(FORTUNE Magazine) – Matt Massengill recalls the precise moment Western Digital hit bottom. It was a late September afternoon in 1999, when technology stocks were surging to all-time highs. Yet his company, a venerable maker of computer disk drives, was coming unhinged. Riding in the rental-car tram at the Minneapolis airport, Massengill, then co-COO, met up with four senior Western Digital executives--"a very grim-looking group of guys," he jokes now--who delivered some devastating news. The company's technicians had discovered a defect in a semiconductor tucked into 400,000 disk drives that had already been shipped to its biggest customers, including Dell, Hewlett-Packard, and Compaq. "We knew by serial number which drives were going to pass and which were going to fail," says Massengill. "We also knew that this could put us out of business."

It nearly did. In the years leading up to the recall, Western Digital had suffered repeated blows in its ultracompetitive market. Disk-drive technology was improving at an astounding rate: Wave upon wave of new drives emerged that could store more and more data at lower and lower costs, on a curve considerably steeper than Moore's law. That was good news for PC companies--and for PC users trying to cram more songs and PowerPoint presentations onto their computers. But it was harrowing for the drivemakers. Plagued by zealous price competition among too many suppliers producing too many disk drives, the industry was squeezing itself dry. Western Digital had tried to protect itself by expanding into new markets, but to no avail.

Now, with the news from his lieutenants, Massengill found his company's flagship product failing. He quickly recalled the drives and replaced them. But the damage was done. In a four-year stretch through mid-2001, Western Digital lost an astounding $1.2 billion on $10.2 billion in sales. Massengill, who became CEO in January 2000, had to fight to save the business--all during the most wildly successful market for technology that ever existed.

Today Western Digital is still bucking the industry. Only this time investors are cheering. While the rest of the tech world is stuck in a two-year funk, Western Digital is soaring. Its stock price is up nearly 20% this year, to a recent $7.50 a share, compared with a 28% drop in the Nasdaq. The company will end 2002 with what analysts expect to be its fifth consecutive profitable quarter. And while desktop computers remain the destination for about 90% of Western Digital's drives, it has broadened its customer base to include such products of the future as Microsoft's Xbox and TiVo's personal video recorder.

This isn't just some Rocky III, back-from-the-brink tale. Western Digital's travails offer lessons for just about every tech company. Since the birth of the PC, the industry has feared one trend more than any other: commoditization. "A commodity used to be something like corn," explains Margaret Graham, a professor of strategy and business historian at McGill University. "Our definition has changed." Now commoditization refers to the inexorable tendency of technology to make products nearly indistinguishable, driving down prices and driving out companies. It follows a predictable pattern: A new market forms, scores of venture-backed companies are created, customers insist on standards so they can integrate the new technology into their products, and soon all the companies are fighting for market share by cutting prices. According to the Gartner research firm, 62 companies supplied disk drives in 1988; fewer than ten exist now.

Today the force of commoditization is making itself felt in new areas. In 2000 alone, VCs invested $767 million into 51 security-software companies, according to Venture Economics. Ninety-three fiber-optic companies raised $2.9 billion that year. And 273 companies making data-communications gear raised $8.3 billion. The economic downturn has accelerated the inevitable shakeout. "This is creative destruction at its best," says Graham. She argues that Western Digital, through its long-standing relationships with customers, huge existing investments, and technical know-how, shows one way that a potential victim of commoditization can survive.

The disk-drive industry is hardly the most glamorous, and Western Digital is far from sexy. But its story offers a glimmer of hope for businesses and investors in the still-devastated technology landscape.

As a 17-year veteran of Western Digital, Matt Massengill has had plenty of time to watch the company flirt with disaster. Western Digital started life in 1970 as a semiconductor manufacturer formed by defectors from Rockwell International. In the 1980s it moved into developing chips for disk drives, and by the 1990s it had become a leading maker of the drives themselves. It also developed the bad habit of scrambling impulsively into hot new areas as they emerged. For instance, when desktop PC growth appeared to be slowing, Western Digital started producing high-margin, lower-volume specialized drives for use in servers and other back-end computers. The company's rationale was to avoid commoditization by staying one step ahead of the trend. Instead the move just drained resources. "Western Digital, throughout its history, has gone in and out like a breathing exercise," says John Monroe, a San Jose-based drive-industry analyst for Gartner. Meanwhile, rivals like Seagate and Conner Peripherals made matters worse by seemingly chasing market share over profits.

The winners of this gladiatorial competition? The PC makers, which kept winding up with cheaper, better drives. Between 1994 and 1999 the price of drives had dropped by 45%. And by 1999 the five major drive companies were churning out more drives than the PC industry could handle. Western Digital was already facing fast-dropping revenues and increased competition when its product failure hit.

So Massengill put a plan in place to kick Western Digital's habit. Instead of running from commoditization, he embraced it. Western Digital from now on would concentrate on doing what it did best: making standard-issue disk drives. But he couldn't do it without inflicting pain.

Beginning in early 2000, Massengill began slashing costs. "This wasn't trimming," he says. Days after becoming CEO, he flew to Minnesota in a blizzard to tell the employees at the company's high-end drive business that their unit was being shuttered. He closed two factories in Singapore and centered the company's efforts on a more efficient plant in Malaysia. Operating expenses quickly fell from more than $80 million a quarter to below $50 million. There was traditional belt tightening as well: Massengill eliminated bonuses for senior managers and moved the company from a glitzy high-rise office building in Irvine into a two-story concrete complex in nearby Lake Forest.

To further refocus the company, he killed off its four new-business initiatives, which were producing everything from software to a system for storing video images. In all, Western Digital had invested $100 million in those units; it recouped about $40 million by selling them piecemeal. The company's R&D lab, under the guidance of former Seagate chief technologist Hossein Moghadam, started focusing on how to accommodate its standard drives for any new box that might come out. That's how Western Digital drives made their way into Microsoft's Xbox. Western Digital would continue researching new drives but deploy them only when the market was ripe. The company still doesn't make drives for laptops, for example; the investment just isn't worth it. Massengill says it'll be ready to do so when the market is big enough. "There's nothing technologically that's keeping us from it," says Moghadam.

Commoditization was squeezing Western Digital's competitors as well. In early 2000 private investors led by buyout firms Integral Capital Partners and Texas Pacific Group took Seagate private (they took it public again in December 2002). Later that year Maxtor agreed to buy Quantum, effectively shrinking the industry by one major player. Companies like Dell suddenly found that the days of pitting drive firms against each other were ending.

By 2001, Massengill's plan finally seemed to be paying off. In the last quarter of that year Western Digital turned profitable, and for the first three quarters of 2002 it has earned $54.6 million on sales of $1.7 billion. The numbers might not seem all that impressive: Analysts hardly start drooling when 3% net margins pop up on their spreadsheets. But the stable profitability the figures represent is the real key. In a commodity business--assuming there are significant barriers to entry, which there are in the capital-intensive drive business--survivors generally make solid, if unspectacular, money. "Technology is a basic industry manufacturing basic products," says Cabot Brown, a partner at Seven Hills Group, a tech-focused investment bank in San Francisco. "People sometimes get infatuated with the glory of technology and forget that."

It'd be foolish, of course, to think that any company so recently recovered from a near-terminal illness is now risk-free. An Xbox flop or the continued slowing of growth in PCs, for example, could halt Western Digital's nascent recovery. The company's slim margins and lean operations could turn one potential slip-up into a major setback. Another potential weakness is Western Digital's reliance on outside suppliers. Unlike industry leader Seagate, which makes all the components that go into its drives, Western Digital counts on suppliers for its parts. That puts it at risk of falling behind when technology changes or being unable to fill demand if the suppliers falter. CEO Massengill dismisses such concerns, estimating that Western Digital's component suppliers spend far more on R&D than Seagate does.

But for now Massengill is basking in Western Digital's newfound success and reflecting on what easily could serve as a prescription for every other tech concern in crisis. "Things will always go bad," he says. "You have to put yourself in a position to break even in a sustained downturn. Then, when the downturn ends, you're going to make a lot of money. There's a benefit to having nearly died." Having to look for the bright side of a near-death experience is certainly sobering for technology executives, not to mention investors. But these are sober times in tech land. The revival of a disk-drive company may be, for the time being, about as good as it gets.

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