Compaq Plans Direct Sales. DTja vu All Over Again?

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Event Summary

Speaking to financial analysts in Houston, Compaq Computer stated it plans to start selling more of its computers directly to customers, and this time the company says it means it.

Compaq executives predicted that approximately 60 percent of its PCs for the commercial market in North America will be sold directly to customers - rather than through distributors or dealers - by the end of the year. Currently, 85 percent of its PCs go through distribution. Overall, Compaq wants to see 40 percent of its systems sold directly.

The move to sell computers in the same way as rival Dell Computer should cut costs and will be helped by the purchase late last year of Inacom's distribution assets. Still, analysts who have heard Compaq talk about direct sales before say that the goal could be tough to meet.

"Anyone who sells indirect loses money today," Compaq senior vice president Michael Winkler said at the meeting, according to Bloomberg. "Anyone who sells direct makes money."

Compaq executives briefed financial analysts for about four hours today, setting the PC maker's direct strategy and a goal of about 15 percent growth for 2000. Compaq also promised it would bring its commercial PC division to profitability by the second half of the year. Winkler said the indirect sales method takes about 15 percent revenue from each machine vs. 2 percent for direct.

The company is also betting big on iPaq, its simplified business PC that started shipping this week.

"It is a dogfight, and iPaq will certainly help us in that regard both as an innovative product and increased margins," Winkler told financial analysts Tuesday. "Portables are becoming an increasing portion of our mix, which bring in increased margins. And as we increase the direct content of our business, that also increases our margins."

Merrill Lynch analyst Steven Fortuna in a short written statement expressed some concern that Compaq could achieve its direct goals. "We do not think this is achievable," Fortuna wrote. "In our view, (Compaq) is being overly aggressive in how fast it can take its business from indirect to direct."

Market Impact

If Compaq can finally implement this successfully, it will help it greatly in its battle with Dell. Compaq has other obstacles to overcome, and well-executed direct sales will not help in all areas. It will provide better margins which can (theoretically) lead to lower prices for users. Dell Computer, the leader in direct sales, and the creator of this model, leverages the model to improve customer satisfaction and quality. It is not clear that Compaq is looking at the change as anything other than a bottom-line improvement.

Successful execution of this model will increase Compaq's market share, leading to increased market consolidation. However, this increase will be short-lived if they do not address their quality and customer satisfaction issues contemporaneously. We do not expect this move alone to increase market growth beyond current rates. Market growth would come in the form of robust iPaq sales, as well as sales of other appliance-like devices (e.g. Dell's WebPC).

Accomplishing the move to the direct model by the second half of this year is aggressive, but not overly so. We believe Compaq stands a reasonable chance of accomplishing its goal - as long as everyone involved is marching in the same direction. [65% probability] (We are assuming that the implementation plan actually makes sense. Considering the number of false starts Compaq has had in this area, that assumption may not be warranted.)

Finally: the market is running out of patience and good will regarding Compaq's inability to commit to a direct sales plan and then execute. Compaq's size and market share will only carry it so far - if it blows it this time, the market may not give it another chance to succeed.

User Recommendations

Although Compaq has a lot riding on the change to direct sales, there is still no guarantee that it will execute as necessary. However, customers need not change their purchasing plans, since the process should be transparent to them. Cautious purchasers may want to discuss their concerns with Compaq, and try to gain performance assurances. These assurances might be of the "penalty for poor performance" clause form.

For the longer term, we see this as a benefit to customers, again assuming Compaq executes sufficiently well (65% probability). We expect Compaq's success/failure will become clear within nine months. As Dell customers have found, the indirect benefits of the direct model include higher customer satisfaction and better response time. Customers will want to monitor whether Compaq is treating this as a "point solution", or part of a new corporate philosophy. Evidence of a point solution would be a thing such as: no improvement in response to customers, no increase in quality. If Compaq shows that they are just looking for the quick score or "short money", then customers should vote with their feet.

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