Crazy Teddy? Gateway Chief Guarantees Lowest Price

You may not have thought it possible for the PC price war to get worse. But it just did, thanks to Gateway GTW.

The personal computer manufacturer Wednesday introduced a new discounting program it's calling the Gateway Guarantee. Under its terms, the company pledges to undercut any competitor's prices to customers who bring in those competitor's advertisements to Gateway Country stores. Gateway will start promoting the Gateway Guarantee Thursday in an ad campaign featuring CEO "Crazy Teddy" Waitt and bearing the slogan, "PC Price War? Cool."

Investors in the PC sector might not find the news too cool, though. Such willingness to go to such lengths to stimulate demand is a stark sign that claims by microprocessor companies Intel INTC and AMD AMD that the PC business has bottomed were premature. Meanwhile, Gateway's move will intensify the pressure on whatever profit margins remain in an industry already roiled by a major price war, and severely hamper the company's own mission to bring its business back to profitability.

Anyone following the PC industry is well aware of the price discounting slugfest that has been going on between Compaq DELL and Dell DELL for the past several months. Dell has largely been in the driver's seat thus far, forcing Compaq's PC business into the red as the company has tried to cut inventory out of its channel of reselling partners. But Dell's own profit margins have been squeezed hard in the process; its earnings declined by 27% from the year-ago period in its fiscal second quarter, and are expected to fall by more than 30% in the third quarter.

But Gateway shouldn't think that Dell isn't willing to take a few more hits.

"Dell is not going to back off," Lehman Brothers analyst Dan Niles said. "If anything, this is going to annoy the heck out of them. And at the end of the day, Dell has a better cost structure than Gateway. They're perfectly happy to watch everyone else lose money." (Lehman hasn't done recent underwriting for either company.)

Gateway, like Dell, has a fully direct sales model, selling none of its products through reselling partners like Compaq and Hewlett-Packard HWP do. The direct model helps keep inventories low, but Dell has other advantages over Gateway. It ships at higher volumes, giving it more leverage when it comes to striking contracts for components. Its overall product mix is more favorable, since it includes large quantities of servers, which are significantly more profitable than PCs. And Dell does the lion's share of its business in the corporate market, where average selling prices, and thus profit margins, are much higher than in the consumer segment on which Gateway focuses.

"If you take pricing to a level where Dell is on just 5% net margins, Gateway is pretty close to break-even," said Niles, who doesn't see that scenario as at all unlikely. Analysts currently expect Gateway to earn 11 cents a share in its third quarter, according to the consensus figure calculated by Multex.com.