Why the eMachines Model Is Paying Off

By eweek  |  Posted 2004-04-18

Why the eMachines Model Is Paying Off

In 1998, when the "smart" money was being placed on Internet startups, eMachines Inc. was founded with the noble, if not tired, mission to build quality, inexpensive PCs for consumers. It was an idea straight out of a 1992 time capsule. And like many PC makers in 1992, eMachines found itself on life support after only two short years. In 2001, desperate to keep his ship afloat, company founder John Hui bought the publicly traded company back for about $1 a share and set it on an intensely focused course of customer focus and low overhead. His first order of business: Hire someone to lead the company who had a more intimate knowledge of the eMachines customer—not the technology. Hui found that person in Wayne Inouye, the companys main man at its top distribution partner, Best Buy. The move paid off. Shipments started to climb, and revenues followed. All the while, eMachines, under the team of Inouye and Hui, stayed focused, and by the time Gateway Inc. completed its acquisition of the company last month, eMachines had shipped a total of more than 5 million PCs. Hui took time out of his schedule earlier last week to give an update on his career, as well as explain the significance of the eMachines model, to Michael R. Zimmerman, eWEEK Executive Editor/News.

Youre now the second largest Gateway shareholder [37.5 mill shares], but other than that you were not part of the reorg after the acquisition was made. What are you doing now?

Nothing. (laughs) No, Im just kidding. After this, and in the spirit of turning eMachines around, Im actively looking for companies that are similar to eMachines. Something I can turn around and do something about.

What kind of company are you looking for?

[A company] that needs some restructuring and needs some direction so I can have a chance to turn it around.

Are you sticking with the tech sector or considering companies outside the industry?

Preferably in the tech sector. Thats the only field I really know. Other fields I dont know that well. But of course, if its not an area that requires a special expertise, I would consider it.

Do you have any potential companies lined up?

No. Honestly, the few that Im interested in are in office supplies.

Are you thinking U.S.-based?

Preferably, yes, U.S.-based.

Youve said publicly that you first started thinking about acquiring Gateway back in 2002. My question is, the stock situation aside—that ts was trading at below cash value—what was it about Gateway that interested you the most?

This is a very sensitive topic. I can tell you as much that at the time we believed we could contribute a lot to the situation. Because we were a very low-cost, low-overhead company. And we believed that Gateways overhead was too high. If we entered into this, we would be able to turn the company around. So that was why we decided to go for it.

But there must have been something. Gateway did have things to offer, but at the same time, in that 2002 timeframe, they were already moving toward their second year of losses. Revenues continued to decline. They continued to reduce their employee ranks, and all the while shipments were down. So I was just curious about what it was that you saw in them. And I have this short list of things that you may have been interested in and I wanted to get your feedback on. Was it customer base? Theyve got over 300 patents. Was it manufacturing?

How about we do it this way-—I cite one example, which is public now.


Because at this time I really cannot talk, because Gateway is a public company and I am one of the largest shareholders and at this moment I am qualified as an insider, so its difficult for me to discuss anything in detail. A good example is that from the very beginning my philosophy was that Gateway should close all the stores—based on the overhead. Because [overhead] is very costly. And so, obviously, they are now closing all their stores. So that was our belief from the very beginning—to reduce overhead significantly. But there are other reasons for the stores to be closed. … Wed save on sales tax, and its very difficult to compete with the reseller. We view people like Best Buy and Wal-Mart [as resellers]; look how strong they are; how powerful they are in the retail area. It would be very difficult for Gateway to … compete with them. For example, if you are Apple theres lots of places to buy them. Everyone knows youre carrying Intel and Microsoft. They can easily go to the store, go shopping and buy [Intel and Microsoft] at Best Buy. And then you get into the situation of carrying the inventories, and that would defeat the purpose of having a mail-order company.

It is interesting how this played out and how it was executed.

I would like to emphasize that Ted [Waitt, chairman of Gateway] is still the chairman, and I have no role in the company at all. And Wayne [Inyoue, Gateway president and CEO] reports only to Ted. I dont talk to Wayne at all about business.

So youre in no advisory capacity with Wayne.

Absolutely not. Because he is the CEO and Ted is the chairman. He only reports to Ted. As a friend we talk, but other than that we dont talk business.

Next page: PC business now a commodity.

PC Business a Commodity

In 2001 you made Wayne CEO of eMachines. At the time hed been senior vice president of merchandising at Best Buy. Now hes CEO of Gateway. And hes brought a couple of execs with him to Gateway who are former Best Buy execs. The question is, has the computer become commoditized to the point, do you think, where marketing is more important than things like innovation, performance and features?

A lot of people have not noticed that the PC business, as far as were concerned, has become a commodity. Especially below the $1,000 or $1,500 range is what we call the commodity market. So at eMachines we purposely looked for a CEO from the retail sector. Someone who knows the consumer. Instead of coming from a technology background. And I think Wayne was one of the few that qualified for this kind of background. Thats why we actively sought him and hired him to be the CEO of eMachines. It was a shift in the industry that a lot of people didnt really notice.

What does that say about the industry going forward? Do you see this as the beginning of a shift in the industry?

Well the industry actually shifted a while ago. But there are a lot of people still living in the old days, where you have to build your own PCs. But theres no such thing anymore. Its become a commodity. The manufacturer in China or Taiwan or Korea has become so specialized that we call them big ODM—they design everything and they can make things much cheaper, and do the R&D much better, over there than here. Over here, it becomes … companies like eMachines, like integrators, innovators because those people have been talking about it for all this time but not one company that I know of has actually hired a consumer guy to really represent the marketing side. … In the old days, it used to always be the technology side. You need a better Windows, you need a better CPU, you need a bigger hard drive. More and more now the consumer says, "Hey, we may not want the speed, we may want a better cable modem. We may want the wireless to be better. We may not necessarily want the [faster] clock speed." We see this all the time. More consumers formulate what products will sell and wont sell.

So then at what point does an eMachines have discussions about choosing one technology over another to go into your systems?

I can only explain to you what eMachines used to do. At eMachines they created what we called a "value formula" that Wayne developed at Best Buy. They attach value to every single component of a PC. They can at any time tell you if you use, lets say a DVD RW versus a CD ROM how much more the consumer is willing to pay. Now that has nothing to do with the cost. Because if the value that the consumer will attach to every single component. For example, how much is the consumer willing to pay for a 512MB system versus a 256? They can attach value to it, because the consumer knows they can easily buy the memory and stick it in themselves. But the memory prices go up and down everyday. So they have a certain perceived value. And when that perceived value is high and the cost is low, thats when eMachines would put those components in there. For example, at the very beginning of eMachines, I was on the eMachines side, and Wayne was on the Best Buy side. We were trying to sell eMachines to Best Buy. In the beginning Wayne penalized us for $150 because we had to compete with HP.

Howd he penalize you?

What that means is, if we had the same configuration—everything identical to HP—he wanted us to be $150 cheaper than HP.

And the reason?

Because of what they call brand name value, tier value. Eventually, as eMachines got more popular and more popular, he reduced the premium, slowly to $100, to $50. Until the last year of eMachines when we were told there was no differential value at all, on the low-end side. On the high end there was still a premium involved.

So Best Buy didnt add value to your systems at that point, right?

No, no, they did not. Let me explain it a little bit better. At that time we had, lets say a 200MHz machine, and [Intel Corp.s] Celeron identical to an HP machine. And if HP was retailing the system at $500 and we would come in at $400, Wayne would not carry it. Period.

He just wouldnt carry it.

He just wouldnt carry it. He would say, "This will not sell. This is not worth the bother." So if HP was at, lets say, $650 and we were coming in at $500, hed say, "OK, well carry you."

Next page: Knowing Best Buys value formula.

Best Buys Value Formula

How did eMachines react to that tough love?

Well fortunately, when we first went in there, HP had a huge premium on their systems, so way below the value formula, and that was why Best Buy was the first ones to pick up eMachines. And I think in the first month we sold 50,000 systems.

But you had to go back and rethink things when Wayne turned you down at first.

Well, fortunately I did [other business with Best Buy] so we knew of their value formula. So we did everything based on their value formula. So when we submitted the machines we passed the value formula. And this was public knowledge. It was not hidden from anyone. If you want to be a vendor of Best Buy, you have to fit into the value formula. And they continued this tradition all the way until the merger.

Why would Best Buy have an issue with having two similar products at the same price?

The reason is shelf space. They need the shelf space to have the quickest turnover. So if they knew the products werent going to sell, why bring them in?

Why have them taking up space on the shelf when they know theyre not going to sell.

Actually Wayne developed this formula because he had a hard time selecting what products to sell. He said, "I have 50 vendors approaching me, they all wanted to sell me 10 different SKUs." Well he has 500 to choose [from]. He [needed to] come up with a formula that was very objective, unbiased and helped him make his decisions. So he came up with this formula, and if you dont meet the number, you dont get in, period. And if you meet the number, even if he did not like you, he would carry you. Wayne is very business-oriented.

So it came down to price and value.

It all comes down to value.

But price, too.

Well, price is only a subset of the value. You have to consider the features, the product itself. So you cannot just say its $399, $499 or $599. At $599, we offer the best value. Ill give you another example. We consistently analyzed the market for something like DIY [do it yourself]. We can at any point in time tell you what it would cost you to build, lets say, a $399 system yourself. Normally, it would cost you $50 more to build it yourself. The higher end it goes the more premium is added. The more value it gets.

So when you had your early dealings with Wayne, it made more and more sense to have him come in and run eMachines with those same philosophies.

Yes, because we realized that the market had shifted to the point where we had to deal with people at Best Buy and Wal-Mart. They represent the consumer and tell you what the consumer wants. And Wayne keeps on saying this: "The consumer is very smart. You cannot fool them." So the value. You cannot overcharge them in the long run. We realized this situation, so when we looked for a CEO for eMachines, we never looked at people from the technology side.

A lot of small businesses buy through places like Best Buy. Was there ever interest on your part or Waynes part down the road to get more involved with business customers?

Well, that part, well leave that up to Wayne to answer for the Gateway side. But on the eMachines side, we were so small in the whole scheme of things. We had very little capital. And we had no equity, a very small bankline. We managed to do $1 million. So we knew that we needed to focus. So we were never interested in the corporate market because it was too costly to get into the market. Wayne is a very conservative, one step at a time CEO. So he was not going international for the sake of going international. Every step he takes, he plans, he gets ready, and then he does it.

So eMachines wasnt as interested in the value proposition for the SMB as much as it was focused on the consumer?

I need to clarify a little bit. We knew a lot of small businesses, actually, purchase their machines at retail. A lot of them would actually go to Best Buy and buy their machines. And so at one time eMachines even eliminated the rebate to accommodate those small businesses. Because the rebate only worked for the single purchase. So you go in there as a small business and want to buy five, but you dont get the rebate for five. Thats why Wayne eliminated the rebate for a short period of time—purely for the sake of those offices. Its not that we werent interested in them per se. It was just that we didnt have the capital to go after them. So, if we couldve, we wouldve done more for small businesses.

Going back to the commodity issue, these days were seeing the computers next to the refrigerators at Sears, what do the next 10 years have in store for the computer?

I call this the billion-dollar question. We know that one day the PC and consumer electronics will merge. Whether the TV will take over the PC or the PC will take over the TV, honestly, I dont know. And if you talk to different people, they will give you different opinions. But we all know that one day the TV in front of you will be a PC. Or the PC will attach to a big monitor to watch TV. I dont know myself, I only know it will happen. … The consumer has not clearly expressed an opinion on which it should go. So as long as the consumer has not expressed an opinion, we just sit and wait.

Given that, where do you see Gateway down the road?

This is a question I cant answer.

You cant answer it, but you were one of the two principals driving the acquisition.

Let me put it this way. I have 100 percent confidence in Wayne. Because he is really one of the best CEOs Ive ever seen. And Ted is also one of the smartest guys Ive ever met. With this combination, thats why I was willing to take a lot of share instead of cash. I told Ted at the time, Id rather take stock instead of cash because this way the company can reserve more cash for the operations, and at the same time Im betting together with them on the future.

Check out eWEEKs Desktop & Notebook Center at http://desktop.eweek.com for the latest news in desktop and notebook computing.

Rocket Fuel