When Dell Inc. (DELL ) announced disappointing quarterly sales a few months ago, CEO Kevin B. Rollins explained away the problems as an "execution issue." But if investors were worried then, the company's Oct. 31 news that it would miss the mark again this quarter is prompting some to ask a question that once seemed unthinkable: Is the much-feared Dell Way running out of gas?
It could well be. While Dell still dominates PC-related gear sold to corporations, it's stumbling in its efforts to sell to consumers -- a critical growth segment that has helped power brisk PC sales in recent quarters. At the same time, resurgent rivals such as Hewlett-Packard Co. (HPQ ) and Gateway Inc. (GTW ) are pricing their products more aggressively and taking advantage of being in thousands of retail stores -- unlike direct-selling Dell. "Dell traditionally has led with the lowest price," says FTN Midwest Securities Corp. analyst Bill Fearnley Jr. "Now it's not unusual to see even lower price points than Dell's."
The PC maker has always had mixed emotions about how to target consumers. While Dell focused all its guns on the corporate market, it reaped consumer sales opportunistically -- never entering markets where it thought it couldn't achieve its profit goals, and quickly pulling money-losing products. For example, it still hasn't wholeheartedly targeted the vast Chinese consumer market, believing it too costly to court so many far-flung newbie customers.
Such pragmatism is one reason for Dell's past success. Selling one computer to a consumer isn't nearly as profitable as signing a contract to sell thousands of PCs to a corporation. Churning out hits for today's tech-savvy consumers also requires design savvy and the ability to gamble on creating and marketing new features -- both expensive propositions. And selling to consumers means investing in help desks to hold customers' hands when their PCs melt down.
But the limitations of Dell's consumer strategy are becoming clear. The Round Rock (Tex.) company's consumer business is expected to grow only 10% this year, to $8.4 billion, estimates FTN Midwest Securities, down from 13% last year and 18% in 2003. And Dell's stock has fallen from about $40 per share in August to $29. Dell declined to comment, citing the quiet period before its Nov. 10 earnings call.
All this creates a major dilemma. To maintain its status as a hot-growth company -- it grew almost 19% in 2004 -- Dell needs to tap consumer PC demand, which is expected to grow 8.4% next year and 10% in 2007, according to researcher IDC. Meanwhile, the corporate market is projected to grow 5.9% next year and 7.8% in 2007. With revenues expected to hit about $55 billion in the fiscal year ending in January, Dell is now fighting the problem confronting all large, maturing companies: how to keep growing.
Can Dell avoid that fate? It faces an uphill battle in righting its consumer business. At least for now, Dell seems to have run out of cost-cutting efficiencies to enable it to underprice its rivals enough to gain share and maintain earnings at the same time. Analysts expect Rollins to maintain Dell's bottom line even if it means losing customers to lower-priced rivals. The goal: to stem eroding operating margins in its consumer business, which last year fell to 5.2%, from 5.9% in '03.
Dell's rivals, meantime, can accept lower margins without disappointing investors. HP, for example is spending far more on research and development. Gateway, meanwhile, has fought its way back to profitability, despite low prices for its eMachines Inc. brand machines. And Lenovo plans to reenter the retail notebook market, using the IBM (IBM ) ThinkPad it acquired as part of its purchase of IBM's PC business last year.
Dell has two choices, according to Gartner Inc. analyst Charles Smulders: "Follow the consumer market down in pricing and adjust its costs accordingly. Or focus just on [business] products" and sacrifice market share and growth rate for profits. Wall Street will be watching.
By Louise Lee and Peter Burrows