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Can Compaq Catch Up?


Information Technology: Computers

Can Compaq Catch Up?

Hiring a new CEO is only the first hurdle in a long race

The $8.4 billion deal to acquire troubled computer maker Digital Equipment Corp. in January 1998 was a defining moment for Compaq Computer Corp. and CEO Eckhard Pfeiffer. With Digital, Compaq hit high-tech's big leagues, competing in every sector of the computer industry from whizzy consumer products to complex corporate systems. Crowed Pfeiffer: "We want to do it all, and we want to do it now." At the time, a giddy Compaq Chairman Benjamin M. Rosen heaped praise on his CEO: "He has a tremendous strategic sense, an ability to execute, and an ability to lead. Eckhard Pfeiffer is unquestionably one of the industry's most talented executives. Just look at his record."

On Apr. 18, Rosen still had praise for Pfeiffer, only it came in a press release announcing that the Compaq board was giving Pfeiffer the boot. It was the second Compaq shocker in as many weeks. On Apr. 9, the company warned analysts that first-quarter earnings would be half what they had expected, the result of slowing PC sales and price competition. Now, Rosen and two directors are moving to Houston to take over operations until a new CEO is found.

Compaq, it turns out, hasn't been able to do it all. Pfeiffer's biggest initiatives haven't jelled. His four-year-old effort to emulate archrival Dell Computer Corp.'s build-to-order manufacturing system is hopelessly behind schedule. Meanwhile, his plan to use Digital to put Compaq on an equal footing with stalwarts IBM and Hewlett-Packard has been bogged down by troubles melding the two organizations, product delays, and an incoherent strategy.

Now, Rosen, who in 1991 ousted then-CEO and co-founder Joseph R. "Rod" Canion to give Pfeiffer the top job, will be acting CEO. "He said he's moving to Houston and wished he could be golfing instead," says Microsoft Chairman William H. Gates III, who spoke to Rosen the day after the announcement. "Ben felt he had to do this once before, and I think that most people would say it probably made all the difference in the world."

It had better work wonders this time, too. Compaq's troubles go deeper than one quarter's results. The company is struggling to fix a distribution strategy that relies mostly on resellers, while Dell is winning big corporate customers through direct sales. At the same time, Compaq faces market-share stagnation or slides in many of the product segments it competes in--from notebook PCs to workstations to large-scale computer servers. Says Gateway Inc. CEO Theodore W. Waitt: "They were clearly on a push to just be big. This is proof that bigger isn't always better."

Rosen has a far different take. He says Compaq's strategy is sound. Execution, he says, has been the hang-up. "We need to execute better and make faster decisions. By doing a little more with what we have, we can show accelerated growth," says Rosen. "There's value in size, but it's not an end." That's a curious assessment since Pfeiffer has been known for tip-top execution. And Rosen refuses to give much explanation on how things went wrong. "We set a more aggressive plan than was appropriate," is all he'll say.

Now Rosen, a 66-year-old venture capitalist, must guide Compaq through turbulent times while searching for a CEO. Analysts fret that the search could take at least six months--an entire product cycle in the PC business. Worse, it's an eternity on the Net. Every day without a new leader gives rivals such as Dell, Sun Microsystems, and IBM time to stake out more Net ground and lock up corporate customers. "We're not waiting for a CEO to arrive," insists Rosen. "The three of us intend to reenergize this company."SUPERB. Can the troika do it? Rosen's record as a venture capitalist is superb. He's a visionary, who saw the potential in Lotus Development Corp. and Compaq, but he's never run a $30-plus billion company day to day. Frank P. Doyle, 67, a former Digital board member who took a lead role in the acquisition of Digital, helped Jack Welch make General Electric Co. one of the fastest-moving giants in the industry. And Robert Ted Enloe III, 60, a former Dallas real estate exec, has been on Compaq's board longer than anyone but Rosen.

All three executives are sharing one office at Houston headquarters. But the job ahead is a tricky one, and the close quarters don't mean decisions will be made any quicker. Says Credit Suisse First Boston's Michael K. Kwatinetz: "It's not that they're unqualified, but troikas don't run companies. Every month it takes them to hire someone is another month of advantage for Dell."

When the new CEO arrives, he's likely to face a learning curve. Why? With the flow of high-tech talent away from today's behemoths to tomorrow's gold-mine Net startups, search firm Heidrick & Struggles Inc. is under orders to look outside of techdom. That's not necessarily bad, since few industry insiders have had experience managing an organization as complex as Compaq. But it could mean one more delay in the company's effort to get back on the fast track. Says Carl Howe, research director at Forrester Research Inc.: "Ousting the CEO condemns them to refocusing their business for at least six months."

The Digital merger was supposed to make all the difference. By taking Compaq into higher-margin markets and turning the company into a full-service supplier of complex corporate information systems, Digital was suppose to lift Compaq above the dangers of the PC price wars. But integrating Digital--and Tandem Computers Inc., a $3 billion acquisition Pfeiffer made in 1996--has proved onerous. Compaq has three consulting firms working on the digestion of Digital alone. "Compaq is like a snake that swallowed a rabbit," says Nick Earle, chief marketing officer for HP's enterprise computing unit. "You go to sleep for a long time when you do that."

While Compaq slumbers, rivals are making headway. Sun, HP, and IBM are locking up big corporate deals to help build the E-commerce infrastructures expected to be so crucial in the 21st century. Now, Compaq seems caught in a no-man's land--between a fiercely competitive core PC business, and the promise of big, rich computer and service sales that are still out of reach. Says one rival CEO: "I don't know what they stand for anymore."

Indeed, Compaq is practically MIA on the Internet, the biggest change to hit the industry in two decades. "It no longer is the computer industry that people have to deal with. It's the Internet economy," says James F. Moore, president of consultancy GeoPartner Research Inc. Compaq says it sells a third of all the PC servers on which Web sites reside, but those are typically straight "box" sales--not the big corporate deals, which include juicy service contracts to help cushion thin hardware profits.

That is painfully clear in Compaq's handling of its AltaVista Web search engine, acquired in the Digital deal. Analysts scratch their heads over why Compaq waited until January--a year after the Digital merger was announced--to map out plans to spin it off into a separate company. That move should have been done sooner, before rival portals such as Yahoo! had built such a huge lead. Admits Rosen: "We only knew what we had in AltaVista when everyone wanted to buy it from us."BELOW EXPECTATIONS. Such missteps can't encourage jittery investors. Nearly twice as large as Dell, Compaq has roughly 40% of its market cap. The Houston company's shares have fallen about 50% from their 52-week high, settling in around 24. On Apr. 21, Compaq announced that first-quarter sales grew 66% over 1998, but earnings were half of Wall Street's expectations, at $281 million. Because of PC pricing pressure and problems in its high-end systems divisions, gross margins fell to 24.7%, down from 26.4% in the quarter before.

To be sure, Compaq has plenty of strong businesses. The company says it met its goals for services in the quarter with $1.6 billion in sales. Compaq had the best-selling PC in the sub-$600 price band, beating out market leader emachines. And sales of storage systems continue to grow. "We have all the pieces [to be a successful rival to IBM and other heavyweights]. We haven't articulated the plan well, but it's coming together very fast," says Rosen.

But Compaq hasn't been able to keep up the pace across the board. Consider NT workstations, the high-powered computers favored by the techie set. In 1997, sales skyrocketed 672% to $525 million. But last year, these revenues grew just 8%, to $569 million, at a time when workstation sales for the industry shot up 67%. Last year, Compaq's market share skidded from 22% to 14%, according to market researcher International Data Corp.

Part of the problem: Digital's workstations turned out not to be the choice of techies. "Compaq thought Digital would help, but they found Digital didn't have a lot of expertise there, either. It used to, but lost it through years of downsizing," says Tom Copeland of IDC.

The Digital deal has yet to pay dividends in the other key areas, particularly large computer systems. Sales of Compaq's high-end Unix servers, which are used to running big corporate jobs, were flat in the fourth quarter from the year before, at $1.4 billion.

At the same time, Rosen has to get Compaq's core PC business back on track. He can't make a radical jump to Dell's approach of selling all its PCs direct to customers. That could cause distributors such as Ingram and Tech Data to revolt and push rival products. Instead, analysts say Rosen should cut back on the number of major distributors from around 20 today to just a handful. That way, the remaining ones get more business and they're more loyal to Compaq. Rosen insists Compaq is committed to selling however the customer wants to buy. "Our top priority is to get much, much closer to the customer," he says.

If Rosen wants to sell more PCs over the Net, he'll have to address Compaq's inability to build machines to order. Four years after announcing plans to build units as orders came in, the company hasn't approached Dell-like efficiencies. Dell can go from order to delivery in 3.1 days, while Compaq takes at least 12, says Donaldson, Lufkin & Jenrette Inc.'s Kevin A. McCarthy. He says Compaq still builds to forecasts from retailers. That's only a half-step better than the old way of building to Compaq's own forecast.

As of mid-1998, the half-step seemed to work and inventories shrank. But Compaq never made the operational changes to quickly fill resellers' orders, leaving many of them in the lurch for products at the end of 1998, say analysts. Moreover, Compaq had planned to get to build-to-order by letting resellers assemble Compaq PCs at their own warehouses. But Compaq backed off--after many resellers spent millions to get ready to respond to customers more quickly. Says DLJ's McCarthy: "All this stuff about an optimized distribution model was supposed to happen two years ago. But it's still not optimized--not even close."

Compaq's ballyhooed efforts to begin selling online didn't help. Last September, Compaq announced that the Prosignia line for small businesses would be available only on its Web site. But when sales softened and resellers balked at being cut off, Compaq reversed course. Says Gateway's Waitt: "It's hard when you rely on resellers and then say you'll compete with them. That creates a problem. For us, life is just simple."

The last time Rosen ousted a CEO, he helped set a new course for the entire PC business: toward less expensive machines. This time, he may have to remake Compaq once again. "We really don't know what lies ahead. We're looking at every issue," he says. What he finds could reshape Compaq--and maybe the rest of the industry.By Peter Burrows in San Mateo, Calif., with Ira Sager in New York and Michael Moeller in ChicagoReturn to top


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