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eMachines aims for empty shelves

The discount computer maker is trying to make a comeback with a new business model that seeks to tackle one of the thorniest problems in the industry: excess inventory.

Discount PC maker eMachines ran out of computers earlier this month, and the company couldn't be happier.

The Irvine, Calif.-based computer maker is trying to make a comeback with a new business model that seeks to tackle one of the thorniest problems in the industry: excess inventory. Instead of building PCs based on expected demand or to pursue a perceived sales opportunity, the company now builds only enough PCs to fill orders from retailers and stock its online store.

The strategy, set in place over the past year, puts a lid on gaining market share but keeps eMachines from getting stuck with excess and rapidly aging PCs.

"We are essentially out of product, and our channel partners are down to a couple of weeks," eMachines Chief Operating Officer Adam Andersen said earlier this month. "That's by design."

eMachines, which is one of the best-selling brands on U.S. retail shelves, is now keeping such tight controls over manufacturing that its own online store ran out of PCs earlier this month. The company literally didn't have anything to sell until its ship, a cargo container from Asia containing some new PCs, came in.

This new way of doing business, however, is allowing the company to achieve something it never could before: turn a profit. According to the company, eMachines had a slim profit in the fourth quarter that would have translated to about a penny a share.

But the company never got to report those results because it became privately held on Dec. 31, after a buyout from board member Lap Shun "John" Hui, who paid $1.06 per share. Andersen said eMachines expects to be profitable for the whole year, although the company is now under no obligation to report its results.

The PC maker did have a rather inglorious life as a public company. Its shares debuted in March 2000 around $8 but quickly headed south. The company was delisted from the Nasdaq in May 2001 when its stock failed to maintain a minimum bid price of $1. The shares were traded over the counter until Hui's buyout.

eMachines, however, wasn't alone in its problems with excess inventory--which has been the bane of the computer industry for years.

Compaq Computer found itself saddled with massive amounts of inventory in early 1998, which eventually led to a worldwide glut and the termination of then-CEO Eckhard Pfeiffer. Meanwhile, Dell Computer has largely become the leader in the industry by, among other actions, minimizing the time that it holds onto components or finished PCs. Because components continually drop in price, PCs in inventory are constantly becoming more expensive compared with newly minted machines. Also, manufacturers must pay credit charges on components purchased but not resold to consumers.

In some ways, eMachines is doing a reverse Dell. Rather than establish a sophisticated manufacturing facility that can capitalize quickly on market changes, the company is retreating to a corner of the market that it hopes it can protect and thus create consistent profit.

Point of no return
The new strategy largely hinges on its return policies for retailers. In short, eMachines won't accept returns. Once large retailers such as Best Buy or Fry's Electronics buy the $399 and $599 PCs, they irrevocably own them until a consumer, or a surplus clearance specialist, buys them. eMachines also won't offer price protection, or refunds on PCs that get sold early to retailers but are later cut in price.

Other manufacturers typically give price protection and accept returns under specific conditions.

Although this strict contract effectively insulates eMachines from unforeseen expenses involved in refunding money for unsold stock, the strategy is not without hitches.

Time, for instance, is not on eMachines' side. Assuming that components are available, it takes about six weeks for eMachines to get the PCs from the moment it orders them, including travel time. Nearly everything arrives by boat from Asia, although the company does use airfreight on occasion, Andersen said.

That means the stores have to do a pretty good job of predicting what consumers want well ahead of time. And if the systems sell out quickly, eMachines remains absent from the shelves until the next round of orders.

The biggest downside to the strategy, analysts say, is that retailers may tend to act conservatively in their ordering, potentially limiting the company's ability to take advantage of an increase in demand.

"There is a chance you are going to limit yourself on the upside," said NPD Intelect analyst Stephen Baker, who follows the retail PC market.

However, Baker said that may be a small price for eMachines to pay for lowering its risk.

"I think it's a survival strategy, and I think it makes sense," Baker said. "There is a lot to be said for knowing what your volumes are."

eMachines is also struggling to rebuild its reputation, wanting to be known for selling PCs at a reasonable price, rather than just selling cheap machines.

Aiming to do so, eMachines recently poured $20 million into improving all aspects of its customer service.

"Before that, eMachines had awful, awful customer support," Gartner Dataquest analyst Mikako Kitagawa said.

Poor customer service hit eMachines' bottom line as well, with too many customers opting to return products rather than deal with support hassles. Because the improvements were made, Andersen said, the rate of customer returns has been cut in half.

The changes have all come under the watch of CEO Wayne Inouye, the retail veteran and CompUSA executive brought in 11 months ago to replace co-founder Stephen Dukker.

The company has maintained its niche as the low-cost leader, a role that is attractive both to stores looking to lure shoppers and to the most bargain-conscious of consumers. eMachines accounted for 11.5 percent of computers sold at U.S. retail stores in November, putting it in third place behind Hewlett-Packard and Compaq, according to NPD Intelect. During certain weeks between Thanksgiving and Christmas, it finished second in unit sales, ahead of Compaq, Baker said.

No contest computing
Baker said he does not expect other PC makers to rush in with more favorable terms to grab the ultralow-end of the market.

"On a head-to-head basis, nobody is going to want to go after them," Baker said. For HP and Compaq, "there's not a lot of incentive for them to go after the same price points."

And as for retailers wanting to pressure eMachines into offering more lenient terms, Baker said that a healthy eMachines helps provide a good counterweight to the retail muscle of Compaq, HP or especially a merged HP-Compaq, should the proposed deal go through.

"It's in most of the retailers' best interest to do what they can...to keep them as a healthy third option," Baker said.

At the same time, eMachines faces plenty of competition anytime it looks to move up the food chain. Dell and Gateway both sell machines at prices comparable to eMachines' higher-end models, as do Compaq and HP.

eMachines is also eyeing a return to the laptop market in time for the back-to-school shopping season. The company was less than successful with its first attempt two years ago when it started selling a $999 laptop known as the eSlate. Bob Davidson, eMachines' senior vice president of product marketing, said the company hopes to do better this time around.

"It was under-featured and, in my view, not of the quality or look-and-feel that we need to move to promote our brand," said Davidson, who formerly worked in Toshiba's notebook unit. "That would not be a good example of what eMachines is going to be able to do in the notebook arena."