By Richard Morochove
First published July 8, 1999
Most makers of personal computers lose money with each PC they sell. Should you care?
While computer buyers are enjoying the opportunity to buy faster and more powerful computers for less money than ever before, PC manufacturers are in a tight bind trying to eke out a profit. And if they don't find a way to make more money soon, some will leave the business or jack up prices. Some PC companies may earn most of their future profits in unconventional ways.
Of course, some former big players in the PC business have already bowed out. AST Computer, once one of the top five selling brands in the country, pulled out of the Canadian market over a year ago. Weak profits here, combined with the Asian economic crisis that hit its parent company, South Korean-based Samsung, forced AST Canada to shut its doors.
Packard Bell, once the price leader in the home computer arena, has faded into obscurity. It has nearly disappeared into the NEC fold after profit disappointments and the departure of its controversial founder, Beny Alagem.
Even the biggest PC maker of them all, Compaq Computer, is in serious trouble. Several high-ranking executives resigned since April, including former CEO Eckhard Pfeiffer, chief financial officer Earl Mason and senior vice-president of human resources, Hans Gutsch.
Money-losing Compaq recently announced a corporate re-organization. It will split into three business units: Enterprise Solutions and Services Group, Personal Computer Group and Consumer Group. The company hopes this move will shave $2 billion (U.S.) a year from its costs.
It's still unclear how Compaq intends to regain its former profitability, since its strategy appears to change from month to month. At the Houston-based computer maker's last bi-annual Innovate Conference, held in April, the company positioned itself as a leader in Internet services, whatever that means.
Yet last week Compaq reduced its exposure to the Internet when it agreed to sell an 83 per cent stake in its premier Internet property, the AltaVista search engine service, to CMGI Inc. in exchange for that company's shares and a note. The securities are worth more than $2 billion (U.S.) in total. CMGI owns a stake in about 40 other Internet properties, including rival search engine Lycos.
Other troubled PC makers include IBM, which reportedly lost $1 billion (U.S.) in its PC business last year. Hewlett-Packard has gained market share, particularly in the home computer market, but continuing concerns about its low level of profitability led CEO Lew Platt to announce his retirement after a re-organization of the company is complete.
HP will spin off its original business in electronic instrumentation and test equipment into a separate company. In theory, this will permit senior management to focus its attention on the increasingly competitive PC and printer business.
One apparently bright spot is Dell Computer, which continues to make money. Unlike most other computer makers, Dell cuts out the retail middlemen and sells direct to consumers through advertisements, catalogs and its corporate web site. Yet even Dell's annual sales growth has slipped, from a blistering 50 per cent pace to a still-heady 40 per cent.
Dell has remained profitable while competitors lose money because, until recently, the computer maker consciously aimed at the high-end of the PC market. This strategy delivered fatter profit margins and eliminated the higher support costs associated with relatively unsophisticated first-time computer buyers.
Dell now wants to boost its market share with first-time computer purchasers. However, how many newbies will feel comfortable clicking on a web page menu of jargon-laden options to buy a PC, sight unseen?
Company CEO Michael Dell sees no storm clouds on the horizon. Last month [June] he boldly predicted the company would reach $90 billion (U.S.) in annual revenues by the middle of the next decade. To put this in perspective, it's almost quadruple Dell's current sales pace. That accomplishment would make Dell bigger than present-day IBM, now the world's largest computer company.
Will Michael Dell achieve his ambitious goal? This appear to be the same ego-driven quest for growth that ultimately led to the downfall of Compaq's former CEO Eckhard Pfeiffer, ousted in April. Dell's desire for growth could lead to the same sort of problems that Compaq now needs to work its way through. However, Dell's growth has all been internal, so it won't need to sort out the issues related to Compaq's acquisitions of big computer makers Digital Equipment and Tandem Computer.
The big brand name computer makers also need to keep an eye on nimble small fry, such as Microworkz and eMachines. These relatively new players sell PCs for as little as an eye-popping $199 (U.S.), without monitor.
What do you get for a couple of hundred greenbacks? The iToaster from Microworkz is designed to look like a stereo component, excluding the monitor, of course. It's based on an Intel Pentium processor (no speed specified by the company) and comes with a 2.1 gigabyte hard drive, v.90 modem chip, keyboard and mouse.
The little box has two Industry Standard Architecture (ISA) board slots and three Peripheral Component Interconnect (PCI) slots for internal expansion purposes. The hard drive is loaded with the Gobe Productive suite of software that includes word processing, spreadsheet and graphics capabilities. I know your question, but I've never heard of Gobe Software before, either.
At that low price it looks like one sweet deal that would be hard for the big computer makers to match, until you realize there's a catch.
It doesn't run Microsoft's Windows. It uses a new operating system that's been described as a cross between Linux and the BE operating system. That means you'll likely be limited to running the software that comes with the iToaster, unless sales top five million or so units, a sufficiently large base of users to entice independent software developers into developing their own applications for the box.
Microworkz touts the iToaster as the computer with no virus problems. A good bet since no virus writers have had their hands on one yet!
Microworkz has been taking orders for the iToaster since July 1 at (888) 306-2044 and plans to start shipping units on July 15.
All PC makers face some common concerns. With each new PC model that comes out at a lower price point, sales surge, at least until the competition matches the price cut. Most of the sales of a new model come in the first three months after its introduction. Six months after launch, the model is obsolete. Any PCs still in stock must be sold off at cut-rate prices to make way for new models with the latest, fastest processors.
While PC unit sales overall are up from last year, lower prices for each machine mean that gross revenues are about the same. While the lower prices do attract some new PC users who couldn't afford a machine before, much of the PC makers' marketing activity is aimed at the replacement market. They want you to toss out that old machine or give it to the kids and buy a new one.
Have we reached the peak of PC sales? Is this the beginning of a long-term downturn in the computer business?
PC makers are loath to throw in the towel. How do they plan to regain profitability? Each company seems to have a different strategy.
IBM plans to boost sales of its components. Recently, it inked deals with Acer and Dell to supply them with PC parts. The Dell deal alone could bring $7 billion (U.S.) a year in business to Big Blue. IBM also has a lucrative financing arm that earns money by leasing both IBM and non-IBM computers and peripherals.
In addition to its parent company's re-organization plans, Compaq Canada recently announced it would get into the Internet services business with a nationwide plan to offer unlimited monthly Net access. Internet services will provide a continuing income stream to Compaq to boost the one-time income it receives from selling a PC. However, the company is a late entrant to the ISP business and it's unclear what competitive advantage it can bring to this low-margin business.
One California-based company recently offered to loan PCs free to users who would agree to view advertisements posted along the periphery of the display. While this plan ultimately fell through, it's an interesting example of the new kinds of business models that PC makers are exploring.
America Online's Compuserve 2000 service is experimenting with a new plan that effectively amounts to giving away the razor if you agree to buy the blades. AOL could wind up providing free PCs to people who sign up for a three-year period.
People who sign up for the Compuserve 2000 online service will receive a $400 (U.S.) rebate to apply against the purchase of an eMachines PC, which retails for $400 to $600 (U.S.). The rebate offer runs through July, but could be extended.
CompuServe 2000 costs $9.95 U.S./month for 20 hours of online time. So people could wind up getting a rebate that pays them back for the entire cost of their online service.
In the wacky world of online commerce, it's the number of people who use your service that's important to stock market investors, not the amount of profit. So increasing the number of members looks good for AOL even if it earns no additional money from member fees.
Yet that's not the only source of income for the online service. AOL increasingly makes money by selling multi-year, multi-million dollar online sponsorship and advertising deals. The more members that are online, the greater the value of these sponsorships.
AOL sees these "giveaway" PCs as the way to break through to new members that don't own a PC. It also reduces the costly churn rate of members who try out the service for a month or two, then cancel. If you're locked into CompuServe 2000 for three years, their thinking is you'll be converted into a loyal long-term member by the end of the contract.
Both Hewlett-Packard and IBM are exploring an interesting alternative that could turn the computer makers into something akin to venture capitalists. Many prospective e-commerce web sites can't afford to purchase the computer server and personal computer hardware that are essential to the business. The PC makers are considering plans to provide the required computer hardware free or for a nominal amount, in exchange for a cut of the e-commerce business.
In effect the computer makers will be evaluating the business plans of e-commerce start-ups for viability. If the big guys like what they see, then the computers will be on their way to run the web site.
If these plans take off, it would make it easier for even more businesses to begin competing for consumers' dollars online. And that would make it even tougher for e-commerce start-ups to make money online, even with free computer hardware.
Furthermore, this road to revenues seems pretty far removed from selling PCs for cash. It will require an entirely different set of skills at the computer makers. I think it would be very hard to do this well, consistently.
As home PCs become more like other consumer electronic appliances, I foresee a round of supplier consolidations. Big computer makers will acquire small companies to achieve the higher computer unit sales volume needed for adequate profitability.
At this time next year I predict you'll find fewer brands on the shelves of your local computer dealer. That means less competition for your computer dollar, which could slow, but not eliminate, the decline in computer prices.
One thing is certain. The days of the fat profit margins for PC makers are gone forever. They will experiment with new and creative ways to add value to their products, service and ultimately their bottom line. CW
Richard Morochove, FCA, is a Toronto-based computer consultant.
Copyright ©1999 by Morochove & Associates Inc. All rights reserved. This work may not be copied or distributed by any means without our prior written permission.
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