Small PC makers under fire

If you are not a top-tier PC vendor, the road ahead will be rough and may ultimately lead to a dead end, analysts say.

Michael Kanellos Staff Writer, CNET News.com
Michael Kanellos is editor at large at CNET News.com, where he covers hardware, research and development, start-ups and the tech industry overseas.
Michael Kanellos
3 min read
SAN FRANCISCO--If you are not a top-tier PC vendor, the road ahead will be rough and may lead ultimately to a dead end, according to analysts speaking today at a conference sponsored by a major investment banking firm.

The Year 2000 will present grand opportunities for PC manufacturers, so long as you are named Compaq (CPQ), Dell (DELL), and Hewlett-Packard (HWP).

These companies, along with IBM, will see their combined market share zoom from 37 percent to 50 percent, and likely enjoy even more commanding growth rates in laptops and PC servers.

For nearly every one else, including Gateway 2000 and lesser names such as AST Research, razor-thin margins, fewer high-end product offerings, and sheer market momentum will likely result in shrinking sales, said Kurt King, a Montgomery Securities analyst, speaking at the NationsBanc Montgomery Securities investment conference.

"In desktops, we see nothing but poor-to-worse fundamentals," he said.

To make matters worse, consolidation will not necessarily mean that these companies get bought by their larger competitors; some of them may just fade away.

"There isn't that much to buy," King said. "You just steal their market share."

Even IBM will not be immune from the pressure. Although the company will remain in the "big four" of computing, IBM's ability to diversify its product line and its track record in desktops mean that the company may not enjoy the same sort of gains as Compaq, HP, and Dell.

"I question their commitment to PCs and their ability to execute," said King, adding, "IBM has yet to make a dent in Compaq's server business."

The drastic consolidation of the market is being driven primarily by three forces. First, these companies have more diverse product lines, which results in higher margins. High-end PC servers, he pointed out, come with a gross margin of 45 percent while workstations and laptops carry margins of over 20 percent. By contrast, desktops carry a 10 percent gross margin. As a result, the more diverse manufacturers will reap more profit.

Server vendors, in particular, will benefit when Microsoft releases Windows NT 5.0 in 1999. The new version of the corporate-use OS will allow PC technology to compete head-to-head against Unix servers in some applications.

Second, the low-priced PC market will continue to grow, a trend that favors the large manufacturers because they have already reduced their price premiums. Traditionally, the gap between the branded and non-branded PCs has been over 20 percent. It is below 10 percent now.

Third, more efficient manufacturing techniques deployed recently by Compaq and others, such as "build-to-order" manufacturing, will begin to accumulate in the near future.

After a point, the success of the large manufacturers becomes almost a self-fulfilling prophecy. The companies will be more profitable because they sell more computers and they will sell more computers because they can make investments for profitability.

Compaq's acquisition of Digital will probably turn out to be an early example of consolidation. The Houston-based manufacturer will likely jettison the $2 billion Digital PC division and try to consolidate sales under the Compaq brand.

King did not predict the demise of other players, but indicated some of the problems they may experience. Gateway, for instance, has yet to establish a corporate brand. More significantly, so far Dell has not aggressively launched an effort targeting the SOHO customer base of its direct mail rival. If Dell does make an effort, the profit cushion it enjoys in servers could be used as a price war weapon against Gateway.

Although King painted a bleak picture, not all fates have been foretold. Micron, for instance, could see growth. "They have a good image in the corporate market," he said. Micron has also managed to organize an effective management team.

Paul Fox, another analyst at NationsBanc Montgomery, postulated that contract manufacturers such as Solectron will do well in the future. These companies currently make most of the low and mid-range computers for the large, branded PC makers. Outsourcing deals will likely increase as desktop and laptop prices plummet.