August 9, 2000 5:00 AM PDT

No such thing as a free PC

Not long ago, some believed PCs would eventually become a free commodity sold with Internet service, following the model of the cell phone industry. But computer makers are finding that they have hit a wall--or, in this case, a floor--when it comes to costs.

The cost of making a computer has declined dramatically in the past decade because of improvements in technology and heightened competition. But even companies that specialize in low-cost machines can't consistently break the sub-$400 level.

"You're not going to get substantially below $300" for the bill of materials, without a monitor, said Stephen Dukker, CEO of low-cost PC specialist Emachines. "Each piece inside the box has a certain base cost. Physics keeps you from going lower."

Add the cost of putting it together, shipping it to a retailer and handling support, and you are right at the $400 level.

Manufacturers of Internet appliances are getting below the $400 mark, but they are doing so by using surplus components selling at clearance prices or by leaving out features.

For example, the New Internet Computer Co., an Internet appliance start-up conceived by Oracle CEO Larry Ellison, markets an Internet appliance with a processor that was discontinued before the unit even debuted.

The cost plateau at times has been masked by manufacturer's rebates and subsidies from Internet service providers, but those promotions provide only so much cover.

Typically, computers cost much more than cell phones. The monthly ISP connection service, at $21.95 a month, usually costs much less. With that imbalance between expenses and monthly payments, it's a safe bet that PCs will come with a price tag for some time. Some ISPs are giving away PCs with more costly DSL service, but it remains to be seen how well that model will work

For PC makers, one of the major stumbling blocks is physics. Unlike their contemporaries in the software market, for example, hardware manufacturers must contend with the tangible barriers of the physical world.

PCs are made from things like plastic, silicon and metal. Mass production requires $2 billion chip factories, PC assembly warehouses, worldwide component trading networks, thousands of employees, and omnipresent delivery systems.

By contrast, a software developer theoretically could get by with a couple of floppy disks and an Internet connection.

Selling a PC for $399, as companies like Emachines sometimes do, is generally a losing proposition, said International Data Corp. analyst Roger Kay. If all the components are in heavy supply, it is possible to make a buck or two above costs, he said.

"When the costs are perfect it's possible to make a razor-thin margin," said Kay, who noted that there still won't be any money left to cover expenses such as marketing, overhead and executives' salaries. Companies can sell Internet appliances for less by chopping off drives and using outdated and often discontinued processors, but the cost of true PCs just isn't going down, he said.

Components improve
Rather than a continuing spiral in price, consumers get better parts. Intel's base-level wholesale price for a processor is $69, the same it has been for more than a year. What has changed is the speed. Today, the cheapest chip is a 500-MHz Celeron. A year ago, the cheapest chip was half that fast. Because a 266 MHz costs nearly as much to make as a 500 MHz, according to analyst reports, Intel merely terminates the slower models.

The list price doesn't necessarily reflect what companies are paying. Often, surpluses mean that chip prices dip below the wholesale price. IDC, for example, estimates the average cost of the microprocessor used in sub-$800 PCs is about $55 this year.

The hard drive industry uses the same formula.


What's inside a cheap PC
processor $69*
case $15
CD-ROM $30
hard disk $70
floppy drive $10
Microsoft Windows about $70
memory $45-$60
core logic $17
graphics processor $2
graphics memory $2
input/output controller $3
BIOS chip $2
 
Total:
 
$335 to $350
 
*list price for Intel's Celeron chip 
Source: Emachines, IDC

A low-end hard drive today holds far more than one did a year ago, but they both sell at wholesale for around $70. Like Intel and other microprocessor manufacturers, drive makers increase the power of their products rather than cut prices to zero.

"There are no $30 hard drives or $50 hard drives," said Michael Slater, founder of MicroDesign Resources and president of PhotoTablet, a company specializing in digital photo management. Although the storage capacity of drives has doubled every 18 months to two years, minimum drive prices have largely stayed within a limited range because of the economics involved.

Memory runs another $45 to $60, with the price fluctuating greatly depending on chip prices and the consensus of how much memory is enough. A CD-ROM drive costs about $30, with another $30 coming from companion chips such as graphics controllers, modem chips and core logic, the chips that connect the processor to memory and other components.

Microsoft's Windows adds roughly another $70 to the cost, with that price varying somewhat based on which computer maker is footing the bill.

ISPs, appliance makers dig in
Consumers who have wanted to get a machine for less than the sum of these parts have been able to do so, thanks to a land grab by service providers.

Services such as America Online and Microsoft's MSN have been kicking in up to $400 in rebates to customers willing to commit to several years of Internet service at a fixed price. This has helped mask the limits of the computer industry to further cut costs.

Internet appliances can be made cheaper, but only by eliminating things. Cut out the hard drive, eliminate Windows and use a bargain-basement processor, and you can get to a final cost near $200, industry experts say.

Internet appliances are smaller, which means the case can cost $5, vs. about $15. There's no need for a floppy drive, which is another $10 savings.

But to keep prices low, you have to be flexible on which components you use.

"It's all about keeping the box at $199," said Gina Smith, chief executive of New Internet Computer Co. The New Internet Computer, or NIC, uses discontinued 266-MHz Cyrix processors made by National Semiconductor.

"As soon as we run out of 266s, we'll move up to 300s," Smith said.

And Smith isn't stuck on Cyrix chips.

"If somebody would come up to us and offer a really cheap chip, we'd talk to them," Smith said.

 

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