PC Companies Look Beyond the Box

They're moving to outsourced production and new technologies in an effort to put some bounce back in the bottom line

For months now, speculation has been rampant that one or more major players may soon exit the overcrowded and, for most of them, unprofitable personal-computer business. There's a definite logic to that line of thought. In the third quarter of 2001, IBM suffered $70 million in losses on about $3 billion in sales of printers and PCs to corporate customers -- with most of that loss coming from computers. Compaq's third-quarter loss from PCs and handheld devices was even worse -- $238 million on $3.3 billion in revenue.

Twenty years ago, IBM was first to market with an Intel-powered PC, with Compaq close behind -- but neither can be expected to continue absorbing such losses for old times' sake. Speaking to a meeting of analysts in May, 2000, IBM CEO Louis Gerstner even said the PC business was no longer "terribly strategic" for the company, adding that "the PC industry is maturing rapidly and moving to commoditization." Indeed, Compaq's proposed merger with Hewlett-Packard could be viewed as a capitulation of sorts.

Rumors on Wall Street notwithstanding, don't bet on IBM (IBM ) or Compaq (CPQ ) quitting the PC business anytime soon. For one thing, corporate customers often prefer to buy their PCs along with software and routine-support services, says Roger Kay, an analyst with tech consultants IDC. So if a company like Compaq were to stop selling PCs, it would likely lose sales in other, healthier product lines as well. "Our customers are telling us they want us to stay in [the PC] business," says Kyle Ranson, Compaq's worldwide marketing and strategy vice-president for the "access business," as its PC and handheld division is now called.


  At the same time, the pressure is easing on major computer makers, thanks to the damage their smaller competitors suffered last year, when U.S. PC shipments contracted by as much as 12%, says Mark Margevicius, an analyst with consultants Gartner Group. Several companies have quit the PC business within the past year, including Micron Electronics. So when the market recovers, probably in 2003, remaining companies may have enough pricing power in the less-crowded field to enjoy the 8% to 15% operating margins that the most efficient companies, such as Dell, already turn in, says Margevicius.

The remaining PC makers have focused for months on cutting costs. One result is that companies will outsource more manufacturing than ever in 2002. On Jan. 8, IBM struck a $5 billion, three-year deal with electronics maker Sanmina-SCI (SANM ) in San Jose, Calif., to make IBM's NetVista line of PCs. Big Blue will continue to design the machines and provide marketing and user support.

Thanks to Sanmina-SCI's economies of scale -- more than 50 PC manufacturing facilities around the world -- IBM will save $30 million to $40 million in production costs this year and $100 million to $120 million more in 2003, estimates Salomon Smith Barney analyst John Jones. That should be enough to bring the business to break-even. The outsourcing deal "is an absolute affirmation that we are staying in the PC business," says Fran O'Sullivan, general manager of PC products and services at IBM.


  Other PC makers will make the big push into outsourcing later this year, predicts Todd Coupland, an analyst with CIBC World Markets. In fact, about two-thirds of the PCs sold in the U.S. by yearend will be made by a company other than the one whose brand is on the machine –- up from about half in 2001, estimates Roger Kay, an analyst with IDC. That should benefit not only Sanmina-SCI but other private-label electronics producers such as Singapore's Flextronics (FEX ) and Canada's Celestica (CLS ). Their market should grow 30% annually, on average, for the next three to five years, says Coupland.

And companies will strive to reduce costs by further flattening their organizations. IBM recently announced it'll cease taking orders over the phone in four European countries, including France and Germany. Instead, it will work through resellers, which could help it cut costs, improve distribution, and boost orders, says Jones.

Alternatively, other companies in the consumer PC market may try -- yet again, in some cases -- to emulate Dell's system of selling directly to customers, say analysts. By not building a PC until it has been ordered, Dell can keep its costs much lower than most competitors (see BW Online, 1/15/02, "How Long Can Dell Defy Gravity?").


  The industry's leaders are also trying to find new ways to make money from PCs. Manufacturers increasingly will package them with consumer-electronic devices such as MP3 digital-music players and video cameras, says Ford Cavallari, an analyst with tech consultancy Adventis. If this trend takes off, consumer-electronics giant Sony (SNE ), which is pushing the convergence of PCs and entertainment devices, could have an advantage. It could gain market share by offering discounts to consumers who buy both its hot-selling Vaio PC and its newest video camera, expected to retail for $1,600 when it goes on sale later this year.

Ultimately, PC companies think, traditional computers will be only a small part of their larger portfolio, in which handheld devices will be the new stars. "Many people talk of the PC being dead," says Ranson. "But the PC didn't die, it's evolving into an access device."

By offering a large array of gadgets, companies can differentiate their products from those of competitors -- and demand higher prices. That's key, since PC prices fell as much as 30% last year, estimates Adventis' Cavallari. Many analysts praise Apple Computer's (AAPL ) new iMac for its unique design and its versatility in handling music, images, and video. Now, Compaq, among others, also plans to make its PCs work well with other gadgets -- a strategy it hopes will account for a major chunk of its hardware profits in as little as two years.


  Compaq could also try to make money by offering Internet access and special services, such as sports scores and stock quotes, through its handheld computers, says Cavallari. (News from BusinessWeek Online and hundreds of other services are available to users of Compaq's IPAQ and other handhelds such as Palms.) That's a tricky proposition, since Compaq would have to compete with the likes of America Online.

Still, says Cavallari, AOL doesn't rule wireless to the same extent that it dominates the regular Internet -- and that could be an opening for Compaq. "In the wireless space, it's a completely different ball game," he says. And besides, Compaq probably has little choice: If its merger with Hewlett-Packard falls through, it might not have enough resources to sustain its consumer line while simultaneously improving its offerings to the corporate market, Cavallari adds.

The downside: Because the market for wireless handhelds is still small, hardware makers may not see sizable revenues from it until 2003. "The use of technology is moving that way," says Joel Wagonfeld, an analyst with Banc of America Securities. "But it's not the sweet spot of IT spending, and it's not going to be for awhile."

Even so, "we believe that the traditional PC is morphing," says Compaq's Ranson -- into a device that can fit into your pocket and connect to the Net from just about anywhere. It that proves to be the case, it would be one more reason for the likes of Compaq and IBM to stay in the game.

By Olga Kharif in Portland, Ore.

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