Competition, Technology Take Bite Out of PC Profits

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With a subtle shift in the back-to-school landscape from clothes and books to high-tech gadgets, it seemed only natural that companies selling computers would be in store for strong earnings. Not quite.

Several direct-to-consumer computer companies took a beating on the stock market last month as some of the lowest prices ever seen for computers failed to produce profitable volumes.

Dell Computer dropped 13.32 percent in this month's DM News Portfolio while Gateway tumbled 27.52 percent. Only PC Mall seemed to buck the trend with a 25.65 percent increase, but that's after the company reported a second-quarter loss at the beginning of August. PC Mall's profit margin actually dropped to 11.3 percent from 13.1 percent a year ago.

For the second quarter, Dell said it missed revenue estimates by $300 million. The main culprit: low-cost computers. Mona Eraiba, managing director with Rosetta Group Research, said Dell's problem is basically a pricing issue.

"It's a tricky problem," Eraiba said. "When they lowered the price, the volume did not respond."

Indeed, consumers looking to snatch up bare-bones computers -- particularly desktops -- may not get better deals. Last week a Dell Dimension Desktop with a free printer cost just $299 while a Gateway 3310S sold for $399. Laptop computers, which traditionally are priced much higher, also are relatively inexpensive. A Dell notebook computer started at only $549 last week. Gateway is offering notebooks for $599.

Robust competition among computer sellers and declines in the cost of technology have forced companies to slash prices on computers, which in turn has cut into profit margins. When Gateway said last month that it missed sales and earnings estimates for the second quarter, president/CEO Wayne Inouye blamed "competitive pressures" on the company's growth margins, though he did say the company's long-term goals remained intact.

Eraiba said the computer industry as a whole is shifting from desktop- to notebook-based, which is affecting pricing and volume.

The direct-to-consumer PC landscape is not all negative as HP and Apple posted positive second-quarter results, and though the after-effects of Hurricane Katrina will be a wild card for companies across the economy, computer sellers should benefit from an increase in back-to-school sales.

The National Retail Federation expects $47.8 billion to be spent on back-to-school merchandise, ranking second only to the holiday season. A solid $8.2 billion is expected to be spent on electronics. Eraiba told CNN Money that back-to-school shopping will be key for direct sellers like Gateway and Dell.

"The biggest event right now is back-to-school, so there is a lot of push to capture this volume," she said.

Dell also seemed unfazed by the market challenges, at least not enough to raise prices. CEO Kevin Rollins said in the company's earnings statement that continued steady purchase rates by corporate customers, the seasonal effect of back-to-school buying and continued growth in foreign markets will drive Dell's third-quarter business. Dell expects third-quarter revenue of $14.1 billion to $14.5 billion and earnings per share of 39 to 41 cents.

In other news, ValueClick (ticker symbol: VLCK) replaced DoubleClick in the portfolio after DoubleClick's acquisition by two private investment companies.


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