. Can he shake up the computer world?

What sparks the relentless, gotta-win drive that marks the most successful people? For Michael D. Capellas, the 46-year-old chief executive of Compaq Computer Corp., it came when he was an eighth-grader in the gritty mill town of Warren, Ohio. The pudgy kid, blind in one eye, had been relegated to the none-too-exciting offensive line on his school football team. He dreamed of something more glorious. But when he asked the coach to give him a chance at playing linebacker, the guy crushed him like a bug. "My coach said, `You're not tough enough,"' recalls Capellas.

Put on the spot, Capellas vowed to prove him wrong. With elder brother George as his exercise mate, Capellas lifted weights like a junior Charles Atlas. One time, he pulled so hard on a thick elastic band they attached to a telephone pole in front of the house that George feared his brother would topple the post. Even though the younger Capellas was not particularly big or fast--or a natural athlete--he not only became a linebacker but as co-captain of the Warren G. Harding High School football team, he also led his buddies to the Ohio state championship and was honored as a state all-star in 1971.

He has been like that ever since. Beginning with an internship at Republic Steel Corp., where his Greek immigrant father had worked his way up from laborer to superintendent, Capellas searched restlessly for his big break. He held 22 different jobs at six companies--including software powerhouse Oracle Corp.--before arriving at Compaq as its chief information officer two years ago. Yet he was never satisfied. "I always wanted the toughest job," says Capellas.

WEB RULES. Psst, Mike, be careful what you wish for. Today, as CEO of the once-mighty--and now humbled--Compaq, Capellas has one of the most grueling jobs in computerdom. His task is to return what had been one of America's best companies to preeminence at a time when the Web has changed the rules that made Compaq a powerhouse. In its early days, the Houston company was the darling of the retail chains as it pumped out the most powerful PCs first. Even IBM ate its dust. By the mid-1990s, Compaq had ascended to the No. 1 spot, standing beside software maker Microsoft Corp. and chip titan Intel Corp. as the three pillars of the industry.

But when Capellas took over one year ago, one pillar was crumbling. Compaq had missed the Net revolution, clinging stubbornly to brick-and-mortar stores instead of cyberspace outlets. That, along with the forecasting gaffes, resulted in huge inventory gluts when demand shifted suddenly. Worse, Compaq's lucrative computer-server business got indigestion from its purchase of Digital Equipment Corp. Total revenue growth shrank to a measly 5% in mid-1998--down from Compaq's more typical 45%-to-65% range. The stock plunged from a high of 47 in January, 1999, to 21 five months later. The PC pioneer seemed headed for the has-been heap. "Nobody knows how close it was," says board member and Texas real estate investor Robert "Ted" Enloe III. "We could have gone into a real tailspin."

Instead, Compaq is stabilizing. One year into his turnaround attempt, Capellas has reorganized the company to make it more nimble, slashed expenses, increased online sales from $1 million to $6 million per day, and rekindled innovation. The bleeding has stopped. In the second quarter, revenues grew 7.5%, to $10.13 billion--after a year of stagnation--with Japan growing at a blistering 40% and Latin America up 29%. The company earned $387 million, compared with a $184 million loss in the quarter a year earlier. And its troubled commercial PC unit eked out a $62 million operating profit--after four quarters with a cumulative $490 million in losses. Thanks partly to the shift online, operating expenses are down 17% and gross margins are up 3%, to 23.6%. As for Compaq's stock, it has returned to respectability--up 41% since Capellas took over, to $34 a share. During the same period, shares of PC pacesetter Dell Computer Corp. sank 5%. "The fog is burning off," says analyst Andrew J. Neff of Bear, Stearns & Co.

Credit the bonfire Capellas lit under employees. He's got the passion of a Bruce Springsteen--bounding across the stage in a rock star outfit and lip-synching at company events or pumping up the energy daily with electric-guitar tunes blasting from a boom box in his eighth-floor office. His pitch to the staff: It's not too late to catch the Web wave. "The Internet has not yet been fully discovered. Whoever builds the most innovative products is going to win," says Capellas. He sums up Compaq's strategy in a slogan, "Everything to the Internet," that employees carry on a laminated card. And they're responding. Ten-year Compaq vet Hugh Jenkins, a marketing director, left for rival Hewlett-Packard Co. in October, 1998, but returned in May. "Look at the results," he says. "Under Michael, realistic goals are being set and being met. I won't be the last prodigal son to return."

BIG PUSH. Now comes phase two of the turnaround. It stands to be even harder than the first because it takes vision to get revenues revving again. Capellas promises double-digit sales growth in the coming quarters. How? He plans to hold on to Compaq's lead in consumer and corporate computers by being first with new technologies. He aims to cut inventory costs by selling 40% of his machines either through a sales force or online, up from 32% today and 15% a year ago. And he's making a bid in the nascent Net-access-device market--which International Data Corp. expects to grow from $2.4 billion last year to $17 billion in 2004. On Aug. 15, Capellas made a downpayment on his bid when he introduced a quartet of Net devices, including a $199 tabletop gizmo for getting e-mail and browsing the Web.

Most crucial to Compaq's future is its e-business strategy. It's vying with behemoths such as IBM to supply high-powered servers and services for corporations so they can take advantage of the Net. "This is where Compaq succeeds or fails," says Capellas. Compaq is No. 1, with a 31% share in the market for servers using Microsoft's Windows software--and Capellas is spending $150 million to soup up these machines to handle the biggest Web sites. To boost his laggard service business, he's seeking alliances with top-drawer services firms such as Andersen Consulting. And Capellas is counting on a new generation of Unix servers--introduced in June--to help win customers in the high-end market.

Most Wall Streeters are cheering Capellas' success. Of the 28 analysts who follow the company, 22 now rate the stock a buy, up from 11 the month before Capellas got the job, according to Zack's Investment Research. The optimists expect Compaq's revenues to jump about 16% and its profits to rise 5% to 6% in each of the next two quarters. Analyst Steven M. Fortuna of Merrill Lynch & Co. predicts strong demand for Net infrastructure gear is going to help propel Compaq's turnaround.

Still, Capellas faces daunting threats--especially from Dell, his nemesis. Compaq's share of worldwide PC shipments dipped to 13.2% in the second quarter, down from 14.3% a year earlier. Meanwhile, No. 2 Dell's market share jumped from 10.7% to 11.5%, according to IDC. While Compaq holds a wide lead in PC servers and is growing at a 40% clip, Dell's server sales grew 46%. Now, Dell is angling for more, using its direct model to take on high-end corporate and Net computing. "People said we weren't going to be able to take our direct model beyond desktop PCs, and they were wrong," says Kevin B. Rollins, a Dell vice-chairman.

NEWBIE. Just as challenging may be overcoming Capellas' lack of stature in the industry. CEOs just don't know who he is--a factor when it comes to persuading major corporations to trust Compaq for their crucial computing needs. Capellas was the surprise choice for CEO after the company's board failed to land a high-profile outsider, such as Continental Airlines President Greg Brenneman.

His appointment was even more startling in contrast with the CEO search at rival HP, which landed Carly Fiorina, the well-known former exec at Lucent Technologies Inc. She's always carefully coiffed and coutured and starred in a series of HP ads on TV. Capellas dresses down, has a five-o'clock shadow before noon, and mingles with employees like a politician working a volunteer fire department picnic. While Capellas is rebuilding Compaq one stone at a time, Fiorina is making bold moves. Example: HP bid ultra-low and offered improved service to win a deal to supply with $500 million worth of computers. Capellas passed because, for Compaq, it would have been profitless. Some analysts think he's too cautious. "He's going in with a scalpel--and he might need a hatchet," says Ashok Kumar of US Bancorp Piper Jaffray.

Capellas might just take the tech world by surprise, though. "I don't think anybody could have made a better start," says Steven A. Ballmer, CEO of Microsoft. The morale turnaround and his solid blocking and tackling in operations stand a good chance of making Compaq a more dangerous competitor in a handful of important markets--particularly Windows servers for e-business. But will Capellas be able to make Compaq the Godzilla of computing once again? That's a stretch. He's no visionary. Rather, he's a skillful implementer of smart techniques pioneered by others. The coming months will show whether Capellas--the regular guy--can transcend his resume and become an agenda-setter for the industry.

What's clear is he's got plenty of character to build on. He's an unusual combo of steely tough guy and almost touchy-feely teddy bear. Capellas inherited his gritty determination from his father, a Greek citizen who fought with the U.S. Army to push the Germans out of Italy in World War II. After the war, he met and married his wife, Juliet, in Italy and came to work at Republic in Ohio. "My dad had an unbelievable work ethic. He was intensely loyal to the company. He worked there for 30 years," says Capellas. His schoolteacher mother, who died 20 years ago from Lou Gehrig's disease at age 58, encouraged him to read and write poetry.

The Capellases were intensely protective of Michael because of his sight problem. He grew up a sheltered, gregarious child who had every kind of pet--from ducks to dogs to snakes. High school toughened him up. He was the first one to start a workout on the athletic field and the last to quit. He applied the same dogged discipline to his academic pursuits, where he was a B+ student. "He just worked harder than everybody else," recalls brother George. "It's the Steel Valley mentality. It's blue collar. You work hard, and you get ahead. And football is the childhood expression of that."

Unlike his father, however, Capellas vowed not to stay in one place for very long. Wife Marie, a former nurse who met him at a party shortly after he graduated from Kent State University, recalls that the two felt an "instant chemistry" and talked until 2 a.m. "I had dated college guys, but never anybody who knew he wanted to do something," she says. What Capellas wanted, as his career developed, was a seat at the strategy table with top executives. Lucky for him, he has always been a quick study. At each stage of his career, he took on more responsibilities than his job titles indicated. As Compaq's chief information officer, for instance, it was his quest to solve the knotty problems the company had in building products to order.

Now, Capellas is applying the best management ideas he plucked from his 22 jobs to transform Compaq's hidebound culture. Compaq got into its pickle because it was bureaucratic and short on innovation. Back in Compaq's bad old days in early 1999, the management team was like a dysfunctional family. The top ranks under CEO Eckhard Pfeiffer were dominated by former Digital executives. "It was the Digital Boys Club. They'd sit around and never do anything. They were professional survivors," says a top Compaq exec who was part of the so-called Classic Compaq faction--longtime Compaq managers. It was easy to get away with doing nothing, since executives didn't have clear responsibility for results. In the vacuum, managers of operations in countries made their own rules. For instance, they would sell PCs ultracheap to meet their sales forecasts--even if it meant zero profits.

Capellas changed that in one fell swoop. His guiding principles: make leaders personally accountable for business-unit performance and insist that they play well together. Last June, shortly after he was appointed chief operating officer, he gathered the company's top 20 executives at headquarters to grapple with a massive reorganization. He practically locked them in the boardroom for three days, 12 hours a day, and convinced them it was smart to organize Compaq around a half-dozen markets--including consumer and corporate Internet computing--instead of functions such as manufacturing. He gave executives profit-and-loss responsibilities. Being an outsider helped him persuade the execs. "He wasn't a Digital guy or a Compaq guy," says Michael J. Winkler, senior vice-president for Compaq's commercial PC unit.

WELL-OILED. Now, Capellas has hard-wired accountability into the way his management team operates. Starting in January, he made customer-satisfaction goals an essential part of each executive's pay package. For Capellas and his top brass, customer-satisfaction gains now account for 30% of their annual bonus. The move already is delivering results: In the past year, the company's on-time delivery record has improved by 60%. These days, 85% of products ordered directly from Compaq are delivered on time.

That still leaves a lot of room for improvement. The next step: overhaul the company's order-taking and manufacturing process to turn Compaq into a well-oiled machine. The company aims to sell 70% of its PCs built to order, with retailers selling the rest. Compaq had been working on a process for efficiently handling direct orders for years, but last fall it still wasn't right. The company even lost track of some customers' orders. Winkler gave Capellas the bad news: They didn't have time to fix things internally, so they had to buy somebody else's build-to-order operations.

The solution was bold. Compaq paid $370 million for the manufacturing and warehousing facilities of hobbled PC reseller Inacom Corp. At first, Winkler wanted to buy Inacom outright, but Capellas was concerned about the company's $300 million in long-term debt. He nixed the deal. Instead, he told Compaq's negotiators to buy just the pieces of Inacom that it needed. "Michael took the team from despair to a high energy level," says William B. McBee III, Compaq's vice-president for quality. A deal was made. Now, 93 of Compaq's largest customers are buying PCs online. The target: 200 by yearend.

Capellas aims to inspire people at every level in the company. To help lower Compaq's 10% employee turnover rate in 1999, last October he spontaneously offered stock options for every staffer during an off-site meeting of the Windows server unit. He made the promise even though he had not broached the subject to his board, much less received an O.K. "I knew we had to be bold and regain the hearts and souls of the employees," he says. In the end, the company handed out 200 stock options to each of its 69,000 employees.

He can dispel a dark mood at a moment's notice, too. On June 17, just before his first telephone conference with Wall Street analysts, Capellas noticed that people gathered in a conference room seemed nervous--and he worried that the analysts would sense it. A fan of '70s rock and roll, he had a Three Dog Night CD in his notebook PC. He turned it on, pumped up the volume, and danced with Alice McGuire, head of investor relations, to the tune Joy to the World. By the time the conference call started, people were grinning like a bunch of kids watching an Austin Powers movie.

MIND MELD. Nothing Capellas can do is more important than winning over corporate customers. With Capellas, it's not just a matter of offering the lowest price; he's willing to forge partnerships. That's how he landed a deal to supply Britain's Cable & Wireless PLC with more than $200 million worth of new computers for its Web application hosting business. It's a joint venture, with Compaq providing 50 consultants to help get the business going this summer and developing four new server products tuned for the hosting business. "They were prepared to put it together as a partnership. With the others, we felt it was just another way to sell us something," says Paul I. David, a vice-president at Cable & Wireless.

Capellas looks for the same kind of mind meld with tech industry players. Before he arrived, the company's long relationship with Microsoft had soured. Their engineering departments were no longer in sync, and communications at every level had broken down. Capellas traveled with Chairman Benjamin M. Rosen to Microsoft for an audience with Ballmer and Chairman William H. Gates III on July 30, 1999. Out of that came a rapprochement that resulted in Compaq's becoming Microsoft's key strategic partner for the release of its Windows 2000 operating system in February. "He's repaired a lot of frayed relationships," says Rosen.

Capellas is no lap dog, though, when it comes to Microsoft. In April, after Compaq engineers grew frustrated with Microsoft's pace of beefing up Windows 2000, Capellas called Ballmer late at night from the Masters Golf Tournament in Augusta, Ga. "There was friction. I wanted to catch it before it became a holy war," says Capellas. He urged Ballmer to accelerate development--which he ultimately did. "He tells me the things we're screwing up, and how we're screwing ourselves up. He's very frank," says Ballmer. "With Capellas, I never worry there's some hidden agenda."

TOUGH ENOUGH. Sometimes, though, Capellas' shoot-from-the-hip style trips him up. He makes decisions quickly, then acts without delay. This has led to one mistake of consequence: He decided early to group services with the enterprise computing unit, rather than with sales--something he recently rectified. Joined together, the two groups are better at landing large corporate contracts. "His strength is his decisiveness. His weakness might be that he makes some decisions too quickly, before he has all the facts," says director Enloe. "But on the whole I'll take that. We have to move at Internet speed."

Capellas has proved himself tough enough to make the hard choices necessary in a turnaround. He jettisoned some businesses--most notably the company's effort to sell Windows servers equipped with its Alpha microprocessors. He has pushed out a number of executives--though he sometimes gives them time to find another job so they can save face.

That kind of sensitivity extends to his family. The Capellases live in a stately brick house on a golf course in a suburb of Houston about an hour from Compaq--where he typically works from 6:30 a.m. to 7 p.m. The family is tight-knit. Michael and Marie learned to play golf a decade ago, and now she accompanies him on business trips that include a round of golf with customers. Says Marie: "We've been best friends for 21 years. When we play at golf events, I'd understand if he played with the guys, but he chooses me."

Busy as he is, Capellas finds time to help organize his family's annual gatherings at Hilton Head, S.C. There, in a rented beach house, the Capellases and their daughters, Julie, 20, who attends Georgetown University, and Andrea, 16, a high schooler, are joined by his father, his siblings, and their families. Each year, they have a golf tournament. A six-inch-tall plastic trophy, called the "Capellas Cup," goes to the winner. Capellas loves this stuff. "My wife won the Capellas Cup two years in a row, then I took it away from her," he says with relish.

He'll turn anything into a game. Edward M. Straw, a former Compaq procurement executive who is now president for operations at Estee Lauder Cos., recalls an evening last fall when he and Capellas went to the piano bar at Resa's Steak House in Houston after dinner. As they strolled from the restaurant to the bar next door, Capellas bet he could name 10 songs in a row before the pianist started singing. In the end, he rattled off 15. "He's just extremely competitive. And it flows over into everything he does," says Straw.

If only every battle was so easily won. Capellas feels confident that he's on the right track. But he admits that the stress of running the company keeps him up at night. His biggest worry: Will Compaq crumble again when bad news strikes? "We are starting to build an organization that has strong character," he says. "At some point, there will be a setback and a real character test for us. We'll see how we all react when that happens. I don't know if we're ready." Compaq may not be ready, but Capellas is. And he may have a grouchy football coach to thank for that.

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