07/22/96 COMPAQ AT THE 'CROSSROADS'

COMPAQ AT THE 'CROSSROADS'
The computer maker is retooling again-and the boss is pushing hard for profits
It was a close one. Faced with a sudden and totally unanticipated slowdown in sales, on Mar. 1, Compaq Computer Corp. Chief Executive Eckhard Pfeiffer was forced to warn analysts that the computer maker was unlikely to hit expected revenue and earnings for the quarter ending Mar. 31. The news sent Compaq's stock plummeting 18%, to 41 3/4, in one day. After the announcement, Pfeiffer jumped into high gear. He ordered incentives for dealers and cut prices 20% to lift demand. It worked: Revenues for the March quarter jumped 42%. The stock quickly recovered most of its loss.
Pulling off such a save would be cause for celebration at most companies. But inside the $14.8 billion PC giant, it was soul-searching time. The cost of hitting Pfeiffer's growth target was a four-point drop in gross profit margin to 20.3%, its lowest ever and far short of the company's 23% to 24% goal. That exposed a troubling truth: For more than two years, Compaq has been running twice as fast only to stay in place--shipments and revenue have been hitting new highs, making it the world's top PC maker. But profits have barely budged.
It was time for a better formula. So on Apr. 15, Compaq drafted 20 managers from around the world for what became known as the ``Crossroads'' meeting. In a conference center at the company's Houston headquarters, Vice-President for Corporate Development Kenneth E. Kurtzman assembled five teams to tear apart Compaq's businesses and assess each unit's strategy and that of key rivals. Three weeks later, the teams presented Pfeiffer with some sobering recommendations: Each business unit must be first or second in its market within three years--or Compaq should consider getting out of that line. Also, the company should no longer use profits from high-margin businesses to carry marginally profitable ones--each unit must show a return on investment.
FAST TRACK. Fine. But Pfeiffer had his own requirement that would make achieving these goals a bit more complicated: Whatever happened, he insisted that the company remain on the superfast growth track that he laid out three years ago. Pfeiffer wants Compaq to keep growing at 20% to 25% a year, so that in 2000 it will be a $40 billion behemoth and the No.3 computer maker in the world, just behind IBM and Fujitsu Ltd.
Now, executives at Compaq have a new formula. To hit Pfeiffer's top-line targets, the company will move aggressively into all sorts of new product areas that will make it a full-line information-technology company--capable of competing across the board with companies such as IBM and Hewlett-Packard Co. On July 2, Pfeiffer announced a sweeping restructuring that created nine new divisions alongside the core desktop, laptop, and home-PC businesses. The new units will focus on fast-growing areas such as Internet products and services, small-business systems, and engineering workstations. Pfeiffer also elevated a fledgling $100 million networking-equipment business to a full division.
By yearend, Compaq will produce everything from computers for toddlers to mainframe-class servers able to run global financial networks. There will be powerful engineering workstations and lightning-quick network switches, too. Meanwhile, the company is stepping up its role as a venture capitalist, investing in companies with promising new products and technologies that can help the divisions compete--especially on the Internet (table, page 72).
``VIRTUALIZING.'' The second part of the formula--for producing profits along with growth--will involve wider use of outsourcing and partnership deals. That's because the new financial yardstick--return on assets--will force the divisions to slash investment in assets such as plant, inventory, and overhead wherever possible. If the $3 billion home-PC business can cut its asset base, for instance, it can still deliver a 20% annual return to the company--even though price competition in home PCs will likely keep operating margins at around 2%.
To get there, Compaq has already started ``virtualizing'' parts of its business. After cutting $57 off the cost of each home PC last year by building the chassis at its plant in Shenzhen, China, the company went a step further in cutting the cost of business desktop PCs: Instead of investing millions to expand the Shenzhen plant, Gregory E. Petsch, senior vice-president for operations, persuaded a Taiwanese supplier to build a new factory adjacent to Compaq's to build the mechanicals for the business models. The best part of the deal: The Taiwanese supplier owns the inventory until it arrives at Compaq's door in Houston. ``This is the right way to do it,'' says Sanford C. Bernstein & Co. computer analyst Vadim D. Zlotnikov.
By 1999, Pfeiffer expects each division to achieve best-in-class return on assets. PCs will have to better Gateway 2000 Inc.'s 21% return on assets, the networking business must beat 3Com Corp.'s 18% return, and workstations will have to top Sun Microsystems Inc.'s 14% return.
If the Crossroads plan is successful, Pfeiffer will have created the blueprint for the computer company of the next century: a giant with the nimbleness of a consumer-electronics maker and the allencompassing service and support capabilities of big computer companies such as HP and IBM. ``We're at a turning point in our company's history,'' says Pfeiffer.
The new plan will also involve a new regime. After living through the four-year growth sprint that took Compaq from $4.1 billion in sales in 1991 to $14.8 billion last year, Chief Financial Officer Daryl J. White resigned on May 29, citing ``burnout.'' A month later, Systems Div. chief Gary Stimac, a key player in moving Compaq into its leading 40% share in PC servers, quit. ``It would take another multiyear commitment in time and energy,'' says Stimac. ``I had to evaluate my personal life.'' Meanwhile, industry reports have Senior Vice-President for North America Ross Cooley resigning by yearend. Cooley, however, declined to comment.
For a few years, Pfeiffer has been assembling a new team of operations-savvy executives. The new CFO, Earl L. Mason, worked at Inland Steel Industries Inc. and Digital Equipment Corp. Michael J. Winkler, general manager of the PC Products Group, came to Compaq after a long career at Xerox and Toshiba America Information Systems. Consumer Group General Manager Michael D. Heil worked at Los Angeles Cellular Telephone Co. and Sony Corp. of America. Chief strategist Robert W. Stearns joined from McKinsey & Co.
``BIG IRON.'' One of the biggest jobs falls to John T. Rose, general manager of the enterprise computing group. Rose, a former DEC executive who joined three years ago, is responsible for pushing Compaq into ``big iron'' territory. With Intel Corp.'s new Pentium Pro chip and Microsoft Corp.'s industrial-strength Windows NT, Compaq figures it finally can build the servers and workstations that can take on even the biggest computing jobs. The first such products are hitting the market now.
Compaq, already the top supplier of PC servers used in smaller networks, sees itself as the standard-bearer for the low-priced ``Wintel'' (Intel-based computers using Microsoft Windows software) technology as it sweeps into the last bastion of the mainframe and minicomputer. And some important customers agree. While IBM and HP are also promising powerful new Pentium Pro-based machines, buyers question whether those companies will push the technology as aggressively as Compaq, since the new setups can compete with their older, more profitable proprietary machines.
That's why SmithKline Beecham PLC chose Compaq over IBM and HP to supply the drugmaker's servers. ``The big difference with these guys is they're intent on pulling this off,'' says Lou Valente, vice-president for North American information resources. ``I don't see that intensity coming from other companies,'' he says.
To compete in the big-iron business profitably, Compaq is counting on a series of relationships with other companies that can supply the kind of handholding that companies such as IBM are famous for. Instead of investing in legions of field technicians and programmers--and building up costly assets--the computer maker will use the resources of systems integrator Andersen Consulting and software maker SAP, among others. These companies have the personnel to install and maintain systems the way IBM or HP do. So Compaq gets to play in the big-iron market without incurring the costs of running its own services or software businesses. Using these partners, Compaq is already delivering packages of networks, servers, and services to big customers including General Motors, British Telecommunications, First Interstate Bancorp, and Deutsche Bundespost.
Compaq, however, may not be able to play through their intermediaries forever. ``The real solution is to create your own capability. It takes longer and is more painful, but ultimately, it is more successful,'' says Graham Kemp, president of G2 Research Inc.
Small and medium-size companies are also a key market for server technology. To reach them, Compaq will rely on its existing network of resellers. But it will give them new tools, including ``blueprints'' for installing and managing networks that can be applied in cookie-cutter fashion. ``Our goal is to create a Compaq standard'' for network and systems tasks, says Cooley.
KID STUFF. The powerful new Intel/Windows NT technology also provides Compaq with a chance to crack a small but lucrative new market: engineering workstations. While only about 900,000 workstations will be sold this year, vs. about 60 million PCs, profit margins are nearly twice as high. Sun, HP, Silicon Graphics, and others sold $13.3 billion worth of such machines last year, and sales should expand at a 10% annual rate through the decade, says market researchers Dataquest/Gartner Group.
Meanwhile, Pfeiffer continues to push into fast-growing consumer markets. On July 15, the company will trot out an all-new line of home PCs. But the company has more than PCs in mind. And, again, Pfeiffer is counting on alliances to cut costs and provide expertise that Compaq can't duplicate. For example, the company is working with Mattel Inc.'s Fisher-Price Inc. to produce PC add-ons for small children. And a deal with Thomson Consumer Electronics Inc. is aimed at new hybrid computer/consumer-electronics products.
Pfeiffer also sees other opportunities for PC technology in the home. One of the biggest, he says, will be ``home automation''--using computers to control air-conditioning, heating, and security systems. Pfeiffer has already pumped funds into startup Intellon Corp., which is developing chips for controlling everything from stereos to refrigerators from a PC.
The challenge in the consumer business, says Pfeiffer, is not finding new products and technologies to pursue but narrowing the focus to a manageable number. Even a $15 billion giant such as Compaq could get distracted by taking on too much, he warns. ``We see lots of opportunity. This field is growing so fast, there is a major challenge in reallocating our resources,'' says Pfeiffer.
One place he's not shy about placing resources, however, is in cyberspace. Despite a late start in the Internet, Compaq is looking to pick up speed by developing relationships with Internet software and service companies. On July 7, for example, it became the exclusive supplier of servers to Internet service company WebConnect Inc.
Compaq also has been aggressively making investments in Internet startups. It paid $6 million in January for 7% of Raptor Systems Inc., a developer of security software for the Internet. Compaq is also a limited partner in Safeguard Scientifics' $40 million Internet Capital Group fund and in funds run by Kleiner Perkins Caufield & Byers, including one that backs startups using Sun's Java.
STRUGGLE. Pfeiffer's No.1 objective on the Net is to make Compaq servers synonymous with so-called intranets. These networks use Internet technology within a corporation for things such as E-mail, employee communications, and electronic purchasing. Since February, Compaq has shipped Netscape's Commerce Server and Microsoft's Internet Information Server programs with all its server computers. ``Compaq is ahead of everyone else in that space right now,'' says Forrester Research Inc. analyst Jon Oltsik.
The explosive growth of the Net will create unprecedented demand for servers and, perhaps, unprecedented competition. Compaq started early in PC servers and holds a commanding 40% market share, which has translated into healthy profit margins. Now, companies such as Dell Computer Corp. are hoping to make this a high-volume, commodity business--similar to desktop PCs. ``Compaq is definitely going to lose some share,'' says HP Marketing Manager James P. McDonnell. ``The question is how fast and how much.''
Indeed, Wall Street worries that price pressure and market-share erosion in servers could hurt Compaq's earnings. Its stock has been trading recently at around $46--well below its 52-week high of $56.75. On July 17, analysts expect Compaq to report earnings for the June quarter about flat with last year's $246 million.
Between the new competitive challenges and the new growth/profit formula, Pfeiffer certainly has taken on a huge job. But the 33-year computer-industry veteran is known for his tenacity. Once a goal has been set, he's not likely to fall short. Says Mentor Graphics Corp. Chief Executive Walden C. Rhines, a former colleague of Pfeiffer's at Texas Instruments Inc.: ``I never, ever saw Eckhard miss a forecast. He'd sell the electricity out of the building before he'd miss a forecast.'' Pfeiffer will need all the juice in Houston to power Compaq through this next growth spurt.
By Gary McWilliams in Houston