BUSINESSWEEK ONLINE : DECEMBER 25, 2000 ISSUE
NEWS: ANALYSIS & COMMENTARY

Are PC Makers Looking at a Price War?
With no incentive to trade up, shoppers are content to make do

The sign adorning the personal computer display at a Staples (SPLS) superstore in San Mateo, Calif., says it all: ''Caution, falling prices.'' In recent weeks, Apple (AAPL), Compaq (CPQ), Sony (SNE), and Hewlett-Packard (HWP) have all cut prices, offered greater rebates, or given away freebies such as a printer or scanner with every purchase of a desktop and monitor. And at least one major retailer says it will introduce another round of price cuts to the tune of $100-$200 on the weekend of Dec. 15 in hopes of clearing inventory buildup.

Clearly, the Staples warning could have been just as easily targeted at the PC makers as consumers. As recently as 1998, price-cutting wreaked havoc on the profits of such companies as Compaq Computer Corp. and IBM Corp. (IBM) Now, judging by the eleven weeks' worth of inventory sitting on store and factory shelves--roughly twice the industry average expected for this time of year--the latest round could prove even more nasty. ''Pricing is going to be pretty soft for the first half'' of 2001, warned Compaq CEO Michael D. Capellas, who announced the company would post fourth-quarter sales of around $11.2 billion, $1 billion below expectations.

Capellas' pessimism may be a huge understatement. Earlier price wars usually broke out when PC makers overestimated demand for some products, such as sub-$1,000 PCs two years ago. Now, however, demand for even the hottest products seems to have dried up overnight. After motoring along at a 30%-plus clip in the first half of the year, analysts now expect fourth-quarter U.S. retail sales to grow just 10%, down from earlier predictions of 21.2%.

Retailers cite lots of temporary reasons, including concern about the stock market and the recent uncertainty over the outcome of the Presidential election. But most observers see a more worrisome trend holding back demand: Without slick new features that encourage PC buyers to trade up, many are simply content to make due with the computers they already own. ''The PC is the TV or the refrigerator in the average home right now, where you replace it only if it's broken,'' says PC Data Corp. analyst Stephen Baker.

Manufacturers should have seen the PC blues coming. They've been betting consumers would rush to replace their PCs in order to take advantage of speedy new chips from Intel (INTC) and Advanced Micro Devices (AMD), updated software from Microsoft, or new industrial designs like Apple's eye-catching G4 Cube. But analysts have been arguing for months that the U.S. retail market was reaching the saturation point, with 61% of American households owning at least one computer.

WHO NEEDS IT? So far, consumers have yawned at the new offerings. Many of their old models can accomplish the main task for which they were purchased--to get online and exchange e-mails, according to industry-tracker Dataquest Inc. Consumers seem more interested in snapping up digital cameras and Palm-like handheld computers as hot new stocking-stuffers. ''If you spend $400 for a PDA, are you going to turn around and spend $900 on another computer, particularly if you already have one that works just fine?'' asks NPD Intellect analyst George Meier.

If lower prices don't light a fire under consumers, even more extraordinary measures may be in order for some PC makers. One retailer is saying another $200 price cut will come in January. Meanwhile, Sanford Bernstein analyst Vadim Zlotnikov believes retail PC margins, already a razor-thin 3%, will fall to zero next year as PC makers hold prices down on new models.

In the wait for a better day, many PC makers are hoping that sales to corporations will make up the difference. That may be chasing dreams as well. The economic slowdown means the corporate spending outlook isn't good either. ''We will be affected by the general softness in the consumer, small and medium business, and dot-com markets,'' Compaq's Capellas told analysts. That's a lot of markets--and more than enough to justify Wall Street's willies.

By Cliff Edwards in San Mateo, Calif.

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