A New Buzz to Fix Dell's Woes

To build cachet among consumers while avoiding the risks of retail sales, the computer maker shouldget thisopen nightclubs

A lot of people are wondering right about now how Dell is going to pull itself out of the drink, particularly in the consumer segment of the PC market. The company gets about 15% of its PC business from consumers, compared with an industry average of about 42%. And the consumer business is hot, a growth rocket these past five years and the main arena for introducing exciting technologies like streaming audio and video.

Dell (DELL) has always made a virtue out of necessity and excels at wrestling concepts and language into a form amenable to its goals. Dell's main avenue to buyers is through direct, rather than retail, sales. A market that Dell dominates—say, U.S. commercial desktops—is one that "gets" the direct model, in Dell's parlance; any market where it's below par represents "an opportunity." By that logic, consumer represents one vast opportunity for Dell.

Retail Realities

Consider where consumers are making their PC purchases. Most consumers buy through retail outlets, and as a channel, retail is gaining steadily on the direct approach. In 2002, retail accounted for 26.8% of all PC shipments worldwide, while direct had a 33.0% share, according to IDC. By the end of 2006, those figures had shifted to 33.2% and 30.3%, respectively.

To explain why this should be so, despite earlier momentum in direct, I'll trot out Wayne's Theory (with a nod to Wayne Inouye, former chief executive officer of eMachines and then Gateway (GTW), who made nearly a religion out of retail and who meditated long and deeply on the wherefores of the resurgence of his favorite channel).

Wayne felt that retail had grown stronger first and foremost because buyers, especially inexperienced ones, like to see and touch the merchandise, particularly if it costs more than groceries. For the same reason, the overall shift in the market to notebooks favored retail. Notebooks are more personal than desktops, and buyers like to check them out up close.

What's more, vendors expert in moving PCs through retail—for example, Hewlett-Packard (HPQ), Gateway, and Acer—figured out that to compete against direct, they couldn't let retailers mark up the goods. However, another fact of retail allowed retailers to sell near cost and still make money: Adding on other goods (e.g., software, peripherals, carry bags) to a PC purchase is common and highly profitable. So, vendors with supply chains as efficient as Dell's could sell PCs for no more than Dell because retailers were foregoing most of their normal 5% markup.

Finally, the advantage previously enjoyed by direct sales—customers not having to pay state sales tax on interstate purchases—diminished when PC prices declined. Saving 5% on a $2,000 box is worth $100, but 5% on a $500 system returns only $25, much less of a motivator.

Off Which Shelf?

Given that Dell must expand its presence in the consumer segment, it really has two main choices: traditional third-party retail, such as Best Buy (BBY) and Circuit City (CC), or "boutique" company stores, such as those run by Apple (AAPL).

The University of Chicago Business School recently published a paper on whether it's better to sell through a boutique or against competitors on retail shelves. In the course of their research, professors Christopher K. Hsee and France Leclerc discovered that if a product is perceived as above average, competitive comparison is detrimental. Think diamond brooch isolated on an expanse of blue velvet. On the other hand, a product perceived as below the mean does better offered against others.

Thus, a guy in Best Buy who notices that eMachines' desktops look about like HP's and have similar specifications, but cost $200 less, will likely opt for the eMachines computer.

So, what'll it be? Boutique like Apple or third-party retail like eMachines? The results of Apple's company stores speak for themselves, but Gateway tried the same thing and got creamed. Why go to the Gateway store for ho-hum products when the selection at Best Buy next door is much broader and the shopper can compare prices? Taking the company-store route requires premium products and a readiness to spend on high-end locations and pricey leasehold improvements, not to mention high fixed costs.

Dell already has two company stores, in Dallas and Nyack, N.Y., and recently said it would open a third in Austin, Tex. Dallas is doing well, Dell says. Nyack opens later this year; Austin after that. The company has not made any public noise about how far it's willing to go with this strategy.

Meanwhile, rumor has it that third-party retailers are interested in Dell's business. But who wants to be the next fool? Selling in U.S. retail is a brutal business, featuring merciless competition, high financial risk, and nanoscale margins. J.T. Wang, CEO of Acer, called U.S. retail a "sick channel" and claims to have lost $3 billion there in the 1990s. It may be an exaggeration, but this channel is no place for the faint of heart.

Dell's Cover Charge

In the final analysis, companies are in retail to get their products in front of buyers. When IBM's (IBM) PC division left retail in 1999, its awareness and sales to consumers shriveled.

So, here's a radical suggestion for raising consumer awareness without abandoning the efficiencies of the direct model: Open high-end nightclubs in the best locations in major-league cities like New York, Los Angeles, London, and Tokyo. That's right, bars—hip, adults-only establishments, complete with velvet ropes, beefy bouncers, and limos idling out front. You get the idea.

Then, outfit tables with Dell computers, monitors, and other gadgets, and run a multimedia floor show at the same time. Charge big bucks for the drinks to discourage punks and build cachet for the brand. Think Studio 54 gone ultra high-tech. No product for sale (how gauche!). But use the venue to showcase sexy products, to associate the Dell name with exclusivity and cool. Generate buzz.

That way, Dell can keep selling direct, avoiding both boutique fixed costs and low-margin retail.

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