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IBM, HP facing big inventories

The PC makers also are sitting on excess inventory, which will lead both companies to further price cuts and lower-than-expected earnings.

Tech Industry

While Compaq Computer (CPQ) appears to be the facing the largest inventory woes of the big PC manufacturers, IBM (IBM) and Hewlett-Packard (HWP) are also sitting on excess inventory--invariably resulting in more price cuts and lower earnings.

Neither IBM nor HP has formally announced its earnings forecasts for the coming quarter, but analysts said supply has clearly overshot demand.

In a keynote speech yesterday at Internet World in Los Angeles, HP chief executive Lewis Platt said excess inventory will cause across-the-board price cuts in PCs and servers. Higher-margin products will not be spared. HP is not sitting on the same amount of excess inventory as Compaq, Platt said, but it will nonetheless follow price cuts.

Other HP executives have said that the company is feeling price pressure on their Windows NT-based products, but not on Unix offerings. Bill Murphy, director of Internet marketing, acknowledged price pressure on NT servers but said Unix-based machines "are doing extremely well."

HP sells a large number of Unix-based servers and workstations based on its own version of the operating system and its own RISC processors. Unix systems are more expensive than their NT counterparts and generally command higher profit margins.

Nevertheless, HP is caught up in the price squeeze that affects the Windows-Intel world. Murphy says the prices are going to continue to fall relatively fast, a drop that is causing a "disruption in the market."

The inventory-earnings quandary can be traced back to the price and market share wars of 1997. Last year's explosion of sub-$1,000 computers drove up unit sales for the big PC makers but came with lower profits per machine. To make up the difference, computer companies counted on selling many more inexpensive units to maintain their earnings growth.

Unfortunately for them, PC shipment growth is going down, not up. Last year, PC shipments grew by 19 percent in the United States, more than expected, and 15.2 percent worldwide, according to International Data Corporation. This year, PC sales growth will shrink to 15 percent domestically and 13.2 percent worldwide.

PC makers have also counted on notebooks and servers, two heretofore sacrosanct high-margin categories, to effectively subsidize lower desktop margins. These products, however, are falling victim to "price compression."

Low-end servers are, for the most part, subject to the same price-cutting pressure that applies to desktops. Digital Equipment, for instance, this week introduced a server priced at $1,000. But even at the high end, price competition among top-tier vendors is eroding margins.

"The volume is there in units. It's just that the revenue isn't there," said Jerry Sheridan, server analyst at Dataquest.

New entrants into the server market are also throwing the supply-and-demand equation out of whack. Dell Computer, Micron (via its buyout of server vendor Netframe), and Gateway 2000 (after its purchase of server maker ALR) are pouring new servers into a market where Compaq was once the only game in town.

Looking at the overall market, Compaq was overly optimistic in its sales forecast for the fourth quarter last year and the current quarter, said Kurt King, computer analyst for NationsBanc Montgomery Securities. "There's no shortage of product out there," he said.

As a result of aggressive cost cutting and inventory imbalances, Compaq has slashed commercial desktop prices about $50 more than IBM or HP, according to Matt Sargent, an analyst with Computer Intelligence.

The average price for a Compaq commercial PC in January 1997 was $1,761. Now, the average price is $1,563. IBM's average business PC price has dropped from $1,611 to $1,481. HP, meanwhile, has seen the average price on its equivalent machines go from $1,739 to $1,600.

These lower prices in turn result in lower profits per machine, Sargent said. "What happened to the retail market in 1997 is happening more or less to the commercial market and the notebook market," he said.

"It is really going to be hard for the smaller vendors to do well--the ASTs, the Acers," he added. Toshiba may also face difficulty, he said.

IBM's lower average price is the result of the breadth of their product line, Sargent noted.

"It's more evident that IBM has a problem too. HP is in the best shape of the big three," said Roger Kay, computer analyst at IDC. "These guys are going to have all sorts of pricing action."

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