XP: It Just May Fan a Consuming Passion


By Amey Stone It's not a happy time for the economy in general. But prospects for the personal computer business are especially dismal. PC sales are down about 20% from this time last year, and most analysts don't expect to see any growth in the coming year.

Take Microsoft (MSFT). On Oct. 18, just a week before the launch of XP, its most significant operating-system upgrade since Windows 95, the company said it expects unit sales of PCs to be flat or down slightly for its fiscal year ending next June (see BW Online's Special Report on Windows XP). Merrill Lynch analyst Henry Blodget predicted in an Oct. 19 note to clients that computer users wouldn't really start upgrading to XP machines until 2003.

TOO MUCH GLOOM? "PC demand is going to continue to be disappointing," says Barry Jaruzelski, managing partner of Booz Allen's global computers and electronics practice. "There is going to be a minimal upgrade cycle -- as much as people can avoid."

To such gloomy predictions I have one thing to say: Don't underestimate the power of the American consumer. Given the weak economy and the apparent saturation of the U.S. computer market, XP's launch certainly won't lead to the kind of surge in PC sales that Windows 95, or even Windows 98, brought about. But to think it can't inspire even a modest uptick is unduly pessimistic.

The big unknown when it comes to estimating consumer demand for PCs is exactly how many potential buyers are on the fence. Analysts think the number is small, since studies show that most consumers have all the computing power they need or want in their home machines. But based on purely anecdotal evidence, I think lots of people are ready for a new computer about now.

UPGRADES DUE? After all, ample evidence shows that consumers buy, not when they need or can afford something new, but when they want it and can finance it. For example, sales of cars -- a far more expensive purchase -- stayed robust as long as the economy did, even though many analysts predicted that everyone who could possibly need a new car had already bought one in the prior three years. After September 11, auto sales fell off again, but they rebounded when carmakers offered 0% financing.

The last time the PC market saw significant growth was in 1999, when sales jumped over 20%. Sure, those machines may work fine, but many computer owners are conditioned to upgrade every couple of years and are eager for the multimedia and communications features the new models offer.

Stephen Baker, director of research at NPD Intelect, argues that PCs have become akin to consumer durables, like refrigerators. "Manufacturers may be coming out with some neat fridges, but if yours is still running, you may not decide now is the time to go out and buy a new one," he says. But I think PCs are less like fridges than cars -- utilitarian, fun, and even worth bragging about, when you get a great deal on a new model.

SIGNIFICANT UPGRADE. The fact is that computers are a better deal than ever. Because of a decline in component prices (including Intel's top-of-the-line Pentium 4 chip), "we've seen a pretty significant upgrade of the configuration of PCs even at the very lowest end," says Baker.

On Oct. 29, Dell introduced a $599 PC that includes a monitor, six months of Internet access, and, of course, XP. For around $1,000, retailers are offering models with a Pentium 4 chip, a DVD player, and CD-ROM drives that also record. Sure, times are tough, but a brand-new PC with features that increase home-entertainment value may be just what the doctor ordered this Christmas.

The same analysts who predict flat unit sales for PCs think Microsoft's XP is a significant improvement over previous operating systems -- especially in terms of stability. The system not only makes it easier for users to experiment with digital photography and music but it also simplifies communications, things like instant messaging and making phone calls over the Internet.

ADS AND INCENTIVES. Plus, Microsoft is planning to spend $200 million marketing XP -- which should go a long way to stimulate demand. For people on the fence, this gives them a reason to go out and buy. "There is nothing like a lot of promotions, advertising, and giveaways to get people thinking about computers and shopping again," says Baker, who still isn't convinced that they will actually plunk down cash.

Finally, as weak as the economy seems now, a massive amount of stimulus is being injected in the form of tax cuts, interest rate cuts, and rebuilding funds. Analysts expect the economy to rebound in 2002 (optimists say the spring, pessimists the fall), which isn't too far off. Plus, since PC sales were flat in 2000 and then have fallen significantly this year, comparisons going forward will be a lot easier. That will make a bump in sales more striking in percentage terms.

For investors, this isn't a call to rush out and buy technology stocks. But it is reason for some optimism -- especially for stocks like Dell (DELL), Microsoft (MSFT), and Intel (INTC) that are leaders in PC-related businesses. These shares have rebounded sharply from September's lows and aren't cheap, but they would be worth considering if they dip down again.

RAY OF SUNSHINE? Better-than-expected PC sales won't translate into great earnings gains for these companies or their competitors. After all, pricing pressure will hurt margins even if sales growth resumes. And corporate buyers with shrinking IT budgets are a tougher sell than consumers. Many business users have already switched to Windows 2000 operating system, and Microsoft's stricter licensing policy, which many businesses claim makes upgrading more expensive, may discourage them from making the leap to XP. That would be a big loss, since business users make up 60% of the PC market. The waning global economy could also keep a lid on worldwide sales figures.

Yet given all the gloom, if consumers in the U.S. start snapping up new machines at a faster pace than expected, it would be a pleasant surprise for the industry -- and for investors. And given all the negative sentiment for many PC-related stocks, a little bit of good news could go a long way. Associate Editor Stone covers the markets for BusinessWeek Online in New York


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