Handicapping the PC start-up odds

Stephen Dukker still has a year and a half to go before he can qualify for golf's senior tour.

The former CEO of Emachines began hitting the links for the first time last August--he meets lots of unemployed technology and dot-com executives who come out in droves when the weekday budget rates kick in--and just turned in his first score of 100.

But Dukker may have to put his golf ambitions on hold. The peripatetic executive--whose curriculum vitae includes CEO stints at mail-order company PC Brand and semiconductor company Opti, along with senior executive positions at CompUSA and Computer City--is close to trading the life of a gentleman of leisure for a new tech venture. (He's keeping mum about details until the official announcement.)

"Other callings will pull me back from golf," he jests, "but at least I've gotten to the point where if a customer asks me to go out on links, I won't be running away."

Dukker, who has kept a low profile since his March departure from the company he helped get off the ground, is credited with shaking up the conventional wisdom about PC pricing. When Emachines introduced its first computers around Thanksgiving 1998, the company offered a $399 model that came with 32MB of memory, a 266MHz CPU and a 2GB hard drive. For $499, you could buy a 300MHz system with a 3GB drive and 32MB of memory.

The monitor came separately, but the low prices for those sorts of tech specs set the market on its ear. Within three months, Emachines accomplished the rare feat of becoming one of the top five sellers of PCs through retail.

PC pricing has never been the same, leading to a sharp increase in computer ownership beyond the narrow confines of the affluent classes. In a recent interview, Dukker talked about directions in new technology and the new business dynamics governing the PC market.

Q: What were the tactical and strategic considerations as you planned how to get Emachines off the ground?
A: At the time, our belief about the PC industry was that what products sell for is driven by what components cost. In 1998, component costs had dropped to the point where high-quality PCs could be built for less than what the major brands wanted to charge.

We also foresaw a real need for lower-cost PCs; ownership was concentrated in households with incomes above $70,000 a year. Below that, PC ownership was very low. We had done the research when I was with Computer City that showed $500 for a computer was the magic number to bring ownership to people making $40,000 to $50,000.

But for most PC makers, there was the fixed-cost issue to consider.
We had a logistic-centered model, farming out engineering and production offshore to partners; we wanted to go to market with the mission of taking care of customers, users and retail partners. So by focusing, we believed we could build a quality brand as the first step toward building a new PC company that would get into other things as well. The good news, bad news of competing in the PC space is that brand loyalty lives less with the brand than it does with companies like Microsoft or Intel. The trust gets put into that company where the consumers purchase their systems.

The initial price points on your systems were $399 and $499. When you hit the market with your systems, the price points caught the competition off guard. But wasn't it a case of live by price, die by price? That is, unlike an IBM or a Hewlett-Packard, you couldn't offset the margin deterioration in your PC business by server or services-related revenue.
Well, the initial mission was to secure a distribution channel and build brand. And a start-up's not going to do that in a significant way in the enterprise corporate space because you don't have the credibility or reputation, etc., as a more established company. So you have to quickly build the economy of scale that comes with volume.

Our idea was to come up with a model that had the lowest possible overhead and to build share quickly--while we had a window of opportunity--and then diversify into higher-priced product.

If I recall, the more established brands responded to the challenge posed by Emachines by lowering their prices.
Yes, they lowered their prices. I would argue that of the 5 or 6 million new households that got new PCs back then, it was because vendors responded to the stimulus of Emachines coming into the space--as well as the subsidized models introduced by AOL and Microsoft.

Let's talk about the company and how it subsequently fared. In retrospect, do you think the decision to go public worked against Emachines? Especially considering the timing of the tech meltdown, were there any particular pressures dealing with the Street as the CEO of a publicly traded company that affected your ability to plan for the long term?
It's certainly a mixed blessing. On the positive side, the process of taking a company public ensured that we got capital and an opportunity to achieve recognition of our long-term plan. If we had not gone public, how much cash would the company have needed to get from A to B to C? We raised over $300 million in working capital and clearly established Emachines with the resources to make it to whatever the current management team defines as its long-term business model.

But the flip side?
On the downside, as a public company, you're standing naked in the breeze. When--and if--there are things that happen, such as an economic downturn, people focus on the intermediate rather than the long term.

Emachines began selling systems around Thanksgiving 1998 and broke into the top-five ranking at retail within 90 days. Were you surprised?
We knew the demand was there. I think all of us--I won't say surprised--we knew it could happen. We were very happy we could execute that plan well. Unfortunately for us, a year and a half later the economy slowed down and we hit our first speed bumps.

So why didn't Emachines get acquired?
I think that question is probably better directed at current management.

(Editor's note: Emachines hired Credit Suisse First Boston a month ago to help it "study options for the business.")

What was the smartest decision you made at Emachines?
Doing it! (Laughing)

So what was the dumbest decision you made?
You know, I like to think we didn't make too many dumb decisions. The most controversial one was going public, and the downside was that it opened up the company to lots of unproductive criticism and speculation about things. Recognizing that Emachines was a 2-year-old company and having analysts take potshots as if this was an end-point company rather than a work in progress--any 2-year-old company is a work in progress, and we accomplished some incredible things.

As a PC manufacturer, what was it like to deal with Microsoft?
Microsoft is a great partner; that's all I can say. We wouldn't have accomplished what we accomplished without a strong, positive relationship with them.

Did Microsoft ever step close to or over the line to get you in line with its wishes?
Our relationship was outstanding.

OK, I see where that one's going. Elsewhere, Dell recently went on record with a declaration of a price war. If the competition follows suit, will there be casualties?
There's been lots of talk about consolidation, but interestingly, as Dell declares a price war, I read about HP and Compaq surrendering. So I think every company has its mission, and there's no question there'll be consolidation. Clearly, scale is important, and the razor-thin margins in the space imply that the biggest will survive or the ones who are true to their model will survive.

Do you think a start-up PC company can still make a go of it in this market?
I think it would be very difficult for a start-up to come into this space. Emachines has shown that you need massive financial resources to weather it. The issue will be financial credibility, not just whether they have resources today but for the long term. The controversy about Emachines makes me question whether that amount of capital could be raised again. Remember, we raised $300 million between the private and public equity rounds.

How low do you think will PC prices go? Or is there a point, say, $500 or $600, where price will remain static but the features will just improve year in, year out?
The way the business is defined today, we're pretty much at the lowest effective prices they can be sold for. PCs will just get better, better and better...it's difficult to imagine them getting less expensive.

And the future? How much longer does the PC in its current incarnation have before it's supplanted by something else?
This is one of the interesting challenges facing the industry. The PC has to continue to absorb more functionality. The challenge there is that those applications are being peeled away from the PC--or they are not starting on the PC as other application-specific computing devices come into the home. For instance, the personal video recorder, as a dedicated function box, could take away $500 of value from the PC and become an easier-to-use, separate, potentially more reliable device in the home-entertainment center.
We're at the verge of seeing MP3 home-audio devices...where you have Internet-connected devices that are part of a home-audio system that aggregates MP3 content. If they take off as a separate class of product, then the PC winds up degenerating in its functionality to essentially become an Internet appliance.

How are consumer tastes changing?
I think consumers will always use the best, most cost-effective, easiest-to-use device to accomplish their needs.

But will that be the PC?
To the degree that the PC does it, then it will be the device. But if 200 to 300 devices do it easier, then that functionality will disappear from the PC. In terms of the hobbyists and workstation users, these high-end machines will always have a place. But you'll see the marginalization of those users into becoming a relatively small chunk of the total PC universe.

What's the most exciting technology coming to market?
I'm very, very excited about the digitization of home media; it's creating a wealth of opportunities unlike anything the market has seen before. Things like the personal video recorder and the home MP3 center are just the tip of the iceberg because, fundamentally, we're about to see a "re-infrastructuring" of the home-entertainment environment. It's going to create such a wealth of opportunities to innovate and create new, cool devices that are really useful to people. Also, I like the PDA space. It's exploding.

Sounds like you're not going to be spending too much more time on the links. Planning to get back into the industry anytime soon?
I'm getting busier every day.