Best Buy tries new subsidized PC strategy

Best Buy is currently offering "free" or subsidized PCs to customers in three test markets and will launch a nationwide program this month or soon thereafter. Although the hardware is free or steeply discounted through rebates, customers have to sign one-, two-, or three-year contracts for Internet service through Prodigy to qualify.

If successful, Best Buy's program could mark a watershed moment for the movement. With computer prices in a free fall, pundits have been predicting that the PC business would rapidly resemble the cell phone business, where hardware is given away or sold at a loss as a way to entice customers into monthly service contracts. So far, several start-ups have launched so-called "free PC" initiatives, but Best Buy will be the first computer retailer to join the fray.

But the revolution hasn't gone off exactly as planned. Customers have flocked to these cheap PC offers, but since then many have come forth with complaints about small companies that take their credit card numbers and then don't deliver PCs for weeks. Customer support lines, consumers have said, are nearly nonexistent at some of these companies. In their defense, free PC executives have said demand has been much higher than anticipated.

Best Buy is far larger than other free PC companies and could be in a position to smooth out some of these difficulties. In addition, these smaller companies generally restrict their offers to low-level PCs. Consumers in Best Buy's program can pick any PC except laptops.

Best Buy declined to comment, although several sources close to the company confirm that the program will launch this weekend.

Best Buy has been testing a system in a few markets that essentially offers a mail-in rebate to customers who sign up for Internet service when they purchase a PC. This rebate covers any computer in the store, and the discount significantly increases, depending on the length of the service contract the customer buys.

The program will be started nationwide this weekend, sources say, after trial runs in Charlotte, North Carolina, Indianapolis, and Orlando, Florida. The initial rebate is expected to start at around $150 for a customer who signs up for one year of Internet service, going up to $250 for those who sign two-year contracts, and $400 for those who agree to three-year contracts. A $2,000 PC under a three-year contract therefore drops to $1,600, but a $500 PC drops to $100. In-store representatives said the deal applies to any PC but a laptop.

Consumers then pay Prodigy separately for ISP service.

Best Buy's subsidized PC plan will differ significantly from previous Strategies. Unlike Free PC, the company is not relying on advertising revenue to offset hardware prices, and unlike Microworkz and Gobi, which also offer subsidies for Internet services, the company is neither a hardware manufacturer or marketing firm.

Instead, Best Buy is one of the first third-party retailers to launch such a plan, and the strategy may be a way to enhance the razor-thin profit margins that accompany retail PC sales, analysts say. The deal in many ways is more in the league with deals offered by PC maker Gateway. Gateway doesn't discount its PCs, but gives a year's worth of Internet access for free, a $210 value, with nearly all of its boxes.

Mail-in rebates are not always redeemed, which could boost revenues, according to Shelly Olhava, an analyst at International Data Corporation. "They wouldn't be doing this if they didn't think there would be some type of profit," she said.

That profit boost may embolden the company to overlook some of the potential conflicts with its computer partners that the plan may create.

For example, PC manufacturers Compaq Computer and Packard Bell NEC offer Internet services which are sold bundled with PCs. These companies generally take a cut of the ISP revenue. Best Buy's rebates would potentially compete with these services.

"Channel conflict is endemic to this area," said Roger Kay, another IDC analyst. "I don't think Compaq is in much of a position to argue," he added, noting that Compaq cannot abandon its retail partners. "The retailers are essentially saying, 'it's life or death for us--our margins are worse than thin,'" he explained.