CANACIO TURNED CEO SAVE COMPAQ?

TO HEAR MICHAEL CAPELLAS TELL IT, HE was as surprised by his appointment to the top seat at beleaguered Compaq as anyone else. For three months after the board's well-publicized ousting of Eckhard Pfeiffer, the search for a turnaround whiz had raged. As murmurs of name-brand contenders like Ray Lane of Oracle and Gregory Brenneman of Continental Air rejecting the role spawned weekly headlines, analysts wagged their heads over the company's inability to fill the top seat and Compaq's stock price languished in the low 20s from a high of $51.

Meanwhile, then-CIO Capellas had been quietly tapped by the three directors--Ben Rosen, Frank Doyle, and Robert Ted Enloe--comprising Compaq's co-CEO interim management team as acting COO. With barely a 10-month tenure at Compaq, he soon found himself hammering our a new organizational structure and being called upon to give "lay of the land" presentations to prospective CEOs. But even as he shouldered more responsibility during the tumultuous transition period, Capellas, 45, says he never saw himself as a candidate for the CEO role. "One day, Ben comes in and says, 'We'd like you to know that you're a serious candidate for CEO,'" he recounts. "I hadn't expected it. And my first reaction was, 'I think you should get someone from outside. I don't believe the market would react well.' I thought the market was looking for name recognition--which I definitely didn't have."

His concerns proved well founded. At the time, rumor had John Zeglis, AT&T president, favored for the post and analysts didn't respond enthusiastically to the perceived change in plans. "It's something of a letdown," Charles R. Wolf, a computer analyst at Warburg Dillon Read LLC, sniped to The Wall Street Journal at the time. "Maybe Capellas is the greatest guy in the world, but his resume doesn't indicate he's ever held a job as challenging as the one at Compaq."

Theory held that even a turnaround veteran would be hard-pressed to skirt the hurdles ahead. The unanticipated earnings shortfall that prompted Pfeiffer's demise was seen as a mere symptom of the deep-rooted difficulties plaguing Compaq. Still encumbered with difficulty trimming costs, declining sales in its corporate PC business, the dismal performance of its European division, and a reputation as an Internet laggard, Compaq also had yet to filly digest two acquisitions--Digital Equipment and Tandem Computers. What's more, the company's executive ranks had been decimated by a litany of defections during the rudderless period.

When the dust settled, a more balanced view, albeit still guarded, of the appointment emerged. Capellas' strong technical background--honed during a 15-year tenure at the French-U.S. oil services company Schlumberger, where he oversaw the company's computer systems--was seen as a plus that would enable him to communicate with Compaq's corporate CIO customers. At the same time, his appointment raised eyebrows as a departure from tradition, since the CIO post is not a typical stopping point on the way to the CEO chair. Naysayers also continued to lament his lack of experience. While Capellas had held management posts at both Oracle and SAP America, previously his most significant profit-and-loss responsibility was spending a year as general manager of a $40 million Oracle unit--a far cry from steering the $40 billion global entity that is Compaq.

By contrast, Capellas' predecessor, Eckhard Pfeiffer, 58, logged eight years with the company before taking the CEO seat, serving along the way as president of Compaq Europe and International and vice president and COO. Credited with driving the company's 500 percent climb in the early '90s, the German-born Pfeiffer's forceful reputation took root with his aggressive program of slashing Compaq's workforce and streamlining efficiencies. Under his reign, Compaq debuted a no-frills $799 home computer and led the exploding sub-$1000 PC marker.

Trouble didn't hit until 1998, when sales leveled off and inventory piled up on dealers' shelves. As Compaq struggled to overhaul its manufacturing and distributing processes, Dell Computer swooped in with its dealer-friendly build-to-order program. Compounding the fumble was the $9.6 billion purchase of Digital Equipment, which added integrating the two entities to the mix of challenges Compaq faced. By 1999, with corporate PC business flagging and profits on the wane, Compaq's stock price had taken a tumble. Clearly, Wall Street had lost faith in Pfeiffer's ability to get Compaq back on track--and so had the company's board.

In Capellas, the board chose a CEO who is the polar opposite of Pfeiffer. Where words like "imperious" and "aloof" pepper company insiders' descriptions of the enigmatic Pfeiffer, the plainspoken Capellas, who schleps his own luggage through hotel lobbies on business trips, is viewed by industry analysts and company executives alike as a "no-bullshit guy," who is "detail-oriented--an organizer."

Capellas' emerging track record suggests that a change in leadership style might have been just what the ailing Compaq needed. Today, Capellas is winning grudging approval from the very same analysts who decried his appointment six months ago. "I'd have to give him a fairly high grade for his six months in the role," says Wolff. "Before he arrived, they were having great difficulty sorting out their priorities in terms of the desk product portfolio they were going to support. Also, while it's not Nirvana, they've been announcing a lot of new Internet initiatives. They were dead in the water before Michael got there."

But the Houston, TX-based firm is still not on firm ground. While Compaq beat analysts' expectations with a 21.7 percent rise in third quarter net profit, commercial PC sales dipped by 16 percent from the previous quarter. In fact, Compaq's corporate PC sales unit lost a hefty $350 million in the first nine months of 1999 on $9 billion in sales. Furthermore, Dell Computer continues to trounce Compaq in the U.S. PC market, snaring an 18 percent total share as compared to Compaq's 16 percent, according to International Data Corp. Although Compaq still leads in the worldwide PC market, analysts report that its operating expenses are nearly twice that of rival Dell, which pioneered the less costly Internet sales distribution method. Dell is now said to be targeting the PC server sector, Compaq's most profitable division. While Compaq's stock is currently holding steady at $27, it skidded down to $18 for a stretch as recently as October 1999.

MEANWHILE, THE COMPANY IS still struggling to create an effective build-to-order system--a deficiency that's long been hindering cost cutting efforts. "Gateway and Dell cur down on how much inventory they have to hold, with build-to-order," points out Wolff. "And inventory is a very bad thing in an industry where component prices fall 31 percent a year on average. Build-to-order also allows companies like Dell and Gateway to bypass the dealer channel, which saves a lot of expenses. Compaq hasn't come to full terms with that issue, but they are nibbling around the corners of it."

According to Capellas, they're ready to bite. His agenda includes efforts to position the company's Tandem mainframes as perfect for processing huge volumes of on-line transactions, and Compaq's storage systems as the ideal solution for storing information on the Web. In November, Compaq debuted the iPaq line of corporate PCs outfitted with easy one-button connections to the Net. Billed as redefining web access, the iPaq is also redefining Compaq's distribution method. To streamline inventory costs, the iPaq is available in a few models and can only be purchased directly from Compaq.

More changes may be forthcoming. "Our supply chain isn't working the way we want it," acknowledges Capellas, who admits that when the time came to move into the direct sales game, Compaq fumbled the play. "We were phenomenally successful for seven years with the traditional distribution model. Then that model changed and was disrupted, but we tried to hang onto it. The world changed around us, and we let our competitors rewrite the rules. We talked the Internet, but we didn't live the Internet."

It's a mistake Capellas, who recently passed out laminated cards bearing the credo "Everything to the Internet" to employees, is aiming to fix. "We're going to make some bold moves," he promises. Among them is an initiative to get the company's Internet presence back on track, including a six-point plan of action poising Compaq for "leadership in Internet access, infrastructure, services, and solutions.

"Three years from now," he adds, "when you think about the Internet, I'd like Compaq to be the heavy engines that allow fault-tolerant computing, and cognizant devices that allow people to access the Internet in different ways. That's what will continue to drive the company."

It's an ambitious plan. But whether Capellas will be able to pull it off is still a matter of debate. "They've certainly lost a battle to Dell," says Wolff. "But they've made a number of moves to address that issue, so they may come back and win a few more. The outcome of the war is still uncertain."

Compaq's Capellas recently spoke with CE's CEO Arnie Pollard and Editor-in-Chief J.P. Donlon.

NO ACCIDENTAL CEO

What lured you to leave Oracle for Compaq?

A very persistent recruiter kept hounding me about becoming a CIO, and eventually he mentioned Compaq. Eckhard Pfeiffer was an icon in the industry, so finally I said, "Okay, I'll go talk to him." I clicked with Eckhard pretty quick, and with his vision, which was to really make Compaq a showplace of what IT could do. More importantly, he said, "We have a huge challenge in really rebuilding a home supply chain." I got enamored with the idea of solving the world's supply chain problem in technology.

How did the challenge compare with what you had expected going in?

I found that the problems were a lot deeper and more complex than I'd imagined. My view was, they didn't see the Dell threat for what it was. These hugely complex multi-tier distribution engines were all built around mass production of a standard unit. Everything that they had done was headed down this path and they did it very well. But it had nothing to do with the model they were trying to go to. They had spent years telling the market, "We're going to direct fulfillment." But they weren't even close to the expectations that they would tell on the Street about what their capabilities were.

Compaq integration was also farther behind than anybody knew. To make a long story short, it was a lot of basic blocking and tackling.

You joined Compaq as CIO, yet your experience-manufacturing, sales, etc.--is broader than that of the typical CIO. In short, you're not a typical geek.

Well, I did come up writing code. Then I broke off, but in my heart, there's a lot of geek in me. I always pride myself on being good technically. I can still talk geekism, but you're right, I'm not a pure geek.

I had run sales. I had run manufacturing. I had done the other jobs. Snapping into a sales role after five years of being in IT at Schlumberger felt very natural to me. And it made a very good combination. As CIO, I was really launching a lot of programs about how to go direct. I created a program where we completely carved out a whole new manufacturing line from ground zero. But I was also dragged into dozens of sales calls because I could talk to both CIO's and CEO'S. I was doing supply chain management. One could argue that I was never really totally a CIO, I was always doing several other things.

How many minutes after you were told that Eckhard was gone did you start low-key auditioning for a top management role?

Never happened. I always assumed that a CEO from the outside was going to be brought in. When they offered the job of COO, I was very surprised. The way I described moving into that role is that one day I woke up and I was COO and nothing really changed, I was doing the same thing I was doing the day before, there was just a formal acknowledgment of what informally was happening.

The soap opera version of your appointment to CEO is that nine name recognition folks were invited and they all said no.

That just didn't happen. Certain people who the press reported as having said "no" were never offered the job. Some of what was written was unbelievably inaccurate. We even had a guy who was almost announced as CEO who had been brought in to interview, but not for the CEO job.

There's conjecture that because Ben Rosen's looking over your shoulder you don't have a free hand to do your job.

That was the perception, but if you look at the history of it, one could never say that Ben was overly active. In fact, you also heard the argument that the board waited too long.

Those two views don't reconcile, and the truth of the matter is that nothing supports the branding of Ben as the puppeteer. And it's certainly not true now. People were saying, "Nobody wants it. They could have given it to this guy because they're desperate." Or, "He's just going to be there so Ben can manipulate him." But that just isn't the case.

There was recognition about those perceptions when the decision was made and it was time to do the launch. And they decided, "The best thing we can do with this guy is to throw him right to the lions." So I walked into this huge press conference and an open Q&A with no constraints. It was just "fire away, guys." In retrospect, that was absolutely the right thing to do. And it's continued. I have been non-stop talking with press, analysts, customers and employees, talking about the future. I think I've been in the office six days in the last nine weeks.

How did the new organizational structure for Compaq come about?

That was back when I was acting COO and a number of people were being interviewed for the CEO spot. There had been some discontent about how we organized the company. So I brought everybody into the room, all the senior managers, and said, we're not leaving until we've got an organizational model that we can work with. And we hammered it out for three straight days, and that's where this concept of the organizational structure of three global business groups--enterprise solutions and services, personal computer, and consumer--each with a separate, market-driven, profit-and-loss accountability came from. We took our consensus to Ben, Frank, and Robert, and said, "We want to make this model, we believe that if we don't do something dramatic that we'll continue to flounder, and we'll have huge turnover because people don't want the status quo."

They said, "No, we need to wait to have a new CEO." I said, "You can't wait." They went off and debated and then said, "You're right." So we launched this major organizational change.

The key right now is for each of those three to run and to drive their business. Then the only other piece is integration and sales work, which we gave to Peter Blackmore, who handles the whole sales force, globally. I felt the worldwide sales had to be under one person, had to be owned, that's the common voice of the customer. Another decision I had to make was to verticalize each of the sales forces, because I didn't want three people calling on the same account. That is chaos.

I wanted to be able to say, "There's a global account and I have one relationship manager, which is owned by the sales force. They have the global accounts, they have the named accounts and they create territory sales forces. Then, when they identify an opportunity, they can bring the storage specialist or the Himalaya specialist."

So these three units don't each have their own independent isolated sales force? What made you go that way?

A couple of things. One is my belief that services and technology had to be tied together on the enterprise base. Personal computing was becoming a commodity being bought by purchasing people, but the technology was still being sold to CIOs. As the CIO, I was never out determining which PCs we'd buy, or how we bought them. But from the enterprise side, I knew my account manager, and what we put in the data center. So there was a shifting in the buying pattern.

Two, the economics of those models were very different. Sales in the enterprise space is a high-touch model, about relationships, making sure you're investing the right things in R&D. And it's about the competition, IBM and HP. In fact, one of the ways that we drove it was to benchmark our business high-end critical computing financially, both market share growth and financial performance, against IBM, HP; to benchmark the storage space against EMC; and to benchmark industry standard service against Sun. I used to use the famous line, "I want you to wake up every morning knowing exactly who your customers are, what they want, who your competition is, and go after them." Because we'd turned into this amalgamous, good for nothing company. Then in the PC space, the enemy was Dell. One of the reasons we shifted to this model was that if you look at the growth rates, EMC's growing at 25 percent per year, Dell is growing 25 percent per year, Sun was growing at 18 percent per year. So you had to be able to compete against the people with a single domain focus.

What advice would you give other CEOs who need to recruit a CIO?

First, an effective CIO needs balance, so that they can relate to the business problem. Second, they need to understand the positioning of the technology. Third, they need to know how to execute. That means that they do, in fact, know their business. You want a CIO who can actually relate to other business partners, who understands how to get the stakeholders in, and has the ability to relate on a business level. There's an unbelievable shortage of those people. If you can't find quite that balance, I would choose somebody who came more out of the customer-facing sales and marketing side, than someone out of the back office side.

Can you share the refocusing of Compaq's strategy with us and put it in context?

I inherited this company that has an unbelievable array of assets. No. 1 in the world in number of total servers, No. 1 in the world in web servers, No. 1 in the world of personal computers, No. 1 in the world in commercial personal computers, and No. 1 in the world in consumer PCs. Sounds like a pretty good company, right? But we got pounded.

The world changed around us and we let the competitors rewrite the rules. But you have to learn from your mistakes. We learned that you have to rewrite the rules before somebody else does.

When I look to the future, I believe that there will be three worlds--one of high-end, fault-tolerant machines for those companies like banks and institutions that need a never-go-down, fault tolerant engine. Two, there will be one of rapid deployment of servers, and three, a world that's about Internet access. I want Compaq to provide the engines, the infrastructure that allows you to drive the Internet, to provide the next generation of Internet access devices, and to provide partnerships like Siebel, which allow you to bring solutions to market.

I want to tell the world that "personal computer" as a term is gone. It's all about Internet access devices. We were the first company to announce a true Internet computer, the iPaq. We did that even though we're the largest producers of personal computers, because if we don't cannibalize our own product line, somebody else will.

What's the future of e-commerce?

Well, the love affair that the U.S. has developed--from retired people to children--with this technology is beyond belief. And it only exists in the U.S.

Fifteen years ago we all thought that we would be the first generation of Americans where our children have a lower standard of living than we do. And IT was the driver that shifted American productivity to the next higher stake. And with the e-commerce wave, we'll shift productivity one more time. The dispute over whether IT would change productivity is over. For 10 years the argument was that there was no evidence of it. Guess what? There's evidence of it. And with the speed of adaptation here in the U.S., which you don't see in other places, there's going to be a definite shifting of the balance of power.

Should Europe be worried?

Damn right they should be. The question is, does it in fact trigger a broader question of the European-wide recession?

What advice do you have for other CEOs about management in an Internet world?

We have to face the fact that in an Internet world, everybody has to learn to manage his or her company like a start-up. That means pep rallies, promoting people to use the Internet, and driving the Internet in everything you do. I actually gave every employee in the company, including the people on the shop floor, stock options for the first time. That's common in start-ups and in software companies, but it very uncommon in manufacturing companies.

There is an unbelievable battle for talent. We now have to change some of our basic management issues and understand that in employees' minds the battle for talent is about having fun on the job. Employees, particularly the young talent, want to be with companies that get it. We are all competing with these crazy little start-up companies.

A lot of our management practices are obsolete. CEOs have to make decisions with less information than they used to and have to lead from the front. Speed is about understanding the details. In this rapid pace of change, every company is an IT company and everybody has to become a technologist. You have to be able to get people all through the company to think the Internet, and the only way to really do that is to manage every company, however big, like a start-up.

Another scary thought is that even if all your employees aren't technologists, all of your customers are technologists. Everybody who buys is pretty slick. You can't assume that the Internet is not affecting your customer base. And, finally, we live in this crazy world where there's capital availability and, whether we like it or not, the market is gonna move your capital value more on perception than economics. Making good earnings is great; having the perception be that you get it and can grow is even better. The market will move on perception more than we've ever seen.

In a Web world, the challenge to all of us is that the things we know and love, the basic economics--the way we're used to driving the share price and the way we're used to managing--will change, so we have to get with it. Future successes and failures will be about CEOs who get it and those that don't.

                           COMPAQ'S PERFORMANCE
                           UNDER CAPELLAS' WATCH
                           Growth
                           Percent
Compaq Computer (CPQ)       5.3%
S&P 500                     7.4%
Dow Jones Industrial        5.9%
S&P Computer Systems Index 23.3%
All return numbers stated above reflect capital
appreciation only and do not include dividends.
                               COMPAQ TODAY
Total Market Opportunity $730B
Consumer                        $60B
Enterprise                     $550B
PCs                            $120B
99 Revenue Mix
Consumer                         14%
Enterprise Solutions and
Services                         53%
Commercial PCs                   33%