Network: Compaq buys its way to the top

Compaq Computer's takeover of Digital Equipment last week propels the company to the top of the IT tree. Stephen Pritchard assesses the impact that the $9.6bn deal will have on the industry.

If you are going to spend, you might as well spend big: that could be the motto of the management of Compaq Computer. The deal to buy Digital Equipment Corp, announced last week, broke records. At $9.6bn, it is the computer industry's largest ever. It also propels Compaq to the very top of the IT company tree.

Compaq has been courting Digital for some time. The talks that led to last week's announcement were the third between the two, whose total business is now behind only IBM and close to or even above Hewlett-Packard, depending on the measures used. "If you take our combined revenues, we are in the top three," says Joe McNally, managing director of Compaq in the UK. "It makes us much stronger worldwide."

The two companies are both computer manufacturers, but they are quite different businesses. In the UK, for example, Digital employs 7,000 people, and Compaq 2,500. All but 500 of Compaq's UK staff work in manufacturing: the company has a production plant in Scotland. Two thousand Digital staff work in manufacturing, too, but that leaves 5,000 in marketing, sales and other support functions, 10 times Compaq's figure.

Within these figures is the prime reason for the takeover. Compaq has traditionally sold its computers through the "channel": dealers, specialist value-added retailers, and even high street stores such as Dixons. Digital has dealers, but it relies far more on its own sales teams, especially to handle large corporate accounts.

Compaq wants Digital's expertise, and its staff, to take on the market above the desktop computer. Compaq wants to be a computer company along the lines of IBM, rather than a maker of PCs alone. It faces increasing competition at the lower end of its business from PC-only suppliers, especially from Dell. At the same time, it needs mid-range computers to make it a single source of IT for its largest customers.

Last year, Compaq paid $4bn for Tandem, giving it a range of very high- end systems. Digital fills the mid-range neatly. The company has its own operating system, VMS, a widely installed base of Unix computers, and a huge amount of experience with Windows NT.

"The acquisition of Tandem left a gap between the big Intel boxes and the Tandem machines," says Jonathan Steel, a director at analysts the Bathwick Group. "They could not leap to being seen as a proper enterprise supplier without service and support from Digital, which has world class NT integration and implementation skills."

It was this service and support rather than hardware that prompted Compaq's interest in Digital. Digital makes desktop computers and laptops, but the future of those is open to question in an already crowded market. "It is too early to say about Digital products, but there will be some that fall by the wayside," says McNally.

Compaq will need to support existing Digital hardware, and it might well integrate some Digital computers into its range. Digital developed its own ultra-fast Alpha chips, and uses them in computers running either Unix or Windows NT. The chips are already being sold to Intel, but the Alpha still offers performance beyond Intel's Pentium II, even in the very fast, multiprocessor workstations Compaq already sells.

Alpha servers look even more likely to stay. "The void that once existed in Compaq's product line in the $100,000 to $1m price band has now been closed. Compaq can now offer the Alpha servers," suggest analysts IDC.

Staff, though, is what Compaq is really buying. It wants to become a full-service IT company, with services such as systems integration and consultancy as well as manufacturing and maintenance.

"We are talking about professional services, not just break and fix," McNally says. "I see services contributing to revenues in the future, although I don't know the ratios. We are still a manufacturer, as are Digital, but to put it simply, our aim is to offer a one-stop shop."

Industry analysts and the financial markets see the deal as a good one for Compaq. Its own research, McNally says, found that 80 per cent of the company's clients used Compaq, Digital and Tandem computers. According to Goldman Sachs, "the acquisition provides a strategic fit, as DEC provides products, services and support that are largely complementary to Compaq's portfolio". IDC agrees. "Compaq needed a robust services organisation to compete effectively in the enterprise marketplace. Roughly half of Digital's earnings are from services," its researchers say.

The merger will have its greatest impact on Compaq's close competitors, Hewlett-Packard and Dell. Michael Dell, for one, is said to harbour similar ambitions to Compaq, offering a single solution to large companies' IT needs. Hewlett-Packard sees a cash-rich company and a very large company going head-to-head for business in the mid-range market.

"Now Compaq looks like a very, very effective force," says Jonathan Steel at Bathwick. "The biggest effect is on Hewlett-Packard."

Joe McNally believes that for Compaq to continue its growth, it needed a partner with strength in services. "We bring to market an awful lot of skills in terms of their people. "It positions us very well for the future. If you want to be a computer company, you have to offer the market these skills."

Whether Compaq will continue on its acquisition trail is less certain. "Compaq is very acquisitive, aggressive, and rich," says Jonathan Steel. "The question is, what would be really useful to them next?"

McNally says that customer reaction to the deal is positive. Suppliers are unlikely to complain, either. Two companies that will welcome the deal are Microsoft and Intel. A strengthened Compaq underlines the dominance of Windows and Intel as computing's de facto standard, and neither Bill Gates nor Intel's Andy Grove are likely to mind that.