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Low prices, direct sales threaten superstores

In the face of market changes, OfficeMax becomes the latest to report that its computer sales have become a drain on the bottom line.

Will the Internet and low PC prices kill the computer superstore? That may be what some executives are wondering as one retailer after another reports losses or steep declines in the profits from computer sales.

When OfficeMax reported earnings today, it became the latest to report that its computer sales have become a drain on the bottom line. The company posted sales of $923 million and earnings of 2 cents per share.

The company's computer business pulled earnings down $5.6 million, or 5 cents per share, during the quarter, while PC sales were down 15 percent to $47.3 million from the same period a year before.

Rather than try to boost sales to cure the problem, OfficeMax will instead cut back on in-store PC specials and will experiment with programs that will shift some of the cost of selling PCs back onto the manufacturer.

OfficeMax is not alone in the mire. CompUSA has talked of shifting its focus to digital consumer technologies such as DVD players, while GoodGuys, a large California-based chain of electronics stores, said recently said it was transitioning out of PC sales.

Office and computer superstores, so named for their breadth of offerings, continue to find the PC, in particular, a difficult proposition. Increased competition from Internet-only retailers and the growing popularity of direct PC makers such as Gateway and Dell Computer are putting the squeeze on already tight profit margins. OfficeMax, among others, has had trouble finding the right strategy to deal with a product analysts say they need to carry but which drags down earnings.

"In general, all [superstores] are suffering from the Internet sales bug. As the Internet continues to siphon retailers' strength, they will try and fight back," possibly by refusing to carry products that are sold over the Internet, said Cameron Duncan, an analyst with ARS, a consultancy focused on the retail market. In the meanwhile, Duncan said the retailers are trying to find a profitable solution, with mixed success.

PC prices, of course, have plummeted drastically in the past two years, a decline that has lead to flat or lower revenues and profits, depending on the company, despite an increase in actual PCs shipped.

"The trend at all these superstores since the mid-90's is that they've been relying more on services and peripheral sales to [be able to] get a profit off PCs," he said. Others agree, noting that PCs are essential to drawing customers into stores.

"The key thing for all these superstores is getting customers across the threshold and into the store," said Roger Lanctot, director of research with market research firm PC Data. "PCs are a necessary evil that they try to turn into a traffic-generating opportunity."

Circuit City and Best Buy each sell more computers than other brick-and-mortar retailers; they've been two of the stronger companies when it comes to diversification. While other retailers continue to see sagging profits or worse from PC sales, Circuit City and Best Buy are making up for that by selling more service contracts, collecting interest on financed purchases, and selling additional products in the stores, like appliances, according to Lanctot.

OfficeMax is engaging in some interesting experiments to try to improve its results. The company said it's testing out a store-within-a-store concept with IBM at four outlets. Unlike IBM's other store efforts with CompUSA, three of four store-within-a-store locations will be staffed by IBM employees on IBM's payroll.

In addition, IBM will be responsible for maintaining inventory of its products. IBM will also keep the revenue generated from sales, according to an OfficeMax spokesperson.

"We're looking to target the small-business and home-office customers still coming in [because of the PCs] yet try and sell them other ancillary products, " said Mike Weisbarth, vice president of corporate communications for OfficeMax.

The goal is the same: Convert consumers of PCs into purchasers of higher-margin office supply products but without the cost of maintaining a PC inventory. "Our focus is to minimize losses that are occurring in the computer segment. We do like having a presence in that segment, but again, we don't want to continue to operate at [these same levels.]," Weisbarth said. The company is also operating an IBM store-within-a-store plan with its own employees in an effort to compare results.

"Is it [the IBM experiment] going to work? This does not represent a magic bullet solving the problem of PC margins," said Duncan. "There's not really much retailers can do."