PC Makers Are Boxed In by Component Shortages

Manufacturers who boost prices now could see their market share dwindle.
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PC makers may feel boxed in this holiday season.

Component shortages are boosting prices, encouraging boxmakers to increase their own price tags. But those that choose this course could see their market share dwindle.

The end result may be shrinking profit margins, which would show up in fourth-quarter reports. Some analysts, for instance, are convinced that

Gateway

(GTW)

has problems similar to

Dell

(DELL) - Get Report

, which missed fiscal third-quarter expectations due to higher memory prices. Dell itself may continue to feel pressure, too.

The problem boxmakers are facing is that this bubble in component prices is continuing. It started this summer when third-quarter PC demand jumped by a bigger-than-expected 26%, according to

International Data

. Companies wanted to get their PCs before Y2K, says Rob Enderle, an analyst at

Giga Information Research

.

Then on Sept. 21, an earthquake hit Taiwan, a chip-manufacturing haven. So chipmakers, already trying to keep up with demand, saw their supply diminished.

Three months after the quake, supply shortages continue to drive up component prices. Prices for ASIC chips -- application specific integrated circuits used for CD-ROMs -- are climbing, pushing up CD-ROM drives by 25% over the last three months, says

Bear Stearns

analyst Andy Neff.

Liquid crystal displays and flash memory chips -- flash RAM used in digital cellular phones and PC cards -- also are in short supply, which could affect PC companies' profit margins still further, says Mark Giudici, a chip analyst at

Dataquest

. Spot prices for 16-megabit flash chips have nearly doubled since the second quarter. These shortages contributed to a fiscal first-quarter

revenue shortfall at contract PC maker

Solectron

(SLR)

earlier this month.

PC price hikes would normally solve this margin squeeze, but the holiday season makes this strategy difficult. No one wants to give up the lowest of the low-end consumer price point without a fight, especially after

eMachines

successfully undercut the top PC manufacturers during last year's holiday season, says Steve Fortuna,

Merrill Lynch's

PC analyst.

Companies are trying just about everything to compensate for this margin squeeze. Instead of raising prices, Dell is offering less memory in some products, essentially sticking a 64-megabit chip into a unit that previously was slated to run with a 128-megabit chip. Others are jumping out of the fray entirely:

IBM

(IBM) - Get Report

and

NEC's

(NIPNY)

Packard Bell

recently announced their exits from segments of the consumer PC area. Duane Zitzner, CEO of

Hewlett-Packard's

(HWP)

computer group, says component shortages "could cause companies like us to increase prices or to change configurations to offset the costs or shortages."

Gateway could be another company that will need to adapt. Merrill's Fortuna says it's only a matter of time before Gateway is forced to admit it has a supply problem.

"I don't buy that Gateway has a better supply chain than Dell," says Fortuna, who rates both Dell and Gateway neutral. Merrill has done no recent underwriting for either company. "There's a fair amount of risk in this stock right now."

Jeff Weitzen, Gateway's chief operating officer, says the company's diversity of beyond-the-box services -- Internet access provider, retail stores and leasing programs -- gives it plenty of breathing room.

Dell also may get hit in its fiscal fourth quarter ending in January by microprocessor constraints, along with Y2K-related spending delays, says Richard Gardner, a

Salomon Smith Barney

analyst.

"We believe these factors could cause Dell to fall short of its 21-cent consensus by one to two pennies," he says. Gardner was one of the few analysts who

called Dell's third-quarter earnings shortfall. His firm has a buy rating on the stock and has done no underwriting for Dell.

Dell declined to comment.