Computers: The Numbers Aren't Quite Adding Up

-- Sales of computer gear will rise modestly in 2003 following two years of steep declines

-- But with manufacturers continuing to slash prices, revenue growth will lag

Two years ago, the computer industry was closing the books on one of its best years ever. Buoyed by the dot-com boom, worldwide sales of PCs, servers, and other computer gear shot up 12% in 2000, to just under $400 billion. Going into 2001, some companies expected demand to soften but anticipated no more than a speed bump.

It turned out to be more like a head-on collision. Sales of hardware products dropped by about 7.7% that year and fell another 8.5% last year, to a recent low of $336.5 billion. The industry will regain a bit of lost ground in 2003, thanks to rising orders from corporations and consumers. Yet price wars will continue to constrain revenue growth. Overall, hardware sales will rise 3.7%, to $348.8 billion in 2003, says researcher IDC Corp.

Many believe that slower growth is here to stay. In a December survey of 100 chief information officers by Merrill Lynch & Co., 62% said their companies are trying to shrink the percentage of their revenue going into info tech to below the current average of 5%. "There's a lid on the IT budget," says Merrill Lynch analyst Steven Milunovich.

Nowhere is that miserly mindset clearer than in the market for servers. This year, nearly 8 in 10 sold will be the less expensive sort--running either Windows or the free Linux operating system--rather than pricier Unix boxes. That's up from 64% in 2000, according to Banc of America Securities. "Low-cost systems are here to stay," says Scott G. McNealy, CEO of Sun Microsystems Inc. (SUNW ), which has seen sales of high-end servers eviscerated by that trend. The result: While server shipments worldwide will rise 7.8%, revenues will actually decline 3.8%.

It's the same story in the data storage business. As demand has dried up, manufacturers have driven the price of storage down to about 3 cents per megabyte, half what it was a year ago, according to researcher Enterprise Storage Group Inc. As a result, though analysts anticipate that unit shipments in some storage categories will rise 15% to 20%, overall global sales will tick up just 3.9%, to $30.6 billion.

At least one sector is holding the line on pricing: networking switches and related equipment. Providers of this gear should see a 7.3% spike in global revenue, to $58.4 billion. Much of the credit goes to Cisco Systems Inc. (CSCO ), which has a 60% share of the market for switches that direct traffic on computer networks, and thus benefits from strong pricing power, says Milunovich. Yet that could change as Cisco sees more competition from lower-cost manufacturers such as Dell Computer Corp. (DELL )

Indeed, Dell's march through the PC market is a cautionary tale for the entire sector. Dell has slashed PC prices, and the segment has turned in two straight years of double-digit sales declines. That has compounded the general lack of enthusiasm for new PCs. Even with the starting price of desktops below $400, customers aren't biting. They're making do with aging machines and upgrading only when they have to. In 2003, Bear, Stearns & Co. estimates that worldwide PC sales will drop 4%, to $162.4 billion.

Handheld devices aren't faring much better. Hewlett-Packard Co. (HPQ ) and Palm Inc. (PALM ) have snazzy new models, but global sales will grow just 2.6% this year, to $4 billion. Who's to blame? Once again, it's Dell, which undercut competitors by some 50% with a $199 unit unveiled in November.

The hardware industry's elite are responding by cutting costs and cozying up to cash-strapped buyers. Sun is pushing inexpensive servers that run Linux and are built with chips from Intel Corp. (INTC ) EMC Corp. (EMC ) is teaming up with Dell to sell storage gear to small businesses. Nearly all manufacturers, meanwhile, are trying to bolster revenues by layering on higher-margin software and services.

Laptop computers seem to be bucking the overall trend. As wireless networks proliferate, worldwide sales of laptops will jump 8.8% in 2003, to $57.3 billion, says Gartner Inc. And spending on peripherals like printer-scanner-copier combinations should rise 7.9%, to $47 billion, driven by consumers' enthusiasm for multimedia applications, according to IDC.

Such devices are no safe haven from Dell, which is entering the printer space. Dell is betting it can drive down prices of printers and ink and steal some of HP's currently cushy profits. With competition like that, "[customers] can buy 30% to 50% more stuff each year with the same dollar," says Milunovich. Nice for buyers, perhaps--but for manufacturers, it means the tech wreck ain't over yet.

By Andrew Park in Dallas

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