Dell Computer Goes Into The Shop

For the legions of competitors that Dell Computer Corp. singed as it streaked to No.4 in the personal-computer business, this is the moment they have been waiting for. The Austin (Tex.) company has seen margins shrink, withdrawn a secondary stock offering because of Wall Street's lack of interest, and killed off a line of ill-conceived notebook computers. Following a 48% decline in earnings in the first quarter, it has warned investors that profits will not match last year's levels for at least two more quarters. Its stock has plummeted from 49 in January to less than 20 in June.

Is the law of gravity finally catching hold of Dell? No way, insists Michael S. Dell, the 28-year-old CEO. "It's not the crime of the century," he says. "It's just physics. We grew 285% in two years, and we're having some growing pains."

DEBT AND CREDIT. So far, the pain isn't crippling. But Dell has seen the writing on the wall--and it's scary. Its low-cost approach to everything--from renting office space to assembling PCs--is beginning to wear thin. Doing things on the cheap enabled Dell to undercut such rivals as Compaq Computer Corp. and IBM, but it can't keep up with the needs of a $2 billion, 5,600-employee company that sells PCs in 95 countries. And its tightfisted style is sorely inadequate for the changes Dell is planning, including bringing more assembly in-house and moving beyond 800-number sales and discount stores to the computer dealers and systems integrators.

So in a matter of months, Dell is scrambling to put in place the kinds of systems and management controls that usually take years to develop. Michael Dell says he is hiring new managers, creating new organizations, and building the new facilities that will give the company the infrastructure to take Dell to $10 billion in sales.

Sounds good, but all of this takes money, and that's in short supply. Closed out of the public-equity market, Dell is meeting its cash needs through a costly combination of debt and credit. And it can't wait for Wall Street to warm up to a new stock issue. "They've been starving infrastructure," says Eckhard Pfeiffer, CEO of archrival Compaq Computer Corp. "They have to open up the purse and say, 'spend, spend, spend' until they have it fixed," he says.

TOP TALENT. Michael Dell is already spending. In the past few months, he has hired a crew of new managers (table, page 140), doubled the budget for internal information systems to link every Dell operation, and sketched plans to build new assembly plants around the world. But the basic thrust remains the same: to increase U.S. market share rapidly from today's 4.1% to as much as 18%. He won't say when he can hit that goal, but he says boosting market share is the best way to ensure survival in a rapidly consolidating industry. "The model is fine," says Dell. "Was it a good strategy to hit the fast-forward button? My answer is yes. Could we have planned better? Sure."

To fix that, Dell is counting on new managers with big-company experience. Since November, he has rebuilt his management with four new top executives and about 10 high-level managers. The list includes three Compaq veterans who helped create that company's Dell-bashing ProLinea line. Dell also has added three new outside board members and says he will hire more than a dozen "impact players" in coming weeks. Overall, the hiring binge, which added 1,700 employees last year, is slowing. Dell will soon add just 10 or 15 employees a week instead of 65, says Chief Financial Officer Thomas J. Meredith, who arrived in November from Sun Microsystems Inc.

The new executives are busy redesigning many of the company's key processes, from product development to shipping. For example, L. Scott Flaig, a former Ernst & Young consultant who was hired as senior vice-president for worldwide operations in December, says his goal is to improve manufacturing productivity by 25% by yearend.

Nice goal if you can make it. But while Dell strives for efficiency, it is also pursuing the CEO's growth goals. To grow 50% this year, to $3 billion in revenues, the company needs to boost shipments--while keeping a tight grip on costs. And it already has little wiggle room. Since last year, when first Compaq, then IBM began chasing it with low-cost models, Dell's net margins have slipped. In the latest quarter, Dell took a $20 million charge after John K. Medica, the new vice-president for portable products, killed off a planned line of notebooks. That dropped net margin to 1.5%. Even before the write-down, however, margins were below Dell's target of 5%. Meanwhile, Compaq, despite dropping prices to Dell's range, still manages a 6.4% net margin.

Shrinking margins could choke off earnings and crimp Dell's expansion plans. Analysts say it has enough cash and credit to last at least another year, but many wonder if the company has the resources it needs to keep pace, should the battle for market share intensify. To bolster finances, CFO Meredith has launched a three-part financial strategy to improve cash flow and raise funds. First, Dell has cut interest expense by reducing its credit line from $175 million to $130 million. Then, in late June, it sold $100 million worth of receivables. Part three: The company is talking to banks about private debt placements.

The new funds may be spoken for. Operating expenses, as a percentage of sales, will rise over the next two quarters as the company builds up its infrastructure, says Flaig. He already has been investing money to beef up some critical processes that have been done the same way since the company was small. Take logistics. Dell assembles most of its computers from a range of parts from suppliers around the world. It uses 20 air-freight carriers to deliver these wares to its Austin headquarters. From there, the parts are redistributed around the world for final assembly. That will change this summer, when the company chooses one carrier each for Europe, Asia, and the U.S. to stock regional staging depots. This should save $10 million a year, says Flaig.

NEW PLANTS. To make distribution more efficient, Dell is putting plants into new growth regions such as Mexico and Japan. Dell is particularly eager to beef up its presence in Japan. Since entering the Japanese market last fall, the company has had trouble meeting a torrent of orders. And Dell is attempting to create more demand in Japan: On June 28, it cut prices by 9% to 23%.

In addition, Dell is also scouring Malaysia and Singapore for a location to build a 50,000-square-foot factory by 1994. More proof, says CFO Meredith, that Dell is not retreating. "You don't make these kinds of investments unless you intend to become a dominant player."

But Dell faces some immediate problems--such as filling the gaping hole where its notebook PC business used to be. Medica, who joined in March, had been a key player in building Apple Computer Inc.'s PowerBook notebook computers into a $1 billion business. He took one look at a new series of notebook models on Dell's drawing boards and realized that by the time the company could get them on the market, they would not be competitive.

Now, Medica is working on getting Dell back in the fast-growing notebook game. Because of its lackluster lineup--it never fielded a notebook using Intel's 486 microprocessor, for example--Dell's notebook sales represented only 6% of Dell revenue for the first quarter, ended May 2. Other PC makers get 20% of revenues from notebooks, and for Compaq they're 30% of the business. So Medica is considering a range of options, from designing a new product in-house to selling another company's machines. A Japanese industry insider says Dell is about to sign Sony Corp. to build new notebooks, replacing the Taiwanese supplier it used before. Dell denies it has tapped Sony, while Sony declines to comment.

"AVOWED ENEMY." Meanwhile, back in marketing, Dell is looking for new channels through which to move its products. For most of its nine-year history, Dell has ridiculed computer dealers as overpriced middlemen. Now, it realizes that to hit its growth goals, it can leave no channel untapped. It has been selling through mass-merchandise retailers for several years and recently added such chains as Wal-Mart Stores, Sam's Club, and Price Club.

But snaring traditional dealers won't be easy. These stores still sell almost 40% mf the PCs shipped in the U.S., and they are skeptical of Dell's overtures. "From Day One, Dell has been the avowed enemy of the dealer channel," says Avery More, president of Compucom Systems Inc. in Dallas. "It's one thing to burn your bridges behind you. It's another to burn them in front of you." Besides, these days there are few compelling reasons for dealers to carry Dell. Its products differ little from its rivals', and if it keeps prices low--which it must do to compete with IBM and Compaq--it's hard to figure how Dell can offer dealers a profit.

One thing Dell can rely on: the continued and supreme confidence of its leader. "We don't have declining revenues, bloated inventories, or any of the signs of a sick company. These are not blow-up-the-company issues," says Michael Dell. Or as Dell President Joel J. Kocher puts it: "We grew 85% in the first quarter and have yet to taste red ink. I refuse to apologize for 85% growth."

All those new hires must be hoping there won't be any need for apologies.

FILLING THE CHAIRS:
      DELL EXECUTIVES HIRED SINCE OCTOBER
      
      Title at Dell/Previous job
      THOMAS J. MEREDITH
      Chief Financial Officer
      Sun Microsystems Treasurer
      L. SCOTT FLAIG
      Senior VP, Worldwide Operations 
      Ernst & Young consultant
      THOMAS L. THOMAS
      Chief Information Officer
      Kraft Commercial Products CIO
      ERIC HARSLEM
      Senior VP, Product Group
      Apple VP, Macintosh
      Desktop Div.
         JOHN K. MEDICA
      VP, Portable Products
      Apple Senior Director, Portables
      STEPHEN C. MARTSON
      VP, Worldwide Procurement
      AMP Purchasing Manager
      CHRIS GOPAL 
      VP, Operations
      Ernst & Young consultant
      Title at Dell/Previous job
      DENNIS PASSOVOY
      VP, Advanced Systems, Dell USA
      Evernet Systems
      VP, Technical Services
      CHUCK CHESHIRE
      Corporate Director, Quality
      Private consultant
      KEVIN O'CONNOR
      Director, Human Resources
      Frito-Lay Human Resources Mgr.
         SEAN BURKE
      Director, Product Marketing
      Compaq Head of
      ProLinea Marketing
      JOHN THOMPSON
      Director, Portable Products
      Compaq Head of
      ProLinea Development
      KEITH MAXWELL
      Director, Portable Engineering
      Compaq Head of 
      ProLinea Operations
      DATA: DELL COMPUTER