PC makers bank on desktop landgrab

Several PC makers report fierce negotiations with a variety of software companies and service providers for valuable Windows XP real estate, but none yet reports reaching a final agreement. An unplanned cash boon from prime placement of icons could bolster manufacturers' bottom lines as PC sales hover at record lows.

AOL, in the most publicized deals for XP placement, has been brokering new arrangements for where icons go with at least nine PC makers, according to documents seen by CNET News.com. PC makers get payments from AOL based on whether consumers sign up for the company's services and how long they remain subscribers, the documents show.

But other companies are also vying for prime location, said sources, in what may be the most important Windows upgrade in six years.

"The floodgates are open," said a representative of one PC maker, describing the interest in Windows XP real estate. The representative wouldn't talk about specific companies, other than to say, "some of them are companies you would never think of."

PC makers contacted refused to disclose the names of potential partners, since any deals under discussion are still in flux. But the clock is ticking. PC makers that sell through dealers need to finalize relationships in the next 30 days to guarantee that new systems will be on store shelves for Windows XP's Oct. 25 launch. But direct-sales computer makers, such as Gateway, could wait until the last minute, possibly using the extra time as leverage for more lucrative arrangements, analysts said.

Search portal AltaVista is in "active negotiations" with "some OEMs" said a person familiar with the discussions. AltaVista representatives were not available for comment.

Other companies potentially involved in negotiations for Windows XP placement include Internet service provider Earthlink and streaming-media provider RealNetworks, said sources. A representative from Earthlink would not comment on any potential deals with PC makers.

A representative of RealNetworks, which sells streaming-media software that competes with Microsoft's Media Player, would not comment on negotiations with PC makers, but said: "We're in constant conversation with all sorts of OEMs to provide as good a placement of Real's properties as possible, and those conversations are new and starting all the time."

Representatives from AltaVista's main rival, Yahoo, also were not available for comment on whether the company is investigating placement deals with PC makers. But in an announcement that didn't offer details, Yahoo on Tuesday said that Sony has agreed to preload software that will allow buyers of its Vaio computers to quickly register for co-branded Yahoo and Sony services.

Kevin Kyle, marketing director for Compaq Computer's access services group, said the amount of interest in Windows XP real estate is substantial. While he wouldn't name specific companies in negotiations with Compaq, he did describe some of their business categories.

"There's a lot of interest from companies delivering broadband," he said. "Clearly, the portals are interested, and search engines are interested. Anybody that has got an instant messenger or wallet service is interested in what's going on with Windows XP. Anybody that has got a backup service or does things around digital photography is interested in Windows XP. Anybody that is doing music, whether that be a player or be it content, is interested in what's going on with Windows XP."

He did give a stronger hint at some of the interested companies. "It's fair to say we will be promoting some of our strategic alliances on our desktop," he said. "I think it's fairly obvious who they are."

Compaq's strategic partners include AltaVista, Disney, Microsoft and Radio Shack. A source close to AltaVista said the company is in negotiations with Compaq to link certain buttons on PC keyboards to AltaVista services.

Interest is widespread
The interest in desktop and Start menu real estate is industrywide and may take in companies with fairly narrow focuses, said Gartner analyst Michael Silver. "It could be folks in the travel industry for consumer machines. It could be folks in the small-business industry for (PCs) targeted at small business."

With U.S. PC sales down nearly 10 percent in the second quarter, according to IDC, sales of Windows XP placement could subsidize weak sales and bolster weak margins.

"The desktop is valuable real estate for PC vendors--without it, they're not competitive financially, (and) can't compete as effectively on price," said Guernsey Research analyst Chris LeTocq. "What this says is that PCs are really a service business."

PC makers, in general, said they are evaluating business deals carefully. "We have plenty of time until October and plan to push out making these agreements for as long as possible," said one PC maker. "A lot of partners are talking to us right now, and we're weighing our options very carefully."

Some existing deals with AOL already reap PC makers as much as a 70 percent increase in gross margins on some systems, suggesting the potential for lucrative deals with other service providers or software makers. One question unanswered is whether companies other than AOL can afford to pay PC makers for Windows placement.

"This is a move by Microsoft that has a great ability to make money for the PC vendors," said Silver. "We're seeing something that Microsoft did to alleviate some legal issues, and it really is a big windfall for PC vendors."

For the most part, PC makers have had some freedom to customize the Windows desktop on PCs they sell and put whatever icons they wanted there. But with Windows XP, Microsoft wanted to eliminate icons on the desktop altogether--and will do so in retail versions of the operating system.

That change would have penalized some PC makers, which long ago had cut lucrative deals with AOL and other ISPs looking for prominent placement on the Windows desktop. Typically, ISPs pay PC makers a bounty on new subscribers gained through the placement.

"It is well known that AOL and other ISPs have had to, over time, forge close relationships with OEMs through promotional fees to get around the Microsoft monopoly," said AOL spokeswoman Ann Brackbill.

With changes to Windows licensing made earlier this month, Microsoft agreed to let PC makers place whatever icons they want on the desktop. Computer makers also gained the right to swap out some icons on Windows XP's redesigned Start menu, opening up valuable real estate some software companies started asking for almost immediately.

"The response was a surprise," said one PC maker. "But I have to emphasize that we don't have any new agreements yet. A lot of people still want to talk to us."

The art of the deal
AOL led the pack in approaching PC makers about placement, said several computer makers. According to internal AOL documents obtained by BetaNews and viewed by CNET News.com, AOL offers cash incentives, or bounties, to at least nine PC makers: Apple Computer, Compaq Computer, Dell Computer, Emachines, Gateway, Hewlett-Packard, IBM, Sony and Toshiba.

"Our relationship with AOL goes back to 1999, but we cannot discuss financial arrangements," said another PC maker. "But compensation is consistent with other (Internet) service providers."

Other PC makers said their AOL arrangements also go back two to three years.

But Microsoft spokesman Vivek Varma accused AOL of being heavyhanded and not just paying for placement "but paying to eliminate competitors." Varma accused the Internet heavyweight of pushing deals that would give it "exclusive offers during the start-up sequence."

Sources close to AOL and PC makers said that the ISP's larger objectives have been twofold: Using existing deals to ensure placement on the Windows XP desktop and gaining a foothold on the Windows XP Start menu. But one source within AOL acknowledged that the company had yet to cut a deal for the Start menu.

Only one major PC maker reported that it would likely place an AOL icon on the Start menu, giving the online service provider equal footing with rival MSN. While Microsoft will let PC makers remove either Web browser--Internet Explorer 6 or MSN Explorer--from the Start menu, they must place an icon for accessing the MSN ISP service.

The policy also applies to the desktop. "If OEMs put any icon on the desktop, they must put one for the MSN Internet service," Varma said.

PC makers were reluctant to discuss other pending deals, particularly since many companies are vying for a small number of spots--at least on the Start menu.

But if longstanding AOL bounties are any indication, PC makers stand to reap lucrative deals for the Windows XP desktop and Start menu.

According to the internal AOL documents, most PC makers are compensated on a tiered basis, contingent on how long subscribers stay with the online service. Some deals include up-front fees at new user sign-up, while others mean a cut of the monthly services fee.

Payment schedules
Some of the arrangements have the potential to be quite lucrative. Apple, for example, gets $125 per user registration if subscribers stay with AOL for more than 90 days. IBM and Sony get $35 and $25, respectively. The ISP agreements are month to month.

No. 1 PC maker Dell has perhaps the best deal: $70 at time of registration and $3.50 per month after the subscriber stays with AOL for 120 days. But there is a 200,000-customer commitment. Dell customers get six months' free access; the company started a new six-month promotion this month.

Given the paper-thin margins on most new PCs, the deals would be significant. "Most vendors make single-digit gross margins, so on a $1,000 PC--retailer's cost--with 10 percent gross margin, a $70 bounty is an increase in gross margin of 70 percent," LeTocq said.

Toshiba collects $65 at time of registration, with $13 withheld as an advertising credit. But the PC maker collects only $1.50 per subscriber a month after 120 days. Toshiba customers start out with three months of free AOL service.

Compaq last week modified its agreement with AOL, giving the online service provider its first sure foothold on the Windows XP desktop. Interestingly, AOL did not win a place on Compaq's Windows XP Start menu.

LeTocq noted that Compaq didn't have "a registration bounty. Maybe they've discovered, a little late, how other vendors are making money."

Before that change, Compaq received only $4.25 a month per subscriber 120 days after registration.

Gateway has one of the more unusual--and potentially quite lucrative--arrangements with AOL on a long-term basis. While computer maker gets nothing at time of registration, it collects half the AOL $24 monthly fee. But because Gateway customers get 12 months of free AOL service up front, the PC maker doesn't start collecting that fee until "portal month 19 and on access month 33," according to the AOL documents.

HP and Emachines have two of the most complicated deals with AOL. HP PCs typically come with three months of free AOL service, for which the computer maker is compensated with $25 after 90 days and $1 per month per user. But after reaching 275,000 subscribers, HP gets more: $35 at 120 days, $35 at 180 days and $40 at 360 days plus a $2.50 per month cut. PC purchased through HP's Direct Shopping Channel, which comes with six months of free AOL or 12 months of free CompuServe service, nets the company $100 at month 13.

Emachines deal is by far the most complex. For machines that pack month-to-month AOL service, the company reaps a $35 bounty at 120 days. PCs with three months of free service net Emachines $35 at 150 days for the first 75,000 subscribers. Beyond that, the company gets $35 at 120 days, $10 at 180 days and $10 at 360 days. For PCs with six months of free service, Emachines reaps from $20 to $65 at 240 days, depending on the number of subscribers.

The documents obtained are approximately 2 months old, and AOL would not comment on their legitimacy.

"We're not going to comment on the veracity of the document, one way or another," Brackbill said. "Needless to say, our relationships with these (PC makers) are very multifaceted, and they can include a variety of elements beyond promotional fees, like online advertising, co-marketing and detailed promotions."

PC makers would not discuss their bounty arrangements with AOL, but two said that their deals have not changed in some time.

Silver said the AOL bounties are indicative other deals PC makers could cut for the Windows XP Start menu and desktop.

"Internet access isn't where it ends. There are a lot of other services where they would like to place those icons on the desktop," he said. "Internet services is only the beginning as we enter a more and more saturated PC market."