Compaq promises punishing server fight

Compaq Computer, which recently lost its title as the world's top PC vendor, says it won't allow the same fate to befall its position as the No. 1 seller of Intel-based servers

"We are going to step up and protect that space," said Compaq chairman Michael Capellas Monday afternoon, defending price cuts aimed at shoring up its server market share.

"We are getting more aggressive on industry-standard servers," Capellas told analysts during a conference call following the release of the company's first-quarter earnings report. "There's no doubt there is pricing pressure on us."

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The strategy is not without a cost, with the computer maker revealing yesterday that despite selling 10 percent more Intel-based servers in the quarter, revenues from those sales fell 9 percent.

"Most people have this notion that pricing aggression only involves PCs, but it obviously involves more than that," said Richard Chu, an analyst with S.G. Cowen in Boston. "I think it's in Intel servers where Dell's hitting hard at Compaq Computer."

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Capellas said the Houston-based company was forced to act in response to pressure not only from Dell Computer, whose strategy has been well publicized, but from IBM as well.

IBM, which last week reported a 15 percent increase in profits during the first quarter, traditionally is not viewed as a low-price competitor in the computer industry. But the industry giant has been quietly leveraging its strong services base to subsidize its hardware sales, one analyst said.

"The only vendor out there who is meeting Dell's pricing is IBM," said Ashok Kumar, an analyst with U.S. Bancorp Piper Jaffray in Minneapolis. "They look at it as a package sell. They may lose money on the hardware -- I mean, they cannot not lose money given their cost structure -- but they make it up in services."

Compaq's determination to preserve its position as the top-selling vendor of Intel-based servers is keyed to a decreased emphasis on PCs and a greater focus on its enterprise business, specifically sales of servers, storage devices and services.

Underscoring that point, a Compaq spokesman last week belittled Dell's ascension to become the world's top PC vendor by calling that distinction the "brass ring of the '90s."

"Now what's important is emerging technologies, such as wireless, and the enterprise space -- where we are very, very strong," the spokesman said.

While Compaq offers a variety of high-end server products, which can cost more than $1 million per device, sales of low-end $1,000 to $5,000 Intel-based servers comprise one of the fastest-growing market segments.

In particular, sales of appliance servers, a segment dominated by Intel-based products, are expected to soar from $1 billion in 1999 to $14 billion by 2004, according to the market research firm Gartner Dataquest in Stamford, Conn.

Unlike high-end proprietary products, low-end Intel-based servers are relatively similar from manufacturer to manufacturer, spurring OEMs to put greater emphasis on pricing to distinguish their products.

In February, Compaq executives scoffed at increasingly aggressive pricing by competitors, and countered that the company would take a "more rational" approach. Since then, the PC maker has made a dramatic about-face.

"Compaq was originally trying to stay above the fray and not get pulled into a price war," said David Bailey, a market analyst with Gerard Klauer Mattison in New York. "But with Dell drawing away sales of PCs and low-end servers, Compaq has no choice but to try to respond."

With today's increasingly competitive environment, Compaq said it constantly scans rivals' pricing and makes adjustments regularly.

"In the direct business, which is a significant portion of our business now, we adjust those prices on a daily basis," said Mike Winkler, executive vice president of Compaq's global business units, which includes the industry-standard server group.

In order to compete more effectively against Dell's efficient made-to-order business model, Capellas admitted yesterday that Compaq must strive to further reduce its own inventory costs.

"Ultimately, for the health of this business, we know that we have to drive inventories down," Capellas told analysts.

While critics have long assailed Compaq for failing to rein in inventory costs, Capellas contended that the computer maker has made significant headway in trimming such expenses.

"During the first quarter, we reduced inventory by $250 million," he said. "During the second quarter, we will reduce inventory across the entire supply chain by almost half a billion dollars -- and fundamentally change the way we price and manage inventory."

Compaq's relatively high inventory costs are tied in part to its sale of consumer PCs at retail outlets and its original reliance on building systems based on projected sales. But in recent months, Winkler said, the computer maker has fine-tuned its projection models and streamlined operations.

"We've been doing a lot of work on the supply chain," he said in an interview following yesterday's earnings call. "So now we can get away with much lower channel inventory and still provide units to customers when and where they want them."

Although the current weakness in the U.S. economy has been blamed for fueling competitive tensions among computer makers, one analyst said the current harsh environment may continue even if the industry experiences a rebound in the second half.

"Dell's in the driver's seat. They're really putting the pressure on all the PC makers right now," said Bailey of Gerard Klauer Mattison. "They're going to continue to price aggressively and grab share, and they'll do that as long as it's successful and profitable."