By Peter Petre RESEARCH ASSOCIATE Kate Ballen

(FORTUNE Magazine) – JACK TRAMIEL IS BACK ON THE WARPATH The master cost cutter bloodied the home computer market as head of Commodore. Now that he's cleaned house at Atari, he's plotting another assault and predicting a big victory. The competition doesn't take his boasting literally, but it does take him seriously. ALMOST NO ONE in the computer industry believed the mercurial Jack Tramiel when he proclaimed in January that Atari, the wrecked video-game and computer maker he acquired from Warner Communications last July, will build five million computers in 1985. That's more than U.S. consumers bought from IBM, Apple, and Commodore International combined last year. Nor did many buy Tramiel's line that Atari will become a booming billion-dollar business this year. So far, he hasn't even been able to attract investors--at least not on his terms. But if competitors don't take Tramiel literally, they do take him seriously. A feared and relentless master of low-cost production whose style is more Seventh Avenue than Silicon Valley, Tramiel turned the home computer into a hot-selling mass-market item during the years he headed Commodore, a $1.2- billion-a-year company he started out of a Bronx typewriter repair shop. Tramiel also launched the bloody price war two years ago that forced Texas Instruments, Mattel, and Timex out of the business. Atari has been a fading also-ran in home computers. Its principal product, a cheap, toylike machine called the 800XL, is overwhelmingly outsold by IBM's PCjr, Apple's IIc, and the Commodore 64. But in the scant eight months he has owned Atari, Tramiel, with continuing help from Warner, has made astonishing progress in turning the company from a nevermore into a menace. If the new Atari attains only half the revenues Tramiel claims--as many in Silicon Valley believe it can--Tramiel's pricing could again rock the market. ! Atari makes no secret of its intention to usurp Commodore's role. ''Atari will be no different from the old Commodore,'' says Tramiel's eldest son, Sam, Atari's president. ''And Commodore will become like the old Atari.'' If their plans work out, the Tramiels could even give Apple and IBM a hard time. The home computer market to which Tramiel brazenly lays claim includes all the machines kept around the house for family use. Today they fall into two categories. Atari and Commodore computers are cheap keyboard units that sell in mass merchandise chains such as K mart. Designed to hook up to an ordinary TV set, they are useful for little more than playing games and learning rudimentary programming. Before they can perform tasks such as word processing, household record keeping, and communicating over the phone with other computers, they must be augmented with hundreds of dollars' worth of add-on equipment such as disk drives and printers. Until last year cheap computers ruled the market. Tramiel's price war had driven the basic consoles below $300, making them impulse items. Today they go for small change: a Commodore 64 costs $150, an Atari 800XL only $100. The other category of home machines includes scaled-down personal computer systems sold in computer retail stores. They are designed to take in stride the diversity of tasks cheaper units must stretch to accomplish. Before last year they appealed only to the well-to-do and hobbyists who weren't deterred by prices upward of $1,000. In 1984, however, the home computer market did a flip-flop. At Christmas, when fully half of all home computers are sold, Apple and IBM drew hordes of consumers into the specialty stores by putting the Apple IIc and PCjr on sale for less than $1,000. According to Future Computing, a research firm, the two giants captured 30% of the $2.8 billion consumers spent on home computers in 1984. Demand for mass-market home computers like Commodore's and Atari's, on the other hand, leveled off; the impulse buyers went after VCRs instead. Caught unawares, Commodore saw its Christmas quarter profits evaporate, dropping 94% from 1983 as hundreds of thousands of computers piled up in warehouses. Market analysts say the shift signaled the emergence of a new, more sophisticated kind of computer buyer. ''People expect to pay more and are more sober in their shopping habits,'' says William Coggshall, president of Software Access, a market research company. These consumers, researchers say, are apt to value the sales help computer stores provide. But Tramiel believes that with the right combination of powerful hardware and low prices, he can lure consumers back into the mass-merchandise stores, the only outlets Atari sells to. ''I don't need market research to tell me anything,'' he says. ''My clientele are smart kids who will go where they can buy the box cheaply and not have to be explained to.'' Although Tramiel plans to make money on the vestiges of Atari's video-game business, at the heart of his plans are two lines of home computers unveiled in January at a Las Vegas trade show. The XE series, the cheaper of the two, is an improved version of the 800XL, which was introduced in 1980 but never made money. Tramiel chopped the cost of the machines by reducing the number of components and renegotiating Atari's contracts with suppliers. The 800XL now costs under $80 to produce, less than two-thirds what Warner spent to make one, and below the manufacturing cost of a Commodore 64. The XE, which is supposed to succeed the XL starting in March, costs still less. TRAMIEL IS BETTING that the price advantage will win Atari market share in the U.S. at Commodore's expense and expand Atari's distribution abroad. Toylike computers are still booming in Europe, for example, and Commodore derives about half its revenues from non-U.S. sales. Commodore recently cut prices on its 64 from $200 to $150--still $50 above the XL--and also introduced a more powerful and expensive machine called the 128. Atari's second new machine, the ST, was the one that drew the crowds at Las Vegas. A bargain basement imitation of Apple's flagship personal computer, the $2,195 Macintosh, Tramiel's machine is nicknamed--of course--the Jackintosh. The Jackintosh cannot use programs written for Apple's machine. But it boasts a color screen--the Mac's is black and white--uses the same powerful microprocessor chip, and apes some of the distinctive features that make the Macintosh easy to use, such as fancy graphics and a ''mouse'' for pointing to symbols and activating commands on the screen. Apple spent tens of millions of dollars on advertising last year to familiarize the public with its Macintosh. Yet the company, which depends heavily on consumer purchases of the Apple II, is aiming the Mac at business users and has made little effort to exploit Mac's mass appeal. Tramiel thinks he can capitalize on all that advertising and use the ST to lure customers away from the PCjr and Apple IIc, which are based on less sophisticated technology. Unlike the Macintosh, which sells as one compact unit, the ST's bulky components are designed to be bought in affordable increments. Consumers can start with a $399 console and later add accessories, such as a disk drive ($150) and a high-resolution color screen ($350). ''The average credit card limit is $500,'' explains marketing vice president James Copland. ''We don't force the consumer to go broke buying the whole system.'' While it may rate an exclamation point as a selling proposition, the ST is still a question mark as a product. At its unveiling, the prototype could perform just a few preprogrammed tricks and could not do basic tasks like storing data on a disk. No one will know how fast or friendly it is until after Atari starts producing it this spring. Hurriedly designed--Tramiel's engineers started work on it only last May--the ST could be delayed, or emerge crawling with bugs.

So far, moreover, Atari has persuaded few software companies to write programs for the ST. Market researchers insist that the new breed of sophisticated consumer won't look at a machine without an abundance of programs. ''The ball game is won or lost in software,'' says Egil Juliussen, Future Computing's chairman. But Tramiel thinks most consumers will buy a computer with a small set of rudimentary programs. As machines find their way into homes, more software will follow. What makes competitors take Tramiel seriously is his track record at Commodore and his fierce determination. Tramiel was forced out of Commodore in a bitter dispute with longtime partner Irving Gould, the company's largest shareholder. He left an immensely rich man, selling his stock for about $100 million, and bought the remains of Atari in a hurry-up deal with Warner last July. Tramiel is undoubtedly eager to give Commodore its comeuppance, but that is not his primary motive. A survivor of Auschwitz who lost most of his family during World War II, he wants to transform Atari into a family stronghold he can pass along to his three sons. Sam had worked for his father in a variety of jobs at Commodore and spent three years running factories of his own in the Far East, where Commodore and Atari computers are produced. Tramiel's less experienced younger sons were assigned to journeyman positions. Leonard, 30, who holds a Ph.D. in astrophysics, is helping to create software for Atari's new products; Gary, 25, who worked as a stockbroker at Merrill Lynch managing his father's big account, now handles odd jobs in finance. When Tramiel bought Atari it was distressed merchandise, and the situation was made to order for him. Atari lost $539 million in 1983 after the video- game fad shortcircuited. Warner Chairman Steven Ross, under pressure from his board of directors, was desperate to unload the company in 1984 before the first half of the year ended. James Morgan, the executive Ross had hired from Philip Morris in 1983 to turn the company around, failed to get Atari's costs under control even though he fired over half its 10,000 employees (FORTUNE, July 9, 1984). In the first half of 1984, Atari was still hemorrhaging cash. The final straw came when Morgan asked for an additional $110 million to help Atari launch new products. The deal with Tramiel took shape during a frenetic week of negotiation at the end of June. The sale-of-assets agreement was a 300-page monument to expediency, full of qualifications, loopholes, and doors left open to be closed later. Tramiel paid no cash. He got the assets in exchange for long- term debt and warrants that give Warner claim to 32% of Atari's stock. The debt has a face value of $240 million, but Tramiel pays interest at below- market rates (Warner valued the notes on its books at $160 million). Warner, which registered a second-quarter loss of $332 million mainly because of Atari, kept parts of the business Tramiel did not want, such as a chain of video arcades. Warner also agreed, astonishingly, to reduce the debt Tramiel owed if his first year of operations revealed Atari's assets to be worth less than their estimated value at the sale. Says a former Warner executive who was present at the negotiations, ''Ross and Tramiel had a verbal understanding that anything could be negotiated afterward and that the contract was a lot of legalese.'' Tramiel pledged he would use $75 million of his own fortune to recapitalize Atari. So far he's put only $30 million into the company--$26 million of his cash, the rest from his sons and lieutenants. The remaining $45 million is tucked away in investments such as municipal bonds. MOVING with sometimes brutal decisiveness, Tramiel wasted little time in transforming Atari into a tightly run family business from a company legendary in its heyday for easy living and loose controls. At 8:30 A.M. the day the deal was signed, he pulled up in his Rolls-Royce in front of Atari's ) Sunnyvale, California, headquarters, where people he had recruited were already waiting. ''It was all very organized. They were like an occupying army,'' Bruce Entin, a former Atari vice president, recalls. Tramiel took over Morgan's corner office and spent the day calling Atari executives in. The message was the same for all: he intended to move swiftly, he was looking for people who understood the value of money and were willing to convert to his ''religion'' of offering consumers sophisticated technology at rock-bottom prices. Meanwhile, casually attired strangers drifted into the building--Commodore veterans and longtime associates whom Tramiel had summoned. ''They were like the Dirty Dozen,'' Entin says, recalling the 1967 war movie in which raffish Army convicts take on a suicide mission. Within a month all of Atari's top managers were gone. In their places were Tramiel's irregulars--marketing vice president James ''Jamie'' Copland, a noisy Canadian supersalesman; sales vice president David Harris, an intense Briton who once quit Commodore and sued it after an argument with Tramiel; and Gregory Pratt, a tough-minded black MBA whom Tramiel put in charge of cutting costs. The headquarters staff was chopped from 1,200 to 250. Tramiel shelved a new video-game machine planned by Morgan, fixing Atari's focus on home computers, and stopped shipping products for two months while he untangled Atari's accounts. The honeymoon with Warner didn't last long. Warner's accountants had assembled the balance sheet working hurriedly from Atari's chaotic records, and both sides of it turned out to be full of comic book surprises. As soon as the sale was announced, remembers Sam Tramiel, ''millions of dollars of liabilities leaped from the woodwork.'' Creditors appeared like ghosts from Atari's days of high living, ranging from the leggy models who had demonstrated video games at trade shows to software firms that had been commissioned, in some cases without the knowledge of Atari's headquarters, to do expensive development work. To reconcile the bills, a squad of Warner executives and accountants set up shop in abandoned Atari offices across the street from Tramiel's men. The so- called transition team quickly learned about Tramiel's nickel-and-diming style. ''We were subjected to a constant harangue that the assets were worthless, so why should they pay the liabilities,'' one accountant remembers. ''The whole thing was a horror.'' Tramiel assigned his son Gary to take care of the settlements. Even minor expenses became matters of dispute. To avoid petty haggling, Warner and Tramiel had agreed in their contract that Atari would absorb unrecorded continuing obligations of under $25,000, while Warner would pay those over $25,000. The distinction seemed clear-cut until Atari started bundling bills by category--leased Xerox machines, for example. Atari argued that when a bundle added up to more than $25,000, Warner should pay. An accountant estimated that Warner has picked up some $6 million of disputed expenses. The asset side of the balance sheet was also controversial. It included $106 million of receivables Warner said were collectible. Since the receivables mostly represented hard-to-sell video games and home computers moldering in retailers' warehouses, few customers wanted to pay Atari's new boss. According to one insider, by August Atari had collected as little as $500,000. Tramiel demanded cash from Warner. Ross, mindful that a disgruntled Tramiel could always dump the company back into Warner's hands, obliged by buying back $10 million in receivables and paying $8 million for some Warner warrants Atari held. Unable to find $50 million in financing he sought last fall, Tramiel avoided a year-end cash crunch by skipping his first $9-million interest payment to Warner, due January 1. Warner, with little to gain by declaring Atari in default, patiently accepted the move. ''Depending how you look at it,'' says a Warner director, ''Jack is either a crack negotiator or a chiseler.'' According to their contract, Warner and Atari are scheduled to renegotiate the debt by June--but Tramiel began dickering with Warner late in January. Meanwhile, to reflect their new estimates of Atari's value, the accountants have been writing the debt down. It was recently recorded at $135 million, and is probably headed lower. SAM TRAMIEL insists the trimmed-down Atari is operating at a small profit. That's not implausible--although the company got most of its $125 million in revenues during the last half by unloading bloated inventories at cut rates, and is still firing people. Turning Atari around the Tramiel way has left 25 of its 30 buildings in Silicon Valley available for lease. Still, the house that Jack is building faces enormous risks. The cooling of the home computer fad could mean that the XE, from which Atari plans to derive much of its revenues this year, may already have been passed by in the marketplace. Jackintosh may not work--or, if it does work, may face stiff competition from other Macalikes that are on the way. Commodore is racing to deliver a premium computer called the Amiga, which it expects to sell as a complete system for under $1,500. And Apple has been adding Macenhancements to the Apple II. Atari will need to raise capital this summer to float the Christmas buildup, pay for advertising, and develop other new products. Tramiel, who has no intention of dipping into Atari's $45-million reserve, has met with institutional investors in San Francisco, New York, and London, saying he needs to raise $100 million this year--he hopes for $50 million each from a private placement and a public offering. To date he has found no takers. By FORTUNE's estimate, around $10 million of the $30 million that Tramiel put into the company remained untapped at the end of January. The Tramiels say that's enough to start shipping XEs and STs--and to put Atari's fate in the hands of consumers, which is where they want it to be. Atari's Goliath competitors will watch nervously. If STs start selling, Tramiel's low prices mean trouble for Apple and IBM--and anybody else with home computer plans. If they don't, Atari could be fighting to the death against Commodore in the aisles of K mart.

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CHART: TEXT NOT AVAILABLE A Gamemaker's Giddy Rise and Fall Atari started the video-game craze of the early 1980s and ballooned into a madca $2-billion-a-year empire. Sales and earnings collapsed in 1983 as the fad ended abruptly. The Tramiels, who took over in mid-1984, claim the company earned a s all profit in the fourth quarter.