PC buyers suffering from upgrade fatigue

For the first time in 15 years, world-wide personal-computer sales will likely be lower this year than last. The Black family of San Jose, Calif., helps explain why.

Michael Black, a 40-year-old engineering manager, his wife, Kim, and their six kids use five home computers, none newer than two years old, for e-mail, homework and online shopping. "For what we need right now, there's no killer [software] that's pushing us to buy that new PC," says Black. He estimates they will wait another year or two, at least, before spending on a new machine.

The personal computer, once the engine of the technology boom, is sputtering. In recent months, the five biggest PC makers have laid off thousands of employees and taken charges totaling $2.1 billion. Even Dell Computer Inc., the industry's fastest-growing company, is signaling that its annual revenue will fall for the first time in its 17-year history.

There have been PC slumps before, but evidence is mounting that this is no mere cyclical downturn. Back-to-school sales, a reliable barometer of Christmas home-PC sales, are off. Companies are upgrading less frequently.

The 15 percent-a-year gains in shipments that made the PC hardware and software industry one of the biggest generators of corporate and personal wealth through much of the 1990s may never return. And the industry's recent spotty record of producing innovations that appeal to buyers is at least partly to blame.

Cutting research
PC makers, squeezed by price wars, have slashed spending on product research, leaving much of the important technology development to Microsoft Corp. and Intel Corp. The software and chip giants have much larger profit margins than the computer manufacturers they supply but are themselves struggling to deliver meaningful-enough innovations to keep users regularly upgrading their PCs and programs.

Lynn Weaver, a software buyer at Waterfield Mortgage Co. in Fort Wayne, Ind., illustrates the upgrade fatigue that has set in. Every two years during the 1990s, Weaver bought a new version of Microsoft Office, the most frequently used collection of desktop software. But the company has ruled out buying the latest version, Office XP, which includes new features, such as a link to a Web site that helps people work together on projects. Instead, Waterfield Mortgage will continue to handle its financial analysis and communications on a 3 1/2-year-old version of the software.

"My people tell me there has not been a compelling reason to go to Office XP for our business requirements," Weaver says.

After selling more than 500 million machines over two decades, the desktop computer business has taken on attributes of other big, mature industries. Like cars, televisions and other home appliances, PCs may be evolving into a product that owners keep unchanged for a relatively long time and replace only when the machines can't handle a popular new use, such as managing digital music files.

Moreover, with the computer market so large now, only major technology advances or striking new uses for the PC are likely to boost the industry's growth rate very much. And most big PC makers are following Dell's lead, reducing spending on research and development, not stepping up the search for breakthroughs.

"I am concerned with the overall level of investment" in R&D, frets Paul Otellini, general manager of Intel's microprocessor business. An industry's "right to grow comes with investment," he adds.

Intel and Microsoft aren't yet resigned to a slow-growth future. Microsoft Friday is expected to give hardware makers a final version of its new PC operating system, Windows XP, which is vital to hardware companies' hopes for Christmas sales. Intel, for its part, is expected in coming days to announce major price cuts and performance improvements to the chips that power most PCs.

The chip maker says this year it will spend $4 billion, or nearly 15% of sales, on R&D. Microsoft says it will spend $4.8 billion, up 37% compared with two years ago. Intel and Microsoft each plans to spend an additional $500 million during the next 12 months to promote new product lines, in a high-stakes gamble to spur computer demand.

But there are signs that even these lavish intentions may not be enough. There are fewer first-time buyers, and existing customers are worn out from spending $1,000 every two or three years for upgrades that they feel don't offer anything new. Black in San Jose says his family doesn't need speedier Pentium 4 chips from Intel. What they have is fast enough for sending e-mail and cruising Internet retailers.

Eric LeSatz, computer chief at the New York securities-brokerage firm A.B. Watley Group Inc., says his company is still happy with four-year-old versions of Office and Windows and has no plans to adopt Office XP or Windows XP. "Right now we just don't see anything in there that would justify the expense of upgrading," he says. In the past, features similar to Office XP's improved capacity for collaboration on projects have gone mostly unused at his company, he says.

Contracting sales
Companies are waiting an average of more than four years to buy new PCs, up from three years in the late 1990s, according to International Data Corp. The Framingham, Mass., research firm estimates that PC unit sales this year will contract 10 percent in the U.S. and remain flat world-wide.

Meanwhile, U.S. back-to-school purchases, an important indicator for the approaching holiday season, are lackluster, according to NPD Intelect Inc., a Port Washington, N.Y., research firm that surveys retailers. So far this year, NPD says, PC sales in the U.S. are off nearly 21%, compared with 2000, and trail 1999, as well.

Despite their heavy spending, Microsoft and Intel often merely refine existing technology. Microsoft, based in Redmond, Wash., has crammed Windows XP with features for handling digital photos, music and movies--tasks that many users already can handle, using add-on software or services. Instant messaging, another key feature of Windows XP, has been offered by AOL Time Warner Inc.'s America Online service since 1998.

Microsoft executives say simplifying and improving such features--making it easier to jump from a messaging session to a video chat, for instance--will spur new consumer uses and sales of accessory hardware. "The only way we can encourage people to upgrade is if they find value ... in the way they can handle digital photos or video, or the ability to do remote support," says Jeffrey Raikes, Microsoft's group vice president for productivity and business services. "We spent a lot of R&D to create that value."

Intel, based in Santa Clara, Calif., next week will add the latest in a series of speed gains--a chip that operates at a staggering two billion cycles per second. But the company's Otellini says it hasn't been preoccupied with "a single-minded drive" toward greater chip speed, neglecting other advances. Sets of Intel chips now come with graphics and communications built in, he says. Previously, such features required separate components.

Past improvements
Improvements in Intel's chips and Microsoft's software have long helped drive the personal computer boom. But in the past, computer makers offered their own innovations, too, making PCs portable and then notebook-size and adding accessories such as modems.

In the 1990s, PC makers prodded suppliers, including Intel and Microsoft, to support features such as sound, video and graphics. These multimedia computers spurred huge sales gains. Led by Compaq Computer Corp., based in Houston, hardware manufacturers in the late 1990s reduced the number and cost of internal components and slashed the price of a stripped-down PC to less than $1,000. U.S. shipments jumped 23%, and today, PC sales to the home eclipse those to business.

But in the past couple of years, PC makers have put more of their energy into improving manufacturing and distribution efficiency, rather than developing substantial new features. A typically cosmetic new offering, and one of the most-copied in desktop PCs in the last 12 months, is the color panel, which users can snap on to jazz up the exterior of their box.

A big part of the reason for the dearth of innovation is Dell. The Austin, Texas, direct seller became the world's largest PC maker by spending little on research to keep its prices as low as possible. Dell historically spends just 1.5 percent of sales on R&D. IBM spends 5.8%.

As Dell grabbed more and more market share with its low prices, Compaq, developer of the first IBM-compatible portable PC and one-time market leader, sliced its own R&D spending. Today, Compaq's R&D budget is 4% of sales, down from 12.5 percent in 1996. Deloitte Consulting, a unit of Deloitte Touche Tohmatsu, in New York, says that as a group, PC makers spent an average of 4.7 percent of sales on R&D during the 12 months ended June 30, compared with 10 percent a decade ago.

What money there is for research mostly goes into notebook PCs and network servers. For notebooks, manufacturers have produced lighter designs, better batteries, larger screens and the capacity to accommodate DVD and CD players. New servers use less power. Not surprisingly, notebook and server sales are rising and delivering higher margins than desktop PCs. But notebooks accounted for just 20% of total PC shipments last year, and servers were only 3.4 percent, according to the International Data research firm.

In the frenzied chase to match Dell's prices, desktop design has largely stalled. Dell says this is just fine. Company Co-President James T. Vanderslice says Dell spends $3.5 billion a year to buy software and components -- money that helps support research by its suppliers. That purchasing power, he says, "gives us access to all the technology that we need."

Dell said last week its second-quarter profit fell 28 percent, before charges for such things as layoffs. But company officials maintain the slump merely reflects the weakening economy, which will eventually bounce back.

Despite its reduced R&D spending, Compaq has done enough to cook up innovations, says John P. Stautner, vice president of PC technology and new markets. The company recently has introduced licensed software that reproduces true-to-life colors and a keyboard with a credit-card reader, to aid online shoppers, among other new features.

Titans step in
With these manufacturers scaling back on R&D, Microsoft is increasingly designing the latest hardware itself. Compaq and a number of other PC makers are expected next year to introduce versions of the Microsoft-crafted Tablet PC, a portable device which can store notes written long-hand with a stylus and has built-in wireless communications. Microsoft gives away such designs in hopes of stimulating sales of its software.

"In the case of the Tablet PC, we did more of the hardware engineering than we normally do," says Microsoft's Raikes. But he says that PC makers have "collaborated" on the Tablet and other new designs.

Unlike most industry analysts, Microsoft, which has close contact with small PC assemblers not counted by market-research firms, expects PC shipments this year to increase at a high single-digit rate. In coming years, industry optimists expect that growth in demand for wireless networking and high-speed Internet service could fuel greater PC innovation.

Intel, which declines to forecast 2001 PC sales, says it is spending nearly a third of its R&D budget in areas computer makers traditionally plumbed, such as video handling and speeding up the transport of data within PCs. Later this year, analysts expect Intel to make available to the industry its own plan for a makeover of the PC.

-- Don Clark and Rebecca Buckman contributed to this article.