PC Makers Get Crunched

By Karl Taro Greenfeld

Admit it: seated in front of a PC with the name scratched off, you couldn't tell the difference between an IBM and a Dell, Compaq or Gateway. And would you care? Probably not. Buying a PC today is no more complex than getting, say, a toaster. Or, if you're looking at something really sophisticated, a microwave oven.

And that's a problem for computer makers, whose industry is fast becoming commoditized. "It's no longer a technology business. You don't need a team of engineers to build a PC today," says Steven Dukker, CEO of eMachines. These issues have computer executives shuddering as the PC business matures into one in which price trumps brand and profit margins are narrowing. Dukker's company is the upstart leader in the ultracheap market that is suddenly rewriting the business model of the personal-computer industry. It's partly to blame for the recent sell-off of technology stocks that has driven major computer-manufacturer share prices down as much as 40%. (Want to know why we didn't make Dow 10,000 on our first run at it? Three letters: IBM.) There was a time in the mid-'90s when PC makers could count on ever more complicated applications requiring ever faster processors, causing consumers and businesses to upgrade PCs almost as often as Japan changed Prime Ministers. Sellers like Dell, Compaq, IBM, Gateway and Hewlett Packard got accustomed to 100% revenue-growth rates, while investors reaped heady returns: $1,000 invested in Dell in 1989 has grown to $640,000 today.

But as we head into the millennium, it's a different market, one that has tech CEOs conceiving new strategies and tech analysts revising earnings expectations downward. In just a week, analysts lowered their share-price targets for Dell, Compaq and IBM. "Hardware margins are approaching [those of] grocery stores," says Roger Kay, research manager at IDC, a technology consulting firm.

Hardwaremakers are also being hurt because softwaremakers aren't producing the power- and memory-sucking innovations that made consumers and businesses race out to upgrade their machines. The next big app, Microsoft's Windows 2000, is likely to require only a 300-MHz processor, already standard in today's bargain-basement PCs. So M. Lewis Temares, vice president of information technology at the University of Miami, figures that besides a few university officials who need high-octane processors for such things as complex med-school accounting software, his people are fine with the hardware in place. And his job is to buy computers--typically 6,000 PCs a year. Right now, he says, "nothing is driving us to upgrade." Experts call it the "good enough" syndrome, as in "My computer's good enough--why do I need a new one?"

Nor will the growth of the Internet help. The narrow bandwidth of standard telephone lines serves as a democratizing bottleneck, rendering all processors, regardless of speed, equally slow. Why buy a souped-up superbox loaded with Pentium III power if the on-ramps to the information autobahn are perpetually jammed?

If you need a computer, now is a perfect time to buy--without having to worry about being out of date in six months. The average PC sold for $1,600 in 1997; it now sells for about $950. The fastest-growing segment of the industry is the sub-$600 market, where you'll find companies like eMachines and Microworkz. The subgroup currently accounts for 20% of PCs sold at retail, according to the market-research firm PC Data. Ultracheap prices have earned eMachines, in business for just six months, fourth place in retail desktop market share, less than a point behind IBM.

How low can prices go? How about zero? A new service, Free-pc.com offers a free 300-MHz PC if you are willing to devote one-eighth of your desktop to a perpetual series of scrolling banner advertisements. It's hard enough to compete with low-priced rivals, let alone free ones. Maybe that's what prompted IBM CEO Louis Gerstner to write in a March letter to shareholders, "The PC era is over."

At least for IBM it is. What an astonishing statement from the head of the company that created the PC industry! But last week Big Blue announced that it lost a billion dollars on PCs in 1998. Gerstner believes the future is in networks and servers, both IBM strongholds.

IBM gets no argument from Dell and Compaq, the two U.S. market-share leaders, which have been slugging it out for more than a decade. They are moving the battle from the saturated consumer market to better-heeled corporate customers. Margins in that market are shriveling as Dell and Compaq bundle heaps of services, software and support to sweeten the deal for finicky clients who have plenty of negotiating leverage. "All brands come with an unbelievable amount of management software, fast CPUs [central processing units] and everything else you need," says Roger Baumann of Affiliated Networks, a small Miami marine-parts e-commerce firm. "It comes down to who's going to sell me those features for the lowest price."

Michael Dell, CEO and founder of Dell, insists there is plenty of growth ahead for his company and his industry. Dell cites Europe and South America as two areas where it can expand. The real problem, he says, is the impossibly high expectations of sales growth that analysts have set for his company. "They keep raising them and raising them. And you play that out logically, and at some point they put their guesses so high that they are not really achievable." Dell's first-quarter revenue is growing 38%, a spectacular number for most companies. But Wall Street had been expecting better, and Dell's stock tumbled.

Dell, as well as Compaq and IBM, is still a powerful brand in an indispensable industry, but then again, Sony is a leading brand in an industry in which pricing and growth rates were once comparable to the PC business: television sets. Today Dell trades at a price/earnings ratio of 75; Sony trades at a P/E of 23.

Even more ominous for the industry is the generation of information appliances touted as the next wave of microprocessor-loaded consumer goodies. What happens when you've got a Windows CE device running at 200 MHz in the palm of your hand and a cell phone with Internet access in your pocket? Not to mention Packard Bell NEC's planned microwave oven with a video-display terminal on the door so you can surf the Web while waiting for your burrito to thaw. E-mail? Web access? Game playing? Will anyone need a PC to perform what today seem like PC functions? Well, there will always be geeks who have to have too much computing power. But the rest of us may be satisfied gazing into our microwaves.

--With reporting by Greg Aunapu/Miami, S.G. Gwynne/Austin and David Nordan/Atlanta

With reporting by Greg Aunapu/Miami, S.G. Gwynne/Austin and David Nordan/Atlanta