From: technews <technews@ou.edu>
To: "'it-fyi@listserv.ou.edu'" <it-fyi@lists.ou.edu>
Subject: it-fyi: Loss-Leader PC Sales Work Well for IBM (NY Times on the W
Date: Mon, 25 Oct 1999 08:36:51 -0500
October 25, 1999
Loss-Leader PC Sales Work Well for IBM
By SAUL HANSELL
IBM (http://www.ibm.com) was once as closely linked to personal computers as
Kleenex is to tissue. But no more.
The company's market share has fallen behind those of Compaq
(http://www.compaq.com) and Dell (http://www.dell.com), and it has not made
a profit on PC's in at least four years. Indeed, IBM's PC unit lost nearly
$1 billion last year and $311 million so far this year.
IBM Chairman Louis Gerstner Jr. even declared in the company's annual report
that "the PC era is over" because computing power was moving onto the
Internet.
So last week, IBM announced a tactical retreat on the PC front, saying it
would pull its desktop computers off store shelves and let customers buy
them only over the Internet.
All this raises a bigger question: Should it get out of the PC business
altogether? IBM certainly does have other business lines that are profitable
and growing, like software, semiconductors and computer services. And it is
pursuing these even at the risk of humiliating its own PC unit.
In recent months, IBM agreed to sell its rival Dell access to its most
advanced technology and its 130,000 service technicians. With those deals
calling for $22 billion in revenue, analysts have asked whether IBM would be
better off ceding the PC business and focusing on areas where it has been
more successful.
"I have argued that they should withdraw from both consumer and commercial
desktop PC's," said Steven Milunovich of Merrill Lynch. "It's a business
they haven't figured out."
But David Thomas, the executive in charge of IBM's personal systems group,
says the company now does have the business figured out. In fact, it has
been figuring quite hard over the last year.
"Any time you lose close to a billion dollars, you have to ask a lot of hard
questions," Thomas acknowledged in a recent interview at corporate
headquarters in Armonk, N.Y.
After an elaborate study, the company concluded that personal computers
would likely remain a tough market with thin margins at best. Yet the study
concluded that the customers who used IBM's most profitable products also
bought lots of personal computers, and that abandoning PC's would thus
create an opportunity for another company to establish a relationship to
steal the good business.
So Thomas has developed a new strategy that essentially treats personal
computers the way a convenience store has sold milk: a high-volume,
low-margin item meant to bring customers in the door in the hope that they
will grab a candy bar and a bag of chips on the way out.
To make this approach work, IBM has decided to emphasize selling directly to
customers, rather than relying on dealers. Selling directly, as Dell does,
is cheaper, and more important, it creates the opportunity to add on other
products.
For example, if a consumer bought an IBM Aptiva desktop in a retail store,
it was the retailer who decided which monitor and printer to offer. On IBM's
Web site, by contrast, the company can push its own products. For
businesses, the plan is much the same: to offer PC's with other IBM services
like leasing from the IBM Credit Corp.
In addition, the PC unit, with the backing of Gerstner, is trying to get the
other IBM units to return the favor and push its products to their
customers. Most notably, David Thomas and Samuel Palmisano, then the head of
IBM Global Services, concocted a plan called Blue on Blue that was meant to
get more services customers to also buy IBM PC's. This was hardly an easy
change for the services unit, which for nearly a decade has competed against
independent companies like Electronic Data Systems by asserting it was
agnostic about what brand of hardware a client chose to use.
For IBM, the motive for the change is clear. Thomas figures that at best,
IBM can make 3 cents in profit for every $1 in revenue on the sale of a
desktop PC. But by adding services, software, financing and other extras,
the company can tack on a further 50 cents in revenue and 9 cents in profit.
"Until now, the profit has been on the system unit itself," Thomas said.
"The next big battle is all things beyond the box."
IBM's strategy echoes the moves by other PC makers to deal with the
competitive price pressures by finding other, more profitable products to
sell along with the computers. Gateway has long offered lease financing and
Internet service bundled with its computers for one monthly payment. Compaq
put buttons on its keyboards to channel users to Web sites that pay for the
traffic. And Hewlett-Packard bundles its computers with its printers, making
the most money on the ink-refill cartridges.
It is too soon to tell whether IBM's strategy will restore its PC unit to
its onetime glory. But there are some early signs that things are getting
better. Over all, the unit's sales, flat for three years, jumped by 34
percent so far this year to $11.2 billion. In the third quarter, the PC
unit's loss was down to $69 million from $122 million a year earlier. Nearly
all of that loss, IBM says, was due to the home PC area it is pulling back
from. (And mainframe computers, not PC's, are the villain in the decline in
profit that IBM warned of last week, as the windfall from corporate
investments in Year 2000 readiness comes to an end.)
Aside from desktop computer sales in the United States, IBM's financial
results from PC's have been better. Thomas says the company has consistently
made good money on PC's in Asia, even selling through retail stores. And
profit margins are much higher for its Thinkpad notebook computers and
Netfinity servers for Windows NT, two areas where customers are willing to
pay higher prices for IBM's technology.
Yet desktops still make up two-thirds of the company's PC volume, and Thomas
has sharply cut prices in order to win business, especially from big
companies that buy lots of other things from IBM.
"Last year, we decided to put our desktop PC's up for bid every month
because we were trying to squeeze the last drop of blood from the
suppliers," said George D. Kunkel, the head of PC operations for PNC Bank in
Pittsburgh. "IBM won most of the time, and I think that's part of the reason
they lost more than $900 million last year." More recently, PNC signed a
one-year deal with IBM, but only because it promised to maintain the low
pricing.
PNC still buys its IBM personal computers through a reseller, but as with
its consumer business, IBM is trying to shift its corporate customers to
buying direct. Already, 10 percent of IBM's sales are direct to customers.
By next year, Thomas hopes that 20 to 30 percent of IBM's sales will be
direct, and ultimately as much as 50 percent.
Compaq, which faces many of the same problems as IBM, alienated dealers by
announcing it would start selling directly last year. So IBM has been
quieter as it set about to do the same thing, in part because the plan had
some growing pains.
"I tried to buy my father an IBM system because I like their displays," said
Kevin McCarthy, an analyst who follows IBM for Donaldson, Lufkin & Jenrette.
"I finally got them on the telephone, and I knew more than the salesman did.
It was so frustrating that I hung up and called Dell."
In addition to its traditional sales prowess, Dell has some new arrows in
its quiver, thanks to its technology and services deals with IBM.
Those deals have challenged IBM's PC group to find new ways to compete.
"Skip the middleman -- 'Be Direct' with IBM," was one pitch suggested in a
letter the company sent to its sales force, playing on Dell's advertising
slogan.
IBM points out that Dell has agreed to buy only three of the 60 services
related to personal computers that it offers. And it does seem to have
gotten some early success with the Blue on Blue program of selling PC's to
services clients. But that is largely because the company is offering
customers even more discounts when they buy a total package.
For example, last Thursday, IBM Global Services presented two bids to a
national retailer that wanted someone to maintain a network of servers at
each of its 2,700 stores. IBM's basic price was $1,500 per server per year
for any brand of hardware. But if the customer bought IBM Netfinity servers,
the price for the server would fall to $1,200. Global Services can absorb
the discount because its own costs are lower when customers use IBM
hardware, said Tom Conway, head of IBM's PC services unit. Support costs are
lower because the company knows its own machines better, and maintenance is
faster because it has supplies of spare parts all around the country.
And just to make sure that it gets the word out on these deals, IBM changed
the compensation for its sales force, so someone in the services unit will
get a bonus for selling hardware, and vice versa.
"The strings of the pocketbook affect behavior," said Conway.
It seems to be working. Last year, before the Blue on Blue program, IBM
services customers bought $500 million in IBM personal computers. So far
this year, PC sales to services customers have doubled to $1 billion, 10
percent of the PC group's total revenue.
Despite these gains, Roger Kay, an analyst with the International Data
Corp., argues that customers and investors should be skeptical about how
long Thomas' plan will last.
"IBM has come out repeatedly with very strong strategy statements,
championed by a strong executive, only to have it all change when the next
executive comes in," he said. "Compare them to Dell, which has been making
the same strategy statement for 18 quarters."