(FORTUNE Magazine) – Once upon a time, there was a place known as "the Personal Computer Industry." In that land many valiant companies vied to win the hearts of maidens and men with hardware. In the halcyon but distant days of, oh, a year or two ago, high honor went to the first company to offer--forsooth!--a new kind of memory cache or a 12-gigabyte hard drive when competitors, heaven forbid, were shipping only gigs of eight. But the champion of PC-dom, which dwelt deep in Texas in a verdant Dell, proved its merit not on the distinction of its products, but on the personal way it courted and served its partisans. And the PC industry grew steadily more powerful in the land, though it was ruled by the two giant, oft-despotic, obscenely wealthy overlords of Wintel.

Well, we're finished with that fairy tale. Those once-proud PC companies--the ones that survived the brutal competition of the past decade--are suffering a very modern identity crisis. Selling plain-vanilla Wintel PCs is no longer an exciting business. While annual worldwide unit sales of PCs are growing in the mid- to high-teen percentages, revenue growth has stagnated. Eking out a profit is getting tougher than ever. And Wall Street has creamed the sector: In September, Dell's stock was off 28%, Gateway's 32%, and Compaq's 19%, while investors knocked off half of Apple's market cap on a single day, Sept. 29. But if you want the ultimate proof that the PC industry as we've known it is toast, just listen to the newcomers who run PC companies. "We don't think of it in terms of the PC business anymore," says Compaq Computer CEO Mike Capellas, a year into his job. "This is the Internet-access business." Says Gateway CEO Jeff Weitzen, who took over from chairman Ted Waitt on New Year's Day: "If in five years we don't make PCs anymore, it wouldn't necessarily trouble me. We're clearly migrating away from [the PC] as the centerpiece."

Behind this alarming talk (imagine Jac Nasser saying that in five years Ford might not be making cars) are fundamental changes in how people use personal computers as we move into the Internet Age. Says longtime industry-watcher Aaron Goldberg, the principal analyst at Ziff-Davis Media: "The PC business has been about products, feeds, and speeds. Now customers don't give a rat's ass about how fast the processor is. The issue is, 'How do I get stuff done with my computer?'" People are more concerned with what it takes, for instance, to download MP3 music files and burn their own CDs than they are with what kind of computer they use to do it. Meanwhile, many corporations now provide workers with a new PC every four years--up from every three years, which had been standard practice. Says Mark Tebbe, chairman of Internet consulting firm Lante in Chicago: "Upgrade cycles have slowed not for any economic reason, but because people don't need the speed. Instead, companies are putting more horsepower in servers and other infrastructure."

Each of the industry's key players has responded differently to these changes. While it's unclear whether Apple's third-quarter earnings woes are a hiccup or serious trouble, the company has been resurrected by the return of Steve Jobs, who proved that customers will pay extra for distinctive user-friendly design and unique capabilities like easy video editing. IBM still sells PCs--at a loss--to businesses, but it has dropped out of the U.S. retail PC business. Compaq is struggling to hold its lead as the global leader in PC sales and has not become a top player in the systems-integration business despite its 1998 purchase of Digital Equipment. Gateway, after stumbling in corporate computing, has refocused on selling to small businesses, consumers, and schools. Hewlett-Packard has crept up on everyone, grabbing big chunks of market share. HP has begun selling its products directly over the Web. And PC boss Webb McKinney says HP makes a profit on every PC it sells. One big reason: As the leader in printers, HP is well positioned to sell complete bundled hardware packages.

To many people, this turbulence reinforces the view of Sun Microsystems, the hot server company that for years has promoted the notion of dumb terminals, or "network computers," which are fed data over the network (by a Sun server, of course). Says Jonathan Schwartz, Sun's senior vice president for strategy: "What people want is access to the Internet. So do they really want to spend all that money for a big, honking PC with a ton of storage, and to pay a big software company up north, when all they want to do is go to Yahoo Shopping?"

Contrary to conventional wisdom, the answer is yes, they probably do. The PC isn't dead; it's being reincarnated. Scoffs Michael Dell: "The PC was supposed to go away 375 million units ago." And while Gateway's Weitzen accepts the possibility that his business might shift away from PCs in the future, he says, "We do not believe that appliances are substitutes for PCs. To access the Internet, I'd still recommend a PC. Aside from the time it takes to boot up and the complexities and stability of Windows, it's still a much more versatile machine."

The idea is that people will pay for that honker if it is integrated with products and services that help them do things like get music off the Net and onto a CD easily, or if it's purpose-built to, say, block pornography from reaching their children. In other words, take a commodity product and give it a new spin. The PC makers have learned a lesson from Jobs' iMac, which succeeds because it has a different look and some unique features. Says Ziff-Davis' Goldberg: "There's a fundamental change away from box marketing, where each company tried to use Intel's product road map and figure out how to create some differences. We're seeing differentiation in industrial design and service and support, and altogether new types of devices." Even Intel gets this. Says microprocessor boss Paul Otellini: "The day of the single-product company appears to be ending quickly. Everyone is looking at how they can add their unique flavor of value to the hardware sale." Compaq's Capellas doesn't seem daunted by the challenges facing his $39-billion-a-year behemoth when he enthuses about what he calls the third stage of the PC era: "The first stage was design and innovation. The second was driving to standardization and almost commoditizing the business. Now we're getting back to creativity."

These days it's hard to find a PC company that markets its product primarily on the strength of the old selling points, like a chip's gigahertz or a hard drive's gigabytes. Sales pitches now emphasize everything from cost savings to wireless to Net access to multimedia. For example, Hewlett-Packard's e-Vectra corporate PC is designed primarily to help companies lower the cost of ownership. It is very small, and its cabinet locks; users can't disconnect cables or open anything. If the machine breaks, the hard drive (where all the data and software are stored) can be readily transferred to another machine. Corporate techies just bring in a new machine, pop in the old hard drive, and the user is off and cruising again. In five months HP sold 160,000 e-Vectras at $549 each. Compaq sells a variety of iPaq products, including a Wintel server that is bundled with wireless e-mail devices. Sony's VAIO laptops are specifically designed to work with digital still cameras, camcorders, and other home entertainment devices. Dell's latest notebooks have wireless transmitters built in that allow for office networking.

Gateway is farthest down this creative path. Says Weitzen: "We're an experience company, not a PC company. For way too long this industry has asked the end user to be the systems integrator. And that is just not going to work anymore." Gateway offers different bundles that combine PCs and services to address particular computing needs. A Photo:)Ware PC comes with a digital camera. A new Companion:)Ware bundle includes a PC, a Handspring Visor handheld device, and several special software applications. Both bun dles come with training, either online or at Gateway's Country stores. With 5,000 classroom seats at those stores--a number that is growing weekly--Weitzen claims that by year-end Gateway will be the nation's largest nonvocational trainer.

Weitzen sees the computer business as more and more like telephony, where the relationship with customers is ongoing and the challenge is to sell them additional features and services. Weitzen has firsthand knowledge of this; he spent 18 years at AT&T and ran all services for business customers before he left in January 1998 to join Gateway. So while he's happy to sell a $1,200 computer at a 15% gross margin, he's more excited about Gateway's selling Internet access for $19.95 a month--because such services can carry a margin closer to 60%. If Gateway can sell more services successfully, it could see its profits increase at the same time that it smooths out its revenue stream. Weitzen's plan will be put to the test soon: By the end of the year Gateway will start selling an Internet appliance co-branded with America Online. Intended for the kitchen counter and other convenient spots at home, the device, expected to cost about $500, will come with a subscription to AOL. Gateway gets a cut of the monthly fee.

Dell executives are the only ones in the industry who show unmitigated enthusiasm about computer hardware. Sure, like everyone else, Dell vice chairman Jim Vanderslice wants to increase sales of services and add-ons--which he's doing, at a 28% annual rate. But Vanderslice is also happy to note that "we're Pac-Manning everybody else in terms of market share." Gloats Michael Dell: "It could be that those other companies are focusing less on product because their product business model doesn't work as well."

At Dell the executives can't stop talking about their skyrocketing return on capital, their $8 billion in cash, and how they're the No. 1 PC company in the U.S. They are completely convinced that their direct-sales approach, which not only produces efficiencies in manufacturing and distribution but also keeps the company in close touch with customers, is a weapon that will help them tackle competitors in new markets, like EMC in storage and Sun in servers. Says Vanderslice: "We've successfully done it with desktops, with mobile PCs, with workstations, and now on servers; ahead of us are storage systems." (For more on Dell, see the preceding story.)

In years gone by, Compaq, Hewlett-Packard, and IBM couldn't come close to matching the efficiency of Dell or Gateway. But all three have radically improved their distribution, manufacturing, and logistics--meaning that Dell's very success has given it stronger competitors. (The PC companies that couldn't adapt? They're gone, like hapless Packard-Bell.) Says Goldberg: "Michael [Dell] has been absolutely brilliant at getting the industry to compete on his best basis for competition--price, delivery, and the ability to configure to order. But now the others can differentiate in ways that matter to the customer."

Another fundamental change from the golden years is the declining power of the lords of Wintel. They still provide the essential hardware and software, but just about every PC company is toying with alternatives. Gateway's AOL device will use the Linux operating system on a processor from upstart chipmaker Transmeta. When users log on they will see not the Windows desktop but customized AOL software. Dell sells servers that run on Linux. Says Michael Dell: "We are very excited about Linux, particularly as an alternative to things like [Sun's] Solaris. Windows 2000 is a far more important product in terms of sales today, but we'll support what our customers want."

This kind of talk had been heresy in the PC business--but then the Department of Justice liberated the boxmakers with its antitrust case against Microsoft. Now executives aren't afraid to openly express their frustration with Microsoft, whose influence was so powerful that they felt locked into software that wasn't necessarily what customers wanted. One reason these companies seem so innovative right now is that they're unleashing customer-oriented features that they were afraid to push before.

This focus on customers will be increasingly important as consumer-electronics companies become bigger players in computing. Sony and Nintendo, for example, are expert at selling easy-to-use products that would be even cooler in fully net-worked homes. Mike Vitelli of Sony, who oversees both PC and consumer electronics operations in the U.S., sees four "gateways into the networked world": the PC, digital television, mobile products like cell phones and Palms, and game machines like Playstation. "We happen to be in all four of those businesses," he says. "Our competitors are in just one or two." Granted, Sony has had limited success so far selling PCs. But if Vitelli's gateway theory is on target, anyone selling devices for any of these gateways could be considered a competitor of the likes of Dell and Gateway. How far could this go? Well, a surprising number of people in the industry now mention Amazon as a potential contender. Like Dell, Amazon has a very close relationship with its customers. Down the road it might even be able to offer them an access device in exchange for their loyalty.

A couple of years ago, the PC makers would not have been ready for a world in which they would have to reckon with competitors from industries as diverse as wireless, videogames, and even books. But now--having restructured, loosened the bonds of Wintel, and launched creative products and services--the PC makers feel optimistic. They even believe that the trends are with them. Says Michael Dell: "Right now there are waves of sales catalysts for 2001--an unprecedented alignment of interest in wireless, new processors and operating systems, and new form factors. All are driving a reason to upgrade."

In the long term, too, there are reasons future sales may surge. The industry's shipments today are divided almost equally among large corporations, small businesses, and consumers. While the corporate market may stagnate, the latter two could grow significantly. No more than 25% of U.S. small businesses are hooked into the Internet. And 50 million U.S. homes still have no PC. Merrill Lynch analyst Steven Fortuna calls that a "wild card" in the industry's future. Then there are Asia and Latin America, where sales are growing much faster than in the U.S. and Europe. While today about 450 million PCs are in use worldwide, by 2005 that number should exceed a billion.

But just which companies will constitute "the industry" in the years ahead is an open question. That's partly why investors are fretting. It seems unlikely that all the top companies will continue to thrive. Of the biggest, IBM has lost the most market share. The company's commercial desktop PC business has bled money for so long that one top official is rumored to have vowed to shave his head if it makes a profit in the fourth quarter, sources say. (IBM refuses to speak to FORTUNE.) IBM's servers and portables do better, but they are marginally profitable, if at all. When Ziff-Davis' Aaron Goldberg looks at IBM's performance, he comes up with this fantasy: IBM stops manufacturing PCs, sells Dell its Thinkpad business, and resells PCs that it buys from Dell. Three years later, the two companies merge. Michael Dell succeeds Lou Gerstner as IBM CEO.

Much safer bets are that Dell will remain a stellar performer in this business and that the stock market will eventually reward Gateway for its creative "beyond the box" strategy. Compaq remains a question mark, though some analysts are predicting a successful turnaround. Merrill's Fortuna recommends buying Gateway and Compaq now as short-term plays, and he's bullish on Dell long term. It does seem unlikely that these stocks can get punished much more. Sure, these companies make a commodity product. But without that commodity product, none of us would have ever known the World Wide Web. And while the industry may never reclaim the fairy-tale power of its past, the survivors of the turmoil of the last few years now seem poised for some thoroughly modern success.

FEEDBACK: dkirkpatrick@fortunemail.com