Dell: Burned by a Fire Sale

The world's biggest computer maker got singed last quarter by selling machines at bargain-basement prices -- and the pain may not be over

In recent weeks, Dell has held a virtual fire sale, offering many PCs at rock-bottom prices. That may be a bonanza for the tightwad consumer, but the super-low pricing once again is taking its toll on the world's largest computer seller.

On May 8, Dell (DELL) said it would post fiscal first-quarter revenue of $14.2 billion, at the low end of its earlier projection of $14.2 billion to $14.6 billion. Worse, Dell said it expects earnings of about 33 cents a share, falling short of a projected range of 36 cents to 38 cents, including an estimated three cents of stock-based compensation. The announcement sent shares down by almost 6% in extended trading.

Dell blamed the shortfall on the aggressive pricing it offered in the second half of the quarter, when it sold, for example, some Inspiron consumer notebooks for less than $600. Currently, Dell's Web site is laden with price promotions, such as: "Don't Miss Out -- Up to 1/3 Off Instantly" on some notebook machines.


  The earnings warning is the latest in a year-long string of financial disappointments for the Round Rock (Tex.) company. Just two years ago, Dell was posting quarterly sales growth rates of more than 18%. By contrast, the current $14.2 billion projection represents a growth rate of only 6% over the year-ago level.

And analysts don't believe Dell's strategy of bargain-basement pricing will change any time soon. "We expect more of the same, limiting the near-term upside in margins and profits," says Brent Bracelin, analyst at Pacific Crest Securities. Additionally, Dell is spending heavily to bulk up its technical-support and customer-service operations. For instance, it's hiring more workers at call centers. While that spending may help attract and retain customers over the long run, it's also eating into Dell's bottom line.

Dell says the pricing strategy will help boost future revenue growth. During the quarter, "we continued to execute on our strategy to reinvigorate growth by making investments in our support infrastructure and product quality and by accelerating pricing adjustments," Dell CEO Kevin Rollins said in a statement. A Dell spokesman said the company wouldn't comment further until it announces quarterly earnings on May 18.


  The trouble for Dell is that unit volumes aren't compensating for price reductions. Besides hurting Dell's sales and profit, sluggish unit growth is also eroding market share, another key measure of overall health. In the calendar first quarter, Dell's share slipped for the first time in memory, analysts said. According to market researcher IDC, Dell's worldwide share of the PC market fell to 18.1% from 18.6%, and in the U.S., share fell to 32.3% from 33.9%.

Dell's key rivals, including Hewlett-Packard (HPQ) and Acer, meanwhile, saw market shares increase, according to IDC. The gains reflect competitors' growing appeal as they're increasingly able to match or even beat Dell's prices to steal sales. "Those companies have gotten more price-competitive," says Cindy Shaw, analyst at Moors & Cabot Capital Markets. "Dell doesn't have the price advantage any more."

Nor does the company appear to have a consistent pricing strategy. Last year, it missed sales projections in the second and third fiscal quarters, partly due to cutting prices too much.


  So Dell vowed to break out of the low-price trap by bulking up its selection of mid-range and high-end machines to balance out its offerings (see BW Online, 09/23/05, "Will Dell's Up-Market Move Compute?"). While analysts say that Dell is selling many of its high-end XPS machines, those sales aren't sufficient, and Dell is still being forced to cut prices.

And compared with some of the competition, in particular Apple Computer's (AAPL) machines, Dell's products simply don't stand out, further eroding its appeal to customers. While Dell's computers are mostly still plain, neutral-colored boxes, "when you look at an Apple Mac, you want to touch it and bring it home," says Shaw. Dell's big challenge now is getting more shoppers to swoon over its products before its longtime domination over the PC industry slips away more.

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