In case anyone hadn't noticed,

Compaq

(CPQ)

has settled in for a knockdown, drag-out battle with

Dell

(DELL) - Get Report

for PC market share.

Such was the manifesto given by Compaq chief Michael Capellas on Thursday at the

Merrill Lynch Hardware Technology Conference

in New York. "The price war will continue," he told attendees at a luncheon keynote speech. "And we will be as aggressive as anyone."

The policy isn't entirely new. Capellas has already revised the

untenable position he laid out in January on Compaq's fourth-quarter earnings conference call. At that time, Capellas vowed that Compaq wouldn't discount computers to match Dell and

Gateway

(GTW)

if it meant sacrificing profitability. He's since acknowledged that market share matters too much to sit back and give it away. So it's no coincidence that Compaq lost money in its PC biz last quarter, compounding a longstanding problem in that segment. In 2000, sales of commercial and consumer PCs represented 49% of the company's sales, but just 9% of its profits.

Some observers are still struck by the company's turnabout. Capellas "was so adamant about any sort of price war, and now he's trying to imitate Dell's strategy without the same cost structure," said

Gerard Klauer Mattison

analyst David Bailey. "Dell is forcing all the other players to react rather than follow their own strategies." (GKM has done no underwriting for Compaq or Dell.)

It won't be easy for Compaq to stay toe-to-toe with Dell. But Capellas was emphatic about his belief that cutting inventories would help Compaq fight on an even footing. "We've got to drive inventories down," he said, "and we've got to do it aggressively."

The key to that campaign lies in getting PCs out of the company's channel, or reselling partners, something that Dell, with its direct sales model, doesn't have to worry about. By reducing the number of PCs it sells to resellers, Compaq cut channel inventories by $100 million last quarter. It plans to cut three times that amount in the current quarter. At Thursday's lunch, Capellas assented to the notion that inventories could head toward 10 to 12 days within one to two years. At the end of the first quarter, Compaq said it had 3.2 weeks of channel inventory. Dell, of course, has absolutely none.

The project won't be painless in the short term. It could trigger price-protection agreements in which manufacturers such as Compaq guarantee partners that they'll get a certain price for the products they resell, agreeing to make up the difference on PCs resellers are forced to discount.

Perhaps more important, it could cost Compaq more market share at Dell's hands. In the first three months of 2001, Dell unseated Compaq as the worldwide market leader in PCs sales, according to

Gartner Dataquest

.