August 29, 2001 1:10 PM PDT

Gateway's make-or-break decision

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Is Gateway getting lean and mean or just fattening up the bottom line for a quick sale?

That is the question analysts were trying to sort out Wednesday, a day after the company said it will slash its work force by up to 25 percent, close several manufacturing and support sites in the United States, and pull back from its international markets.

Gateway Chief Executive Ted Waitt has promised that his company will become smaller and nimbler and therefore better able to serve its customers. However, the history of the PC market has not shown that strategy as a path to sustainability. Instead, the PC industry's recent history has been either about growing, like Compaq Computer and Dell Computer, or about withering away, like AST Research and Packard Bell.

Gateway's "management is trying to decrease expenses faster than revenues. But we are unconvinced this approach will work," UBS Warburg analyst Don Young said in a research note Wednesday.

Merrill Lynch analyst Steven Fortuna suggested that Gateway's focus on the United States alone could be a precursor to a sale of the company. Gateway's management could be "dressing up the company for sale to a potential suitor that would likely have a more established international presence," he said.

But if Gateway can't find a buyer or prefers to go it alone, analysts say the company will have to succeed where others have failed.

"This is exactly what AST did in the late '90s. They pulled out of Europe and Asia...which hurt their volumes and did not allow them to compete on cost. This is what Gateway is in danger of falling into," IDC analyst Roger Kay said.

Packard Bell, once a leader in the PC market, attempted a strategy similar to Gateway's in the late 1990s, but the company was unable to turn itself around. Still, Dataquest analyst Charles Smulders distinguishes the plight of the two companies from one another.

"Packard Bell suffered from an inefficient supply chain...Supply chain efficiency is a key part of the PC business," Smulders said. "Gateway differs from Packard Bell because it sells directly to its consumers, allowing it to be much better with supply chain efficiency and to have better control of its customers. And they can instigate changes more rapidly if they need to."

Investors were somewhat pleased by Gateway's moves. The stock closed up 18 cents, or 2 percent, to $8.78 on Wednesday after trading as high as $9.15 earlier in the day.

Service matters
Smulders had one specific beef with Gateway's decision, though.

"My only concern with their recent moves is the closing of support centers. If their cuts result in a decrease in customer service, that could lead to very negative and dangerous results," he said.


Gartner analyst Charles Smulders says that given Gateway's return to a strong focus on the consumer, small business, government and education markets, there is little need for a worldwide presence to service the few large accounts it has.

see commentary

Support centers play a key role in customer service, which used to be a hallmark of the company but became less of an emphasis under Jeffrey Weitzen, the former chief executive who was ousted in January. The San Diego-based company has been making a concerted effort to improve customer service since then.

"We haven't done a good job of taking care of our customers," Gateway Senior Vice President Bart Brown told financial analysts in late February. "We didn't treat our customers like friends. We've done some stupid things in the past two years."

The massive restructuring comes amid the worst PC market in years, plagued by stagnant growth and brutal price competition. Industry watchers have been predicting that none of the major players will abandon the PCs but that some will pull out of specific market segments and try to focus on their strengths.

Gateway, like Compaq and Hewlett-Packard, has been trying to reinvent itself as a "solutions" company, hoping to follow in the footsteps of IBM.

IBM pulled out of the U.S. retail PC market in 1999 but has expanded its overall business by offering a wide range of hardware, support and services to corporations.

However, Gateway is not planning to target corporations, which currently make up a very small part of its business. Instead, it is trying to serve what it calls an untapped market for PC-related services geared toward consumers and small businesses.

Waitt, who founded Gateway and left as chief executive only to return when Weitzen left, said earlier this month that Gateway is looking to serve as the chief information officer to companies that can't afford their own IT departments.

"We'll be your CIO," Waitt told CNET News.com in an interview.

A tough road
Yet that is a tough road to take. The small-business market has long been dominated by local resellers who sell brand-name and "white-box," or generic, computers and provide software and on-site services.

Needham analyst Andrew Scott said Gateway, as well as other companies, has tried to go after this market before.

"Gateway has been speaking about this opportunity since the late 1990s," Scott said. "The problems that they encountered with their small and medium business pushes previously have certainly not disappeared."

Scott said the one advantage Gateway has that other companies don't is its 300 Gateway Country stores. Having a local presence is a critical selling point to small businesses, Scott said.

"The question is 'Do they have the resources to dispatch individuals to go to the offices of small and medium businesses?'" Scott said. "Dell could never go after this business, and they know that. They don't need to."

Smulders noted, however, that the Gateway Country stores have not realized their full potential.

"They have to get their core U.S. business running properly. Key to that will be getting a return on investment from their stores," Smulders said. "The stores are underutilized, and Gateway really doesn't understand store retailing. They have yet to find the right formula to get a significant return."

Analysts were split on Gateway's decision to pull out of Asia and its expected withdrawal from Europe. On one hand, a number of analysts have noted that the company has a weak presence overseas and gets more than 85 percent of its sales from within the United States. On the other hand, Merrill Lynch's Fortuna said in a research note Wednesday that much of Gateway's restructuring is needed but that pulling out of Europe could hurt Gateway in the long run.

"If Gateway exits Europe now," he said, "its chances of successfully re-entering the market in the future are lower than that of fixing its operations there now."

 

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