PC industry poised for 'game of chicken'

Price war!! PC makers begin price cuts heading into the down-turn. While low-cost computers are welcomed by consumers, a protracted price war could hurt manufacturers and force some PC makers out of the market.

Executives at Gateway Inc., staggered by a $94 million quarterly loss that will force over 3,000 layoffs, have vowed to win back consumers by escalating an "industry game of chicken" -- a price war.

But the tactic might make a bad situation worse for a PC industry already struggling with a slowing global economy, analysts said, by not only further undermining earnings but by ultimately forcing some computer makers to abandon the market alto-gether.

Gateway announced its pricing moves after reporting fourth-quarter results Thursday well below what Wall Street had expected. Reeling from a 15 percent drop in PC sales, the computer maker detailed a number of steps it would take to streamline operations and cut costs, including laying off more than 3,000 workers, or 12.5 percent of its workforce.

But while San Diego-based Gateway will bear the brunt of those cutbacks, the company's pledge to become "much more aggressive" on pricing will likely have more far-reaching implications.

"We'll be more competitive on price at every level and across every segment of the consumer and business market," said Jeffrey Weitzen, Gateway's chief executive, in a conference call with analysts Thursday evening.

To demonstrate Gateway's new resolve, Weitzen touted a 933MHz Pentium III system with 17-inch monitor and color printer that the company is now selling for $999, a $300 markdown from a few days ago.

"That's indicative of how we plan on working ... to be extremely competitive on price," he said.

'Bloodbath environment'

The move by the nation's fifth-largest PC maker could accelerate what has already become a price war, said market analyst Andrew Neff of Bear Stearns.

"The pricing has been real aggressive, real tough. It's an industry game of chicken," Neff said.

While low-cost computers are welcomed by consumers, a protracted price war could hurt manufacturers and force some PC makers out of the market, he said.

"This is an industry which needs consolidation, there's over-capacity, somebody has to leave," Neff said. "I think that two of the top 10 PC makers will exit the market this year."

Despite the obvious risks, PC makers have little choice buy to cut prices, said analyst Roger Kay of International Data Corp. in Framingham, Mass.

"They really don't have any choice because it's imperative that they get rid of inventory," Kay said, adding that the PC industry will face mounting difficulties in the next six months.

"I've been saying for a while that it look liked a bloodbath environment, it's just only more so now," he said.

A lousy holiday

Significant price reductions started occurring last month amid what Weitzen called "possibly the worst Christmas sales period in the history of our industry."

Prior to Thanksgiving, several PC makers, such as Compaq Computer Corp. and Hewlett-Packard Co., stocked the channel and boosted their inventories in preparation for an expected surge in holiday sales that never materialized. As a result, PC makers and their partners, faced with rising inventory costs, slashed prices and offered rebates to rid warehouses of unsold inventory.

The cost cuts quickly spread across the industry as PC makers sought to remain competitive.

But despite those aggressive actions, Weitzen said, there's still "a lot of inventory sitting out there that's basically rotting on the shelves."

For now, the Gateway executive said he sees no hope that prices will stabilize anytime soon.

"We're going to see an awfully aggressive pricing environment in the first quarter, if not for the first couple of quarters," agreed Rob Cihra, a market analyst with ING Barings in New York.

But while he expects computer makers will face some tough times, Cihra said he doubts any major U.S. companies will abandon the PC market this year.

"I think the least competitive PC vendors are actually IBM and HP," he said, "but they can probably afford to stick it out longer than anybody."

The most likely competitors to be forced out in a continuing price war would be some of the second- and third-tier companies, Cihra said, including many companies based in Asia.

Rebound in second half?

But it's already clear that the downturn in PC sales and an escalating battle to offer lower prices is having an effect on major computer makers, he said.

"Dell's hiring pace has certainly slowed or stopped," Cihra said, adding that "Compaq has already been trying to reduce their headcount for a while now."

HP also warned Thursday that its earnings for the current quarter were falling below expectation, blaming a slumping demand for computers as well as other high-tech equipment. It marks the second straight quarter the giant computer company has missed Wall Street's estimates.

Summarizing PC sales forecasts for the year, Cihra said, "the next six weeks look pretty dismal, both in terms of weak demand and aggressive pricing. But I think you might see things pick up in the third and fourth quarter."

However, he said, a worsening economy might undermine predictions that the PC industry will rebound in the second half of the year.

"The big question mark right now," Cihra said, "is if the economy continues to slow and corporate IT spending falls off a cliff -- then all bets are off."