[tt] NYT: Industry Rethinks Moneymaking Software Practice

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Industry Rethinks Moneymaking Software Practice
http://www.nytimes.com/2008/08/28/technology/28software.html

By MATT RICHTEL

SAN FRANCISCO -- Before they ship PCs to retailers like Best Buy,
computer makers load them up with lots of free software. For $30,
Best Buy will get rid of it for you.

That simple cleanup service is threatening the precarious economics
of the personal computer industry.

Software companies pay hundreds of millions of dollars to PC makers
like Hewlett-Packard to install their photo tools, financial
programs and other products, usually with some tie-in to a paid
service or upgrade. With margins growing thinner than most laptops,
this critical revenue can make the difference between profit and
loss for the computer makers, industry analysts say.

If the programs are removed, the software makers gain no value out
of the $2 to $10 they typically pay H. P. and others to install them
on each PC -- and PC makers miss out on their cut from
revenue-sharing deals. But Best Buy, the nation's largest
electronics retailer, tells computer buyers that the preinstalled
software, also known as bloatware, can clutter their machines and
slow them down.

"You'd be surprised how often consumers tell us to get rid of it,"
said Robert Stephens, the head of Geek Squad, the technical support
division of Best Buy that removes the software. He declined to say
how many people were paying for the service, but said that "it's
going to increase in popularity."

The demand for the service, along with similar offers from Circuit
City and other chains, reflects an outpouring of consumer
frustration with the way that a brand-new computer can feel as if it
is full of digital infomercials -- even if those come-ons knock a
few dollars off the PC's price tag. The Web has dozens of
do-it-yourself guides to removing such software, which, as one
tutorial puts it, "turns your computer into a messy battleground."
Mr. Stephens said the personal computer makers should be worried
about the demand for less cluttered computers.

"No matter what manufacturers want, we'll give consumers what they
want," he said. But he added that he believed computer makers would
find different ways to profit: "While they may be scared by these
trends, they'll be O.K."

As it turns out, H. P., the world's largest technology company, is
already working on a fundamental change in the way it packages
software on its new computers, and thus how its business model
works.

Stephen DeWitt, who oversees H. P.'s personal computer business in
the Americas, said that starting next year the company's new
computers would point users to a Web site where they can buy and
download games, productivity software and other programs. Revenue
from the site will be split in some fashion among H. P., a retailer
like Best Buy and the makers of the software.

Mr. DeWitt said the change would cut how much software comes
preloaded.

Mr. DeWitt said this was happening because consumers were demanding
something different, but also because the technology was now in
place to allow downloading of software on demand.

For now, he said, the benefits to consumers of the free software far
outweigh whatever small slowdown it might cause. And he said Best
Buy's cleanup service was not pressuring H. P. to move to a new
model. "There's no tension coming from Best Buy on this -- none," he
said.

But in Best Buy stores in Northern California, there is clear
evidence of the different agendas of Best Buy and the computer
makers. The stores display two H. P. computers, identical except
that one desktop is cluttered with software icons from eBay,
Quicken, AOL, Yahoo and others, while the other is entirely cleaned
up. Best Buy workers use the display to promote the company's $30
"optimization" service.

Industry analysts said that the planned change in H. P.'s approach
could well reflect Best Buy's growing influence -- and its ability
to exact new concessions from computer makers. They said Best Buy
has benefited from two key changes: the declining fortunes of
competing retailers like CompUSA and some large regional chains, and
the addition to its shelves in the last year of computers made by
Dell and Apple.

Bob Kaufman, a spokesman for Dell, said, "This is an evolving story
and Dell is evaluating how it can best deliver software to its
customers." Best Buy's offer to remove software began in 2006. But
recently the toll its policies are taking has heightened
considerably, analysts and industry executives say.

"Best Buy's sway is definitely growing," said Matt Fassler, an
industry analyst who covers Best Buy for Goldman Sachs. He said the
company had good relationships with computer makers, and, while it
wouldn't seek to harm those relationships, "if they have a strong
competitive position, it is incumbent on them to use it."

Mr. Fassler estimates Best Buy will have sales of $44 billion this
year. Of that, $1.5 billion to $2 billion will be from the sale of
H. P. computers, analysts estimated.

One important question is whether the new model being developed by
H. P. will be as profitable as the current one. Mr. DeWitt said he
expected it to be more profitable. But A. M. Sacconaghi Jr., an
industry analyst at Sanford C. Bernstein & Company, said the change
could imperil H. P.'s profitability, in part because there is no
guarantee that consumers will buy software offered through H. P.
instead of another site.

As software buying moves online, Mr. Sacconaghi asked, "what makes a
consumer go to HP.com over Google?" He also says the challenge for
personal computer makers is that they are losing control of what
shows up on PC screens -- a form of real estate that they have used
to sell billboard advertising for software.

"They no longer have that real estate advantage," he said. "There's
a substantial profit pool at risk."

And there can be little profit to begin with, analysts said.

The profit margin on many personal computers can be 5 percent or
lower, depending on the model. The margins are slim in part because
of intense competition that has driven down prices. In some cases,
the computers are profitable only because their makers earn $30 or
more for each computer for preinstalling the software, according to
Shaw Wu, an industry analyst with American Technology Research.

And J. P. Gownder, an analyst at Forrester Research, said, "For the
average PC, that could be the entire margin." Without the preloaded
software, Mr. Gownder said, "it could put them in the red. That's
why they've become so addicted to it."

Mr. Stephens of Geek Squad says he agrees with H. P. that the future
is in allowing computer buyers to choose and download what they
want. But he said he believed Best Buy, not H. P., was in the best
position to help people choose what works for them because, he
argued, the in-store technicians are in closest contact with them.

"Geek Squad agents have one thing over Apple and Microsoft
engineers. We spend most of the day talking to people," he said.