November 15, 1999

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Compaq Struggles With PC Business
Nonstop E-business initiative is vital to vendor's successful turnaround

By Paul McDougall

ersonal computer maker Compaq perhaps best represents the tumultuous times in the hardware market. The company has been struggling mightily in its corporate PC sector, and the talk on Wall Street is that it has yet to find a way to extract meaningful value from its widely heralded buyouts of Tandem and Digital Equipment two years ago.

"The irony is that, in spite of all the acquisitions, the real trend at Compaq is that they are going back to becoming a commodity player again," says Ashok Kumar, an analyst at U.S. Bancorp Piper Jaffray. "There's a lack of coherent strategy on the Tandem side, and Alpha has lost the support of Microsoft, so most of those customers are migrating en masse to open systems."

Indeed, Compaq's core desktop PC business is under siege. The company lost its lead in the U.S. market for business and consumer PCs to Dell Computer in the third quarter, drawing a 15.3% share to Dell's 17.1%, according to Dataquest. Compaq still holds the lead in the worldwide business and consumer PC market, but there its share has dropped from 13.4% in the third quarter of 1998 to 12.8% in the third quarter of this year, while Dell's jumped from 8.2% to 10.8%. In the U.S. commercial PC market, Dataquest reports that at midyear Dell led with a 19.9% share compared with Compaq's 13.7% share.

The company's troubles became apparent in April: It posted first-quarter net income of $281 million--about half of what analysts were expecting. That, combined with a failure to issue a timely warning to Wall Street, led to the resignation of CEO and president Eckhard Pfeiffer. The tumult was accompanied by a precipitous decline in Compaq's stock price, which in late 1998 had traded in the $50-per-share range but has since plummeted to less than $20 per share.

Meanwhile, the past several months have seen the departure of other key executives--some, but not all, by their own volition. In June, senior VP and general manager of enterprise computing John Rose resigned. John Rando, the head of the company's services business, left in May. In April, worldwide sales chief Michael Heil quit. "They have not been able to stop the talent bleed," Kumar says. "The high-level defections have been the most publicized, but the talented worker bees are leaving also."

While Compaq's results for its most recent reporting period provide some grounds for optimism, they also reveal weaknesses that must be addressed if the company is to re-establish itself as a pre-eminent supplier of computing equipment to businesses. Compaq beat Wall Street's expectations in its third quarter ended Sept. 30 by posting a net income of $140 million--an increase of $25 million, or 22%, from the previous year's third quarter. Sales grew 4.5% from the previous year's quarter, reaching $9.2 billion.

But the results also revealed that Compaq's corporate PC business remains troubled. That unit reported an operating loss of $169 million, compared with a profit of $116 million one year ago. In disclosing those numbers, Compaq CEO and president Michael Capellas said part of the problem was the company's failure to implement a cost-efficient, direct-sales strategy over the Internet. "We have not kept pace with shifts in the PC sales and distribution model," Capellas said.

Meanwhile, in the server market, Compaq has been struggling to sort out what many suggest is a confusing line of overlapping operating systems and hardware architectures. Observers say Compaq has yet to fully digest operations it gained as part of its $4 billion purchase of Tandem in late 1997 and its $8.5 billion acquisition of Digital Equipment in January 1998. It's still determining how products from those companies best fit with its own industry standard offerings.

On its Intel ProLiant series, Compaq offers Windows NT, Novell NetWare, SCO Unix, IBM OS/2, Linux, and Sun Solaris. On its non-Intel servers, Compaq offers the NonStop Kernel OS, Tru64 Unix, Open VMS, and Linux. It also says it will support the upcoming Monterey version of Unix for Intel and RISC architectures.

Though many analysts suggest that all this presents to customers a dizzying array of hardware options, software choices, and migration paths, Compaq executives make no apologies. "We often get criticized for having so many offerings," says Rick Frazier, Compaq's marketing VP for its recently formed Business Critical Server Division. "But, quite frankly, the immense demands that our customers have put upon us--particularly for these rapidly growing, unpredictable E-business applications--has played to our strength in terms of being able to meet a very wide range of needs."

Still, Compaq does appear to be taking some steps to streamline its offerings. Recently, the company said it will no longer offer Windows NT on its Alpha servers, a turnabout from previous statements and a move that didn't sit well with customers, according to analysts. "It was a fundamental issue of the ratio of the revenue vs. the business expense to support it," Frazier says. Additionally, Compaq has pulled the plug on VAX hardware, though it will support its OpenVMS operating system on AlphaServers. It's also shifting its high-end Tandem Himalaya systems off of Tandem's Mips chip and onto the Digital Alpha CPU.

However, many of the problems Compaq has experienced recently have little to do with its technology. For starters, key executive positions remain open. The company's halting search for a CFO, the post Capellas himself held, is chief among these. Compaq's failure to lock in an experienced, process-oriented CFO has slowed its efforts to drive more efficiency into its supply chain, something it needs to do if it is to restore margins that have eroded in the face of low-cost competition. Indeed, according to Piper Jaffray, Compaq's operating expenses as a percentage of sales are twice that of Dell's.

Frazier says Compaq will create more direct sales in the coming months, but only to a point. "From the standpoint of our channel strategy across the ProLiant series, and for the Alpha and the Himalaya, we are staying our course by maintaining a channel strategy that emphasizes customer choice. Customers have established patterns; we're not forcing them to go direct."

The company's employees, rather than its sales channel, are bearing the brunt of Compaq's efforts to cut costs. This past summer, Compaq said it would eliminate 7,000 positions, mostly in marketing and administration.

On the upside, the company is diversifying its product line in a number of key areas, particularly in the wireless and palmtop markets. "We intend to drive a new generation of Internet devices, from desktop to palmtops, that we'll build around simple form factors, customized functions, and wireless mobility," Capellas said when announcing Compaq's third-quarter earnings. This week, Compaq was set to disclose new details about that strategy.

But Compaq, like other large PC vendors, stands to make most of its profits going forward in the services market. For instance, the company's Enterprise Solutions and Services Group, which now accounts for slightly more than half of its total revenue, and includes services as well as high-end servers, posted an 87% increase in operating profit and a 12% increase in revenue in the third quarter.

Last month, the services Compaq provides under its NonStop E-Business strategy helped the company land a deal with America Online, whereby it will provide NonStop Himalaya and AlphaServer systems to the Internet service provider. "The longer-term objective is that we can build relationships with customers that will allow us to sell more hardware," says Lex Dekkers, the company's director for messaging and collaboration solutions.

But some customers say that Compaq, despite its 27,000-strong services force, doesn't always deliver. "We couldn't even get anyone to call us back, let alone get on-site service," says Margaret Bouline, who was a customer of Compaq's when she was CIO at aviation parts supplier Aviall Inc. Bouline left Aviall in September to become CIO of wireless communications vendor Bearcom Inc., where she plans to use Dell equipment.

The company needs to address those kinds of problems, say analysts, because relationship-building is key, to drive more hardware business to Compaq and to keep the company in tune with market demand for one-stop solutions that let customers tap a single vendor as a gatekeeper for all products and services. "I wouldn't say it's the most important strategic imperative for them, but it's in the top five," says Richard Gardner, an analyst with Salomon Smith Barney.

Meanwhile, Compaq has rolled out some important new server technologies, including its Zero-Latency, NonStop E-Business engine. Designed for high-volume installations such as call centers, the system can handle 1.2 billion call-detail record transactions per day in real time and its 111-terabyte Operational Data Store can support more than 40,000 customer-service agents simultaneously, Compaq says.

Compaq's shifting focus from beige boxes to NonStop E-Business Solutions is meant to help it maintain its position as an important technology supplier to large enterprises. But its ability to fulfill that vision with real products and sustainable service will be key to any successful turnaround.

And the coming months will present some big challenges. Compaq officials concede that the company has yet to experience the full sting of Y2K, but it expects to shortly. "This hasn't been seriously felt until recently, but there are a lot of weeks left in the year," says Frazier. And as for the company's prospects for making a full turnaround in the coming year, Piper Jaffray's Kumar puts it bluntly: "I don't see a simple way for Capellas to do that."

Go on to the next story, "Strong Network Focus Makes Sun's Future Bright ."

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