Dell's Revival
the phone or online, cutting out the
Strategy Runs
Into Trouble
By Justin Scheck
Nov. 28, 2008 12:01 am ET
Michael Dell's plan to fix the
company he founded, Dell Inc. once
the biggest personal-computer maker in
the world -- is stalling.
Dell reported falling revenue and
shrinking profits last week for its most
recent quarter. And while profit
margins grew, the gains resulted from
painful cost cuts, including massive
layoffs and decisions not to invest in
launching products like portable music
players and cellphones -- the kinds of
gadgets Mr. Dell had described
previously as building "brand lust."
By contrast, Dell's main
rival, Hewlett-
Packard Co. HPQ 1.69% , on
Monday announced increased
quarterly sales and a 10% jump in
PC revenue from last year.
Mr. Dell, who famously founded his
company in a University of Texas dorm
room, once ruled the PC market with a
simple strategy: Build reliable desktop
PCs, and sell directly to customers over
middleman.
When he left Dell in 2004, it sold more
PCs in the U.S. than its four closest
rivals combined, according to the
analysis firm Gartner. Back then, H-P
was struggling in second place.
Now the tables are turned. Dell's core
business of selling desktop PCs directly
to companies keeps slowing, and it has
lagged behind H-P and others in
adapting to the growing popularity of
consumer laptops -- which people
would rather buy in stores, where they
can try them out.
Dell's challenges are testament to the
rapidly changing global gadget
business. The rise of notebooks, tiny
"netbooks" and smartphones such as
Apple's iPhone is forcing PC makers to
rethink the very definition of a
"personal computer."
At the same time, Dell has lost its
low-cost edge as its rivals shifted to
using Asian factories-for-hire to
build their wares. Today, many of
Dell's own factories, such as one in
North Carolina that's only about
three years old, can no longer
compete on cost.
Dell is trying to sell off some plants.
But in October, tech-industry
analysis firm iSuppli suggested that
Dell may actually have to pay other
companies to take them.
In an interview earlier this year, Mr.
Dell acknowledged the frustration with
the slow pace of his turnaround.
"Everything takes longer than I've
expected, than I'd like it to take," he
said.
Mr. Dell has made some significant
progress. Despite recent weak sales, the
company's operating profit is up thanks
to a nearly two-year cost-cutting effort.
That resulted in higher profit margins
than last year, beating analysts'
earnings predictions. Dell has almost
10,000 fewer employees than a year
ago.
Dell has also released more new
products this year than in past years,
and has boosted sales and profits in its
consumer division -- the fastest-
growing segment of the PC market, and
historically a Dell weak spot.
Its quarterly earnings per share of 37
cents beat analysts' estimate of 31
cents. The company's expenses were
down 11% from last year.
Dell shares have bounced back in
recent days, but are still trading at
about $11, down from a 52-week high
of more than $28.
A Dell spokesman referred questions
about its turnaround plan to statements
made during last week's earnings
conference call. During that call, Mr.
Dell and the company's chief finance
officer, Brian Gladden, pointed out that
Dell has succeeded in making
international sales, as well as higher-
profit items like corporate server
computers, a bigger part of revenue.
The two also blamed sales declines on
the weak economy, which is slamming
the entire tech industry. In recent
weeks, H-P and Cisco
Systems Inc. CSCO 1.89% have
announced cost cuts.
Mr. Dell, 43, returned to the
company as chief executive in early
2007 with a two-pronged rescue
plan: Cut costs in the thin-profit PC
business, and invest in new areas,
including not only music players
and new portable devices, but also
"business services" such as running
corporate in-house networks.
Now, Mr. Dell's dual aims -- cutting at
the low end, while pushing new high-
end gear and services -- are in conflict.
Dell's slim profit margins make it tough
to invest heavily in R&D even in good
times.
A Dell spokesman says that investing
in new products and slashing costs
"aren't mutually exclusive."
The impact of the economic downturn
is particularly clear in corporate sales,
Dell's single biggest business, which
generated about 80% percent of
revenue the past year. After posting
annual unit increases of 12% or more
each quarter for the past year,
commercial shipments dropped 5% in
the most recent quarter, and revenue
declined 6%. For years, commercial
PCs had been a reliable growth source
for the industry.
Partly due to the weakening tech
market, Dell this fall killed plans to sell
a portable music player, even though it
was already testing prototypes, say
people familiar with the matter. It's also
backing away from tentative plans to
design a mobile phone, say people
briefed on the business.
A spokesman declined to comment on
Dell's phone plans. Earlier this year,
Mr. Dell said the company continues to
consider the phone business, but has no
imminent plans to enter it.
In its heyday, Dell boasted industry-
leading profit margins and assembly
system so efficient that it was the
subject of scholarly papers. Dell today
is in a "squeeze play," says Paul
Argenti, a professor at Dartmouth
College's Tuck School of Business who
has studied the company.
On one side are low-cost Asian PC
makers, while at the other is Apple,
which commands premium prices that
help fund R&D. But while the
challenges are formidable, Mr. Dell is
"enormously talented" and is capable of
formulating a new strategy, Mr.
Argenti said.
Mr. Dell, who remained chairman
during his three years away from the
CEO's office, stays closely connected
with product development. He fires off
late-night e-mails asking about
individual components in new PCs,
colleagues say. And Mr. Dell says he
routinely dismantles rivals' PCs in a
room in his Austin, Texas, home.
H-P has a significant advantage over
Dell. Its highly profitable printer
business and business-services division
are far bigger than Dell's. This has
helped insulate H-P from PC-market
weakness. PCs are about 35% of H-P's
revenue; they're about 60% of Dell's.
H-P has continued to beat Dell in PC
sales. Last month, analysis firm IDC
reported that H-P remained the world's
largest PC maker in this year's third
quarter. Its shipments increased 14.9%
compared to the year-earlier period.
Dell increased shipments only 11.4%.
On Monday, H-P announced a gain in
quarterly revenue.
Dell's disadvantage is magnified by
falling PC prices. For the quarter ended
Aug. 1, it reported a 17% annual drop
in profits largely because a European
division cut prices to chase large
corporate deals, said a person familiar
with the matter.
In the recent earnings call, Mr. Dell
said the company has decided to keep
profit margins up, rather than lower
prices to spur growth.
Dell's fortunes looked much better four
years ago, when Mr. Dell left the CEO
post. The low-cost business model of
selling PCs directly to customers had
propelled 2004 sales above $40 billion.
But growth stalled in 2006.
A big factor: H-P found Dell's weak
spot by focusing its sales on retail
stores, where Dell had no presence.
Mr. Dell took back the reins from then-
CEO Kevin Rollins in early 2007,
pronouncing his old business model
dead. After his return, he announced
the company would start selling in
stores.
Today, Dell needs to worry about retail
sales cannibalizing its higher-profit
direct sales. An executive at Best
Buy Co. BBY 1.92% said recently in
an interview that it expects its sales of
Dell PCs to take away from Dell's
direct sales.
Dell doesn't report retail profits, but
profit margins there remain slim,
analysts say.
A Dell spokesman said that "retail has
actually enhanced the online business,"
since it has raised Dell's profile with
consumers.
Mr. Dell also focused on the consumer-
laptop business, which by that time
suffered from a troubled reputation. For
instance, tech blogs had a field day
after Dell and a few other
manufacturers' notebooks caught fire
due to battery problems. Dell recalled
the faulty batteries, which it hadn't
manufactured.
Mr. Dell hired top executives from
outside the company to push into new
markets and cut costs. Mobile
technology was also to be a promising
new foray, since smartphones have
recently been a sweet spot of computer
growth.
Mr. Dell brought in Motorola Inc.
veteran Ron Garriques to run the new
consumer division. "The phone is a
very different animal for us," said Tim
Mattox, Dell's strategy chief, in an
interview earlier this year. "It's one of
the reasons we brought in Ron."
Mr. Garriques set up a Chicago office,
hiring ex-Motorola employees to
develop portable devices, including
mini-notebook PCs. In August 2007,
Dell acquired Zing Inc., a company
founded by an Apple veteran that
develops portable music players and
software. Dell said it planned to release
a Zing music player this year, along
with Zing software.
Mr. Dell paid close attention to the
consumer division. "I'll come down
from a meeting, and he'll be in my
cubicle," Mr. Garriques said in an
interview earlier this year. "Michael
knows no boundaries."
Early this year, Dell executives
discussed entering the phone market in
2009, said people briefed on the matter.
But it has held back due to cost and the
uncertain market, they say.
A Dell spokesman declined to
comment on the company's phone
plans.
Dell has pushed into the hot market for
netbooks -- small, low-power laptops
designed mainly for internet access.
However, netbooks have thin profit
margins and sell for as little as $350.
Meanwhile, H-P this year introduced a
line of two consumer-oriented
smartphones in Europe. It also beat
Dell into the netbook market.
Dell's biggest transformation may be in
manufacturing, which was narrowly
tailored to its original direct-sales
strategy. The company eschewed
inventory, and its famously efficient
factories quickly assembled build-to-
order PCs. Plants were often located in
local markets to speed up delivery
times.
But Dell stuck to that approach too
long, opening new plants in the U.S.
while rivals like Apple and H-P shifted
to Asia.

At a conference in Switzerland early

last year, Mr. Dell approached Mike
Cannon, a former CEO of a contract
manufacturer. On a plane back to the
U.S., Mr. Dell told Mr. Cannon that
Dell "needs a lot of help," Mr. Cannon
recalled earlier this year. Shortly after,
he was hired as Dell's operations chief.

Mr. Cannon soon began efforts to

outsource Dell's manufacturing to Asia
and to start the process of selling off
factories.

On a conference call with analysts

Thursday, Mr. Dell said his leadership
team has laid "important foundations
that position us to be a stronger and
more nimble company."