IBM: PCs down, chips up

First-quarter earnings take a hit as IBM's bloated inventories resulted in a "terrible" price war.

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IBM's first-quarter earnings, not unlike those of competitors such as Compaq Computer, took a hit today as bloated inventories caused a "terrible" price war that resulted in a significant decline in PC business revenue.

IBM said hardware sales dropped 8 percent to $7.1 billion See related story: 
Price cuts hurt IBM profits during the first quarter of 1998 and gross profit margins for hardware sales fell 4.1 percent amid a torrent of price cuts by competitors.

Poor results in the PC business contributed to the company's first year-over-year profit decline since the second quarter of 1996. Company executives cited lackluster performance in commercial desktop and notebook and consumer desktop sales as culprits in the decline.

"What we did not fully anticipate is the extent of turmoil that our PC business would undergo as a result of PC price wars," said Larry Ricciardi, acting chief financial officer for IBM.

But in other areas,

IBM's Larry Ricciardi on pricing pressure
IBM appears to be doing better. Big Blue continued to shift toward microprocessors and other specialized semiconductors because these products generate higher profit margins than memory chips. In 1995, almost half of the company's semiconductor business relied on DRAM (dynamic random access memory) sales; now, it constitutes just one-sixth, executives said.

For example, in March IBM announced that it will begin to make low-cost, low-power processors based around designs from Advanced Risc Machines (ARM) and act as a contract manufacturer for Integrated Device Technology, which designs low-cost Intel-compatible chips.

Advanced Micro Devices also signed a deal under which IBM will make K6 chips later this year. Most observers said AMD pursued the deal because the company has had difficulty producing chips in its own plant, while IBM's manufacturing is considered state of the art.

IBM may also become more involved in making more of the building blocks for Intel-compatible computers such as chipsets, which work in tandem with the main processor, sources say.

Positive news for IBM can also be seen in its PC manufacturing business, which includes semiconductor product sales and sales of storage products such as hard drives. Revenues grew more than 30 percent to $1.6 billion during the quarter in spite of pricing pressures in memory and hard drives, IBM said.

But on the PC front, IBM faces many of the same problems its larger competitors do. Like Compaq and Hewlett-Packard, the company has suffered from bloated inventory as PC sales have trailed off in recent months. All are working on moving to a hybrid model of manufacturing and selling where systems are built as orders come in, and not to forecasts of demand; but so far, Compaq and HP have had little success in making the transition, while IBM is claiming that its program is further along.

Under the Advanced Fulfillment Initiative (AFI), IBM is shifting more responsibility for parts inventory management and final computer assembly to resellers and distributors. IBM has also redesigned some computer models so as to ease the manufacturing process.

So far, IBM has about eight weeks worth of inventory to sell, analysts note. The company said it will try to halve its inventory level in the second quarter as it continues to build more products under AFI.

IBM's extensive reach into the Asia-Pacific markets also played a significant role in the hit on profitability. IBM's Japan operation is huge and includes a large PC operation and other businesses including a liquid crystal display joint manufacturing venture with Toshiba.

Ricciardi said the company generates 20 percent of its overall revenue in those markets; two-thirds of those Asia-Pacific revenues come from Japan. Revenues were down 7 percent in Japan and 21 percent in Korea, although results in China helped offset those declines and produced a 2 percent overall growth rate.