Will PCs Rebound? Doubt It

As users jump off upgrade cycle, vendor consolidation looms, revenues decline

There were warnings more than a year ago, but few in the computer industry paid heed.

As PC makers raked in profits amid surging sales, analysts cautioned that the spending spree could soon dry up. The high demand was unsustainable, they said, and corporate buyers would eventually reduce their purchases after buying enough systems to meet future needs.

They also warned that there were few differentiations between the various PCs being sold and that there was little technological innovation—both on the hardware and software sides—on the horizon that would entice enterprises to upgrade.

With those problems already beginning to percolate, the PC industry was crippled by the weakening U.S. economy, which chilled once-red-hot Internet-related businesses. The demand for PCs collapsed, resulting in thousands of industry layoffs, dwindling earnings and an ongoing price war.

Now, after enduring months of an industrywide slump, PC makers are looking for a second-half rebound and a new wave of prosperity. But problems facing the industry before the recent downturn have lingered and may well thwart a hoped-for resurgence.

In large part, many corporate system managers said they see no compelling need to upgrade to faster PCs, contending that their existing computers are more than sufficient to meet their demands.

"As I told our corporate staff, the big expenditures are over," said David Howell, information system manager at PED Manufacturing Ltd., in Oregon City, Ore. "We had to spend a bunch of money here for Y2K, then for Windows 2000. But I see little need to upgrade our PCs over the next 12 months."

The closest thing to new software coming down the pike is Microsoft Corp.s much-hyped Windows XP. But Howell, who recently bought 800MHz Pentium III systems, is testing Windows XP and doesnt see a need to integrate it into his company over the next year.

"Its got a few more bells and whistles, but I believe Windows 2000 more than satisfies our needs for now," he said.

An air of desperation

even pcs far slower than todays newest models are more than sufficient to handle many companies applications.

Bob Reeder, vice president of information and communications services for Alaska Airlines, said the Seattle-based company last year finished a major upgrade of the PCs it uses at airport ticket counters and boarding gates. Most of those PCs, Reeder said, featured 450MHz and 500MHz Pentium III processors. In contrast, Intel Corp.s fastest processor on the market is a 1.7GHz Pentium 4.

But Reeder said the companys software doesnt need the newer, faster chips.

"The most common application used by our airport workers is a front end to the Sabre reservation system," Reeder said. "On administrative workstations within the company, the most common application is e-mail, and the second is a Web browser, so we dont have a need for more powerful processors."

Nevertheless, he said, his company is being besieged by computer vendors.

"Calls from people selling hardware and software have probably gone up fivefold in recent months," Reeder said. "Theres an air of desperation to it."

After demand for PCs crashed late last year, leading computer manufacturers began slashing prices and aggressively pursuing corporate customers with lower prices and good deals. But those deals are being offered to a customer base that is increasingly more interested in new technologies than cheaper PCs.

"We are getting tons of vendor calls saying, Have we got a good deal for you. But Im not interested in their low prices," said Joel Salamone, MIS director of The Motley Fool Inc., in Alexandria, Va., adding that his company is cutting back on IT spending.

Having already upgraded to PCs featuring 800MHz processors, Salamone said theres little pressing need to upgrade over the next year.

"Our developers, the power users of our company, are not complaining about their systems being slow," he said, "so its hard for me to say well be buying new things for them because there is nothing wrong with what they have."

Rather than pitching price, PC makers would do better focusing on technological innovation, IT managers said.

"PCs really havent changed that much over the last several years," said Marshall Fernholz, procurement manager for the American Medical Association, in Chicago. "PC makers should focus less on just adding faster processors and more memory and focus more on redesigning the basic architecture to eliminate other performance bottlenecks, such as improving bus speeds and hard drives."

Salamone agreed, saying that what interests him more than new PCs is new technology such as the blade servers that are now hitting the market from major vendors and startups—such as RLX Technologies Inc.—that will enable data centers to put more servers in the same amount of rack space. There are few such new innovations in PCs, he said.

Charles Smulders, an analyst with Gartner Inc., in San Jose, Calif., was among those last year warning of market saturation. Smulders said computer makers can still count on drawing significant sales as companies upgrade their hardware but that OEMs wont see a return of the dramatic growth that marked the late 1990s.

"We expect to see replacement cycles kick in either later this year or early next year as companies who bought in preparation for Y2K seek upgrades," he said. "We also may see some buying tied to Windows XP later this year, but we certainly wont see the sort of growth we saw in the past."

Statistics compiled by Gartner Dataquest bear that out, showing the growth of PC units sold falling from 24 percent in 1999 to an expected 1 percent this year.

The most recent figures compiled by another research company paint an even gloomier outlook for the industry.

According to Roger Kay, an analyst at International Data Corp., in Framingham, Mass., the most recent data suggests sales will decline this year, in contrast to the companys earlier prediction of slight growth.

"This year and next year were looking at as the industry being in a trough," Kay said. "This year, according to our latest data, sales now appear to be clearly in the minus territory for 2001."

While a weak economy is largely to blame, Kay said other factors, including market saturation and a lack of new technology, will reduce demand.

"Were not forecasting dramatic growth for desktops and notebooks as we once were," he said.

Further adding to the PC industrys woes is that a predicted consolidation among vendors that would have benefited the companies left standing has yet to occur, leaving a crowded field competing for fewer available dollars.

"Everyone knows there should be consolidation, but no one wants to be the one to leave," said Andy Neff, an analyst with The Bear Stearns & Co. Inc., in New York.

Part of the problem is that, while Dell Computer Corp.s efficient business model gives it an advantage over other top-tier competitors—smaller companies, known as "white box" makers—those companies insist that they remain the low-price leaders and arent about to be driven out of business.

"They are not playing in our sandbox," said Phil Senff, director of Internet services for iBiz Technology Corp., in Phoenix. The company makes custom Intel-based servers for its customers.

"Dell is not hurting us any. We use the same Intel boards and processors and much of the same stuff they use in our servers," Senff said. "But they have a bad habit of putting their name on it and then charging three times more for it."

While Dells aggressive price strategy has apparently paid dividends—the Round Rock, Texas, company earlier this year surpassed cross-state rival Compaq Computer Corp., of Houston, as the worlds top computer vendor—the low-ball pricing has hurt industry profits overall.

According to projections from Gartner Dataquest, PC revenues will decline 9 percent this year, even though unit sales may total the same as last year.

"The price war is definitely having an affect on OEMs profits," Gartners Smulders said.

Overall, there appears little in the way of good news for PC makers. They should be able to eke out modest single-digit growth, but that pales in comparison with the more than 20 percent growth PC makers enjoyed only two years ago.

The price battles will continue to cut into their profit margins. Some, like Dell, will continue to push pricing cuts in hopes of riding out the downturn. Others, including Compaq and Hewlett-Packard Co., will continue to try to diversify their portfolios to lessen their financial dependence on computer sales.

But until corporate buyers, already well-stocked with computers, see an incentive to upgrade what they have—read, new technologies—the once red-hot PC industry will continue to limp along.

"Its a pretty sorry picture this year," Smulders said.