Crashing Prices

It is the best of times in the personal-computer market. Prices are in free fall. Options that were once prohibitively expensive are now packaged at rock- bottom prices. The fastest chips and the biggest hard drives are cheap and plentiful. For consumers who have often had to wait years to buy the latest, most powerful machines at affordable prices, the market has entered what seems to be a golden age.

It is also the worst of times. For most of the companies that make those computers, that market has suddenly become a lethal place. Once successful companies such as IBM, Compaq, Dell and Apple are floundering; profits are plunging, margins squeezed. Last month one of the personal-computer industry’s leading lights — the pioneering Tandy Corp. — became a prominent casualty. Faced with $52 million in losses in the past year and an even bloodier future, Tandy decided to abandon the PC business, which accounted for 10% of its sales last year. The company simply could not survive the intense price competition.

Tandy has been swept up in the personal-computer industry’s most savage shake-out ever. Squeezed by falling demand on one hand and a destructive price war on the other, PC makers are realizing their worst nightmare: their once exotic, high-technology products have become little more than cheap, interchangeable commodities. Since the PCs all use basically identical hardware, consumers are no longer picky about what brand of computer they buy so long as the price is right. The result: retail prices are falling an average of 8% every three months. A fully loaded IBM PS/1 computer with the latest hardware typically sells for $1,699, for instance, in contrast to $1,999 for a similar model two years ago. That is in part because one can order a computer in every way comparable to the PS/1 from a mail-order discounter like Gateway and pay up to $1,000 less than IBM is asking. Consumers love it; the industry is in full panic. “This is no longer a business for the faint of heart,” says James Cannavino, head of IBM’s personal-systems division, “and if you think things are tough now, there are no rest periods ahead.”

So far this year the price war has claimed as many as two dozen firms, including CompuAdd Computer, a big mail-order firm based in Austin, Texas, that filed for bankruptcy in June, and Everex Systems Inc., a PC manufacturer located in Fremont, California. It has also left many others gravely wounded. Dell Computer is expected to report losses of $68 million this week, its first quarterly deficit ever. Ironically, Dell, which built a $2 billion-a-year business by selling cheap, reliable computers by mail, is being done in by copycat mail-order firms offering bigger discounts.

Even Apple Computer, whose wildly popular Macintosh computer — and proprietary software that pretty much prevented competitors from producing clones — made the company recession-proof in the past, has been badly bruised. Apple, which surprised Wall Street a week ago by reporting a larger than expected quarterly deficit of $188.3 million, has been losing its edge to software systems like Microsoft’s Windows, which endow practically any PC with easy-to-use, Mac-like features. In a desperate bid to halt defections, Apple this month cut prices on 23 models of computers as much as 34%.

But Apple’s — and the industry’s — woes are just beginning. By the time the dust settles, analysts predict that fewer than 100 of the 350 PC makers in business today will be left standing. Says Richard Shaffer, editor of the Computer Letter: “What’s going to happen to the personal-computer industry in the next few years won’t be a pretty sight.”

The primary instigators of the price war have been new small companies that function more as assembly lines than as manufacturers. Many of these firms, ; such as Zeos, Graystar and PC Brand, don’t invest in costly research or development, nor do they own expensive manufacturing plants. Instead they operate out of factories and garages. Rather than make PCs from scratch, they buy everything from circuit boards, displays and disk drives to entire computers from foreign firms that largely copy American PC designs. Says Brad Smith, vice president of PC research at Dataquest: “All you need to start a PC company today is a fax machine to take orders and a Black & Decker screwdriver to assemble the parts.”

The price war, though, is only a symptom of more fundamental transformation taking place in the industry, not all of which will be to the advantage of the U.S. As the PC has changed from a magic black box to a run-of-the-mill commodity like a television set or a radio, so has the economics of the business. Since there is no mystery to the technology, PCs can be manufactured as well as priced like any other commodity. That fact has helped make computers a more global business, but it has also played into the hands of copycat, low-cost producers: up to 75% of the internal components are imported.

Ironically, the price war may have strengthened U.S. computer leadership in some key markets. American firms, which feared a takeover by Japanese firms during the 1980s, have exported their cutthroat pricing to Tokyo with stunning success. Led by IBM, Dell and Compaq, U.S. companies sent shock waves through the Japanese PC establishment by trimming prices up to 30%. While Japanese domestic manufacturers, such as Fujitsu and NEC, have responded with deep discounts of their own, they have been unable to shake off the Americans, much to the delight of Japanese consumers.

Still, more victims than victors are expected as falling prices and changing economics force many U.S. PC makers to re-evaluate the market. To compete in the future, say analysts, PC makers must bring unique products to market in order to stand out from the pack. As a result, many companies are placing big bets on such emerging technologies as pen-based computing, hand-held PCs and multimedia. Says John McCarthy, director of technology at Forrester Research: “If you’re just a boxmaker, with nothing else to offer, your days may be numbered.”

IBM’s strategy is both to outpace the competition with unique products such as the ThinkPad notebook PC, and to beat them at their game of discounting. The company has filled practically every market channel with a new line of PCs, including models aimed at homes and small businesses. Next month Big Blue will introduce a bargain-basement line called Ambra that will not carry the IBM logo. The overall strategy has apparently worked. After losing $2 billion in the past two years, IBM’s PC business is expected to report a small profit this week. “We’re here to stay,” says Cannavino. “When the music stops again, and there’s one less chair, we intend to have a seat.”