PC vendors take the direct challenge

In the face of a successful onslaught of direct marketers led by Dell Computer, most of the top PC makers are overhauling their outdated methods of selling computers. The result could be even lower PC prices.

The secret of success for Dell (DELL), Gateway 2000 (GTW), and Micron (MUEI) is a dull and often overlooked part of a company's operations: inventory logistics.

Selling direct to the customer by mail order helps Dell and Gateway manage their inventory more efficiently. And that lets them undercut conventional computer manufacturers by $100 to $150 per box. "Inventory management is the key," added Todd Bakar, an analyst at investment firm Hambrecht & Quist.

The trick is minimizing the amount of time that the vendors hold on to computer components. That's the trick that Compaq Computer (CPQ), Hewlett-Packard(HWP), Sony, and Packard Bell NEC all want to learn.

"If you can't do this, you are going to have a very difficult time competing in the PC business," said Eugene Glazer, technology analyst at Fortis Adviser. "You may be out of the PC business."

All four of these companies are now making plans to add some kind of direct sales channel to their current sales model. Once the channels are in place, consumers are likely to likely to benefit from yet-another all-out price war.

Mail order companies shave cost on computers, servers, and notebooks in two basic ways. First, they cut out the middlemen--distributors or dealers--and thereby save five percent or more off the top, according to various estimates.

"There are a lot of extraneous costs that you don't need anymore," said Jeffrey Matthews, partner at Ram Partners, an investment group in Greenwich, Connecticut.

Secondly, direct marketers save money through just-in-time manufacturing. Under traditional computer manufacturing, computer makers have to design a line of computers, buy components on credit, and then sell finished computers through distributors and resellers, often on more credit extended by the manufacturer. That leaves them only to hope that customer demand meets their forecasts.

The pace of the industry has made this fraught with risk. Components can become outdated by the time the reach the reseller or customer. Some computer models can fail to find their market. If the forecasts go awry, manufacturers have to find a way to dump product fast.

With just-in-time manufacturing, most of the guesswork gets thrown out because vendors don't have to predict what customers will want. The manufacturing-to-sales time is also compressed so that companies don't have to buy the parts on credit.

"From the time the component is ordered to the final sale, Compaq holds the parts for over 100 days," said Glazer. "Dell holds them for 20...The implications are enormous financially."

Dell has just-in-time manufacturing down to an art, according to Roger Kay, an analyst at International Data Corp.

Not only does the company have a massive part tracking system, but its component suppliers maintain a warehouse across the street from the Dell factory; shipping the parts requires no more than a forklift ride. This methodology gives Dell a 10 to 15 percent manufacturing cost advantage. The result is a cheaper, but also a fully customized machine, a combination that Kay believes customers will demand in the future.

Sony will start to sell direct to the customer through mail-order sales toward the end of the year.

Many of the other computer vendors, however, are more reluctant to throw over the dealers and resellers that they have relied on for years to move their boxes. These companies are moving to variations on the direct-sales themes that don't cut out the middleman altogether.

While resellers on one hand add cost, they serve as an extended sales force and as service representatives. Compaq has vowed that the company will continue to sell the bulk of its computers through its dealers. Packard Bell has made similar comments.

Hewlett Packard (HWP) will begin to direct-market its computers through a massive web site but will then funnel these orders through its dealers, said Jim McDonnell, group marketing manager for the personal information products group.

IBM (IBM) is championing "channel assembly." Under this technique, the manufacturer ships semi-built computers to distributors or resellers, who configure the system after the customer submits an order.

This method lets the manufacturer rely on a variety of channel partners, but poses quality control problems, according to Michael Dell, CEO of Dell Computer, and other critics.

Compaq is trying several dealer-based techniques while Packard Bell is planning to have both mail-order and a dealer channel optimized for just-in-time manufacturing.

All of these new sales techniques will take an enormous investment to increase in-house consulting and sales staff. Compaq, for example, plans to hire 2,000 consultants.

If imitation is the best form of flattery, then Dell and Gateway must feel pretty flattered. But they can't afford to remain complacent if everyone else is coming to their party.

Dell is itself moving to build up its in-house consulting capacity. The company recently hired Joseph Marengi, one of the architects of Novell's (NOVL) customer service unit, to take charge of Dell customer relations.