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Industry rethinks moneymaking software practice

Before they ship PCs to retailers like Best Buy, computer makers get paid hundreds of millions of dollars to load them up with free software. For $30, Best Buy will get rid of it for you. (From The New York Times)

5 min read
SAN FRANCISCO--Before they ship PCs to retailers like Best Buy, computer makers load them up with lots of free software. For $30, Best Buy will get rid of it for you.

That simple cleanup service is threatening the precarious economics of the personal computer industry.

Software companies pay hundreds of millions of dollars to PC makers like Hewlett-Packard to install their photo tools, financial programs, and other products, usually with some tie-in to a paid service or upgrade. With margins growing thinner than most laptops, this critical revenue can make the difference between profit and loss for the computer makers, industry analysts say.

If the programs are removed, the software makers gain no value out of the $2 to $10 they typically pay HP and others to install them on each PC--and PC makers miss out on their cut from revenue-sharing deals. But Best Buy, the nation's largest electronics retailer, tells computer buyers that the preinstalled software, also known as bloatware, can clutter their machines and slow them down.

"You'd be surprised how often consumers tell us to get rid of it," said Robert Stephens, the head of Geek Squad, the technical support division of Best Buy that removes the software. He declined to say how many people were paying for the service, but said that "it's going to increase in popularity."

The demand for the service, along with similar offers from Circuit City and other chains, reflects an outpouring of consumer frustration with the way that a brand-new computer can feel as if it is full of digital infomercials--even if those come-ons knock a few dollars off the PC's price tag. The Web has dozens of do-it-yourself guides to removing such software, which, as one tutorial puts it, "turns your computer into a messy battleground." Stephens said the personal computer makers should be worried about the demand for less cluttered computers.

"No matter what manufacturers want, we'll give consumers what they want," he said. But he added that he believed computer makers would find different ways to profit: "While they may be scared by these trends, they'll be OK."

As it turns out, HP, the world's largest technology company, is already working on a fundamental change in the way it packages software on its new computers, and thus how its business model works.

Stephen DeWitt, who oversees HP's personal computer business in the Americas, said that starting next year the company's new computers would point users to a Web site where they can buy and download games, productivity software, and other programs. Revenue from the site will be split in some fashion among HP, a retailer like Best Buy, and the makers of the software.

DeWitt said the change would cut how much software comes preloaded.

DeWitt said this was happening because consumers were demanding something different, but also because the technology was now in place to allow downloading of software on demand.

For now, he said, the benefits to consumers of the free software far outweigh whatever small slowdown it might cause. And he said Best Buy's cleanup service was not pressuring HP to move to a new model. "There's no tension coming from Best Buy on this--none," he said.

But in Best Buy stores in Northern California, there is clear evidence of the different agendas of Best Buy and the computer makers. The stores display two HP computers, identical except that one desktop is cluttered with software icons from eBay, Quicken, AOL, Yahoo and others, while the other is entirely cleaned up. Best Buy workers use the display to promote the company's $30 "optimization" service.

Industry analysts said that the planned change in HP's approach could well reflect Best Buy's growing influence--and its ability to exact new concessions from computer makers. They said Best Buy has benefited from two key changes: the declining fortunes of competing retailers like CompUSA and some large regional chains, and the addition to its shelves in the last year of ="9733201">computers made by Dell and Apple.

Bob Kaufman, a spokesman for Dell, said, "This is an evolving story and Dell is evaluating how it can best deliver software to its customers." Best Buy's offer to remove software began in 2006. But recently the toll its policies are taking has heightened considerably, analysts and industry executives say.

"Best Buy's sway is definitely growing," said Matt Fassler, an industry analyst who covers Best Buy for Goldman Sachs. He said the company had good relationships with computer makers, and, while it wouldn't seek to harm those relationships, "if they have a strong competitive position, it is incumbent on them to use it."

Fassler estimates Best Buy will have sales of $44 billion this year. Of that, $1.5 billion to $2 billion will be from the sale of HP computers, analysts estimated.

"No matter what manufacturers want, we'll give consumers what they want."
--Robert Stephens, head of Geek Squad

One important question is whether the new model being developed by HP will be as profitable as the current one. DeWitt said he expected it to be more profitable. But A. M. Sacconaghi Jr., an industry analyst at Sanford C. Bernstein & Company, said the change could imperil HP's profitability, in part because there is no guarantee that consumers will buy software offered through HP instead of another site.

As software buying moves online, Sacconaghi asked, "what makes a consumer go to HP.com over Google?" He also says the challenge for personal computer makers is that they are losing control of what shows up on PC screens--a form of real estate that they have used to sell billboard advertising for software.

"They no longer have that real estate advantage," he said. "There's a substantial profit pool at risk."

And there can be little profit to begin with, analysts said.

The profit margin on many personal computers can be 5 percent or lower, depending on the model. The margins are slim in part because of intense competition that has driven down prices. In some cases, the computers are profitable only because their makers earn $30 or more for each computer for preinstalling the software, according to Shaw Wu, an industry analyst with American Technology Research.

And J. P. Gownder, an analyst at Forrester Research, said, "For the average PC, that could be the entire margin." Without the preloaded software, Gownder said, "it could put them in the red. That's why they've become so addicted to it."

Stephens of Geek Squad says he agrees with HP that the future is in allowing computer buyers to choose and download what they want. But he said he believes Best Buy, not HP, is in the best position to help people choose what works for them because, he argued, the in-store technicians are in closest contact with them.

"Geek Squad agents have one thing over Apple and Microsoft engineers. We spend most of the day talking to people," he said.

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