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Gateway's Big Gamble


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Gateway's Big Gamble

Ted Waitt is building the "IT department for the masses"

The morning is late in La Jolla, a seaside community just north of San Diego, and PC mogul Ted Waitt, dressed in blue jeans and a blue silk shirt, shows off his new digs. The ponytailed 37-year-old has come a long way from the Iowa farmhouse where he started PC maker Gateway Inc. 15 years ago. The griddle-flat prairie views have given way to a stunning vista of waves crashing into jagged ocean coves. The smell of garlic-laced seafood wafts into Waitt's airy, second-floor office from a trendy restaurant below.

This hideaway has been Waitt's base since he handed over control of Gateway's operations in January to CEO Jeffrey Weitzen. It's just a few minutes' drive from his home and from Gateway headquarters--so he can easily head to the house for lunch or to the company for an important meeting. He keeps in touch with colleagues by e-mail and phone. Two 40-inch plasma displays hanging on the bright yellow walls keep Waitt plugged into what's going on in the world. One screen taps the Internet for news headlines and stock prices. The other shows CNNfn. When Waitt wants to escape the high-tech world, all he has to do is step through French doors onto his veranda, where he can take a deep drag on a Camel Light, stare off across the Pacific, and think.

What does Waitt ponder when he's out there? The wrecking-ball transformation of the computer industry. As the Web winds its way into businesses and homes, the old-fashioned way of selling PCs loaded with bloated software programs seems destined for the scrap heap. Instead, Waitt envisions a not-too-distant day when the Internet is so pervasive and so reliable that it is piped into businesses and homes much like telephone service. Always on. Easy to use. No-fuss computing. And oh so cheap.Beyond the box. That's when the PC world as we know it ends. Computers, says Waitt, will become about as fascinating as phones. Margins on PCs will crater as they're relegated to the warmup act for the Main Event--the World Wide Web. The real value? It will be in all the services that sit on powerful computers in massive Net data centers all over the world. If you need to schedule a meeting or buy a plane ticket, just click in. Each month, just pay your "technology bill" based on how many services you use. "PCs will go the cell-phone subsidy route," says Waitt. "But if you have tens of millions of customers paying $50 a month for service at 60% margins--do the math. I'd be totally happy if I didn't sell a PC five years from now."

It's a radical thought. Fortunately for Gateway, Waitt has had it for some time. Indeed, for the past five years he has been on a rip, refashioning the company for the Internet Generation. In 1995, when online sales were just a measly $150 million, Gateway became the first PC maker to sell its wares on the Net. Two years later, Waitt daringly launched his own Internet access service, called gateway.net. Then, in May 1998, he took the first step toward a technology bill by selling PCs on the installment plan--offering a PC, financing, software, and Internet access for as low as $33 a month.

Now he's getting ready to up the ante again. Within a year, Waitt will break more new ground by becoming one of the first big PC makers to sell an array of Web appliances--starting with a desktop Net cruiser, a touchpad for the kitchen, and a wireless gadget that you can carry around the house. "Gateway has executed a beyond-the-box strategy better than any other company," concedes rival Michael Larson, senior vice-president of Compaq Computer Corp.'s Consumer Products Group.

Waitt's move to the Net is at Net speed, with the company's dependence on PC revenues rapidly receding. Today one-quarter of operating profits come from non-PC sales, with the number rising to 40% by yearend, predicts Waitt. Gross margins on non-PC stuff average about 35%--compared with Gateway's overall margin of about 22%. The margin for computer-based-training, for instance, is a sky-high 90%. Now Waitt is betting Gateway's non-PC revenues will jump fivefold, to $9 billion, by 2004, a rate that will allow it to beat consensus forecasts of 25% annual growth in earnings--without making a dime on PCs.

If Waitt pulls this off, Gateway could become the model for the consumer-PC company of tomorrow. Wall Street already is celebrating the possibility. Gateway's stock price is up 54% in the past year, to $51, compared with a 9% gain for perennial PC poster company Dell Computer Corp. "Gateway is the flag-bearer for the beyond-the-box strategy," says analyst Robert Cihra of ING Barings LLC. "They've recognized that the value of PC sales is not just the box. The real value is where the PC is a platform for other revenue streams."

Gateway's new strategy offers little room for error, though. For starters, Gateway is more dependent than any other major PC company on narrow-margin sales to consumers and small businesses. Less than 15% of its sales are to large corporations, vs. two-thirds for Dell. The result: In the latest quarter, Gateway's revenues grew just 11%, vs. 31% for Dell. Rivals also are encroaching on Gateway's home court--the direct sales channel. And they're pursuing their own diversification strategies. Compaq, the world's biggest supplier of PCs to consumers, now sells 10% of its consumer PCs direct in the U.S. and plans to hit 30% in the next year or so. Hewlett-Packard, the fastest-growing consumer PC brand, is beginning to offer e-services, including its Cartogra.com site, where people can make online photo albums. "This is the way the entire business is going," says Robert R. Wait, worldwide marketing manager for HP's home products division. "Nobody is saying, oh, Gateway is so brilliant."

It's hard to argue, however, with Waitt's results. His instincts have lifted Gateway from obscurity to become the sixth-largest PC company in the world with $10 billion in annual revenues. The secret to his success has been the company's direct bond with a huge mass of consumers--whether on the Web, on the phone, or at its Gateway stores. No other PC company knows its customers so well or has so many ways of reaching them. Gateway says by the end of next year it will have a base of 22 million customers--2 million more than premier e-tailer Amazon.com Inc. Says America Online Inc. President Robert W. Pittman: "Gateway is obsessed with the consumer. They're willing to reach them in any way that makes sense."

That drew Internet powerhouse AOL to Gateway. A chance encounter between Waitt and Pittman last summer spawned discussions between the two companies. Initially, AOL was hoping Gateway would refer its customers to the online service. At the same time, Gateway had discovered that running its own Internet access service was complex and costly.Unlikely visionary. The courtship quickly blossomed into a marriage of Gateway's computer skills and customer hand-holding with AOL's burgeoning array of Web services and media properties. Today they co-manage gateway.net, an Internet access service and Web portal where software and peripherals are sold. Gateway's Net appliances are being designed to connect instantly to AOL's services. AOL is investing $800 million in Gateway over two years. And the pair are sharing revenues on their Net access customers.

Now the duo is cooking up all sorts of e-commerce services that will be rolled out over the next two years. The details are sketchy, but the goal is clear: "We want to be able to answer the question, `What do you want to do?"' says Waitt. "We can help people make the best use of their time--from travel, buying things, and financial services to setting up My TV Channel where they watch what they want when they want." All, natch, over the Net.

The AOL partnership is shaping up as the most significant strategic alliance ever for Gateway--and Waitt's biggest gamble yet since it hitches Gateway's future to the online giant. Not everyone thinks it's a wise move. Says Garry Betty, CEO of EarthLink Inc., the nation's second largest Internet service provider after AOL: "Gateway has basically abdicated control of their desktop to AOL."

Waitt isn't too worried. "We'll succeed if AOL pays us," he says in an unguarded moment--but then insists that he remains committed to his vision of an Internet-centric future where AOL plays a big role. "We have a common view of how the world will develop with devices and how they'll be sold and how the whole solution will be packaged."

Waitt, the country boy who dropped out of college, seems an unlikely visionary. On the surface, he is easygoing and jocular, an everyday guy who likes rock `n' roll, beer, burgers, and fries. Scratch the surface, though, and you'll find a hard-driving, hard-thinking man who expects a lot of himself and those who work for him. He's never been one to fall in love with technology for its own sake. Instead, he focuses on what people can do with it. Now, as the Internet Age dawns, Waitt sees a new chance to make technology even more useful and to spread it more widely to those who have been too intimidated or too poor to afford it.

To achieve his goal, Waitt has presided over a radical overhaul of Gateway. He moved the corporate headquarters to California from South Dakota so it would be easier to attract top-flight executive talent. He retooled the management ranks. And he's done a smart job of differentiating Gateway from the rest of the PC pack.

His Gateway Country stores, for instance, are a creative amalgam of the best aspects of direct and physical retailing. Defying conventional wisdom that PC retailing was a dead end, he set up zero-inventory storefronts where Gateway employees could give demos and help people buy products via the Web. That broadens the company's reach to consumers who are still uncomfortable, unable, or unwilling to purchase PCs over the phone or the Web.

Now the Country stores have become one of Gateway's most strategic assets. Two-thirds of PC buyers at the stores are signing up for training. Gateway is adding new courses for digital photography, music, and personal finance. By the end of the year, the stores will have some 5,000 classroom seats. Gateway hopes to rack up $1 billion in training revenues per year within the next three to four years. And as a new generation of Net devices emerges, Gateway sees growing potential in home-networking installation services and selling broadband connections. "We're the IT department for the masses," says Waitt.

While Waitt coos with customers, he can be downright prickly when it comes to dealing with the powers that be in the computer industry. That's because he can't stand to kowtow to anybody. Waitt's independent streak doomed a potential merger with Compaq. In 1997, when Gateway was desperate for a way out of the industry price crunch, Waitt opened merger talks with Compaq's then-CEO Eckhardt Pfeiffer. Waitt believed the combination would strengthen both companies, since Compaq didn't yet have a direct-sales business. He got close to cutting a deal, but backed out at the last minute. Says Waitt: "A deal would have made sense, but I never wanted to work for someone else. It's simply not an option."

Waitt has never quite been housebroken. He was born Jan. 18, 1963, in Sioux City, Iowa, the youngest of four children of a fourth-generation Iowa cattleman. His father, Norman Waitt Sr., was a rough-hewn fellow, whereas his mother, Joan, grew up among the county-club set. "There was a bit of a culture gap," recalls Waitt. "She and her sisters spoke French at the dinner table, and my dad's wearing cowboy boots with manure on them." Young Ted took after his old man. As a kid, he always expected to go into his father's business--until the bottom fell out of the cattle trading game.

As a teenager in the '80s, Waitt was a party animal. "Ted and his group of friends ran pretty hard. He was wild," recalls a friend, Bart Brown. "They played a game every Friday and Saturday night. You'd drop a quarter off your nose and if it landed in the beer glass you had to drink it." It wasn't much different when Waitt went to the University of Iowa. "I was enrolled. I don't know if I was studying," Waitt says.

But Waitt knew he wanted to be his own boss. "I came from an entrepreneurial family. My father and five generations of people in my family do not make good employees," he says. In his junior year of college, Waitt dropped out and took a job handling mail-order sales at PC and software seller Century Systems in Des Moines. Just nine months later, Waitt and a friend, Mike Hammond, started a similar operation. Backed by a $10,000 loan guaranteed by Waitt's grandmother, they set up shop as Gateway 2000 in a farmhouse near Sioux City that had been converted to an office for the Waitt family's cattle company.

They had to operate surreptitiously. During the day, Waitt and Hammond filled orders--answering the phone under the pseudonyms Max Wheeler and Ed Zimmerman, due to a noncompete clause with Century. They slept upstairs and were often awakened in the middle of the night to help unload the cattle trucks. The next year, Waitt, Hammond, and a few friends began assembling PC clones. By January, 1988, they broke into the national market with an ad in Computer Shopper with the caption "Computers from Iowa?" The phones began to ring.

There were hundreds of similar outfits, but Waitt prospered by selling high-end systems at cut-rate prices. "We had no dealers or resellers and for 2,000 bucks we sold what Compaq was selling for $3,500," boasts Waitt. Gamers and power users flocked to Gateway, and sales soared from $1.5 million in 1987 to $12 million in 1988. It was time for Waitt to reclaim his true identity. "Early that year," he jokes, "Max Wheeler was killed in a horribly disfiguring motorcycle accident, along with Ed Zimmerman."Zero tolerance. Gateway moved to larger, new facilities in North Sioux City, S.D. It was basically just a giant screwdriver assembly operation. No matter--marketing and customer service were spot-on. By 1993, sales topped $1 billion, and Gateway went public. Suddenly, Waitt was wealthy. He was worth $700 million on the first day of trading--and is worth more than $6.5 billion now. "The first thing I got was a jet. And it's the last thing I'd get rid of if I go bankrupt," he says.

Waitt's affection for his Gulfstream may seem a bit over the top, but friends say he hasn't been warped by wealth. "He's not much different than the day I met him in Iowa City," says Hammond. Throughout gateway's changes, Waitt has been a good leader of people. "He's patient, but demands a lot of others. If you miss a beat, you'll get a second chance. But if honesty and integrity are not there, he's got zero tolerance," says Brown, who now runs gateway.net.

Still, Waitt's no big-time corporate manager--and he knows it. In 1997, Gateway had a hard time dealing with the economics of the sub-$1,000 PC. He slashed prices, sending margins into a tailspin. Then, to get into the higher-margin corporate market, he spent $190 million to buy Advanced Logic Research, a server maker in Irvine, Calif. Waitt grossly underestimated what it took to win over corporate customers. Gateway lost $107 million in the third quarter of 1997--its worst quarter ever. Clutching for a lifeline, Waitt hired Weitzen, the former executive vice-president of AT&T'S Business Markets Division.

At the same time, Waitt decided to move the company's headquarters out of the Corn Belt so he could recruit "the right people to get the right innovation." He ruled out Silicon Valley because it was expensive and he felt people there aren't loyal to their employers and change jobs too quickly. In the end, San Diego won because, besides near-perfect weather, its small-town feel made it a natural fit for Gateway's down-home corporate culture. In May, 1998, Gateway moved into its new headquarters, and in September, Waitt, his wife, Joan, and their four kids moved into a $14 million hilltop home overlooking La Jolla and the Pacific Ocean below.

Not many managers from South Dakota got to enjoy the same view. In 1998, Waitt hired 10 of the company's top 14 managers, most of them with experience in big companies such as GE Capital and PepsiCo. And nearly half of Gateway's 180 middle managers have been hired since January, 1999, says John M. Renfro, senior vice-president of human resources. "It's a completely different company," says one former exec. "It has matured."

Since then, Waitt and Weitzen have worked as a tag team. Waitt handles long-term strategy and chairs the board of directors. Weitzen handles execution. Each has his areas of expertise. Waitt knows more about Internet content and e-commerce. Weitzen understands more about communications and big-time dealmaking. Day to day, the boundary lines are clear. "I don't want to meddle with Jeff as it would interfere with his doing his job," says Waitt, who adds that Weitzen "is probably a better manager and CEO" than he is. The two meet for lunch almost every week, discussing issues ranging from the strategic to the mundane. Waitt also gives Weitzen a chance to blow off steam. "Sometimes I just want to vent because I don't get to vent to people around here," Weitzen says. "Sometimes it's as simple as that, and he'll say, `Are you done?"'

The new freedom is giving Waitt room to explore other business interests and to think seriously about his legacy. He spends about one-fourth of his time on the Waitt Family Foundation, a $450 million fund focused on narrowing the digital divide. "There's a large risk to our society if a group of people doesn't have access to technology or even the desire to get on the Net and see what opportunities are out there," he says. "Technology can be a great equalizer. Look at me."

Waitt also is stepping up his personal investments. He's liquidating about 3 million Gateway shares each quarter, and in May he hired Rick Schutte, a highly regarded PC analyst from Goldman, Sachs & Co., to manage a broad-based private venture fund. A lover of hard-edged rock, Waitt's investments so far have centered on the online music space, which he calls "the first wave of convergence." He's thrown tens of millions into music-related upstarts such as MP3.com, Listen.com, and Palm Pictures, a venture led by friend Chris Blackwell. These investments give Waitt a window on the new world of digital entertainment--which ties back into Gateway's Net strategy.

As music from a progressive-rock radio station mixes with the sound of ocean waves at Waitt's seaside retreat, he admits there's much more to his life now than earning the next dollar. "If you have great content, it will be a great business," he says. "Plus, it's fun." For this Net-generation mogul, life really is a beach.By Steven V. BrullReturn to top


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