Gateway shifts retail strategy

Starting Friday, the Poway, Calif.-based company said it will begin stocking 265 of its 277 Gateway Country stores with a select number of PCs. Gateway also plans to later add some notebook models. The moves come as the company also begins replacing the stores' barn motifs with more high-tech interior designs.

Gateway said last month that it was testing such an approach, stocking three of its most popular desktop models at about 40 percent of its stores.

Like fellow PC manufacturer Dell Computer, Gateway more typically sells computers directly to customers, either online or over the telephone. But now the company plans to carry computers in the stores on a permanent basis.

The move is a risky one, warn analysts, who caution Gateway could increase its cost structure by selling PCs through the retail outlets. Offering select models in stores, where salespeople have more incentive to move stock on hand, could sap other systems. The PC manufacturer also must absorb the cost of moving and maintaining stock and the financial risks of carrying inventory.

"They're definitely going out on a limb here," said ARS analyst Toni Duboise. "This is a big challenge for Gateway to build up their store image to be more like a Best Buy or CompUSA."

Still, the move could make better use of Gateway's retail stores, increase sales of services and software, and boost sagging computer shipments.

"There undoubtedly is a percentage of customers that walk into a store that want to walk out with a computer," said Technology Business Research analyst Brooks Gray. "Gateway believes they're seeing enough requests from their customers walking in the door for keeping their highest-performing models on site. But you've increased your risk slightly doing that."

Besides taking orders for custom-configured systems, Gateway will initially offer two cash-and-carry fixed PCs. The company chose two models in high demand.

The 300S, with a 1.3GHz Intel Celeron processor, 256MB of SDRAM (synchronous dynamic RAM), a 16x CD-RW (CD-rewritable) drive and Windows XP, sells for $899. The PC also comes with an Epson Stylus C40UX printer and two software bundles. The second model, the $1,299 500S, sports a 1.8GHz Pentium 4 processor, with 256MB of SDRAM, a CD-RW/DVD combo drive, Windows XP, two software bundles and a 15-inch flat-panel monitor.

Raising PC volumes
Gateway first tried carrying stock in December 2000 for late holiday shoppers. But the company pulled its inventory right after the holidays. For Christmas 2001, Gateway brought back cash-and-carry systems, but this time continued selling product at some stores throughout January and February.

"We had the two holiday tests," said David Turner, Gateway's senior vice president of sales and marketing. "This year we decided to put a little inventory in the stores after Christmas to extend the test. The results of that and the market research we did indicated that not only during the holiday season would we get some demand for it but even in the non-holiday season."

But Gray faulted Gateway on the timing of the new program. "The third and fourth quarters are the best quarters to implement this kind of model," he said. "Attempting it in the first and second quarters increases your risk without a high level of foot traffic."

Drawing store traffic and with it sales, is something Gateway desperately needs right now. The company has been in turnaround mode since CEO Ted Waitt returned in January 2001 to run the company he founded. Waitt's return sent seven of 14 top executives packing and set off a series of strategic initiatives that have yet to right a company listing from stormy PC sales and a pounding by Dell.

In January, Gateway announced another 15 percent work-force reduction and the closing of 19 underperforming Country stores. Additional restructuring would mean the company could lose money for 2002, as Gateway struggles to streamline its cost structure.

That bloated cost structure pinched Gateway PC profits even as lower sales volumes created their own problems during the fourth quarter. Gateway ranked No. 4 in the fourth quarter in terms of U.S. consumer computer market share, according to IDC. But Gateway's market share fell to 8 percent from 14 percent, year over year. Worldwide, Gateway ranked seventh with 3 percent, down from 5 percent a year earlier.

Gateway reported fourth-quarter gross margins of a robust 21.2 percent, but overinflated infrastructure costs and other factors reduced operating margins--what Gateway actually made on PCs--to 0.1 percent.

IDC analyst Roger Kay sees selling PCs from the stores as part of a two-prong attempt to raise PC volumes, which could boost operating margins.

"They have made a judicious gamble," Kay said. "It's low-risk because of the amount of inventory they plan to carry in stores, and it raises their profile. They're hoping they can pump up the volumes and turn over their operating margins."

But Gateway also has engaged Dell and other PC manufacturers in a price war, which comes with its own risks.

"Becoming more price aggressive will increase the volume, but it lowers (Gateway's) revenue per box and will apply pressure to their gross margin level," Gray said. "What happens if they lower the price to their PCs, but don't see a volume to justify it? Then they take a hit to their gross margin level."

Chewing cud or riding steers?
Initially, Gateway is taking a cautious approach to stocking stores, which will carry a very limited number of pre-configured computers. One of the largest risks retailers take is getting caught with too much stock they can't sell before new computers are ready for store shelves.

"This (strategy) doesn't put us in the inventory business," Turner said. "Most of the retailers carry four to six weeks of inventory. We don't have a need to do that because we are an OEM (original equipment manufacturer). We can reorder on a store basis every single day and ship it every single day. We're not going to carry much inventory. We'll have much less than a week's inventory in the stores."

Turner also sees another opportunity to further sell services, software and other extras along with PCs bought and carried out the same day.

"They're also going to be focusing more on peripheral products," Duboise said. "We're talking digital cameras, camcorders, games and all of that."

All of those high-margin add-ons could benefit Gateway's gross margins and eventually operation margins.

But Gray warned it could be too easy for salespeople to focus on the systems in the store, which could have an unforeseen impact on the mix of computers Gateway sells and, therefore, margins.

"You're no longer in the build-to-order business; you're in the retail business," he said. "It's up to the salespeople in the stores to push two specific models."

But Duboise is more hopeful, as she sees stocking shelves as part of a broader strategy to better utilize the Country stores and make them more competitive with other computer retailers.

Gateway's sales model would offer three buying options: cash-and-carry PCs, custom-configured models delivered with seven days, or pre-configured models delivered in 24 hours.

"What they're trying to do is compete for a piece of the retail pie," Duboise said. "If they can do this--refocus on the second-time buyers and get more traffic--they give their customers three selling options that could more effectively compete with the Best Buys."