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The free PC revolution begins

Following last year's low-cost PC battle, 1999 became the year of the "free PC," promting speculation as to whether or not companies can continue to make profits on hardware alone.

In 1999 the "free PC" arrived. The computer will never be the same.

If 1998 was the year of the low-cost computer, 1999 was the year of the "free," or subsidized, PC. The vanguard of this movement was a group of start-ups that gave away PCs to make money on multiyear Internet service contracts and side e-commerce deals.

See special report: PC free-for-all These start-ups--armed with no-holds-barred strategies to gain customers--turned the computer industry, in one sense, on its head. The focus was no longer the box but the Internet. The PC essentially became an enticement to sign up for Internet service. And later in the year, several of these start-ups were also reeling.

The impact has been profound. Major Internet service providers (ISPs) began to offer $400 rebates, while computer makers themselves cut prices and offered other incentives such as periods of free Internet access. Companies are now openly discussing how Internet and advertising partnerships may be used to offset some of the cost of manufacturing, a change in an industry that has been centered on making profits from hardware. Computers for $1 or less--after the rebate kicks in--became a common feature of Sunday newspaper inserts.

In the wake of these shifts, large PC makers are laboring to adapt their sales strategies to those of the nimble "free-PC" start-ups. The shift has been huge.

"There will be a time in the future where we won't be dependent on hardware for profitability," said Mike Larson, senior vice president and general manager of Compaq's consumer division in an earlier interview

At the same time, several of these new PC firms have already gone out of business. International Data Corp. expects to see more consolidation by the end of 2000 in the market, with possibly a number of companies gone by the end of the year. Retailers, meanwhile, are entering into tight marketing and investment alliances with AOL and Microsoft's MSN which will likely lead to further discounting techniques.

"Circuit City is now giving the $400 rebate on almost anything in the store," said Martin Reynolds, an analyst at Gartner Group Dataquest. "What we have here is a shift in the dynamics of the ISP market, not the PC market."

Though that may be true, the fallout for PC makers has been unmistakable. The level of competition became so high that superstore stalwart Packard Bell NEC dropped out of the retail market that it once molded while giant IBM launched a new marketing plan that will take Big Blue out of most stores, at least temporarily.

But this wasn't totally unexpected. Back in January, Paul Otellini, general manager of the Intel Architecture Business Group, said that declining component costs and a desire to expand the consumer market beyond the 50 percent home penetration level would force PC makers into "a lot of interesting experimentation."

"Free" PC start-ups proliferate
Some key events in one of the most talked about trends of the year.
Feb. Free-PC offers a free Compaq PC to 10,000 applicants. Customer interest knocks site out temporarily.

Microworkz announces it will begin selling $299 PC with free Internet service from EarthLink.

Mar. Start-ups DirectWeb, Gobi say they will give away PCs for customers who agree to three years of Internet service. Skeptics raise concerns about such start-ups.
June CompuServe, Prodigy begin to offer $400 rebates through Circuit City, BestBuy and others.
July Surge in "free" PC sales boost June retail sales beyond expectations, according to PC Data. Trend continues through the year.

Signs of trouble: Enchilada, a start-up that began to advertise "free" and discounted PCs in April, stops accepting orders.

Dell unveils plan to sell ISP service to U.S. customers. Free year's worth of access given on some PCs.

Aug. EarthLink sues Microworkz for breach of contract. Microworkz customer complaints later culminate in suit by the State Attorney General of Washington.
Oct. Prodigy says it has signed up 120,000 customers in the six weeks following the launch of its rebate offer.

Gateway and AOL team up on $800 million deal. Gateway begins to give away AOL access for free.

Nov. Emachines and Free-PC merge, bringing an end to Free-PC's experiment.
Dec. Microworkz officially closes doors, also ending its experimental business strategy.
Some of the options would include giving away the box under extended Internet service contracts, similar to the "cell phone business model," he said at that time. Some would survive; many would not, he predicted.

How right he was. A trickle of companies in early spring of this year turned into a summer flood. The "free" movement officially began on February 8 when Free-PC said it would give away 10,000 PCs to qualifying customers--and then had its Web site knocked out by inquires. Microworkz, now defunct, Gobi and DirectWeb then followed.

"We think we can achieve one million [subscribers] over the course of a year," said Ganesh Ramakrishnan, Gobi's chief executive at the time, characteristic of the ebullience of those heady months.

On June 30, the dam burst when AOL said it would begin to offer $400 rebates to new PC buyers who agreed to a three-year service contract with CompuServe, an AOL sub-brand. AOL also announced an investment in Emachines.

Customers took to the idea. A report in July from PC Data said free PC sales contributed to a jump in sales in June. The number of computers sold climbed 35 percent as hardware makers and Internet service providers teamed up to offer rebates based on three-year Internet access contracts, according to PC Data's July report.

The Apple Macintosh camp joined the fray too. in August unveiled a plan to give away one million Apple iMac computers over a two-year period. ( as of December 1, however, had yet to give any PCs away.)

But trends for manufacturers turned ominous. As sales rose, prices fell. By mid-year, the average cost of a Windows-Intel architecture PC fell by 20 percent from year-earlier levels to $890, according to a PC Data report.

Statements from executives at the legions of free PC start-ups also began to tell a tale of rickety business models. "If I recovered just cost on the box, I'm happy," said Rick Latman, founder of Microworkz before his company collapsed. At that time, Microworkz was planning what would in retrospect be seen as an overly ambitious offer: a $199 device that would come with free unlimited Internet service.

More evidence of trouble came as inexpensive PC maker Emachines announced plans in November to merge with Free-PC and phase out the "free" part. The reason for the buy-out, according to executives at the two companies, was 1999: The year in technology that Free-PC was not generating the business necessary to sustain a strategy based on free hardware.

But with the "free" enticement gone, what does Emachines get? Free-PC was making its money by selling ad space to third parties, which Free-PC customers had to look at as a condition of getting a free computer. Emachines will absorb these deals, which in the end will allow them to reap additional revenue. Either way, the deal means that Emachines' future is not tied to simply lowering manufacturing costs, or increasing market share.

Others concur that the future for hardware makers isn't necessarily in hardware.

Is the PC dead in 2000?
Does this mean death to the PC? The answer to this is a resounding no, but there will be alternatives.

CNET TV: Free computers
CNET TV: Free computers

The most distinctive new twist to the market will be highly specialized Internet devices. Both IBM and Compaq are planning strategies that offer a simple appliance centered around a robust set of Internet services. IBM has been mulling, among other ideas, a simple countertop Internet appliance that it would supply to telecommunications companies which, in turn, would sell it with a host of Internet and phone-like services to their customers. At Comdex, Compaq showed off the "Clipper" a squarish box with a built-in screen that connects to a phone line. Microsoft will likely market the product as part of its MSN Companion push.

"[The PC] is definitely not dead," said Schelley Olhava, an analyst at IDC. "We see really healthy growth for the PC over the next five years...People need to get on the Internet and the first thing they will think of [buying] is the PC."

Instead, the PC will become the hub of the home with ancillary devices that connect to the PC or compliment the PC in some way.

"Think of the kitchen," Olhava mused. "You have an oven but then you also have a microwave and toaster."

But Gartner Group's Reynolds warns that the PC industry may begin to suffer from rebate hangover next year: "Once the base is turned and people are locked into their ISP contracts, PC sales will suffer. I don't have a clear view as to when this happens, but next year will be a transition year."