Short-Circuiting Retailers : PC Buyers Finding Latest Technology, Best Buys Direct

So you’re proud of the great deal you got on that fully loaded Pentium personal computer you’ve just shelled out $2,500 over the holidays for at the local electronics store?

Well, the PC industry has bad news for you: Starting Jan. 8, Intel will begin shipping most computers with either a high-performance Pentium Pro or a new, more multimedia-savvy MMX chip. Your month-old computer is already looking like a dinosaur.

Chris Voss won’t face that problem. For the same $2,500 you paid for that Pentium at the computer store, the 25-year-old Seattle public relations manager is ordering a Pentium Pro computer from a small Laramie, Wyo., manufacturer called Blitz Computers.

In search of cutting-edge computers at bargain prices, a growing number of consumers, like Voss, are turning to direct channels.

Companies that sell directly to consumers over the telephone account for 24% of all personal computers sold, up from just 17% at the end of 1994, according to Stephen Baker, senior analyst at IDC Corp., a Framingham, Mass.-based market researcher. And that doesn’t include substantial sales through catalogs.

Even as direct sellers are prospering, retailers are suffering from growing competition, high costs and falling PC prices that are squeezing profit margins. Major chains such as Circuit City, Good Guys and Best Buy are seeing their profits plunge. On Monday, Tandy Corp. announced it would close or sell its 17-store Incredible Universe chain and 19 of its Computer City stores. Even retail giant CompUSA reported less-than-expected sales in December. Regional electronics superstores such as Sound Advice in Miami and DOW Stereo/Video in San Diego recently stopped carrying personal computers after prices and profit margins on PCs plummeted.

“It was a question of cutting back on service to our customers to maintain profit margins or getting out of the category altogether,” says Tom Campbell, a corporate director at DOW Stereo.

The shift to direct sales is expected to accelerate in 1997 as a greater proportion of PC sales go to corporate buyers who are more likely to buy direct to save money.

Also favoring direct sellers, Baker says, is the rapid growth in the number of experienced, second- or third-time home-PC buyers who are more comfortable buying direct.

Meanwhile, as the proportion of first-time buyers shrinks, retailers who benefit most from such “newbies” could find it tougher to grow.

What’s the magic of direct sellers?

It has little to do with the Internet--electronic shopping malls are still under construction. Direct sellers such as Dell and Gateway are growing at twice the industry average by exploiting a tried-and-true technology: the telephone.

Call an 800 number, choose the parts you want to go into your computer, and your PC is being put together on the production line within 48 hours. It arrives at your doorstep by UPS truck in less than a week. And there is no sales tax and no retail markup.

Since every computer is made to order, companies such as Dell make sure they never have parts around that are more than 12 to 13 days old. Reducing inventory costs and skipping the middleman allow direct sellers to offer PCs for 10% to 20% less than retail stores.

By keeping inventories down, direct sellers can immediately pass on the savings when component prices fall. They are typically months ahead of retailers in offering technology like super-fast CD-ROMs.

Compare that with the traditional channel where parts and finished computers are warehoused by the computer manufacturers and by retailers.

The system has become more efficient in recent years as computer superstores have replaced smaller computer dealers and distributors. Such chains now handle about a third of all PC sales. But even with the superstores, the retail pipeline typically maintains at least 70 days of inventory, analysts say.

When there are major shifts in technology, as occurs frequently in the PC industry, retailers face a logistics nightmare.

Consider the MMX, an Intel chip that will replace the Pentium on most multimedia computers after it is released this month. Direct manufacturers only have to change their advertisements to begin offering the chips in their new machines. They likely will be the first to offer MMX machines.

“On the day Intel announces availability [of the Intel MMX processor], we ship,” says Kevin Rollins, general manager at Austin, Texas-based Dell. “We don’t have to take time filling the pipeline.”

By contrast, manufacturers that sell through traditional retail outlets must first find ways to flush out old models, typically by offering sharp discounts.

Lower prices, while good for consumers, cut deeply into the earnings of the computer stores. Lower earnings have, in turn, forced many stores to be less generous in serving customers.

Tom Binder, a Santa Monica art dealer, says he had trouble getting CompUSA to answer questions about a product he recently bought at the store. “They told me to call the manufacturer,” he said.

After that experience, Binder would rather buy direct. Unfortunately, as a Macintosh user, he is out of luck. Unlike the IBM computer market, Apple’s computers aren’t available directly from the manufacturer.

For direct sellers, the biggest obstacle is convincing customers that it’s safe to make such a big purchase over the telephone.

“You’re spending $2,500 for something that you haven’t seen and that hasn’t even been built yet,” said James Taylor, a senior vice president at Gateway 2000, a manufacturer based in North Sioux City, S.D., that sells direct. “This business depends on a fair degree of trust.”

But a growing number of experienced computer buyers, like Voss, won’t even consider buying retail.

“If it was my first time buying, I might be more comfortable having a corner store nearby,” Voss said. “But I figure I know more about computers than the average salesman at Best Buy.”

Jesse Slicer, a Kansas City, Mo., programmer, always buys direct. “The computer chains hire teenagers at minimum wage who don’t know anything about computers,” Slicer said.

The growing market of experienced users is creating room for new direct sellers that offer more for less.

Quantex Microsystems Inc., a Sumerset, N.J., PC manufacturer, expects about $350 million in sales this year after just four years in business. The company, which frequently scores high in price performance reviews by PC magazines, such as the monthly Windows Magazine, boasts that it is the only company to offer such new technology as Intel’s video phone system.

“If new technology comes out, we can refigure our production line in a day,” says Tim Mulligan, an assistant sales manager at Quantex.

And if a buyer has a problem with a system that can’t be handled over the phone, Quantex will send a technician to virtually any buyer’s home to fix it.

The direct channel is getting so attractive it’s beginning to bring in first-time buyers.

“It appears that 30% to 40% of our first-time Gateway customers are first-time PC buyers,” Taylor said. The company has recently put money into advertising on television and in consumer publications to attract such buyers.

Retailers won’t disappear. New offerings from consumer companies like Toshiba and Sony that boast interesting designs and special consumer features will attract new buyers to stores.

And although PC magazines consistently rate Dell among the best in terms of its service, many buyers still feel more comfortable buying from a nearby store where they can return a computer if it doesn’t work.

“It’s too early to call the game over,” said Scott Miller, an analyst at Dataquest. He sees companies such as Compaq slashing inventories and accepting lower profit margins to narrow the cost gap with direct sellers.

But even Compaq seems sold on the advantages of selling direct. The company is expected to begin offering business customers the opportunity to buy using the same build-to-order approach that direct sellers use.

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Buying Direct

Direct sales of personal computers have been taking a bite out of the retail market. Percentage of tatal PC sales direct from U.S. manufacturers (not including catalog sales):

1997*: 24.7%

* Projected

Source: IDC Corp.