Gateway: A computer company reborn

Chicago (IL) - There are few PC companies that were hit by the PC crisis of the early 2000s as hard as Gateway. Staggering losses threatened the existence of the firm in 2001. Today, the company is the third largest PC company in the US, growing at a faster pace than any of its competitors. Tom’s Hardware Guide spoke with Gateway and took a close look to the firm’s newly found success.

PC sales rankings have been dominated by Dell and Hewlett-Packard (HP). With Dell’s business apparently immune to any economic influences and HP battling its competitor with less success with every passing quarter, its easy to overlook what else is going on in the industry. But the Q1 figures released by Gartner and IDC listed a surprise - a company we haven’t seen in the top five for several years.

Both market research firms listed Gateway as the third largest PC manufacturer in the US - with a market share of 5.4 (Gartner) and 5.7 (IDC) percent clearly behind HP (17.2 and 18.2 percent), but well ahead of IBM (4.1 and 4.3 percent) and Apple (3.7 and 3.9 percent). Gateway shipments increased more than 90 percent from 422,000 in Q1 2004 to 826,000 in Q1 2005, according to Gartner.

So, what is Gateway’s secret ? On a closer look, Gateway’s sales increase is not that surprising, as the 2005 figure represents combined sales of Gateway and eMachines, the entry-level focused PC builder Gateway acquired last year. In this respect, combined sales even decreased from 2004 to 2005 from about 1.1 million. Despite the decline, eMachines was key for Gateway to initiate one of the most impressive turnarounds of a PC maker to date.

Its current growth phase in fact is very similar to the early 90s, when Gateway pioneered the direct sales model for PC together with Dell. Streamlined operations and without retail outlets, margins were much higher and PCs could be offered at lower price points. Today, Gateway however does not focus just on direct sales, but rather puts its bets mainly on a streamlined retail channel strategy that was established by eMachines. The firm’s goal is to trim cost from the retail channel to underbid price points of its competition.

The new strategy as well as the decision to acquire eMachines are the results of two lessons Gateway learned from its early days. First, selling PCs just online with a focus on the consumer did not work out as planned : "Although Dell and Gateway pioneered the industry in the early and mid 90s, they did it in two different perspectives," said Marc Demars, senior director for Gateway’s desktop products. "Dell was more focused on the professional channel. Gateway’s focus was more the consumer." When the retail market took off, Gateway was not able to keep pace. "There are a number of folks out there who just did not feel comfortable buying online or over the phone. They want to see the product and have a contact for returning the product or asking for advice. That is what prompted Gateway to get into brick and mortar retail in the late 90s," Demars said.

This is when the second significant mistake was made : The company built its own retail outlets, a total of 300 "Country Stores" nationwide. This new strategy inflated overhead cost to a dramatic level and soon revealed a flawed strategy : "Country Stores were standalone buildings. In contrast, Apple stores are usually in proximity of other destinations, you seem them primarily in malls and they get a lot of walk-ins. The Country Store was a destination by itself and required people to go directly to it, ultimately resulting in little customer traffic," explained William Diehl, senior director for Gateway’s notebook products. The skyrocketing cost of the Country Stores was dramatic and convinced the firm to focus on building PCs : "You will not see us reinvest in being a channel," Demars said.

Instead, the company builds on what it got out of the eMachines acquisition : Sales channels in the US and abroad, an efficient supply chain and development model as well as a management team that has experience in this business model. One year after closing its Country Stores and adapting eMachines’ model, Gateway has decreased its cost of sales from about 23 percent to about 8.5 percent and is present in all eMachines retail channels. "Instead of 300 Country Stores, we now have 3000 points of presence in the US and expanded in four additional geographies," Diehl said.

Working with established retailers increases Gateway’s brand and product exposure, but also enabled the firm to concentrate on building PCs and leave promotion, advertising and selling to others. And eMachines’ channels appear to carry Gateway products well : "It took us by surprise how quickly the demand for Gateway has grown nationally and internationally," Demars said. He claimed Gateway is already outselling HP/Compaq computers in US retail "in certain weeks". "We are right on HP’s heels", he said.

Growth however has to be planned and Gateway will have to master some challenges to stay on track. For the near future it will have to find ways to make eMachines’ channels more efficient, scale its operations accordingly and expand into new markets. According to Demars and Diehl, Gateway is eyeing professional markets, international expansions, as well as keeping its direct sales and consumer electronics business in a growth path. While the company believes "there are no holes" in its retail chain at this time, Demars said he could imagine selling PCs through new channels such as grocery stores : "We think we can be successful in that environment."

Analysts meanwhile take notice of Gateway’s success. "They made amazing progress", said Marin Reynolds, an analyst for Gartner. However, he saw limitations to the firm’s growth in the future. "In direct sales they are squeezed by Dell. In retail, they have to take more shares from HP - which is likely since HP is vulnerable due to their huge presence." According to Reynolds, Gateway will have to further improve its channel alignment and work out the consolidation of its products lines. In the foreseeable time, he said he does not see Gateway’s market share to decline, but he does not see any "dramatic increases" either.

A simple look onto Gateway’s balance sheet however reveals that Gateway has discovered a strategy that appears to work for now. The firm is still far away from its record results in 1999 when yearly earnings reached $428 million on sales of $8.6 billion, but presents itself in a much better picture than in 2001 when losses topped $1 billion per year. Unit sales are back on 2001 levels, sales in the fourth quarter were slightly above $1 billion and earnings were $94 million. Compared to the more than 21,000 people the company employed in 2001, Gateway today runs with about 1,900 employees.

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