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Betting the Farm
 

Profile of Gateway 2000, the #1 Inc. 500 company.
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Betting the Farm

Mail-order computer maker Gateway 2000 doesn't offer state-of-the-art technology or provide extraordinary support or run expensive ads -- and it does have hundreds of furious competitors. So how has it earned the top slot on this year's Inc. 500?

* * *

Just how brutal is the competition in the personal-computer business? So brutal that Craig Dwayne's idea of a relaxing holiday weekend is to load his young son and daughter into the family Toyota Forerunner, set out with them and his wife on the 12-hour drive from suburban Chicago to North Sioux City, S. Dak., spend a grand total of 90 minutes there, then reboard and head home.

It's not that Dwayne's company, PC Pros/Touché, couldn't live without its founder and chief executive for longer than that. Rather, it's that Dwayne, whose company sells direct-mail PCs, had set aside the recent holiday weekend for a very personal fact-finding mission. He made the trip only so he might peep through the windows and prowl about the gravel parking lot of a company he considers his nemesis, Gateway 2000. "You have to know what your competition is doing," contends Dwayne, whose company claims annual sales of $35 million. "This is warfare."

If he's planning to battle Gateway, Dwayne had better radio for reinforcements. There is hardly an adjective that would adequately describe Gateway's growth over the past five years. Astounding? Dizzying? Unparalleled? Well, yes, all of those. And also perplexing. From sales of about $1 million in 1986, Gateway has grown to $275 million in 1990 -- a five-year compounded growth rate of 26,469% -- earning it the top spot on this year's Inc. 500 (a one-slot promotion from last year). That brings us to the perplexing part: Gateway has grabbed a commanding share of the market for mail-order PCs without offering state-of-the-art technology or even extraordinary support. Gateway's ads are hokey; its name isn't especially catchy. And there are, at last count, some 400 other companies nipping at the same market, from bellwether Dell Computer to countless contenders that fall into the category that Ted Waitt, Gateway's cofounder and chief executive, dubs "Billy Bob's Bait & Computer Shop."

How on earth has Gateway prevailed?

Dwayne's makeshift investigation -- he has carried on so much about Gateway that even his wife wanted to see it -- didn't yield many solid answers. After wandering around the shipping and receiving docks, and peering through the windows into Waitt's empty office, Dwayne took out a bunch of the "GateBuster" T-shirts he had designed and put them everywhere he could: he tied them around door handles, laid them on the seats of trucks, and set up a crude mannequin that stood like "a little GateBusters ghost" outside Waitt's office window. "It was exciting to be there and leave gifts," says Dwayne, who is 31. "But I never got a thank-you note."

He never really got what he came for, either. But then the key to Gateway's success isn't really something he could have spied. To be sure, Waitt often answers -- or graciously deflects -- hard questions about Gateway's growth by pointing out visible symbols. The company's gravel parking lot, for example, serves as testament to its low-overhead religion. "People try to make things more complicated than they are," argues Waitt, clad in deck shoes and a polo shirt. "There's no magic formula. It all revolves around the way we do things."

That sounds like less of an answer than it actually is. Gateway's growth, and Waitt's genius, can't be reduced to just one overwhelming advantage. America's fastest-growing private company got there by managing, practically without exception, to come out on the right side of several dicey gambles. Waitt has gambled on his gut to figure out what customers want; he has gambled on his own taste regarding how best to advertise it to them; and he is gambling on his brain to make sure the company's growth doesn't smother its clearest impulses.

Fueled by that ever-dangerous propellant called instinct, Gateway's speedy trip to the top has left the company at a treacherous intersection. And there are plenty, like Dwayne, who would like to see it crash. "There is a brick wall out there waiting for everybody who grows this fast," notes Arthur Lazere, the 59-year-old chairman of Northgate Computer Systems, another competitor. "It's invisible before you hit it. I don't know what Gateway's brick wall is, but there is going to be one. There always is. Remember, I'm not a 25-year-old kid."

Maybe it's not worth quibbling about, but neither is Ted Waitt. Just for the record, he's 28.

* * *

Here is an important difference between Ted Waitt and the Diet Cokes he constantly guzzles: the sodas spend time chilling.

Waitt, on the other hand, is always wired. He pops in and out of his chair, tearing open another carton of Camel Lights, his ponytail bouncing, his dimpled grin flashing. "Ted is very emotionally involved with this business," says his brother, Norman Waitt Jr., who stepped down as vice-president this past March. To picture Ted Waitt, just imagine Woody Harrelson, who plays the bartender on the TV show "Cheers." Except instead of exuding goofy midwestern naïveté, Waitt seems nourished by . . . well, what is he on, anyway?

That question naturally spills from the lips of those who attempt to reorient themselves after a journey into Waitt's frenetic inner sanctum. What is this man on? A mad ride, for one thing. At only six years of age, the precocious company is charging through an exhilarating adolescence. "Gateway is the best show in town," notes Bruce Stephen, director of PC-hardware research at International Data, "and Waitt knows it."

Just when Waitt realized Gateway's star potential is another question. These days he makes it sound almost plausible that after dropping out of two different colleges, he returned to the family cattle farm in August 1985, intending to take advantage of the low-cost locale to set up a PC operation that would slaughter all comers. More likely, Waitt and his partner, Mike Hammond, slowly discovered that -- holy cow! -- they could operate on astoundingly low costs. Since day one, Gateway has undercut its competitors on price, consistently by at least 10%. "We can't operate on the margins they are operating on," grumbles Lazere, whose company is based in Eden Prairie, Minn.

But Waitt didn't just put his faith on price to get Gateway off the ground. After his college stints, he spent roughly nine months working at a retail computer store in Des Moines. While there, he began to develop his notion of the "value equation," a pet theory whose name serves as a soothing mantra for Gateway's 1,100 or so employees. Essentially, Waitt says, it comes down to this: "The PC business is not about price, it's about value, or what you can give the customer for his or her money." From what Waitt could see, purveyors of PCs were selling either cheap bare-bones systems that nobody really wanted or computers stuffed with too much technology to be affordable. The middling strategy, he thought, would be "not to add technology for the sake of adding technology, but to go after it when it offers the best value for consumers." Timing was key.

So was holding the line on prices. Before leaving the computer-store job, Waitt stored a relevant observation in his flawless memory: the back room, where salespeople sat at phones. "I was fascinated to see that if you knew what you were doing, you could sell a $3,000 computer system over the phone," says Waitt. "Everybody seemed to be looking at those sales as just gravy." Waitt envisioned a national business that could be launched handsomely using almost exactly the same sum he had saved up. Namely, zero. After all, such a business required little inventory (assuming customers prepaid) and no showroom. And it could be based anywhere -- even in the middle of nowhere. Inaugurating the Gateway tradition of low overhead, Waitt took advantage of his father's shrinking cattle brokerage to occupy some empty office space in a farmhouse. Since Waitt was "never a techno-nerd," as he puts it, he brought along Hammond, a fellow salesman who had actually trained him. "He soaked in everything from day one," recalls Hammond, who now serves as Gateway's vice-president of product development.

So there they were, Waitt the marketer and Hammond the technical whiz, living upstairs while they launched a business downstairs. Sometimes their days were framed by the phone ringing with orders: they woke up with it, and they collapsed on their bedsprings when it finally hushed. There were three-day stints when neither one took a bath, which explains why most of their company consisted of two dogs, Jake and Bunky. With one two-legged exception: Norman Waitt Jr., Ted's older brother by nine years. Norm often arrived at the office before his brother or Hammond had even awakened, simply for the spectacle of watching one of them tear down the stairs, buttoning a shirt or pulling on a pair of pants while diving for the ringing phone. But around six months into the new business, in early 1986, Ted got to feeling that maybe he needed his brother's financial skills; he so hated opening bank statements that he had restricted his financial activity to calling the bank and asking about his balance. Norm agreed, but only if he could be an equity-owning partner. So the brothers split the company; Hammond has never owned any stock.

Though Ted Waitt had his sights on selling PCs, that was not the business he and Hammond started in September 1985. Until the end of 1987, they called themselves the TIPC Network -- set up as a division of the company Waitt dreamed about starting, Gateway 2000. As such, they sold add-on equipment by mail to owners of PCs made by Texas Instruments. The niche seemed obvious to Waitt: the store where he and Hammond had worked sold Texas Instruments computers but didn't support them in the aftermarket, since the company did not adhere to the industry standard set by IBM. With his phone operation, run from an Iowa farm, Waitt could undercut competitors' prices significantly. Within a few months, the direct-mail venture was bringing in $100,000. That would grow to roughly $1 million a year. And most of the start-up capital came from the $20 membership fee each customer paid.

In 1986 Waitt and Hammond tinkered with assembling some PCs, and they even sold them locally. But in mid-1987, Texas Instruments handed Waitt just the opening he had been hoping for: the company offered its PC users a trade-in program that required them to cough up $3,500 to get an IBM-compatible machine. "We figured we could do the same thing for $1,500," recalls Hammond.

As Hammond scoured computer publications for the best deals on such components as motherboards, monitors, and disk drives, Waitt began to apply his concept of the value equation in deciding what to build. The earliest Gateway model included such amenities as a keyboard with function keys across the top and a separate cursor pad. It had two floppy-disk drives, instead of just one, to accommodate two different sizes of diskettes. The monitor was color, not monochrome; the memory had greater-than-usual capacity. Gateway bundled it all into one fully configured system at one price, $1,995, instead of considering, for example, a hard-disk drive as an extra cost. Competitors offered fewer features at $1,950 or so. "We gave people more for their money," says Waitt.

That, in essence, is the strategy from which Gateway has never veered. By keeping careful track of costs, and pricing to achieve a fixed margin, Waitt could add newly affordable features and still keep prices down, as other components shuffled along what he calls "the value curve." No matter how technical he makes it sound, though, what Waitt was really doing was gambling on his gut-level ability to divine what his customers wanted. It was he -- and he alone -- who decided what features mattered. Would customers pay an additional $75 to own a 40-megabyte hard-disk drive? "The first question would always be, Would I buy it?" says Ham mond. "Everyone wants smaller, faster, and cheaper. So it's a fairly educated guess." Then Gateway would test the component to see if it performed as the manufacturer promised. From there, says Waitt, "we didn't do a whole lot of market research on it. A lot of it was instinctive."

How good are Waitt's instincts? The company grew from $1 million in 1986, to $1.5 million in 1987 -- with the boost of the trade-in offer -- but sales exploded to $12 million in 1988. Waitt made it clear, though, that he was not about to sacrifice any profitability for the sake of adding overhead. The Waitt brothers did move the business into more spacious quarters, paying $350 monthly rent for 5,000 square feet in Sioux City's 100-year-old Livestock Exchange Building, where they had to sidestep cow manure in the halls. They found they could start employees at $5.50 an hour -- in 1988 Gateway began supplementing that figure with a monthly cash bonus based on profits -- and turnover was nonexistent. Gateway needed no research-and-development function and no design team, and there was plenty of used furniture around. South Dakota, where Gateway moved in January 1990, collects no income taxes. In a business where margins can expire of emaciation -- Gateway's publicly owned competitors report net aftertax profits of no more than 5% -- Gateway needed every advantage it could scrounge.

But its greatest advantage, perhaps, was Ted Waitt himself. As his brother notes, "he has an uncanny ability to figure what people will want and how to package it." His biggest mistake so far, selling a disk drive that was ahead of its time, was "expensive, but not catastrophic," he says. It's a balancing act: keeping track of the emerging technology and still lowering prices about a half dozen times a year. "I look at all the information, and I assimilate it in my head," Waitt explains. "Usually, the right answer just pops right up."

Or, as Hammond succinctly explains, "it's kind of a crapshoot."

* * *

With all his talk about the value equation, Ted Waitt would have you believe that Gateway got where it is today -- 1991 sales are projected to hit a boggling $600 million -- by giving consumers more for their money. Which is true, sort of. Seymour Merrin, whose company publishes a newsletter covering PC-distribution channels, notes, "They've done a great job of convincing people that they have a great product at a great price."

In most quarters, they call that advertising.

Here, Waitt has gambled on his own idiosyncratic tastes, ignoring advertising conventions. In fact, Gateway's ads have sometimes not even shown its own product.

Back in his retailing days, Waitt had helped enough people shop for PCs to know they wanted to feel that a stable company stood behind the machine. Waitt's positioning trick -- and it was masterly -- would be to establish Gateway as a trustworthy company that also offered rock-bottom prices. Low-end, but not scary.

The customers who were willing to buy PCs through the mail were a select and sophisticated bunch; usually, they determined the quality and support they needed and then shopped for the best price. To find it, they were willing to risk the hernia-popping experience of lifting -- and the eye-numbing experience of leafing through -- publications like Computer Shopper, which could run to 800-plus large-format pages. Waitt couldn't help noticing that the ads were lacking in sophisticated advertising tools -- like, for instance, cows.

Cows? Waitt's first Gateway ads actually featured a picture of his father's cattle herd, with the Sioux City water tower hovering protectively in the background. "Computers from Iowa?" the headline read. Rather than sell the product, the ad -- variations of which ran until October 1989 -- sold Gateway. Waitt knew whom he was selling against; well, not exactly, since ease of entry meant that competitors were always breezing in and out. But many of the clone makers were of questionable reputation, and their long-term intentions fell short of noble. Waitt's copy, which has come to sound like something Tom Bodett might read on those radio ads for Motel Six, established Gateway as a bunch of plain folk who planned on being around awhile. There was some not-so-subtle psychology at work: here was an American product, not one of those no-name Taiwanese or Korean clones, and wouldn't you rather buy from the honest heartland than from either of America's cynical coasts?

Once Waitt felt comfortable that people knew the company's name, he traded the cows in the ads for people -- specifically, the Waitt brothers themselves. In early 1990 Waitt hired Barb Gross as advertising manager. Gross, local photographer George Lindblade, and designer Kevin Kjeldseth form the inner circle that brainstorms with Waitt to come up with new ads every two or three months, a pace Waitt considers crucial because "this is a fast-paced, rapidly changing business."

Often, the meetings consist of Waitt throwing out ideas and the others refining them, even as they try to keep Waitt from trying to draw. "His biggest frustration is that he can't draw well," confides Gross. He does come up with clear concepts -- often, inexplicably. Once, so jet-lagged he was practically hallucinating, Waitt blurted out a fully formed idea for the "PC Saloon" ad. Eventually shot in Tucson, the July 1990 ad featured an 1890s double-door saloon, where a group of men are playing poker. Waitt, decked out in pinstripes, smirks right into the camera and shows his hand: a royal flush. The others at the table, including a frustrated young man and an older, stodgy businessman, are meant to represent various Gateway competitors. "It was a bit of an in-joke," says Gross. One ad, which featured buffalo, happened to coincide with the release of Dances with Wolves, the Kevin Costner movie. Hey, someone suggested at the next brainstorming session, let's find out what Kevin Costner is doing next. When they did, recalls Gross, "I said, 'You absolutely cannot do Robin Hood. He was a thief, for goodness' sake.' "

But she was outnumbered, and Gateway staged its own ad using a Robin Hood theme, with you-know-who casting himself as the champion of the poor. When the ad came out, this past August, it set records for the number of inquiries from new customers, chalking up as many as 2,000 a day. "I was wrong," says Gross. "Ted's gut feelings were right."

Not that Waitt's satisfaction with ads comes from having his hunches reconfirmed. As a man who never wearies of battling overhead, he insists that every ad pay for itself. Anybody who calls the 800 number first is asked, "Where did you hear of Gateway?" Waitt uses the answers as a guide to where he should spend the 2.5% of sales he's committed to marketing. He sticks pretty rigidly to computer magazines and never consults an ad agency. Often, employees serve as models in the ads. As usual, he finds his own ways to cut costs. For one ad, which featured the nifty gimmick of having a photo wink from black-and-white into color, Waitt was outraged when the lowest quote he got amounted to $3 a pop. So he had the ad printed locally and paid church groups, employees on their free time, and temporary workers to assemble it. The ad came in "far under" that original price.

As long as Gateway's telephone operators stay busy, Waitt sticks with his idiosyncratic traditions. He refuses, for instance, to employ reader-response cards, contending that they attract too many people who are just collecting information. He intentionally skimps on technical information because he wants consumers to call in with their questions. There have been ads in which the computers were squint-distanced in the background, in which prices were barely visible, in which there were so many elements, the eye couldn't possibly behold them all. Waitt admits the ads "have alienated people at some times."

But not enough to worry about. By early 1990 sales had risen to $70 million. "We get horrible marks from the marketing-guru types," Waitt says. "But it seems to work."

* * *

Ted Waitt's gambles on his unpredictable gut and his unorthodox tastes have paid off on a scale that he could hardly have predicted. "I was just hoping this thing would eventually evolve into some kind of business that would provide a good income," says Norm Waitt Jr., who has no operational role but still owns 45% of Gateway.

Remarkably, though, all the growth-inducing risks Ted Waitt has taken have only forced on him his biggest bet yet: he is gambling that he can think through the implications of Gateway's enormousness fast enough to keep the company flexible. "The biggest challenge for us right now," Waitt says, "is figuring out how to add the necessary bureaucracy without becoming slow moving." The more fundamental question, though, is whether Gateway can adapt its core strategy to grow into a sturdier niche.

Gateway's ads do their darnedest to convince consumers that they ought to buy based on value -- a combination of price and factors such as service and component quality and reliability -- but analysts suggest that price carries a disproportionate load of the so-called value equation. "In mail order, the three most important factors are price, price, and price," says David Evancha, director of research at WorkGroup Technologies, a market-research firm specializing in information technology. Gateway has earned industry merit badges in most areas, but price has been its strongest suit. How long before an upstart undercuts the company? It's not hard to imagine, for example, a vertically integrated PC maker from, say, Taiwan, strangling Gateway by living on less. "The pressure on Gateway's margins is never going to abate," says Evancha.

As consumers become even more comfortable with PCs, they may become more willing to dip into no-name cheapies. But snipers aren't just taking shots from the lower end. "The pricing delta is narrowing. We're coming after them," vows Michael Dell, chairman of Dell Computer, which is expected to post nearly $800 million in sales this year. "And we're not exactly Little Bo Peep."

The pioneer in selling cheap computers by phone, Dell says he came to the realization as far back as 1985 that counting on price "becomes a zero-sum game after a while. Those customers are likely to be less loyal. It's hard to sustain a company on that." Dell has since added a sales force to call on the Fortune 500 entities and government agencies that provide roughly half of his business; he even sells computers through retail superstores.

Gateway isn't concealing its own desire to penetrate the profitable corporate market. This past fall, its ad depicted starchy executives, brows all a-furrow, huddled around their prized Gateway. Clearly the accompanying slogan, "Because we've stood the test of time," was designed to appeal to the conservative instincts of a corporate type. As of September, four ads Waitt had designed expressly for BusinessWeek remained "in limbo," according to Gross. Around that same time, Gateway began releasing some quarterly financial results in press-release form. "People don't realize that Gateway is a real company," says Rick Snyder, executive vice-president. "We don't want people to think we are just a revenue generator."

But changing what people think -- and the mix of consumers who buy -- is likely to take more than aggressive marketing. "To play in the big-company market," says Evancha, "you have to offer more." For Dell, that meant investing more than $22 million in R&D last year, when sales hit about $550 million. According to Dell, it has also required beefing up support and training. "These companies want the kind of support that is hard to give if you are just assembling product," says Dell. "The trip from what Gateway is to the Dell model is a treacherous road."

Waitt doesn't seem interested in hitching a ride, though. "Our intention is to go after the corporate market without raising our cost of doing business, so we don't have to raise our prices to all our customers," he says. Waitt has no plans to begin developing technology, though he has actively hunted acquisitions. And he suggests that Gateway may begin adding products -- such as software and peripherals -- to its systems. He claims that Europe offers "tremendous potential for us," though Dell, Compaq Computer, AST Research, and others have established significant beachheads there.

Waitt -- who has recently recruited a half dozen vice-presidents from giants like Digital Equipment, Rockwell International, Texas Instruments, and Coopers & Lybrand -- intends to leverage the advantages of size to save money in areas such as purchasing, while at the same time invest cash in projects that should increase efficiency. For instance, he says, "Gateway is spending money to train people and set up proper troubleshooting procedures." Also, last summer Gateway moved its production workers into a 44,000-square-foot facility down the road and reorganized them under a cellular manufacturing plan. Craig Culloton, director of manufacturing, says he expects productivity to increase by at least 30%. And Jerry Mayer, vice-president of operations, notes that the company is moving toward "what is basically a pay-for-knowledge" compensation system.

Once again, Gateway is so far achieving a touchy balance. Back in 1990, for instance, a transitional Dell absorbed a 65% drop in profits. "Every company stumbles at some point," observes Tom Quinlan, hardware editor of InfoWorld magazine. "You reach a plateau where you have to make the right choices. And even if you do, it's difficult to move to the next level."

And Gateway can't shimmy like it used to. A 20-member group now scouts out technology; another bunch, the Road Map Group, evaluates options; Waitt meets with his 10 lieutenants every two weeks, in a configuration called the Action Committee. The company has hired a media buyer to help quantify its advertising decisions. And Rob Cheng, director of marketing, now has four people working the phones full-time to ask customers pertinent questions such as "How does this price sit with you?" and "What kind of technology interests you?" "One person can't do it anymore," says Waitt. "We were unknown before, and that was an advantage. Nobody knew who we were, so we snuck up on the competition."

These days the competition is -- quite literally -- sneaking up on Gateway. But Craig Dwayne, for one, swears he's through slogging out to South Dakota. His latest ruse to gain information involves asking consumers to send him proof they've returned a Gateway computer. They get a free GateBusters T-shirt and become eligible to win a trip to Hawaii. "I learn the serial number and get some idea of what went wrong," says Dwayne. "We'll learn some interesting facts. I'm very serious about Gateway."

And Ted Waitt, in his own way, is serious about Dwayne's company. "We spend as much time looking at companies that are smaller than we are as we do at those that are bigger," he says. "He came here, and that bothers me. It's almost demented, and it did rattle some of our people. But we can't focus on that. Our biggest competitor is ourselves. And that keeps us busy."

Last updated: Dec 1, 1991




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