To keep growing, Iomega must make them a PC standard

The ads for Iomega Corp.'s Zip disk drives are certainly catchy. They show people in a variety of scenes, getting big news from an obstetrician or a probate lawyer, who interrupt to ask the improbable question: ``Is that a Zip drive on your desk?'' The gag--that a superhigh-capacity floppy disk could be absolutely fascinating--has worked. The Zip is one of the hottest-selling PC accessories around.

Now, however, Iomega must do something more: It needs to make the Zip fascinating enough for computer makers to build into their machines--or the highflying company could be in for a slowdown. The Roy (Utah) company, which has been building data-storage products for 15 years, finally took off two years ago after overhauling its disk- and tape-drive lines--and pitching them directly to consumers. Iomega became one of the fastest rising stocks on the NASDAQ, thanks in part to computer enthusiasts who hyped it in online discussion groups. The shares rose a hundredfold, from a split-adjusted 0.54 in the first quarter of 1995, to a peak of 55 in May.

But by the end of July, the stock had fallen to 15 7/8. Second-quarter sales and profits met or exceeded analysts' expectations, but investors were spooked by signs of increased competition and slowing growth: Iomega's second-quarter order backlog was down, and its inventory of finished goods was up, due partly to slow sales in Europe. Things may not turn around quickly, either. ``The third quarter will be challenging,'' concedes Chief Executive Kim B. Edwards.

MARKETING BUZZ. Has Iomega hit a wall? Not yet. Analysts haven't slashed their bullish 1996 projections. J.P. Morgan & Co. analyst Daniel Kunstler predicts revenue of $1.3 billion and earnings of $67 million, more than eight times last year's figure (chart, page 86). But now there are questions of just how far Iomega can go. If the company can make the Zip drive the successor to the standard 3 1/2-inch, 1.44-megabyte floppy drive found on all PCs, it could see its volumes swell from an estimated 5 million units this year to nearly 40 million in 2000. If not, Iomega could remain a niche supplier of specialty drives.

The only way to make the Zip a standard is to go beyond selling it as an aftermarket accessory. In the past 18 months, the company has sold more than 2 million drives, which retail for about $200 and hold 100 MB of data on pocket-size, removable disk cartridges that cost about $20. The Zip caught on because it was a simple way to back up information stored on a computer hard disk or to transfer massive files--and because Iomega created a marketing buzz around removable backup storage, historically a sleepy product category.

Iomega's challenge now is to persuade PC makers to design the drives into every one of their machines. But the Zip isn't the only option. PC giant Compaq Computer already has chosen a Zip alternative, the LS-120 drive, backed by 3M and Matsushita-Kotobuki Electronics. It costs about the same as the Zip but has one huge advantage: It is ``backward-compatible'' with conventional 3 1/2-inch floppies, which means it can read and write information on such disks--an estimated 5 billion of which are now in use. With the LS-120, computer makers could use a single drive to replace the floppy. But with Iomega, they would need to have the Zip and a conventional floppy drive, too.

CHICKEN OR EGG. There are other Zip alternatives, as well. One is a 128-MB, backwardly compatible drive under development by floppy-disk giant Mitsumi. Further out, meanwhile, are recordable versions of the Digital Video Disk (DVD), the 6-billion-byte replacement for the CD-ROM.

For Iomega, it all boils down to a classic chicken-or-egg situation. Some PC makers remain unconvinced that there's huge demand for Zips. Packard Bell Electronics Inc. offers them as options in a few models, but ``consumers are not clamoring for a Zip drive in their PCs,'' says Packard Bell Marketing Vice-President Mal Ransom. Dell Computer Corp. doesn't offer the Zip as an option because corporate customers are leery of providing employees with an easy means of walking off with huge data files, according to marketing manager Neil Hand.

PC makers also are reluctant to pay the price to build in Zip drives. The standard floppy drives they now use cost them about $20. Iomega charges computer companies $70 to $80, analysts estimate.

So far, that has limited the Zip's acceptance by PC makers. Only a handful of them offer it, and only on a few high-end models or as an option. IBM, Acer, Hewlett-Packard, NEC, Packard Bell, Micron, and three other companies have signed up. ``They're only testing the waters,'' says analyst Todd D. Bakar of Hambrecht & Quist.

Edwards acknowledges that sales through PC makers were ``insignificant'' in the second quarter. But Hewlett-Packard Co. and NEC Corp. recently announced plans to expand use of the Zip in additional models. Analyst Cliff Josephy of brokerage H. D. Brous & Co. predicts that sales to PC makers will triple this quarter.

If Iomega can make the Zip an industry standard, it will be the second time in three years that the company has beaten the odds. In 1993, Iomega was moribund--sales had stalled, and the company was losing money. Edwards, a marketing veteran of General Electric Co. and battery maker Gates Energy Products who became CEO in January, 1994, recognized critical needs for customer research, new products, and aggressive marketing.

That's how the Zip was born. But when Iomega approached PC makers about buying the drives, they were skeptical that customers would pay for the higher-capacity floppy. So Iomega took the product directly to consumers. ``We had to prove that there was huge acceptance in the aftermarket before we could get PC makers excited,'' says Iomega Marketing Vice-President Timothy L. Hill. By mid-1995, Zip drives had caught on. Revenues jumped from $141 million in 1994 to $326 million in 1995--mostly from Zip sales. For the first six months of 1996, sales hit $505.6 million, up a staggering 445% from the first half of 1995.

A BILLION BYTES. Before Iomega gets PC makers to commit to buying larger quantities of drives, though, it not only must prove there will be sufficient demand, it must also push down prices and assure PC makers that there's a reliable supply from multiple sources. On the pricing front, Iomega has started to offer a $50 rebate to consumers, part of a planned price-cutting strategy, Edwards says. The company's goal is to bring the price down to $99 at retail and less than $50 for PC makers.

On the manufacturing front, both Iomega and the LS-120 camp are scrambling to add capacity. Matsushita announced that Mitsubishi Electric Corp. would build the LS-120 starting in early 1997. Most Zip drives are now made under contract by Seiko Epson Corp. Iomega recently purchased a factory in Penang, Malaysia, where it will build its new $500 Jaz drive, which features a 1-billion-byte removable disk cartridge costing $150, in the fourth quarter. The factory may produce Zip drives next year, as well.

With the new plant, Iomega will be able to match its competitors' output. Now, all it has to do is make sure that storage enthusiasts aren't the only ones lining up to buy the new drives.

By Andy Reinhardt in San Mateo, Calif.


Updated June 14, 1997 by bwwebmaster
Copyright 1996, Bloomberg L.P.
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