Compaq in Command

We’ve seen the power of the PC, and we’ve seen that it’s unstoppable,” says Compaq CEO Eckhard Pfeiffer. Some people feel the same way about Pfeiffer’s super-charged company.

After completing a mega-merger with Digital Equipment earlier this year, Compaq got some bad news. Price cuts by competitors Dell and IBM slowed Compaq sales and wiped out its profits in the first quarter of 1998.

Pfeiffer’s response was both quick and steady. He cut prices promptly to match the competition. But Compaq continued its multipronged strategy for becoming one of the world’s top computer companies by the year 2000. Some executives worry about the Year 2000 problem, when all that old 20th-century software develops dating glitches. Pfeiffer is aiming for 2000 like he has aimed for everything in his life: thorough in planning his strategy but quick at adjusting his tactics.

Eckhard Pfeiffer used to be a salesman.

He started his career as a 22-year-old accountant for Texas Instrument’s European Division, shifting into sales and then marketing for TI. He moved to Compaq in 1983, launching the one-year-old PC maker’s European operations. In the next seven years, Pfeiffer grew European sales to $1.9 billion, more than half of Compaq revenues.

By 2000, according to Pfeiffer’s latest plan, Compaq will hit $50 billion in sales.

Pfeiffer was named CEO of Compaq in 1991, a critical year for the company. Compaq had one of the fastest starts in U.S. corporate history, reaching the Fortune 500 within four years of start-up. But the computer age shuffles the deck quickly. New firms like Dell Computer were beginning to expand even faster with a business model that emphasized direct selling of build-to-order PCs at ever lower prices.

Pfeiffer and Compaq shuffled their own cards. Compaq cut its PC prices to meet the competition. To keep margins steady, the Houston-based firm halved its administrative and selling overhead from 22 percent of revenue in 1991 to 11 percent in 1996, partly by selling through Value-Added Resellers – “VARs” for short.

Compaq’s revenue began growing again at an even faster pace. And profitability jumped to more than 22 percent return on investment. Pfeiffer said in 1993 he wanted to be the world’s number one PC maker in three years. He made that goal the very next year, two years ahead of schedule. Compaq made 9.5 million PCs in 1997, more than 10 percent of the world market and still ahead of aggressive pricer Dell.

And Pfeiffer firmly believes PCs hold the key to the future. “As computing and communicating have fused,” he argues, “the PC has evolved into a connector and coordinator. When combined with the Internet, it can radically transform communication, commerce, education, health care delivery, entertainment, play – and perhaps even government.”

In addition to competing on volume and price with Dell, Compaq is vying with IBM and Hewlett-Packard for the high-end network-server market, where prices can run from $800,000 to $2 million per unit. It sells total solutions to its major business customers who want service, support and reliability for critical information systems.

For consumers, Compaq makes a PC-TV, a prototype for a future where, Pfeiffer thinks, PCs and TVs will merge into one easy-to-use, multifunction home appliance. And Compaq has already entered the “sub-$1,000” market with a simpler computer called the Presario that can handle most common home computing tasks.

Isn’t this the age when companies are supposed to concentrate on their “core competencies?” Does Pfeiffer think Compaq can do everything well?

Not at all. Pfeiffer trusts his partner Microsoft to define the future of software and his friends at Intel to set the standards for PC processors, while he stays in close touch with his selling channels, those VARs, who sell to and service customers cost effectively. Compaq still sells more than 90 percent of its business through resellers, and less than 10 percent directlyCompaq also works closely with firms that make memory chips, motherboards, and crucial software for PCs and servers. Supplier relationships have allowed Compaq to grow fast without borrowing heavily. Debt was only 5 percent of long-term capital at the end of 1996.

Pfeiffer has three convictions about the computer age that fuel his multiproduct ambitions.

First, all customers, from giant corporations to students doing homework, will want the “lowest total cost” solution to their problems. Pfeiffer explains: “Customers define value as the highest quality, most reliable products and services, backed by around-the-clock support, delivered for a low total cost of ownership.” The corporation buying a $50 million data network wants to minimize downtime, training and waiting-for-service cost. The student wants an economical, easy-to-use PC that taps reference materials fast.

Pfeiffer says the business and the student are basically looking for the same thing – and should get it.

Second, PC technology is “scalable.” The same basic elements can be sized and combined to crunch numbers for a major bank, run a spreadsheet or shop from home by television. A Pentium II microprocessor can do calculations as fast as a mainframe did eight years ago. The next Intel chip will be even more powerful. “Today’s PC has just entered its adolescence,” Pfeiffer argues. “Its hormones are just kicking in. Its major growth and the realization of its full potential lie ahead.”

Third, all this technology will run best if designed around a single industry standard for both hardware and software. Computers and televisions will merge around this standard, as will the rest of communication and computing equipment. “You don’t want to force the consumer to buy into two systems, one for PCs, one for TVs, when they are doing a lot of common things in the end. It just doesn’t make sense.”

So – at least as far as computer equipment goes – one company can do it all. And perhaps one company can be an industry leader, if it pays attention to all the needs of all its customers.

There is a precedent for Pfeiffer’s ambition. GM led the auto industry in revenue, while earning 20 percent return on equity, by building everything from Chevies to Cadillacs. Pfeiffer, who likes to push his Porsche pedal to 100 miles per hour, likens the computer to the car. “I think the PC is about where the automobile was back in the 1920s. We’re past the equivalent of drivers needing to crank and choke their cars by hand. We’re not yet to the point of automatic transmission – let alone antilock brakes and airbags.”

Back up and smell the speed

Pfeiffer is pressuring what was already a fast machine. Compaq averaged 28 percent annual sales growth in the four years before Pfeiffer took over. Since then, the company has accelerated to 40 percent a year. “We said very clearly in November 1991 that we were going for market share. That was a major change,” Pfeiffer remembers. “We wanted to open up to the total PC opportunity.”

The opportunity is enormous. Information technology is a $700 billion-a-year business worldwide. Computer equipment accounts for $280 billion, 40 percent of that total. Compaq still has only 7 percent of the equipment market. So Pfeiffer has plenty of open track ahead of him.

“The PC has become so versatile,” he emphasizes. “Can you think of any other mass-market product that has proved so adaptable, so multiform, so elastic in function, definition and price?”

To keep profitability high, Compaq wants at least double the share of its closest rival in each market. Pfeiffer has that advantage in one fast-growing market – network servers – but leads in his other crucial segment, PCs, by a bare 1 percent.

How do you go so fast and stay in control of profit margins? Pfeiffer divides the track into four lanes and has reorganized Compaq’s divisions to race on them.

First, there are the PCs that still account for about two-thirds of Compaq revenue. Second, there are the network servers for businesses, what Pfeiffer calls the “enterprise” market. Third, communications, which Pfeiffer expects to boom with the Internet and better technologies. Fourth, the consumer market, which Pfeiffer thinks can boom if computers can be sold for less than $1,000 and be made much easier to use.

Adapting to meet Dell

PCs are sold chiefly on the lowest price for the latest and right-size machine. Dell is Compaq’s toughest rival in what Pfeiffer calls “the consumer space.” Dell pioneered direct selling to consumers and build-to-order (BTO) assembly. Direct selling holds delivered prices down, while the BTO strategy cuts inventory risks.

Both techniques are important, so Pfeiffer has adapted Compaq’s business model for limited direct sales and its own version of BTO. In the fast-changing PC world, prices can drop or technology improve so suddenly, manufacturers are forced to eat losses on their latest equipment. “A PC on a shelf is as perishable as an apple in a supermarket if price drops sharply,” explains Bob Scheier, industry editor of the reseller magazine VARBusiness. Kevin Knox, a research analyst with GartnerGroup, agrees: “When memory prices plummet, you can have systems sitting in the channel priced at five times what they are worth.”

Compaq sped up the shift to BTO, in place of build-to-inventory, in mid-1996. But Compaq still sells mostly through its VARs. So it is really building to its resellers’ order forecasts, rather than consumer orders.

Pfeiffer thinks that this modified BTO strategy can work. The VARs are closer to customers and save Compaq selling costs. And they can take over important support work, perhaps more cost effectively than Compaq itself.

Pfeiffer wants to deliver a PC-plus-support to the consumer, but do it as economically as possible. Sometimes, that means an emphasis on specialized VAR support. Sometimes, especially up-front on major sales, it will require Compaq staff.

How important are these VARs to Compaq? Very important, especially the way Compaq views the purchase from the customer’s perspective.Pfeiffer tries to think like a customer – or like the customer would think if it were extremely smart about computers. GartnerGroup estimates that a typical business PC costs a company $60,000 over five years of use. Only $12,000 of that is for the computer and other equipment. Half, or $30,000, is the operational cost for such items as breakdowns, fix-ups, training and user downtimes, with the remainder for administration.

Compaq aims to make the most reliable PCs possible, then to minimize other costs by tailoring support contracts to individual needs.

Total cost

Compaq may get as much as $10 billion in network server sales in 1998. Significantly, server sales rose 35 percent in 1997, much faster than the PC market. Profit margins have also been healthier for servers than in the more fragmented PC market. Compaq competes for this enterprise space chiefly with IBM and Hewlett-Packard. Partners provide one competitive edge.

Applications drive server sales along with technology improvements. Windows NT, which Compaq servers run, has been gaining on the UNIX-based applications. And Pfeiffer stays very close to the German software maker SAP AG, which has grown at 40-50 percent per year making management systems for giant corporate accounts.

Compaq’s traditional advantage against its bigger rivals has been server price. Pfeiffer’s servers have sold for less than $800,000, versus up to $2 million for the equipment of his larger rivals.

Here, too, those supplier partnerships count. By letting suppliers know his plans and figure out how to meet them, Pfeiffer keeps Compaq’s own costs down. The company spent less than 2 percent of its revenue on research and development through most of the 1990s, yet stayed at or near the leading technology edge. After acquiring Tandem in 1997, the research budget rose to 3.5 percent, still less than half the R&D burden shouldered by Compaq’s larger competitors.

Pfeiffer’s key to entering this enterprise space has been “scalability.” Industry-standard components and tools that do spreadsheets, Net surfing and word processing for most users can be expanded and linked to do the heaviest data and other work needed by big companies. A network server is “not just a PC on steroids,” but PC elements combined to do a mainframe job. One proof the muscle is real: A Compaq system runs NASDAQ, handling the trading of one to two billion shares per day.

But larger companies are getting more competitive on server prices. IBM has 20 times the 8,000-person field support staff that Compaq deploys, making its service commitment very impressive.

Meanwhile, Dell is entering the server market with its direct-sale, rock-bottom price approach. GartnerGroup’s Kevin Knox estimates Dell’s direct-sale strategy gives it a price advantage of 10–15 percent over Compaq. Michael Dell has promised to beat Compaq prices by at least 5 percent.

How does Pfeiffer plan to maintain his momentum against both the heavyweights and a nimble dancer like Dell?

He returns to his total-cost model. Major network-server customers want a few suppliers who can provide “total solutions, at the lowest total cost of ownership.”

Pfeiffer says there are three reasons big customers seek large suppliers. First, the market is changing so fast even sophisticated buyers cannot keep up with all the changes. Second, computers, peripherals, software and communications are getting much more complex even as they get more powerful. Third, many computers are “mission-critical” to today’s businesses – not just a faster way of doing things, but the only way to do essential tasks at all. So today’s IT managers must make several tough choices to minimize their total costs, according to Pfeiffer. “What do you do? At which point in time? Which standards do you choose? Which hardware decisions do you make?” Finally, “Do you go upscale or downscale?”Make any of these choices wrong, and the cost consequences can be enormous.

Pfeiffer sees Compaq as one of the handful of large, sophisticated suppliers that can help IT managers navigate these choices intelligently, minimizing their total costs, not just server prices. To buttress Compaq’s technical prowess, Pfeiffer started Compaq Capital Corp. to help finance the acquisition of its equipment in 1996.

He is headed in the right direction, according to market observers. “The entire IT industry is moving toward a total-solutions sell,” notes Bob Scheier. “That includes providing hardware, software, services, financing, disaster recovery and asset management.”

In the server market, Pfeiffer also wants to use his channel partners, not replace them. Compaq does up-front consulting for its enterprise customers and support when necessary. But Pfeiffer seeks partners who can share the support function with Compaq. “We need partners who can do, ideally, everything we’re not doing,” Pfeiffer says.

The new challenges by Dell are creating some tension between Compaq and its VARs. Briefly, Pfeiffer wants to sell directly to big customers when they want direct sales and move product through VARs when they have the best relationship with customers. In either case, service contracts must be arranged. Who gets the support business?

To fend off IBM’s ample support resources, Compaq is quadrupling its own field staff with the DEC acquisition. How will they be used?

“What we all want to do,” Pfeiffer tells his VARs, “is deliver what the customer needs, and not try to impose a concept that isn’t in the best interest of the customer, ourselves and our resellers.”

The principle is sound, but it clearly signals the need for flexibility from resellers as well as Compaq. “Compaq has been the most loyal to its channel partners over the years,” observes Bob Scheier. “Ironically, that means they are also most paranoid about changes at Compaq.”

Pfeiffer is asking his VARs to stay alert and decide what they are really good at. Compaq will move some assembly work downstream to its VARs, continue to sell product through others, and ask still others to join in service and support contracts. If a VAR makes the sale but Compaq ships the unit, a commission can be paid. Pfeiffer is, as ever, very adaptable to new market conditions. Whatever it takes to provide “the lowest total-cost solution” for the customer.

Dell says channels only raise costs and get in the way of fast service. The reserved Pfeiffer responds bluntly: “Stop fooling my customers.” Bob Scheier of VARBusiness estimates that up to 25 percent of Dell’s sales now go through channels. So maybe Dell is starting to learn from Compaq, just as it worked the other way a few years ago.

An information highway house

The Internet will bring major changes in communications and commerce, Pfeiffer believes. “The Internet is now the biggest reason for buying a PC,” he says. Full-transaction commerce on the Net is expected to blossom. Pfeiffer thinks commerce on the Net will soon develop into a “full-blown parallel economy.” Net shopping will be increasingly convenient, and purchases can be made instantly. It will also give consumers the widest range of product choices at the most competitive prices available anywhere in the Net’s world, which is the whole world!

Security of transactions is one challenge to Net commerce now. Pfeiffer thinks this challenge will turn into an opportunity, as Net security becomes better than the clumsy systems for handling paper and checking IDs used in personal transactions.

The possibilities are also immense, he thinks, for education and entertainment.

Furthermore, the Internet is “morphing” into a means for voice communication – a substitute for telephones across national borders when service is bad or regulated prices too high.

The electronic marketplace is still a few years away, but Pfeiffer is ready. Compaq puts a modem into every PC it sells.

Pfeiffer has predicted that 50 percent of homes will have some sort of PC this year. By the century’s turn, there will be a PC in every room of many homes, but these will be specialized PCs doing special functions. “Households with more than one computer will be as common as households with more than one TV, VCR or phone,” Pfeiffer says.

What Pfeiffer calls the “Information Highway House” may have a PC in the den to pay bills and buy stocks, one in a child’s bedroom for homework and reading, another in the kitchen for recipe retrieval, and a PC-TV in the living room for entertainment.

Next will come the total integration of the PC and the TV, with a single standard for transmitting information to both. The true PC-TV will recognize voices and use video or 3-D for electronic commerce.

Pfeiffer calls the package “high functionality and performance at low pricing points.” In the end, “computers will change the way we watch TV,” he says confidently.

But only if prices can be brought down. There is that customer-sensitive salesman again. Ease of use is a critical element of total cost, but purchase price matters as well.

To get computers into the homes that do not use them, Pfeiffer believes prices have to be brought below $1,000 and the equipment must be made much easier to use. “You need to compare it to a television set. You switch it on. You change channels. That’s about where the PC will have to go.”

To facilitate the journey, Pfeiffer favors what is called “push technology.” “You don’t want to go through a huge search process to find new information or areas of interest. You want the information to come to you.” A program like Pointcast finds out a consumer’s interests and brings the consumer information relevant to those interests. Pfeiffer calls it a “human-centric PC.”

Compaq is pushing Pfeiffer’s vision on all fronts. Its Presario home PC sells for less than $1,000 and is 200 times as powerful as the first PCs sold in the early 1980s. Compaq already produces a PC-TV with RCA, called PC Theatre. It has a 60-inch screen and costs $5,000, well above the $1,000 price point Pfeiffer thinks necessary for wide-scale sales. But it exists, and Compaq is learning how to use it and sell it while others just think about it.

No time to slow down

That’s the vision, and it is still the most important thing in the information age. “Seeing what’s coming is the most difficult thing, not tactics or implementation,” says Kevin Knox. “For instance, Pfeiffer saw the sub-$1,000 PC coming. A lot of companies didn’t see it.”

“Pfeiffer is very good at thinking things through,” Scheier agrees.

“He has a very good team and he drives them hard to think who of all the people at Compaq or outside Compaq can best deliver the product or service.”

“Their great strength has been leveraging through their reseller channels,” says Knox. “Pfeiffer is a great businessman. He has not allowed anybody to dictate to Compaq.”

Could Pfeiffer be too tough with his partners and staff? “He’s not easy to work for, there have been a lot of top executives in and out,” Knox notes. “Still, I don’t see any holes in top management.”

What is Compaq’s biggest challenge as it goes for $50 billion in 2000? “They’re so big now, they have got to keep their eye on the ball,” says Knox. Pfeiffer describes an IT executive’s challenge as if it were his own: “Once you’re set on a course, you’re set for quite a while. By the time you’ve made a decision, you’re beginning to see the next challenge ahead of you.”

Editor’s note: We wish to thank the editors of VARBusiness in Jericho, New York, for their help with this article.