March 15, 1999 4:15 PM PST

PCs nearly free, but questions loom

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Price drops, Net transforming PC industry

March 5, 1999
The free PC dream took another step forward today when Microworkz announced it would give away a year's worth of unlimited Internet access with a $299 computer, but observers question whether the company, and even the industry in general, is stepping over the bleeding edge.

The problem, say analysts, lies in the untested nature of these free, or nearly free, PC businesses. Manufacturers say they will recover hardware expenses through service contracts and other downstream revenues. But there is no guarantee that the future revenues will materialize as planned.

"The whole segment of the market is in the trial stage," said Sean Kaldor, consumer electronics analyst at International Data Corporation. Of Microworkz's $299 PC, he said: "They will probably find a market for this sort of thing, but I don't know how they will make money."

Microworkz is the latest in a series of computer makers and dealers aiming to gain fame and market share by selling PCs at seemingly impossible prices or giving them away in a quid pro quo for other services. (See related story.)

EMachines started the trend last year by selling a $399 machine that cost, according to some, around $380 to make. FreePC followed with an offer to give a select few applicants a free machine, as long as they were willing to accept a barrage of advertising.

Seattle-based Microworkz has taken the concept further with its $299 WEBzter junior today because the computer comes with a year's worth of unlimited Internet access from Earthlink. Subtract $240 for the average cost for 12 months of Internet service, and Microworkz's computer costs $50. Overall, this is $50 less than one year of the most basic service offered by WebTV.

"We do nothing at a loss, and the $299 machine will net a profit on a direct basis. Our costs are less than $299," said Rick Latman, president of Microworkz. Nonetheless, the WEBzter junior does not appear to be profitable in the traditional sense. The company receives unspecified subsidies from its partners which help it hit the $299 price point.

Cheap as it is, though, others will follow. Emachines is expected to release machines for $299 and lower, as long as consumers agree to extended ISP contracts, said Roger Kay, an analyst at IDC. Similarly, computer refurbisher ReCompute is currently offering a free used PC in conjunction with ISP services for $39.95 a month, said Brian Kushner, ReCompute's CEO. Other deals will follow, Kushner said.

"This is an escalation of the free PC wars," said Kay of the Microworkz deal.

The free PC movement has its roots in the component costs declines of 1998 and the explosive rise of the Internet. Declining prices on memory, processors, and hard drives drove entry level PC prices to well below the $1,000 mark last year. Concurrently, many PC vendors began to sell more of the products online and directly to customers, cutting out the middleman and further expenses in the process.

At the same time, many studies have shown that the No. 1 reason consumers buy PCs is to get on the Net.

Soon, some theorized, PCs could be given away for free like cellular phones, because manufacturers could recover costs through service contracts. The success of the Gateway YourWare program, through which Gateway customers can buy service contracts or ISP service, showed that service revenues could be captured in this way.

Cheap has certainly worked for Emachines. The company only started selling machines toward the end of the year. But it ended up with the ninth largest market share in the U.S., according to IDC.

Cell phone strategy might not work
Unfortunately, the cell phone business strategy may not be the perfect analogy. The customer support costs, for instance, are much higher with PCs. A single customer support call to Emachines might cost $20 to $30, said Kaldor, which wipes out earlier margins on the cheapest models. At the same time, component prices have begun to stabilize.

"I don't think it makes sense to give it away," Kaldor said. Some sort of charge has to be levied directly, or built into the service contract in a rational way, he added.

A particular problem with Microworkz's model, added Kay and Kushner, is the fact that cost recovery seems to depend on the customer signing up for a second year of ISP services. Customers are getting the benefit in advance. "They are working on an assumption," said Kushner.

Latman for his part said that Microworkz does not depend upon prospective revenues from a second year of services, but also declined to comment on how the Earthlink relationship works.

Interestingly, executives from both Microworkz and Emachines recoil from characteristics that they are trying to build on a free PC company. "There will never be 'free' and will always be strings attached. This system is the best I see in this industry for the next few quarters at least," said Latman.

Steve Dukker, CEO of EMachines, meanwhile, claims that his company is dealing with low prices by selling in volume.

"Our business model is to get incredibly high volume," he said.

Nonetheless, escalation seems inevitable, said Kay. As long as PC makers continue to eye downstream revenues to excite customer demand, vendors will seemingly inch closer to free PC dreams.

 

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