December 11, 1995
Prepared By:
Workgroup Strategic Services, Inc.
75 Congress Street
Portsmouth, N.H. USA 03801
603 - 431 - 4409
© 1995 - Workgroup Strategic Services, Inc.
The retail marketplace for personal computers is the single most
cutthroat distribution segment in which vendors compete. Walk
into any computer superstore or mass merchandiser and you will
see marvels of technological wizardry, all at rock bottom prices.
Retail sales for PCs have climbed from barely a blip on the computer
industry radar to almost half of all PC sales today. Retail outlets
have evolved into distribution channels with incredibly competitive
dynamics.
Think about the issues vendors and retailers are currently struggling
with in selling PCs to consumers.
The emergence of a significant retail distribution channel for
personal computers is a relatively recent phenomenon. Sales of
PCs through consumer electronics, mass merchandisers and computer
superstores really began around 1990. In the short five years
since, the computer superstore has emerged to become a credible
outlet for high tech multimedia based computers for the consumer
end user and a low cost source for corporate buyers. One of the
surprising elements of the original computer superstore and mass
merchant customer base was the corporate buyer looking to add
a PC or two to the departmental LAN at work. Retailers found the
corporate customers were looking for product availability and
the low prices, many times allowing the corporate customer to
expense a PC rather than jump through hoops for a capital budget
item.
As retail channels emerged, Packard Bell moved into the leadership
role in consumer electronics stores, followed by Commodore, may
they rest in peace. In the mass merchant stores, Packard Bell
also held a dominant role, early on showing its merchandising
savvy. Analysts may have questioned the quality of the Packard
Bell PCs, but the company sold thousands to first time buyers
with its low prices and wide availability. Packard Bell continues
to dominate retail channels.
Back in 1990, Workgroup Strategic Services estimates the computer
superstores sold two percent of all PCs in the United States.
Computer dealers still ruled the storefront business model, selling
about sixty percent of all PCs in the United States. This type
of traditional dealer quickly realized the larger retail channels
would begin to encroach on its customer base, and for good reason.
With the increase in the available outlets for computer purchases,
the customer suddenly had a variety of sources for computer hardware
and services. Therein lies the problem for dealers. Large retail
chains have incredible buying power, their business model reflects
a volume perspective, and their prices were consistently lower
than a traditional dealer's price. Dealers were used to bundling
service within a hardware sale, at that time margins ran close
to fifty percent, with plenty of room to pay for the additional
service a dealer provides. Suddenly, dealers had to compete more
aggressively on price, with the end result of a lower margin structure
for hardware products. Suddenly hardware sales could not fund
the service and support a dealer's customer demanded. Since service
and support still carried high margins, savvy dealers moved toward
a service business model for revenue. Most shut down or reduced
their storefront presence and began to look more like a value
added reseller or integrator.
To better understand the nature of PC distribution channels dynamics
some definitions are in order. Workgroup Strategic Services uses
the following definitions for computer distribution channels and
end user market segments.
Direct Sales Force - Computer vendors' use of its own direct
sales force. This type of sales is usually reserved for a vendor's
top revenue producing accounts. Many times the consulting, integration
and other services will be outsourced to a third party support
firm. Examples include Hewlett Packard and Digital's use of account
representatives to service its top 100 customers.
Direct Marketing/Mail Order - Computer vendors that use
direct mail and telemarketing to drive sales. Examples include
Dell, Gateway 2000, IBM Direct, as well as smaller mail order
vendors.
VARs/Assemblers/Systems Integrators - Resellers that offer
value added expertise to the sale of hardware. Usually this involves
LAN, WAN and multivendor integration activities. The systems integrators
differ from typical VARs in that they offer higher levels of consulting
and Business Process Reengineering services. Assemblers usually
focus on build to order products, relying more on a production
line business model than service and support.
Computer Stores with Outbound Sales - This type of retailer
is the traditional computer dealer. Many have moved toward service
and support to generate revenue and higher margins; for this reason
they have developed outbound sales forces that target corporate
customers for network integration, service and support. Dealers
such as MicroAge franchisees are examples of computer stores with
outbound sales.
Computer Superstores - Very large retail outlets that tend
to follow a high volume, low margin business model. The typical
advantages of a computer superstore are low prices, wide product
selection, and product availability. While their business model
clearly follows the box pushing mentality, some computer superstores
are developing service, support, and training products for its
customers. CompUSA and Computer City are examples of computer
superstores.
Consumer Electronics Stores - Retail outlets that offer
myriad electronics products. Typically part of a national chain,
consumer electronics stores offer a wide range of products but
do not have the large, voluminous facilities of the consumer electronics
superstores. Radio Shack is an example of a consumer electronics
store.
Consumer Electronics Superstores - Similar to the consumer
electronics stores but with the added leverage of size. Consumer
electronics superstores carry the wide range of electronics products
but look and feel more like a discount warehouse than the small
local electronics dealer. Examples of consumer electronics superstores
are Circuit City, The Wiz and Fryes.
Office Product Superstores - Similar to the consumer electronics
superstores except for the product focus on office supplies and
equipment. Office product superstores tend to have the same look
and feel as the consumer electronics superstores, and they offer
very little in the way of service and support for the customer.
Staples, Office Depot, and Office Max are examples of office product
superstores.
Warehouse Clubs - Discount membership outlets that offer
low prices and very little service and support. Warehouse clubs
tend to have a limited selection of computers, most models seem
to be somewhat behind the technology curve. Sam's Club and BJ's
Wholesalers are examples of warehouse clubs.
Other Mass Merchants - This type of retailer includes outlets
such as Sears, Montgomery Ward and others that sell a wide range
of consumer products. Most sell items ranging from clothing to
automotive accessories. For the most part, this type of outlet
offers little in the way of service and support. The exceptions
are outlets such as Sears, which has a dedicated Business Center
and sales function.
Market Segment Definitions
Small Office/Home Office - The businesses in this segment
tend to have less than a dozen employees. Many are run out of
the owner's home. This group is the fastest growing market segment
for PCs. Their needs are very similar to the larger businesses
in that the computer is a crucial element of the firm's business.
Home Office users are those that use the home as their primary
work environment.
Small Business - Small businesses have less than 100 employees.
This type of computer customer is usually Intel/LAN based.
Medium Business - Medium businesses have more than 100
employees but do not have the revenues of the larger Fortune 1000
companies. This type of computer customer is usually Intel/LAN
based, but many are using or considering multivendor computing
environments.
Fortune 1000 Firms - This group of the largest 1000 companies
in the United States tends to have different service and support
needs than the smaller businesses. Fortune 1000 firms tend to
use higher level management information systems and would be more
likely to use high level outside consultants as part of its service
and support needs.
As Table One shows, it was the value added channels (VARs/assemblers/systems
integrators and computer stores with outbound sales) that supplied
the bulk of the personal computers to end users from 1993 onward.
Direct sales efforts, from the vendors and direct marketing/mail
order firms, provided over one quarter of all PCs at that time.
This channel segmentation shows that corporate customers were
primarily using partners that provided value added services, with
only limited use of the direct marketing/mail order channel that
deals with a high volume/low service sales model.
At the same time, corporate customers (defined as small business
or larger) purchased the vast majority of PCs. The SOHO and home
segment combined to purchase less than one quarter of all PCs
sold in 1993.
By 1995, all retail outlets have increased their market share,
at the direct expense of those channels that usually offer value
added services. Vendor direct sales, VARs, and traditional dealers
(computer stores with outbound sales) all lost ground to the emerging
retail outlets of the computer superstores, consumer electronics
superstores and office product superstores. It would be easy to
dismiss this channel change as the result of price conscious corporate
buyer until one looks at the changing customer mix in the market
segments for PCs.
In 1995 the SOHO and home market segments have grown to 30% of all PCs sold in the United States. Small business purchases grew to 12.5% of the total PCs sold. Further, the Fortune 1000 and medium business segments are now a smaller part of the overall PC market in 1995. This shift in the customer market segments also points to the shift in the PC distribution channels over the same time period. Table two shows that as the typical PC buyer comes from smaller and smaller businesses, purchase behavior changes. Smaller companies, and particularly SOHO customers, have more simplistic computing environments. This small business/SOHO customer usually has an Intel based computing environment, with limited network complexity. Most have not moved to multivendor environments that require higher levels of service and support. This type of customer usually has different budgeting and purchase procedures than the Fortune 1000 companies. Small business customers have shorter budget cycles and more flexibility in choosing computers than the larger firms with company wide PC standards and capital budget processes.
Workgroup Strategic Services believes the shift in computer distribution channels and market segments will continue through 1998. In fact by that time, SOHO and home users will purchase over 37% of the PCs sold in the United States. Corporate customers, defined as small business or larger, combined to purchase almost 70% of the PCs in 1995. In 1998, this market segment will account for less than 63% of the PCs purchased in the United States.
Source: Workgroup Strategic Services Inc.
During this time, all of the retail channels will increase their
presence in the market. As Table One shows, all of the superstore
outlets, the consumer electronics stores, and the warehouse clubs
will increase their market share at the expense of those channels
that offer value added services. This change clearly mirrors the
smaller number of large business customers who requires service
and support with the purchase of a PC.
Early on, discounts to computer dealers and retailers (the difference
between suggested list price and the dealer/retailer's cost) typically
ran from thirty to fifty percent. In other words, there was a
lot of room to make your money back for any type of service or
hand holding the seller provided the customer. Two things contributed
to an escalating war of discounts for computer products. The first
dynamic was the standardization of computer components, in particular
the Intel processors and Intel's rapid pricing moves, designed
to entrench Intel as the core CPU platform of choice. Secondly,
this low buck commodity component strategy enabled smaller 'clone'
manufacturers to emerge, with low cost production and marketing,
that drove PC prices through the floor. First tier vendors reacted
until the cycle became a way of life. Every three months, computers
seemed to be faster, cheaper, smaller…..everywhere. Playing
the low margin game eventually killed off many of the second tier
vendors, those that remain still play in the low margin legacy
created by the cloners. This low margin playing field means that
even the largest buyers of computer products are now lucky to
see discounts in the teens.
Vendors then sought to match the appropriate distribution channel
to the product, pricing, and customer service and support required
for each target market. The price sensitive retail channel provided
little more value than pricing and availability, all that a sophisticated
consumer or corporate buyer requires. The traditional computer
dealer ran for the hills of the high margin service and integration
products. Customers that needed higher levels of support or integration
looked to the dealers and value added resellers. As dealers moved
out of the retail and/or storefront space, the computer superstores
filled the void, chains such as CompUSA, Computer City, and others
continue to thrive.
| Packard Bell Model | Configuration | Retail Outlet | Price |
| Legend 102CD
Legend 406CD Axcel 455 Force 480 | Pentium 75
8 MB RAM 850 Hard Drive 1 MB Video 4x CD-ROM 14.4 fax/modem | Sears
Circuit City OfficeMax Elek-Tek | $1599 |
Source: Workgroup Strategic Services
Vendors began to package computers for each type of distribution channel and customer. Pure consumer based PCs were developed, sporting ease of use features, bundles of software, on line capability and robust multimedia technology. In fact, the consumer PC market is now one of the most competitive technology areas in the computer business today. But the margins are still low. What to do…
How do the vendors compete so fiercely on technology features,
while still hitting competitive price points for each model of
PC? Packard Bell is the master at price positioning. During a
recent retail pricing study, Workgroup Strategic Services found
four separate Packard Bell models that all had similar configurations,
all priced at $1599 (see Table 3).
Packard Bell has a very effective strategy of using multiple model
lines and pricing points to differentiate its PCs. As Table 3
shows, similar configurations have the same price point but are
sold through different retail outlets under different model names.
While there are some differences in the physical configuration
and layout, they are too subtle for the typical consumer to understand.
Packard Bell's goal is to provide the different retailers with
slightly distinct product lines and configurations. For example,
Sears will usually have Packard Bell systems with larger hard
drives and less RAM than other retailers. With myriad product
lines and choices, Packard Bell can fine tune the available configurations
to the retailer's target customer.
Source: Workgroup
Strategic Services
Further, during the same study, Workgroup Strategic Services found the pricing between retailers for vendor's PCs were virtually identical. In looking at the top retail chains as shown in Figures 1-4, Workgroup found pricing for particular models to be nearly identical except for differences in the available RAM and hard drive size.
Source: Workgroup Strategic Services
As shown in Table 3, pricing for the same system across different retail chain varies by only $100. Most models sell for the same price in all retail outlets. This clearly highlights the sensitivity of vendors in hitting their target price points.
Source: Workgroup Strategic
Services
The successful vendors have looked at all aspects of their manufacturing,
distribution, and marketing strategies to leverage any and all
cost efficiencies possible to lower prices. Many OEMs are leaving
the bulk of the computer design to Intel's default component selection.
While this provides little room for value added design, OEMs are
relying on standardized components and compatibility while taking
advantage of the quick time to market advantage realized in offering
'vanilla' products.
Source: Workgroup Strategic Services
Vendors have two problems to solve in looking at their manufacturing
capability. The first concern is to develop the most cost effective
production line possible. Vendors now competing so fiercely on
price will pass any cost savings or efficiencies downstream to
the retailer and consumer. Vendors are carefully cultivating relationships
with their suppliers, looking for Just In Time delivery for parts
and price breaks wherever they may be found.
To further complicate the problem, vendors must now apply new
design standards to the development of consumer based PCs. Acer's
Aspire line uses new colors and textured design features to make
its PC look like one integrated unit, with the look of an appliance
more than a high tech computing device. Others, such as Packard
Bell, are using unique footprint configurations to save desk space
and help the PC blend into the background of the desktop. Some
vendors have also incorporated a remote control, very much like
one's TV/VCR set up, to power up and run the computer.
Retailers are using very sophisticated inventory forecasting and
control systems to minimize their exposure to slow moving products.
According to most of the retailers Workgroup Strategic spoke to
during this recent study, very rarely does product stay on the
shelf long. In most cases, the retailer will go back to the vendor
for price adjustments or markdowns. Some of the rebates, markdowns
and sales for consumer PCs are driven by Intel's CPU price/performance
segmentation strategy. Once Intel announces a new processor and
subsequent CPU price cuts, all of the vendors must fall in line
and cut prices on their current models, making way for the next
generation of consumer PCs.
Although the retailers use scientific forecasting techniques,
Intel's rapid processor introduction and price segmentation strategy
puts more pressure on retailers to turn inventory. At this point
the retailers look to the vendors for help through markdown soft
dollars.
All vendors offer thirty day return policies for desktop PCs,
while fifteen days is the standard return policy for laptops.
All specify the PC returned include all of the original packing.
In reality, a vendor can be liberal with its return policy, granting
the retailer some extra days to qualify returns and offering a
higher level of total returns from the retailer to the vendor.
Most allow about 8% of the total purchases to be returned, much
higher than the actual DOA rate of one or two percent, and about
average for the level of returns due to 'buyer remorse.'
To combat high returns, many retailers tie sales commissions to
returns, incenting the sales person to make sure the customer
will keep the PC. On the vendor side of the equation, efficient
supply allocation lessens the need to go back and adjust prices
or provide markdowns to the retailer.
Vendors are tightening their return policies, asking for more
rigorous testing of components before authorizing returns. Vendors
are trying to manage the total level of returns as well as ensuring
that retailers are not taking advantage of liberal return allowances
as an inventory control mechanism.
Once a computer is returned, vendors must manage the delivery
and reuse or disposal of PCs as carefully as the front end process
of manufacturing and distribution. Packard Bell for example, is
probably the best at turning around PCs and either repackaging
the computer for sale or stripping out the components for use
as parts inventory for production. Packard Bell's turnaround from
the time a PC arrives as a returned item to when it is heading
back out the door to be sold is one week. All vendors are now
looking very carefully at the entire back end management of returned
PCs. Some PCs get repackaged, others are sold through brokers
and auctioneers, some occupy space in landfills. Vendors are investigating
ways to maintain value for returned PCs, whether they are sold
outright, become parts inventory, or used through leasing services
and the like.
Soft dollar programs are one of the most flexible areas for vendors
to use in supporting retailers. Soft dollar programs are used
to help the retailer fund advertising and promotional campaigns,
train its sales and technical support staff, and provide Point
of Sale (POS) material for the customer. Soft dollar programs
include price adjustment policies, rebates, and retroactive markdowns
for slow inventory. The importance of vendor provided soft dollar
programs is twofold. Vendor support for advertising and promotions
brings the customer into the store with a product or brand in
mind for purchase. Secondly, once the customer is in the store,
the shelf positioning, POS materials, and rebate or sale offers
now become important in closing the sale. In effect, the vendor
soft dollar program creates the image recognition, or demand creation.
Once in the store, the promotional materials and special pricing
closes the sale for the customer.
Since vendors must be very careful to offer consistent pricing
to all retailers, it is the soft dollar programs and funding that
are negotiated on an ad hoc basis. There is a lot of room for
movement within soft dollar programs to tailor funding and support
for the retailer. Some retailers charge for end cap displays,
others work out shelf locations based on overall pricing and volume
purchases. Some take advantage of training and education for staff,
others want help in funding weekly advertisements.
One of the traditional soft dollar promotional tools, the spiff,
seems to have fallen by the wayside. Vendors do not use this type
of sales incentive much anymore. Many retailers found the spiff
incentives tended to change the store profitability mix, incenting
the sales staff to sell systems that did not have the profit margin
of others. Even though the sales staff may enjoy the pocket money
from spiffs, retail outlets found spiffs tended to skew its total
margin structure. Some retailers will now pool spiffs to split
among all sales staff rather than use this money for individual
incentives.
Although the vendors are not proactively driving corporate sales
through retailers, most computer superstores now have a corporate
sales department. At this point, retailers say corporate sales
tends to be reactive, servicing corporate accounts that come to
the superstore for products. In time, computer superstores may
increase the capability of its outbound corporate sales to capture
higher levels of revenue to commercial accounts.
With the increasing complexity of the PCs and operating systems,
driven by power and ease of use needs, comes an increased need
for customer support. Retailers are finding that its customer
base, that so readily bought into the Windows 95 promotion, now
requires significant technical support. Users typically must add
RAM and larger hard drives to run Windows 95 adequately and many
are still stymied by Plug and Play and Windows 95's new interface.
Systems that come bundled with Windows 95 may experience higher
than normal returns due to the consumer's lack of experience with
the new operating system. While industry return rates average
about 8-10% of all shipments, only one percent or so have specific
problems, the rest are returned due to 'buyer remorse.'
Microsoft's support lines have been flooded with calls from new users. Will computer superstores and other retailers find they need to provide more support for its customers?
The retail channels, in particular the computer superstores, drove
the traditional computer dealer into a value added business model
where dealers rely less and less on the storefront to draw customers.
Computer superstores replaced the dealers as the retail storefront
source of consumer PCs, originally offering only low prices, product
availability and little else for value added activities.
As retailers are now discovering, consumer PC buyers require significant
amounts of service and support. A careful look at today's retail
chains also shows a movement toward training, service and support
products for the consumer. In fact, Microsoft's recent Windows
95 promotional blitz was clearly designed to capture add on sales
for retailers. Microsoft set up the pricing for Windows 95 to
allow for 4 points of profit margin for retailers. At a street
price of $89.99, retailers keep about four dollars for themselves.
What most were counting on were the additional sales of RAM, hard
drive storage products, and fast modems that are associated with
the new requirements of Windows 95. As technology evolves, and
operating systems become more complex, retail customers also require
the installation of memory, processor upgrades and the like; something
retailers now perform with their own technical staff.
So we have come full circle, the traditional dealer was pushed
out of the retail space, not able to offer the rock bottom prices
of the larger retail chains. Now the new breed of retailers, the
computer superstore and mass merchant outlets, are developing
service oriented products for its customers. This is a reaction
to a consumer need for training and education as computers and
operating environments become more complex.
In addition, the large retail chains see service, support and training as high margin revenue opportunities. In this way, the computer superstores and mass merchandisers are evolving into a similar business model as the traditional computer dealers. In this case however, the new breed of retailers is working with a more narrow margin structure, but is able to take advantage of the buying power inherent in its large size. In essence, the retailers are reinventing the storefront but with the advantage of large volume buying power. Because these large retail chains have more access to capital, and are already in a lean business model, Workgroup Strategic believes they will continue to evolve toward more value added services, but only to the extent that the new service products are appropriate for the retail customer and continue to be profitable. Workgroup Strategic believes retailers will slowly find a balance between customer service and support needs and the cost and opportunity of providing such products.