CNET también está disponible en español.

Ir a español

Don't show this again

Christmas Gift Guide
Tech Industry

Compaq hurt by bloat

Ambition, not sales, seems to be at the root of the trouble.

Ambition, not sales, seems to be at the root of Compaq Computer's current woes.

The world's largest PC vendor, which today reported a substantial drop in earnings and profitability, is struggling to get a handle on inventory levels and has not effectively implemented several large business initiatives it launched in 1997 and early 1998.

At the same time, See related story: Compaq earnings crash in a year when PC sales have begun to slow Compaq is laboring to maintain titanic growth rates--even while cutting prices. The result has been dropping margins and shrinking profits.

Margin erosion caused by price cuts can be gauged by Compaq's earnings. Revenues for Q1 1997 and Q1 1998 were roughly equal. In 1997, however, that revenue generated $414 million in earnings. The same amount produced only $16 million in earnings a year later.

Next quarter will likely bring the same: Unwieldy levels of inventory, flat earnings, and more margin erosion.

"They're working through this painful transition process and we'll probably take our [earnings estimate] numbers down a bit for the year," said Louis Mazzucchelli, an analyst with Gerard Klauer Mattison.

Compaq's struggle to implement its Optimized Distribution Method (ODM) demonstrates both its inventory problem and also an unfulfilled business initiative. Announced last July, the effort is designed to make Compaq more competitive with Dell, cost-wise, by putting in place a build-to-order manufacturing scheme. Unfortunately, the program has barely begun.

"They [Compaq] remain fairly weak in channel management expertise and many have underestimated the difficulty in executing," said Kurt King, analyst with NationsBanc Montgomery Securities.

Like King, International Data Corporation analyst Kevin Hause said that implementation of build-to-order strategies is taking longer than Compaq apparently planned. "It takes more than just senior management saying, 'Hey, this is something we want to do,'" he observed. "It didn't happen as quickly as they wanted."

Under the build-to-order scheme, resellers undertake the final assembly of a PC, installing components like memory and the hard drive to match customer orders. In addition to being more responsive to demand, build-to-order allows resellers (collectively known as the "channel") to keep less inventory, which pares manufacturing costs.

In its financial statement, Compaq said that inventories had been reduced, but Hause and others questioned whether there has been a true reduction in the number of Compaq PCs. That is, Compaq's own inventory may be down, but it's hard to say how much of that has been sold to customers, and how much of that has merely been shifted to computer resellers and distributors.

"They need to forecast demand better and quit stuffing the channel," King said. "Stuffing the channel" is industry parlance the condition where for PC vendors force resellers to buy more PCs than they'd like to have in inventory.

"They have essentially been unsuccessful in reducing their inventory at all," said King, who estimated that Compaq may have as much as 12 to 16 weeks on inventory available right now. IBM, by contrast, has been more successful in reducing its smaller inventory load.

Meanwhile, in January 1998 Compaq bought Digital Equipment in a stunningly large $9.6 billion purchase. The acquisition, which had been the subject of high-level, on-again, off-again negotiations for at least two years, essentially will provide Compaq with the high-end hardware technology and the worldwide corps of consulting engineers it has needed to act as a global technology provider.

But digesting a company the size of Digital is no small task. Among other issues, the two companies overlap in several areas, and the deal raises questions about the future of Digital's 64-bit Alpha microprocessor.

The purchase itself awaits Federal Trade Commission approval.

Last June Compaq bought server vendor Tandem, creating another management chore.

Amid such activity, Compaq has continued to set high sales goals, Hause pointed out. "You've got a company that is growing at multiples of the marketplace trying to maintain that pace. Demand didn't come in as strong as they had hoped," he noted.

Compaq's current setback and the one expected for the upcoming quarter are likely to prove temporary, Hause added. The big question, however, is whether the Houston-based company can figure out how to raise PC prices again. "I don't think they are going to be able to raise it for the foreseeable future," he said.

"Senior management has got a lot on their plate," Hause summarized.

Although the company is preparing to roll out new products in the second quarter and will continue to effect the build-to-order model, these steps will not offset the Compaq's problems in the second quarter, Mazzucchelli said. "There will probably be some spill-over into the third quarter," he noted.

Notwithstanding, investors today bid up the stock. That's good news for Compaq, which has seen its share price fall roughly 30 percent since February when it traded around in the 37 range. Compaq, which released its results before the market's open, closed yesterday at 26-1/16.

"I think a lot of people are willing to give them the benefit of the doubt. Shipment demand is good and they have a good market position," Mazzucchelli said. "But I think this transition will take a lot longer. Once they get through this inventory problem, then they have to start digesting DEC."