Wayne Inouye left little mystery over his comeback strategy when he took the helm of PC maker Gateway (GTW). Nearly every move he has made since last year's $290 million merger between Gateway and eMachines resembles the steps he took while he was chief executive of eMachines.
Take his fanatical devotion to controlling expenses (see BW Online 8/16/04, "It's Wayne Inouye's Way at Gateway"). When Inouye stepped into the new job, Gateway was a bloated 8,000-person organization with expensive leases on 188 individual retail locations. Selling, general, and administrative costs added up 42% of sales in the quarter ending June, 2004. Inouye promised investors he would get that number down below 10%.
For the quarter ended Oct. 27, he more than made good on that pledge: SG&A costs were $78 million, or less than 8% of sales. That's half the size of a year earlier and less than a quarter of what SG&A was when Inouye came on board.
"FAR MORE COMPLEX." Shutting the retail stores took care of most of the savings, Inouye says. Closing manufacturing operations South Dakota helped more. Also gone: consumer-electronics goods, which Gateway entered in 2002. With prices and profit margins falling on TV sets, and lacking a retail presence to sell them, Gateway exited that business, too.
But Inouye's transformation of Gateway -- still incomplete -- isn't just about replicating what he did at eMachines on a grander scale, he recently told BusinessWeek Online in his first wide-ranging interview since completing the merger last year. "Although it's similar, and the results so far look similar, Gateway has a far more complex business than eMachines did," he says. "It's not all about SG&A. The computer business is a very competitive business, and the industry benchmark is Dell (DELL). We just figured we'd better have a cost structure to compete with Dell over time."
With costs under control, Inouye is now focusing on sales. Having closed Gateway's own outlets, he's depending on other retailers to sell his machines. As of August, Gateway products were in nearly 8,000 retail shops, including several large overseas chains. The strategy has met with success: Market share for the Gateway line in retail stores rose 55% from a year earlier, according to NPD Group (see BW Online 8/15/05, "Will Flash Bring Cash for Gateway?").
THE NAVY AND NEW YORK. Here's where Inouye sets aside the eMachines playbook. He won't concentrate solely on retail sales, as was the case at eMachines. He's also gunning anew for big contracts from large companies and government agencies. "We're competing in a market where the way you make money is not necessarily through hardware," he says. "Retailers don't make much or any money through selling hardware. And when you sell into a professional customer base, what you're trying to do is establish a relationship and over time sell them products that we can make money on, like software, services, and peripherals."
In the last six months, Gateway has landed customers like the U.S. Interior Dept., the U.S. Navy, the states of California and New York, and the University of Arizona. But turning Gateway around in the professional arena will take time. In the most recent quarter, volume in the professional segment increased by 224,000 units, and revenue was $286 million. Both numbers were an improvement over the prior quarter, but still below year-ago levels.
"After losing $2.2 billion over three years, people didn't necessarily feel we were a viable business," Inouye says. "A big part of this is just reestablishing ourselves in the professional market as a viable brand."
FINAL ASSEMBLY IN THE USA. One way to improve that operation, Inouye says, will be to take a half-step back into manufacturing. Like much of the rest of the industry, Gateway has shifted away from building PCs itself and relies mainly on outside manufacturers. But now, Gateway will embrace a "configure-to-order" business model for its professional customers, Inouye says.
That means PCs will arrive mostly built, needing only a few key components -- microprocessors, optical drives, hard drives, and a software installation, based on the customer's specific needs. "For our professional customers, this will help us deliver better products faster," Inouye says.
Sometime next year, Gateway will open a new U.S. facility in a yet-undetermined location that will employ about 300 people who'll do final assembly and configuration on machines sold to professional customers. The job of running it will fall to Bruce Riggs, tapped as senior vice-president for operations and customer care. An old hand in the PC industry, Riggs's last job was running the corporate PC operations of Quanta Computer, the Taiwanese contract manufacturer that's the world's largest assembler of notebook PCs. That followed stints at Dell and NCR (NCR).
STALLED STOCK. The hard part is doing it profitably. Inouye says low-margin retail sales will dominate the revenue picture in the short term, while rebuilding the professional business and its recurring revenue streams will take longer. He has also promised more big contracts. "This year we're going to go after the top 100 colleges and universities in the U.S., and you'll see some announcements about that this quarter."
Analysts are slowly warming to the Gateway story. Andrew Neff of Bear Stearns upgraded the shares to peer perform from underperform in late October. In a research note, he praised the stabilization of sales, but he worried that despite adding new customers, the professional segment looks "weak."
And even though Gateway turned a $16 million profit on sales of more than $1 billion in the most recent quarter, investor aren't bidding up the stock. It closed on NOv. 11 at $3.12, nearly 55% off its 52-week high of $6.92 and a far cry from its late-1999 record of $82.50.
"NO SINGLE THING." One reason is where at least part of the profit is coming from. About $11 million of it results from a big legal settlement with Microsoft (MSFT). Its terms require Microsoft to pay Gateway $150 million over four years to resolve a long-standing antitrust complaint. "Most folks don't know how to deal with that," says analyst Rob Enderle, head of research firm Enderle Group. "Basically what it does is offset marketing costs," says Enderle. "But the way it's treated, it flows to the bottom line, and so it looks like a revenue item."
Investors, Enderle says, are interested in companies with outstanding products. He adds that the PC maker is "clearly on a recovery path, but it's hard for investors to get excited about a firm that doesn't have any single standout product. There's no single thing you can wrap your arms around."
But with Dell stumbling (see BW Online 11/1/05, "It's Bad to Worse at Dell"), this may be the right time for Gateway to attack, Enderle says. "I think there's a big competitive opportunity right now," he says. "Look at the PC vendors who are doing better right now, which are Gateway, HP (HPQ), and Acer. All of them have one thing in common: A presence in retail, and all of them have a relationship with Advanced Micro Devices (AMD)."
A MORE FLEXIBLE MODEL? Dell, which builds PCs using only Intel (INTC) microprocessors, has been long rumored to be considering a machine using chips from AMD but has yet to make one (see BW Online 11/11/05, "Dell's Slight Change of Emphasis"). Computers with AMD chips tend to sell well to consumers through retailers. In fact, market researcher Current Analysis recently said AMD-based PCs outsold Intel-based PCs among U.S. retailers in October. Dell also sells its PCs only direct to customers, and not through retailers.
"Suddenly Dell looks channel-bound and partner-bound," Enderle says. "For a company that was always perceived as successful because it was so flexible and fast-moving, [Dell] is being perceived as inflexible. Now, Gateway has a level of flexibility that Dell lacks. The gives Gateway a pretty nice story to tell."
Inouye counsels patience. "I think investors are looking for immediate performance so they can make a lot of money very quickly," he says. "I'm not here for short-term gains. We want to build something that's real. That just takes a little bit of time." Judging from Inouye's results so far, that may be a reasonable strategy.
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Hesseldahl is a writer for BusinessWeek Online in New York
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