June 27, 2001 2:00 PM PDT

Dell dogs PC rivals

As top dog in the PC industry, Dell Computer is looking to make its bite as nasty as its bark.

With about 13 percent of the global PC business already in his company's paws, Dell Chief Executive Michael Dell growled last week that the company is looking to grab 40 percent over the next several years. The question is whether its competitors will stick around to fight or settle for the scraps of an industry in which already slim profit margins continue to decline.

Recent strategic moves by PC makers and comments from research and financial analysts seem to indicate that Dell's competitors are leaning toward the latter to avoid a bloody price war.

"Over time, as ambitious as 40 percent (market share) is, Dell can probably pull it off," Lehman Brothers analyst Dan Niles said this week.

In April, Dell overtook Compaq Computer as the worldwide leader in PC market share, according to market researcher Gartner.

Speaking Wednesday in Prague, Dell said his company isn't about to let Compaq take back the top spot.

"I haven't heard many suggesting that Compaq is at risk of regaining its No. 1 position...Certainly all the data that we have for the second quarter so far suggests that once again Dell is significantly outgrowing the market," Dell said, according to Reuters.

When Dell overtook Compaq this spring, it marked the first shift in PC rankings in seven years--a period during which the price battles were less severe than they are now, Needham & Co. analyst Charles Wolf said.

But since late last year, the PC industry's stability has been rocked by a price war among its biggest players: Dell, Compaq, IBM, Hewlett-Packard and Gateway. Dell initiated the war, ostensibly in response to slowing worldwide PC sales and based largely on the cost advantages of the company's low-inventory, build-to-order business strategy. But Wolf contends that price cuts were actually meant to send competitors to the doghouse.

"This has nothing to do with the economy," Wolf said. Dell is "trying to force" a major PC maker to leave the market, he added.

In addition to losing its profitability, the PC is now missing some of its luster. In fact, at this week's annual PC Expo trade show, handheld computers and other gadgets have grabbed the spotlight away from personal computers.

Holding their ground
The potential departure of one of the major PC manufacturers is not a new prediction. Earlier this year, Bear Sterns analyst Andy Neff issued a report predicting consolidation among some of the big names in the PC industry. At the time, the report rankled many analysts and company executives but raised the possibility that big-name PC makers might leave the once highly profitable market.

"At this point, I would assume that everyone is looking at an exit strategy," IDC analyst Roger Kay said.

However, others say a price war alone may not knock out a major contender.

Michael Dell "Irrespective of cost and expense differences, we believe it's virtually impossible for Dell to drive Compaq, HP and IBM into submission," Wolf wrote in a report. "Economics aside, IBM, Compaq and HP are not about to cede strategic segments of their business to Dell without a fight. They may continue to allow Dell to capture sales that are tactical in nature. But they most likely will match Dell's pricing in accounts that they regard as strategically important."

Instead of companies acquiring competitors, as Neff's report suggested, other analysts are predicting that companies will make more limited retreats, pulling out of market segments that aren't profitable and don't have other strategic value.

"Under the current conditions, there are several companies that are vulnerable, but it's more likely companies will leave portions of the business," Gartner analyst Charles Smulders said.

Strategic decisions
Already, two companies have limited their exposure to the PC market. IBM pulled its desktop PCs out of retail stores in late 1999, while Micron Electronics earlier this year sold its PC business. Micron had once been the No. 3 direct seller behind Dell and Gateway.

However, Smulders said, leaving the PC business entirely would be too costly for any of the major computer makers.

"Exiting the PC market would be expensive because companies are legally bound to support existing units. And by leaving the market, a company would have to pay to maintain support without revenue from new sales coming in," Smulders said.

Kay agreed. "For companies where PCs are just a part of their overall business, getting out would be crazy if PCs are still contributing to the bottom line," he said. "Right now every contribution to the bottom line helps."

At the same time, Smulders doesn't see one of the big companies gobbling up a major rival.

Dell
Stock price from June 2000 to present.  
Source: Prophet Finance
"Acquisitions would not make sense because a company may gain share but would likely lose money in the process of merging operations, and this is something all the companies would hate to do," Smulders said.

He added that all PC companies are cutting operating expenses to boost their competitiveness and become "lean and mean" for continued rough times.

SG Cowen Securities analyst Richard Chu said that as long as prices for PC components continue to sink, direct PC sellers will have the advantage of leaner inventories over their rivals.

But Compaq maintains that all of the largest PC makers--regardless of their sales models--will endure.

"The big four (Compaq, Dell, IBM, HP) will continue to survive and grow," Mike Winkler, executive vice president of Compaq's global business unit, said last month. "The others are in question."

Compaq reshuffles
Nevertheless, Compaq announced on Monday a restructuring that will transform the hardware giant into a company focusing more on software and services for large businesses. As a result of this change, the company expects to save $200 million per quarter, including a 20 percent decrease in its manufacturing costs by the end of the year.

"Under tough economic times, products become a commodity and IT tends to buy more on price, which plays into Dell's hands," Lehman's Niles said, referring to Dell's commitment to slash prices to boost share. "So Compaq has to focus on services and support and become more like IBM and use technology as a utility."

Added Needham's Wolf: "Given their heritage, they (Compaq) are the last ones that are going to exit the market. They can subsidize a war" for a while with profits from other business segments.

IBM was one of the first major manufacturers to pull out of an area of the PC market. In late 1999, the company yanked its Aptiva PCs from retail stores because of poor sales. Although IBM continues to sell consumer desktops directly, its PC business has languished, and many analysts have predicted that its PC division will be axed entirely.

"IBM will likely get out of desktop PCs first rather than notebooks, which still contribute significantly to the overall business," one analyst said.

HP is also likely to pick its battles in the PC market. The company recently became the market share leader in worldwide sales of consumer PCs, according to a report from IDC.

"In home PCs via retail, (HP is) the No. 1 (player). Everything else being equal, they will be far less willing to give up ground," SG Cowen's Chu said. "I think they are willing to back away and give up market share" from the corporate PC market.

By sticking with the consumer market, HP has an opportunity to sell its scanners and printers and to keep its name out there, Chu said. In addition, HP became the leader in retail after being the first to capitalize on the market for digital music and CD burning.

However, other analysts have said that concentrating on the consumer market could hurt HP given the weak profit forecasts in that area.

Gateway's challenge
A number of analysts are pointing the finger at Gateway as being the PC manufacturer likely to be most affected by price competition from Dell and by the slowing PC market.

"Gateway faces more challenges than others because it is heavily focused on the U.S. consumer PC market, and that's the most heavily hit segment in the market," IDC's Kay said. "You have to wonder how deep are their pockets and how long can they sustain a price war."

Gateway's recently launched promotion, in which the company will beat the advertised price of major competitors, puts "Gateway in the game," UBS Warburg analyst Don Young wrote in a recent report.

With the most to lose, Gateway has chosen to take Dell head-on, competing on price and focusing on boosting market share. The return of CEO Ted Waitt has also meant a shift in focus to selling computers rather than pitching all sorts of add-ons and services, which Chu said is a positive move.

Chu said Gateway will continue to battle Dell but questioned whether the company has any advantage over its larger rival.

"There is little to distinguish Gateway from Dell, and Dell has greater scale," he said.

But David Turner, a Gateway vice president, said that having a retail presence is a key advantage, given that two-thirds of PCs are sold in stores. Turner said Gateway is unique in that it has access to retail customers while having the cost benefits of a direct seller as well.

Focusing on the consumer may not be all bad, Young said in his report. "The consumer PC plays have probably seen the worst in pricing and may be the first to see a recovery in consumer spending," he wrote.

Continued price cuts, though, could hurt everyone, including Dell, Needham's Wolf said.

Last month, Wolf cautioned in a report that Dell will suffer as a result of its price moves. He asserted that a strategy aimed at gaining profits by chopping prices alone works if others don't retaliate.

"However, it's difficult for competitors not to," Wolf noted. "If they do respond, then Dell--along with everyone else--loses."

 

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