Why Rivals Are Thanking HP and Compaq

Wary retailers now give smaller players more shelf space

Just last summer, PC maker eMachines Inc. was at death's door--delisted from the Nasdaq stock exchange, burning through cash, and so despised for its poor customer service that many retail clerks tried to talk customers out of buying its machines. But on Sept. 4, the company got a new lease on life in the form of Hewlett-Packard Co.'s (HWP ) proposed purchase of Compaq Computer Corp. (CPQ ) Since then, retailers once again have been making room for eMachines. As of February, its PCs took up 13.8% of shelf space in U.S. stores, vs. 10.1% in August. "We had eMachines on the sales floor periodically before, but now they're there 100% of the time," says James Sinegal, CEO of the warehouse retailer Costco Wholesale Corp. "It's an attractively priced machine, and we think we'll do well with it."

What gives? With trailer trucks full of proxy cards still being counted, it could be weeks before it's known whether HP won its Mar. 19 shareholder vote to approve the Compaq deal. Yet the proposed merger already is working in favor of second-tier, home-PC makers. The reason: An HP-Compaq combo would claim 70% of the $7.5 billion U.S. retail PC market. So to give customers more choices and to keep HP from becoming strong enough to dictate prices, retailers are stocking up on other brands. As a result, HP-Compaq's share is expected to fall to 50%. "Retailers are far too smart to let leverage shift to the supplier," says one HP rival. "Retailers will either find a competitor or create one."

That puts up for grabs the 20% of the home PC retailing market HP and Compaq could lose--some $1.5 billion in business. Fierce competition has forced others--IBM (IBM ), Packard Bell, Acer (ACEHF )--out of stores. And except for a few models sold at its Gateway Country Stores, Gateway Inc. (GTW ) sells direct, as does biggie Dell Computer Corp. (DELL ) That leaves the spoils to the B-team.

Those most likely to gain ground are eMachines, Sony (SNE ), and Best Buy (BBY ). EMachines is becoming a sought-after alternative for sub-$1,000, no-frills PCs. Sony Corp. is expanding its niche as a supplier of high-end models with all the bells and whistles. In February, Sony grabbed 11% of total retail shelf space for its VAIO PCs--double the amount it commanded the year before. Meanwhile, retailer Best Buy introduced its own brand of PCs, called vpr Matrix, in January. With the number of major PC brands sold at retail falling in the last few years from eight to five--and now maybe four, "we have to represent choice," says David Morrish, a Best Buy senior vice-president.

Extra shelf space, however, doesn't guarantee success for the PC also-rans. The hardscrabble business is suffering from sluggish demand, a bloody price war, and rising component costs. That makes it tricky for PC makers to maintain profitability, especially since the models don't differ a lot from one brand to the next. Of the home-PC leaders, only Dell and HP consistently have been in the black. "Brands can limp along for years without gaining traction," says IDC analyst Roger Kay. "They have to deliver on their promises."

If they do, the added volume could do wonders for the smaller players. Sony stands to gain the most. For starters, it's profitable: Sony boasts a gross margin of 20% on its PCs, vs. an industry average of 18.5%, says Technology Business Research Inc. Designed for those who want to make home movies or create music, its PCs have pricey features--such as an attached digital camera on its high-end notebook that takes still and moving pictures.

Best Buy also hopes to win with entertainment-oriented PCs. The vpr Matrix line sports DVD players, CD burners, and plug-in ports for digital cameras and camcorders. Sure, there's a history of store brands that flopped due to low brand recognition and the complexities of managing inventory. Still, early signs are promising: Many stores are selling out of the Matrix.

EMachines has yet to overcome its rep for abysmal service, although it is retraining service staff and has cut return rates by 60% by mailing replacement parts. "The staff seems poorly trained," says David J. Marshall, a student who bought an eMachines PC three months ago. "I'm still waiting for replacement speakers." With gross profits of under $100 per PC, only big volumes can lift its bottom line. If the HP-Compaq deal gets the green light, eMachines will get that chance.

By Arlene Weintraub in Los Angeles

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