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Tuesday, 4 September, 2001, 14:24 GMT 15:24 UK
Computer industry faces a shake-out
By BBC News Online's James Arnold

Most people enjoy their 20th birthday: it means you're old enough to cut it with the adults, but still young enough to party.

But the 20th anniversary of the personal computer last month did not cause the computer industry much celebration.

Top PC makers, Q2 2001 shipments, '000 units
Dell: 3,979
Compaq: 3,590
IBM: 2,133
HP: 2,065
Fujitsu-Siemens: 1,375
Source: IDC

The industry, accustomed only to glamour and success, is suffering its first-ever serious slump, as corporate buyers scale back their spending.

The big PC manufacturers are slashing costs and jobs, and slugging it out for market share by driving prices downwards.

And now, with Hewlett-Packard's takeover of Compaq, the second biggest PC maker in the world, the industry is facing a period of uncomfortable consolidation.

How far can it go?

Computer crash

These are grim times for computer makers.

Just over a year ago, high-tech shares slumped, as after went bust in a sharp and unexpected reverse of the heady boom of the late 1990s.

But the industry's problems go far beyond the mere bursting of a bubble.

US energy officials using computers
Companies don't feel confident enough to buy more computers

PC demand in the United States fell this year for the first time ever, as the global economic slowdown persuaded corporate buyers to postpone or cancel investments in IT.

The pessimistic mood is now quickly spreading to Europe.

According to research firm IDC, the damper economic climate could reduce worldwide IT spending by as much as $150bn over the next two years.

And while the market in home computers has so far shielded manufacturers from swings in corporate demand, that might not be enough this time around.

Computer industry analysts say that PCs are so well-made these days that home users feel no need to upgrade their models as often as manufacturers might like.

Crippled companies

Companies are feeling the pain.

Dell's second-quarter profits were down by 28%; HP's by 89%.

IBM was just about able to maintain its profitability, but Gateway suffered its third successive quarter of heavy losses.

A Gateway store
Gateway is seen as the weakest of the big PC firms

Of the big five multinational computer makers, only aggressive Dell recorded a year-on-year increase in shipments in the second quarter of 2001.

A string of companies on the fringes of the computer industry - notably those making chips and other high-tech components - have also announced disastrous results.

Between them, the once-mighty high-tech giants have shed tens of thousands of jobs this year, and plan to cut tens of thousands more.

Trimming the fat

So far, the main corporate response has been to slash prices.

Dell has been the keenest price-cutter, voluntarily reducing its profit margins with the aim of grabbing market share.

This enabled it to nose ahead of Compaq during the first quarter of the year.

But not all big firms are willing to risk their necks in a price war that will only batter revenues for the sector as a whole.

Instead, HP and Compaq are hoping to save money, and increase their global reach, by combining their operations.

The merged firm, which will be by far the biggest computer manufacturer in the world, aims to squeeze out $2.5bn in cost savings.

And because Compaq is strongest in PCs, and HP focuses more on corporate servers and printers, the two firms are seen as having the sort of natural fit that could result in stronger group performance.

Merger mania...

Within hours of the HP-Compaq announcement, pundits were predicting that it could spawn a wave of consolidation in the industry.

[Computer firms] want to move out of the risky low-margin hardware business, and into the high-margin services business

Brian Gammage, Gartner Dataquest

The urge to merge, it is argued, not only springs from the industry's straitened circumstances, but from the fact that the computer industry is increasingly a commodity business.

A decade ago, the world needed a host of computer firms, in order to ensure that research and development - and the resulting innovation - was actively pursued.

Now, one PC is pretty much like another, and the imperative is to deliver a cost-effective product, rather than necessarily one that will outperform its rivals.

So the bigger the manufacturer, the better.

Smaller PC makers - notably struggling Gateway - are reckoned to be especially vulnerable to takeovers.

... or not, as the case may be

But not everyone is sure that a wave of mergers is around the corner.

Compaq workers in Germany
Just making PCs is no longer so attractive

The computer business is already pretty tightly consolidated: the top five manufacturers account for more than half of worldwide PC shipments.

Brian Gammage, principal analyst at Gartner Dataquest, says there really is not the scope for another merger on the scale of HP-Compaq.

A takeover of Dell by IBM, for example, could run into trouble from the competition authorities.

Now will PC makers be tempted to spread themselves sideways by buying companies producing computer-related products such as software or chips.

"That would be a step backwards," says Mr Gammage.

And since a merged HP-Compaq will have to eliminate excess capacity in markets where the two firms overlap, the deal should reduce the overall merger pressure in the industry for at least 12 months, analysts say.

Service charge

Instead, says Mr Gammage, companies "want to move out of the risky low-margin hardware business, and into the high-margin services business."

Under chief executive Carly Fiorina, HP has already begun the shift towards the more reliable revenue streams to be earned from long-term service contracts and consultancy work.

Last year, HP made an abortive bid for the consultancy arm of accountants PricewaterhouseCoopers.

IBM has become the most resilient of the big computer firms precisely because it earns a big chunk of its revenue from consulting and services.

HP's move for Compaq, says Mr Gammage, is essentially "defensive" in the short term, but will help position the company for a drive into services in the longer term, when the IT market starts to pick up again.

But that could be a long way off yet.

See also:

04 Sep 01 | Business
HP and Compaq agree $25bn merger
16 Aug 01 | Business
Profits slump at tech giants
20 Jul 01 | Business
Global PC sales slump
25 Jul 01 | Business
Sharp fall for Compaq profits
10 Jul 01 | Business
Compaq cuts jobs and sales forecast
18 Apr 01 | Business
Hewlett Packard cuts 3,000
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