COMPAQ CEO OUTLINES CHALLENGES IN INTERNAL MEMO

August 4, 2000

FEATURES & COMMENTARY

New York, N.Y. — Joe Wilcox reports that Compaq Computer CEO Michael Capellas praises employees for moving the PC maker toward a turnaround in his first year at the helm, but he also calls for an increased focus on the meat and potatoes of delivering products and improving customer service, according to an internal memo obtained by CNET News.com.

Capellas delivered the memo to employees last week via email. Although much of the memo’s content was positive, Capellas wrote that Compaq still faces some tough challenges.

“We need to accelerate our progress in building a world-class customer delivery model, or supply chain,” he wrote. “This is absolutely essential if we are to get to the next level of growth.”

Capellas took over as Compaq’s chief executive in July 1999, following the unexpected April ouster of then-CEO Eckhard Pfeiffer. The Compaq insider and unexpected pick stepped into the tough role of revitalizing a company in decline. A year later, with the commercial PC division profitable again and the company’s revenue on a rebound, Compaq is poised for a strong second half of 2000. In a conference call with financial analysts last week Capellas said the company is forecasting third-quarter revenue of $10.8 billion, or 17 percent more than a year earlier.

Customer satisfaction remains weak – an area, Capellas wrote in the memo, that the company will try to shore up with better marketing and customer services.

He also noted that Compaq’s commercial and consumer divisions will announce new Internet appliances and devices in mid-August.

“If I had to pick one area where we executed even beyond my highest expectations during the past year,” he wrote, “it would be innovation. We said we were going to accelerate innovation. We said we were going to deliver ‘cool stuff.’ But we’ve done more than that. We’ve demonstrated that delivering better technology matters.”

Compaq also needs a further shakedown in its complicated manufacturing and distribution operation, Capellas wrote, by delivering “predictable cycle times,” increasing “visibility to customers,” and achieving “linearity, meaning a more even distribution of orders and fulfillment throughout the quarter rather than a mad dash in the last two weeks.”

Capellas, in the memo, said employees will reap the benefits of some of that growth, even if it is less than what might have been hoped for. “We had an operating profit of $1 billion for the first six months of 2000, but our customer satisfaction rating remained a “C,” he wrote. “As a result, the payout will be 2.4 percent of employee eligible earnings for the first half of 2000.” The profit-sharing payout will appear in the employees’ Aug. 11 paychecks.

Capellas noted that customer satisfaction, which rated a “B” in seven key areas, was a problem overall, with Compaq lagging behind in three other areas: “delivering solutions that are ready for installation; making sure our solutions are available when promised; being a more customer-focused company.”

The big news – the commercial computing group’s return to profitability after a year of losses – was in part due to “a relentless focus on innovative products with simpler designs and higher margins,” Capellas wrote. During the second quarter, Compaq shipped its 100,000th iPaq Internet PC but struggled to produce enough iPaq Pocket PC handhelds.

“We have increased production of the extremely popular iPaq Pocket PC to 50,000 units per month to meet strong customer demand,” the CEO wrote.

Compaq’s CEO also touted the consumer group, with revenue growth of 32 percent year-over-year and 94 percent internationally. Capellas also highlighted new back-to-school models and noted that on Aug. 15 the group “would introduce some seriously cool products that will further expand our presence in the market for Internet devices and appliances.”

Other areas did not perform as well as expected, and Capellas’ memo glossed over their weakness. During the second quarter, Compaq started shipping its long-delayed AlphaServer GS, or Wildfire, series. Although at the product’s launch in mid-May Compaq said it had advance orders for more than 200 Wildfire servers, Capellas wrote that “we shipped more than 50 of the servers during Q2.”

During last week’s second quarter earnings announcement, in which Compaq posted $10.1 billion in revenue and $387 in profits, Capellas said there were about 200 AlphaServer GS back orders, indicating only a small number of new orders since the product’s launch. Compaq projects $1 billion in revenue from the product line this year.

In the memo, Capellas recognized that effective marketing is a crucial area sorely lacking and touted the hiring of new executives and an outside PR agency. The company’s marketing strategy has been somewhat disjointed since the departure last year of longtime PR agency Shandwick International.

“Now we are focused on an aggressive new brand campaign that will more clearly communicate who we are and how we are helping customers use technology to accomplish more in their work and personal lives,” Capellas wrote. “You will hear more about this in the coming weeks.”

Capellas also wrote that Compaq’s “goal for the second half of the year is to deliver strong, double-digit growth with continued improvement in profitability…The time is now.”

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