Dell Outfoxes Its Rivals

But a new focus on PC margins may take heat off the competition

Aug. 12 couldn't have played out more differently for PC giants Hewlett-Packard Co. (HPQ ) and Dell Inc. (DELL ). Early that day, HP stunned the market by missing quarterly earnings estimates and lowering its outlook for the rest of the year. Later that day, Dell hit its profit targets and delivered a sunny forecast for the quarter.

Dell has outfoxed HP before, but this time it's using different tactics. After three years of slashing prices to grab PC market share, Dell is backing away from the industry's bloodiest price wars in a bid to goose its profits. Since July, the company has raised prices as much as 13% on some desktops, including its low-end ones, and held pricing firm on most others, according to researcher Current Analysis Inc.

If Dell stays the course, could this mark a significant shift in PC pricing after years of downward pressure? Most experts say that's unlikely since Dell's rivals are locked in a brutal battle at the bottom of the market and in no position to raise prices. Budget-price PCs, says Chuck May, vice-president of desktops for Gateway, "are critical for driving sales."

But whatever its rivals do, Dell's shift is already helping the bottom line. While raising prices has slowed sales growth -- second-quarter unit shipments were up just 19%, the slowest rate in more than a year -- revenues rose 20%, to $11.7 billion, while net income soared to $799 million.

Those meatier profits are helping to separate Dell from the pack even as worries about the strength of the tech spending recovery mount. On Aug. 25, the Commerce Dept. reported that new orders for PCs and related products fell 6.7% in July. As a result, the rest of the industry likely will keep chasing low-end sales to keep volumes high. "Dell doesn't wait around as long as its competitors when there's weakness in a market," says First Albany Capital Inc. analyst Joel Wagonfeld.


Dell has promised 15% annual revenue growth over the next few years so its stepped-up focus on profits is not without risk. As it moves away from the bottom of the market, it will have to ensure it replaces those sales with other products, including servers, printers, and data storage gear. So far, it's working: Sure, profits from consumer sales in the U.S., which account for 13% of revenues, fell 3% in the second quarter. But earnings from sales of more profitable equipment to businesses, which bring in 55% of revenues overall, grew 20%.

Why the tactical shift? Dell Chief Executive Kevin B. Rollins began to fret when gross margins fell slightly, to 18%, from 18.2% in the fiscal first quarter. Dell was pricing too aggressively, he says, given that costs of key components such as memory chips and flat-panel displays were spiking. "In that environment," he told BusinessWeek, "you get a bit of a margin squeeze."

The company, which sells directly to customers over the phone and Internet, acted quickly. It moderated its pricing in markets where it thought there was a risk of losing money. One such niche was low-end consumer PCs, where desktops have dropped to $299 and notebooks to $699. Dell also cut the standard warranty of its lowest-priced consumer PC from one year to just 90 days. Dell is being similarly pragmatic in China, where it is leaving the low end of the consumer market mostly to local makers, while focusing on higher-margin goods, such as servers.

Dell's rivals are far more constrained. HP, for one, needs consumer PC sales to drive sales of printers, ink cartridges, and digital cameras, which bring much higher profits. And it dare not raise prices lest it lose market share to such aggressive players as eMachines and Acer. Sam Szteinbaum, HP's general manager for consumer PCs in North America, says "we need to ensure we are competitive" in all PC categories -- even low-end boxes.

Dell's fatter PC profits should give it room to keep the heat on HP in printers, servers, and storage gear. The company is readying its first color laser printer, a key area of strength for HP. "We're not backing off," says Rollins. Given Dell's history, you can bank on that.

By Andrew Park, with Lauren Young in New York, and bureau reports

    Before it's here, it's on the Bloomberg Terminal.