Windows 7 Fails to Boost Profits of PC Makers

By JUSTIN SCHECK Microsoft Corp.'s new Windows 7 operating system has fattened the company's earnings and boosted personal-computer sales at retailers like Best Buy Co. But it hasn't increased the profits of PC giants Hewlett-Packard Co., Dell Inc. and others. While consumers purchased more than 90 million new PCs during the holiday quarter, when Microsoft released Windows 7, up 22% from a year earlier, PC revenue grew at just a single-digit rate, analysts say. That's largely because laptop prices posted a record year-over-year drop, falling 23% to an average of $581 last quarter from a year ago, according to market-research firm NPD Group. PC makers had hailed Windows 7 as a way for them to launch feature-laden new machines that they could sell for bigger margins. With Windows 7, said Dell Vice President Alex Gruzen in October, the PC market would no longer be a "race to the bottom" in terms of prices. But the opposite happened as PC makers ran into tight-fisted consumers and retailers that were selling PCs at deep discounts over the holiday quarter. Since PC prices dropped so quickly, analysts now expect Dell and H-P to announce slimmer PC profit margins when they report quarterly results later this month. Dell, which tried to resist cutting its prices, has already seen slower sales growth as low-cost competitor Acer Inc. has stepped up. A Dell spokeswoman says the company is focused on profitable growth rather than undercutting rivals to gain market share. But price declines are now "the trend," says Sumit Agnihotry, a vice president at Acer, the second-biggest PC maker by units behind H-P. "You can't fight too much against the trend." In the face of the falling prices, H-P has tried to maintain its profit margins by putting the squeeze on suppliers. An H-P spokeswoman says the company has used its huge size to negotiate lower component prices, allowing it to profit on lower-priced sales. The inability of the PC makers to boost profits with Windows 7 stands in stark contrast to the impact on other players. Last week, Microsoft reported a 60% jump in quarterly earnings, largely because of Windows 7 sales. Meanwhile, Intel Corp., which supplies chips to PC makers, last month reported a 28% jump in revenue and a tenfold increase in profit from a year earlier thanks to strong chip sales. Stores such as Best Buy also benefited. The electronics retailer cited strong PC sales early last month when it reported that same-store sales were up more than 8% from a year earlier. Retailers can withstand big price cuts on PCs because much of their profit on computers comes from extended warranties and accessories like laptop bags. Dropping prices "keeps us competitive in the marketplace," says Keeley Noreen, a senior merchant at Best Buy who works on PC sales. In October, for example, Best Buy introduced a package that included an H-P desktop PC, laptop, netbook and router for $1,200, far less than the $2,000 or so that such bundles would typically have cost. Similar discounts continued through Thanksgiving and Christmas, a departure from most years when such deep discounts occurred only on the Friday after Thanksgiving. To counter the falling profits, PC makers have introduced products with new features and entered new businesses. H-P has been heavily marketing touchscreen computers to consumers and has said it plans to introduce a touchscreen "tablet" machine with no keyboard. It is also offering financing to small businesses on PC purchases as low as $1,500. Meanwhile, Dell and Acer, which already sell tablet-style devices, last year entered the phone business in the hope of boosting profits. Acer recently said it plans to enter the e-reader market. Acer's Mr. Agnihotry predicts that PC prices will stabilize in coming months now that the holiday period is over. In addition, Microsoft said last week it anticipates Windows 7 will spark a wave of new purchases from corporate buyers. Until then, consumers are continuing to take advantage of cheap PC prices. Ginia Lucas, owner of Y-Knot Party and Wedding Rentals in Mesa, Ariz., recently went shopping for a new H-P PC for her business at Sam's Club and ended up deciding between a $1,000 desktop PC that ran Microsoft's old Windows XP software and a $1,200 model with Windows 7 and a bigger monitor. "We were debating," she says, because the cheaper machine was tempting. But she liked Windows 7 enough to spend the extra $200. Now, she says, "I might go buy another Windows 7 so I can install it at home."