Adapting to Competition : Technology: Xircom is an innovator in connecting mobile computer users to their corporate networks. But it’s resorted to layoffs as other firms invade its turf.
As they returned from lunch April 12, the 320 employees at Xircom Inc.’s headquarters were summoned to an urgent companywide meeting. Some workers may have thought the gathering was going to be another of the friendly events the corporation regularly mounts to celebrate birthdays, employment anniversaries and its own successes. The thick pile of financial statements waiting on their chairs quickly told them otherwise.
For the first time in Xircom’s history, Dirk Gates, 33, chief executive and co-founder of the 6-year-old computer hardware maker, had bad news to deliver.
In measured tones, Gates told his staff that Xircom’s earnings for the second quarter had fallen well below the company’s own projections and 44% behind the forecasts of stock analysts. Sales showed a small but unprecedented slip from the previous quarter and were unlikely to rebound for several months as distributors unloaded excess inventory. As a result, 35 people, or 10% of the corporation’s worldwide work force, would be laid off immediately, he said.
“You have to do what you have to do to make the business healthy,” Gates said last week, reflecting on his first brush with every executive’s nightmare. “No, it’s not pleasant. . . . Yes, it hurts when you lose 35 people, but for the remaining 300 and some-odd people, it’s the right thing to do.”
The layoffs, difficult for any company to digest, must have been particularly sobering for the folks at Xircom, a company that until last month had grown like a dandelion, enjoying 14 consecutive quarters of record sales and profits.
It had become a darling of the portable-computer industry with a pioneering plug-in adapter that enables mobile PC users to tap into their corporate networks with the ease once reserved for desktop users. Later, they came up with a best-selling line of credit card-shaped adapters enabling portable PC users to connect with their company computers on the road or in the office. Just last month, for the second year in a row, Fortune magazine named Xircom as one of the 100 fastest-growing small companies in the nation.
Company officials insist that although the layoffs may seem like a drastic response to unforeseen circumstances, the slowdown in Xircom’s growth was actually inevitable and not at all unexpected. High-tech companies are notoriously volatile and if anything, Xircom enjoyed an unusually long ride, noted Jerry N. Ulrich, chief financial officer. Rather, the layoffs were part of a broader strategy designed to let Xircom’s competitors and shareholders know that the company would fight aggressively to preserve its lead in a market that until recently it had occupied virtually by itself.
“We have enjoyed a position . . . in the past where we could take the high road” and not worry about the competition, Gates said. “Today, it’s war.”
To understand “the attitudinal shift” Gates has been promoting at Xircom in the wake of the disappointing quarterly results, it is important to know that in the obscure world of computer network adapters, the Xircom brand name has developed a cachet not unlike that which Mercedes-Benz enjoys in the automotive world.
The company was the first to introduce a device that used a portable computer’s parallel port to link the machine with other computers and databases in the local area networks, or LANs, that many offices use as alternatives to mainframe-based systems. Xircom’s early technology, which is primitive compared to its current products, was considered cutting-edge at the time because it allowed workers to take their computers home, continue their work and reconnect to their corporate networks the next day.
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Even after several other companies began making similar devices and charging less for them, Xircom was able to keep its prices and sales significantly above the competition’s because its adapter was regarded as superior, said Matthew Barzowskas, an analyst with Hancock Institutional Equity Services.
Xircom “thought they could charge a premier price for it with the understanding that buyers were willing to pay a little more for a top-notch product that was very reliable,” Barzowskas said.
The result was fat profit margins exceeding 10% for every $1 of sales. Xircom posted earnings of $9.6 million on sales of $82 million during the fiscal year ended September, 1993. In fiscal 1994, Xircom added wireless adapters that allow laptop computer users to roam inside their offices while remaining connected to their corporate networks, and its net income rose to $16 million on sales of $131.5 million.
Still, clouds were lurking behind that sunny landscape.
About two years ago, computer makers started widely equipping their portable notebooks with standardized credit card-sized slots for installing modems, additional memory and network adapters similar to Xircom’s.
The innovation not only made Xircom’s port adapters increasingly obsolete, but also invited serious competition. Before long, IBM, U.S. Robotics and at least two dozen other manufacturers were making credit card-type network adapters and vying for a piece of a market that International Data Corp. estimates could reach $428 million this year as portable PC sales heat up.
At first, Xircom weathered the storm well. Continuing to position itself as the top-of-the-line adapter maker, Xircom commanded more than half of all card-type adapter sales last year, even though it continued to charge prices 5% to 10% higher than the competition.
That began to change last year, when Santa Clara-based 3Com, a maker of network adapters for desktop computers, unveiled its line of card-sized notebook adapters. 3Com’s products were not quite as fancy as Xircom’s, but they offered the same sort of reliability and brand-name recognition, several analysts said.
“Basically, Xircom didn’t bring a lot to the party the other companies didn’t,” said Kimball Brown of the technology market-research firm Dataquest. “If there are unique features a product has, people fall in love with them. But if the same functions can be accomplished with something cheaper, people will buy that.”
Xircom soon found itself in a price war with 3Com. Xircom is now selling its combination adapter/modem for $579, a price 28% lower than it was a year ago. The result is that although Xircom has kept its market leadership in adapter cards--it holds about 40% compared to 3Com’s 30%--the company has become less profitable.
“Most people thought yes, Xircom was going to lose market share, but that the company would still be able to post up relatively strong growth numbers because of the speed at which the market was growing,” said Randall Yuen, an Oppenheimer & Co. securities analyst.
Yuen had predicted Xircom’s per-share earnings would reach 27 cents during the second quarter, but the company posted disappointing net income of 15 cents per share.
When the company’s sales stopped growing, Yuen and other analysts dramatically revised their profit estimates for Xircom, and the company’s already weak stock took a brief beating.
Analyst Barzowskas noted that Xircom is like a lot of other young high-tech companies that suddenly find people dwelling on their problems, despite their impressive growth in the past. The stock closed Monday at $11.13 per share.
Gates has responded to 3Com’s challenge by offering discounts to customers and setting up special contests for his salespeople. At the moment the company mostly uses an outside domestic manufacturer to produce its products. But to keep costs down, Gates has decided to open Xircom’s first manufacturing plant this year in Malaysia, where labor is cheaper.
In addition, Xircom is developing a new breed of wireless adapters for notebook computer users, and it recently acquired a New Hampshire company that makes computer products that utilize high-speed digital telephone lines.
Despite Xircom’s recent problems, analyst Yuen, for one, is still high on the company.
“I give them a lot of credit. They essentially defined a new space in the computer networking industry and built something from nothing,” Yuen said. “The odds were stacked against them. And yet now, Xircom is a well-known name.”
