December 21, 1999 4:00 PM PST

Compaq's readiness for iPaq launch uncertain

Houston, we have a problem.

As Compaq prepares for the January launch of a newfangled business system, there are growing signs the computer maker does not have all the operational assets in place needed to lift the important product line into orbit.

The forthcoming iPaq--a miniaturized, modernized corporate desktop--is at the center of Compaq's revitalization strategy. Selling for $499 and up, its low price is designed to recapture lost market share, and could potentially account for more than 50 percent of business shipments in a few years.

Although relatively inexpensive, the systems will cost less to make, say Compaq executives, and will be sold directly by the Houston-based company rather than through dealers and distributors.

The distribution system is arguably the most important, and troublesome, factor in the product's launch. Compaq has been trying to sell PCs direct for years with mixed results, because it has not had adequate logistical systems.

This shortcoming in the company's strategy likely accounts for recent rumors that Compaq is in talks to buy assembly and manufacturing facilities from distributor Inacom, say analysts.

There are also alternatives to acquisitions being bandied about. For example, the company could tighten its relationships with Inacom and/or other distributors, build its own assembly capabilities or acquire a direct competitor, such as Micron Electronics.

Whatever the company decides, the clock is ticking, say analysts.

"With the iPaq being rolled out for direct sale to the customer, Compaq needs to ramp up that build-to-order capability," said Technology Business Research analyst Lindy Lesperance. "Their build-to-order capabilities are still not what they want them to be, and if the iPaq takes off they need something in place."

To compound the problem, the PC maker is also expected to unveil a consumer version of iPaq at next month's consumer electronics show, also sold direct to customers.

"They've got to do something fast," said Jeff Matthews, general partner in Ram Partners, a Greenwich, Connecticut investment firm. "The inertia of human nature is to not bite the bullet and to make incremental changes."

Compaq has made some painful decisions this year as it reaches for increased profitability, such as unloading AltaVista and killing development on porting Microsoft Windows 2000 to the Alpha processor. To solve its supply-chain problems, Compaq may have to take more drastic measures, Matthews said.

That could mean buying a PC wholesaler, such as Inacom.

"I wouldn't rule [an acquisition] out at all," said Kurt King, an analyst with Banc of America Securities. "They realize they need to bring the capability in-house and rely less on the 'channel,'" he said, referring to the network of resellers commonly used by Compaq and most PC makers.

Although Compaq needs more logistical and delivery systems, the company may technically avoid an acquisition and instead strike a deal where the company is more tightly aligned with a back-end distributor. Essentially, what the company needs is an efficient way to get product to customers without having to send it through third parties, which will reconfigure the product or mark it up in price, said King.

Compaq's direct/indirect dilemma has been a long-simmering issue. "I think they first started telling us that they wanted to go direct in...1996," King said.

Lesperance questioned the sense of buying a distributor and speculated that a cozy alignment would be more likely. Inacom's Nebraska location would only further complicate distribution, she added. Direct manufacturers typically keep the bulk of their assembly and distribution operations in one location. Moreover, Inacom has its own problems: last week it laid off 1,000 employees.

Lesperance also ruled out Compaq beefing up its own assembly and distribution facilities. "The problems are obviously beyond internal repair, so they need to look outside to the resources that are there," Lesperance said.

Compaq also recognizes its back is against the wall. In a recent filing with the Securities Exchange Commission, the company acknowledged it "does not currently have in place processes for order entry, production of individualized units and direct distribution that can operate efficiently to manage a large portion of its current personal computer sales."

Another option would be Compaq buying a direct manufacturer, but Matthews said it might be too late for that. "Compaq needed to buy Gateway two years ago, and they missed that chance. They wouldn't be in the trouble they are today if they had."

Unlike direct PC makers such as Dell and Gateway, Compaq has traditionally used computer wholesalers and dealers to get product to customers. In August, Compaq reduced from 39 to four the number of distributors it uses but increased their role in building and selling PCs.

Compaq's only choice in the short term may be relying more on its hybrid model, where the four distributors play an increasingly important role, said International Data Corp. analyst Joseph Rigoli.

Since last summer, Compaq and its distributors have used a common configuring and ordering system provided by PCOrder.com. This has helped Compaq greatly reduce inventory, close to two weeks, said some analysts.

"Not only did Compaq pare down the number of distributors, they rely on them more for fulfillment and the build-to-order ordering process," Rigoli said.

Through the restructuring, Compaq reduced to 30 from nearly 100 the number of stocking locations it uses to build PCs and the number of distribution centers from 90 to 24. While an improvement, the changes are still not as efficient as Dell, which typically builds PCs for half what Compaq does, Lesperance said.

With iPaq, Compaq hopes to cut some cost out of its supply chain. By shedding legacy ports and connectors, Compaq can use simpler components that are cheaper to produce. Shipping direct to customer is also cheaper than using a dealer.

But Compaq still has to meet demand for iPaq, and that could be a problem. While Compaq may sell the new PC direct, it won?t match Dell's build-to-order capabilities, say analysts.

"What Compaq will do is maintain inventory at the distributor level, so they will have the ability to same-day ship these products. But it is not true build-to-order," Rigoli said.

If Compaq is to meet its goal of 40 percent direct sales, it must do better than that, Lesperance said.

 

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