Compaq Casts Rosier Profit OutlookCompaq Casts Rosier Profit Outlook

Compaq raised eyebrows last month when it estimated that its profits this year would be almost 30% higher than most stock analysts had forecast. What's surprising is that Compaq issued the good news at a time when the PC market, which last year accounted for about half the company's revenue, has shown few signs of awakening from its prolonged slumber. Sales in the company's PC division fell 45% in the fourth quarter, compared with a year earlier.

So what's behind Compaq's optimistic outlook? Company executives say increased earnings will come not necessarily from selling more computers but as a result of IT-driven operational improvements. Last year, Compaq improved its inventory turns to 62 from 31 in 2000, meaning the company moves through an entire inventory cycle in less than a week. "That's better than anyone else in the industry except for Dell, and it's getting pretty darn close to Dell," says Mike Winkler, Compaq's executive VP of global business units.

Compaq also increased its ratio of direct-to-indirect sales in the fourth quarter. Direct sales, less costly because they cut out middlemen and keep inventory low, rose 10% compared with a year ago. Compaq reduced costs by $155 million, or 28%, in the fourth quarter.

Changes in the way Compaq sells, manufactures, and distributes PCs account for the bulk of the savings, Winkler says. The most significant change came last year, when Compaq completed the integration of assembly plants and IT systems that it purchased from now-defunct reseller Inacom Corp. in January. Among other things, the purchase gave Compaq assembly hubs in Nebraska, New Jersey, and Ohio, from which it can assemble, configure, and ship PCs directly to customers under a scenario the company calls one-touch fulfillment. Compaq previously relied on resellers to configure the bulk of its business PCs and ship them to customers.

To drive the one-touch model, Compaq integrated all of its existing supply-chain operations, powered by SAP software, with Inacom's proprietary Vista system. The company has integrated the ordering, fulfillment, and asset-tracking processes, Winkler says. The moves helped Compaq reduce its supply-chain cost per unit by 29%, while reducing the number of supply-chain workers by 30%.

The improved numbers come at a critical time. Compaq's proposed takeover by Hewlett-Packard is on shaky ground as key shareholder groups have voiced opposition to the deal. But whether Compaq will be a standalone company or part of HP, its logistical systems will be crucial to its ability to stay competitive.

Still, Compaq has a long way to go before it can restore profitability to its PC operations, some analysts say. Despite the improvements, its PC business posted a fourth-quarter loss of $69 million. "It's unlikely Compaq will ever close the PC economics gap with Dell," says US Bancorp Piper Jaffray analyst Ashok Kumar.

But the direct-sales infrastructure is about more than just cutting costs, Winkler says. It lets Compaq offer more-advanced PC-related services such as computing-on-demand. Under the program, Compaq assumes full management of a business customer's PC deployment and charges per unit. Companies can expand or contract their PC infrastructures as business conditions dictate and thereby adjust costs. The program has helped Compaq land big customers such as American Express, Bank of America, and Shell, Winkler says.

Compaq wouldn't have been able to offer computing-on-demand without the beefed up direct-sales infrastructure, Winkler says, because most PCs sold under the program require custom configuration along with asset tagging and tracking services. He also notes that when customers want to expand their infrastructures, they usually want to do so quickly. That means Compaq needs to turn around custom-configured PCs within five days.

No problem, Winkler says. "We've achieved end-to-end integration, and I couldn't have said that before the fourth quarter." As a result, the next four quarters are looking just a little brighter for Compaq, with or without HP.