PC makers seek telco, service providers' help with new products

Gateway, IBM, Compaq Computer, Microsoft's WebTV, and Intel are all coming out with Internet devices that provide consumers access to email or the Web cheaply and easily. But unlike the past, when PC makers simply produced a system and sold it, these days companies are seeing the need to market their products in conjunction with businesses that provide online access.

Many, if not most, of these cross-industry partnerships involve revenue sharing, another new twist.

Computer makers often portray these shotgun weddings with Internet and communications companies as a "natural" evolution of their business. Their long-held goal is reaching the majority of American households that do not have a computing device. But behind these deals seems to lie a fear of the unknown and a need to lean on partners that have a clearer picture of the future.

"As PC makers strive to reach the last 50 percent of consumer households, more and more liaisons with services companies will be needed. And most PC companies do not know how to do this," according to Richard Doherty, a principal at The Envisioneering Group.

"They want the Internet"
IBM, which is more diversified and therefore better situated than many of the purist PC companies, reflects the industry's belief that many of these remaining users may only want one thing.

"People don't want more computers or technology in their lives. They want the Internet," according to Mark Bregman, general manager at IBM's Pervasive Computing division.

Big Blue is already partnering with cell phone makers Nokia and Ericsson and has plans to cut a bevy of deals with communications firms in the coming months, all to hurry along growth in new markets, according to IBM executives.

"Home [PC] penetration in the U.S. has stalled at 38 percent for the second year in a row. Compare that to the growth of other devices...[that put] the Net within the reach of masses of people who could never afford or be bothered with learning to use a fully loaded PC," according to the text of a speech Bregman plans to make later this month in Stockholm, Sweden.

The writing is on the wall, the text says. "The adoption rate of mobile phones worldwide is three times larger than PCs...In China, more than 1 million people are signing up for mobile phone service a month."

More than 60 percent of the new Internet devices will be wireless and in a few years IBM expects there to be about 600 million PCs worldwide--but these will be sharing the Internet with 2 billion networked handheld devices, he said.

The upshot is that all these devices require Net access services to make them useful.

"This is very different from the PC, which has value without the Internet service. This is why most companies that are focused on these devices are positioning themselves more as service companies than hardware companies," said Kevin Hause, an analyst at International Data Corporation (IDC).

Services
That's certainly what PC maker Gateway is trying to do. In fact, in the wake of October's landmark marketing agreement with America Online, the company is taking every opportunity to boast of "non-PC income" and a "beyond the box" strategy, both of which Gateway intends to expand as it dives deeper into the Internet with new information appliances and services.

"Our non-PC income exceeded 15 percent for the first time," chairman and chief executive Ted Waitt said in a recent earnings conference call.

Jeff Weitzen, Gateway's president added, "We'll ramp up the proliferation of wired and wireless devices...we'll advance the 'AOL Anywhere' strategy by developing and marketing Internet and home networking appliances as more and more consumers extend their Internet online habits beyond a single PC."

Meanwhile, Intel, the quintessential PC hardware maker, has put together a number of deals with companies such as NEC in Japan, PCC Corporation in Asia, and Hughes Network Systems. The chipmaker will be involved in developing and supplying components, centered on the core chips that go into these devices.

(Exemplifying the complexity lurking behind of many of these arrangements, AOL is in turn investing $1.5 billion in Hughes, which is developing the set-top box that will be provided to Hughes' DirecTV's 7 million subscribers and AOL TV interactive television, with its potential customer base of 20 million subscribers.)

Though Intel still firmly believes that the PC is the No.1 Internet access device because of its functional diversity, it's also hedging its bets. "We need to be a part of solutions that enable Internet access through other media devices. We need to work with people that are supplying data technology and have this expertise," said an Intel spokesperson.

Where's the beef
In the meantime, the shift toward low-cost Internet appliances has some analysts worried because of the potential for erosion of hardware profits at PC manufacturers and components makers like Intel.

"As profit engines, these business models have little value," according Martin Reynolds, an analyst at GartnerGroup Dataquest.

Martin says device prices will be cut to the bone. Because they compete on the open market, "ultimately any fat in the pricing has to be cut. However, for both parties, these partnerships can create customer loyalty and therein lies their true value."

Envisioneering Group's Doherty says loyalty to service equals financial dividends. "The entertainment and value which flows through a PC during its 2-4 years maximum useful service life are now more valuable than the hardware."

Doherty also maintains that IBM has leg up on PC makers such as Compaq and Dell. "IBM knows how to link services with hardware," he said.

Events seem to bear this out. IBM is partnering with telecommunications companies like France Telecom and Deutsche Telekom to develop network technologies for screen phones and working with device manufacturers like Palm to put software on their devices that eases connection to the Web and [corporate] enterprise data, according to IBM's Bregman.

But Gateway is formulating--at least in the public record--the clearest vision of where future revenue streams will come from in the beyond-the-PC Internet era.

"The operating economics are based on the principle of sharing each other's economics on access, portal, the software store, and training. Simply, this means that...we will share the dual economics of...Gateway.net subscribers as well as the economics of the AOL subscribers," John Todd, senior vice president and chief financial officer at Gateway, said during the recent earnings conference call.

Gateway also has aggressive plans for making its portal profitable.

PC makers or service providers?
But nobody, by any means, has figured this out completely yet.

IDC's Hause says success will depend on a tricky, and possibly monumental, shift from PC makers' core business: comparatively high-margin PC sales. "For a PC company, there are new challenges associated with this model. For the most part they would rather have the hardware produced cheaply by someone else, allowing them to reap the profits from the service."

But the problem is that in addition to being in the dark about the certainty of future revenue streams, computer companies are not yet structured in a way that makes this business model work.

"While several have entered the service space to some degree--for example, branded ISPs--they are not primarily service companies," added Hause.

"At the same time [PC makers need to] stick to higher-priced systems where they can attempt to differentiate and add value."

Of course, all of this could be a rush to judgment. The personal computer remains a remarkably versatile device and an item that tens, if not hundreds, of millions of consumers worldwide will likely continue to snap up every year, analysts say. Many believe that most users won't be in a hurry to drop PCs packed with DVD video, stunning graphics, high-quality audio, digital photo editing, sophisticated printing, and word-processing, presentation, and spreadsheets software--in addition to Internet access--for limited Internet devices.

"The average buyer wants one thing--flexibility. That is, a PC," said Frank Dzubeck, president of Washington DC-based Communications Network Architects.

Still, it seems certain that profit margins from personal computers will continue to shrink as the Internet becomes the most important reason for using a computing device, forcing computer makers to redesign hardware and services around the Net, rather than subordinating the Net to the computer.