Dell's Revival Strategy Runs Into Trouble

Article
Stock Quotes Comments

MORE IN TECH smaller Larger

facebook twitter linked in in Share 0

Email Print Save More smallerLarger By JUSTIN SCHECK

Michael Dell's plan to fix the company he founded, Dell Inc. DELL -1.23%-- once the biggest personal-computer maker in the world -- is stalling. Dell reported falling revenue and shrinking profits last week for its most recent quarter. And while profit margins grew, the gains resulted from painful cost cuts, including massive layoffs and decisions not to invest in launching products like portable music players and cellphones -- the kinds of gadgets Mr. Dell had described previously as building "brand lust." Enlarge Image

Close

Associated Press Dell CEO Michael Dell smiles at Oracle Open World conference in San Francisco last year By contrast, Dell's main rival, Hewlett-Packard Co., HPQ -6.45%on Monday announced increased quarterly sales and a 10% jump in PC revenue from last year. Mr. Dell, who famously founded his company in a University of Texas dorm room, once ruled the PC market with a simple strategy: Build reliable desktop PCs, and sell directly to customers over the phone or online, cutting out the middleman. When he left Dell in 2004, it sold more PCs in the U.S. than its four closest rivals combined, according to the analysis firm Gartner. Back then, H-P was struggling in second place. Now the tables are turned. Dell's core business of selling desktop PCs directly to companies keeps slowing, and it has lagged behind HP and others in adapting to the growing popularity of consumer laptops -- which people would rather buy in stores, where they can try them out. Dell's challenges are testament to the rapidly changing global gadget business. The rise of notebooks, tiny "netbooks" and smartphones such as Apple's iPhone is forcing PC makers to rethink the very definition of a "personal computer."

At the same time, Dell has lost its low-cost edge as its rivals shifted to using Asian factories-for-hire to build their wares. Today, many of Dell's own factories, such as one in North Carolina that's only about three years old, can no longer compete on cost. Dell is trying to sell off some plants. But in October, tech-industry analysis firm iSuppli suggested that Dell may actually have to pay other companies to take them. In an interview earlier this year, Mr. Dell acknowledged the frustration with the slow pace of his turnaround. "Everything takes longer than I've expected, than I'd like it to take," he said. Mr. Dell has made some significant progress. Despite recent weak sales, the company's operating profit is up thanks to a nearly twoyear cost-cutting effort. That resulted in higher profit margins than last year, beating analysts' earnings predictions. Dell has almost 10,000 fewer employees than a year ago. Dell has also released more new products this year than in past years, and has boosted sales and profits in its consumer division -- the fastest-growing segment of the PC market, and historically a Dell weak spot. Its quarterly earnings per share of 37 cents beat analysts' estimate of 31 cents. The company's expenses were down 11% from last year. Dell shares have bounced back in recent days, but are still trading at about $11, down from a 52-week high of more than $28.

A Dell spokesman referred questions about its turnaround plan to statements made during last week's earnings conference call. During that call, Mr. Dell and the company's chief finance officer, Brian Gladden, pointed out that Dell has succeeded in making international sales, as well as higher-profit items like corporate server computers, a bigger part of revenue. The two also blamed sales declines on the weak economy, which is slamming the entire tech industry. In recent weeks, H-P and Cisco Systems Inc. CSCO +1.00%have announced cost cuts. Mr. Dell, 43, returned to the company as chief executive in early 2007 with a two-pronged rescue plan: Cut costs in the thin-profit PC business, and invest in new areas, including not only music players and new portable devices, but also "business services" such as running corporate in-house networks. Now, Mr. Dell's dual aims -- cutting at the low end, while pushing new high-end gear and services -- are in conflict. Dell's slim profit margins make it tough to invest heavily in R&D even in good times. A Dell spokesman says that investing in new products and slashing costs "aren't mutually exclusive." The impact of the economic downturn is particularly clear in corporate sales, Dell's single biggest business, which generated about 80% percent of revenue the past year. After posting annual unit increases of 12% or more each quarter for the past year, commercial shipments dropped 5% in the most recent quarter, and revenue declined 6%. For years, commercial PCs had been a reliable growth source for the industry.

Partly due to the weakening tech market, Dell this fall killed plans to sell a portable music player, even though it was already testing prototypes, say people familiar with the matter. It's also backing away from tentative plans to design a mobile phone, say people briefed on the business. A spokesman declined to comment on Dell's phone plans. Earlier this year, Mr. Dell said the company continues to consider the phone business, but has no imminent plans to enter it. In its heyday, Dell boasted industry-leading profit margins and assembly system so efficient that it was the subject of scholarly papers. Dell today is in a "squeeze play," says Paul Argenti, a professor at Dartmouth College's Tuck School of Business who has studied the company. On one side are low-cost Asian PC makers, while at the other is Apple, which commands premium prices that help fund R&D. But while the challenges are formidable, Mr. Dell is "enormously talented" and is capable of formulating a new strategy, Mr. Argenti said. Mr. Dell, who remained chairman during his three years away from the CEO's office, stays closely connected with product development. He fires off late-night e-mails asking about individual components in new PCs, colleagues say. And Mr. Dell says he routinely dismantles rivals' PCs in a room in his Austin, Texas, home. H-P has a significant advantage over Dell. Its highly profitable printer business and business-services division are far bigger than Dell's. This has helped insulate H-P from PC-market weakness. PCs are about 35% of H-P's revenue; they're about 60% of Dell's. H-P has continued to beat Dell in PC sales. Last month, analysis firm IDC reported that H-P remained the world's largest PC maker in this year's third quarter. Its shipments increased 14.9% compared to the year-earlier period. Dell increased shipments only 11.4%. On Monday, H-P announced a gain in quarterly revenue. Dell's disadvantage is magnified by falling PC prices. For the quarter ended Aug. 1, it reported a 17% annual drop in profits largely because a European division cut prices to chase large corporate deals, said a person familiar with the matter. In the recent earnings call, Mr. Dell said the company has decided to keep profit margins up, rather than lower prices to spur growth. Dell's fortunes looked much better four years ago, when Mr. Dell left the CEO post. The low-cost business model of selling PCs directly to customers had propelled 2004 sales above $40 billion. But growth stalled in 2006. A big factor: H-P found Dell's weak spot by focusing its sales on retail stores, where Dell had no presence. Mr. Dell took back the reins from then-CEO Kevin Rollins in early 2007, pronouncing his old business model dead. After his return, he announced the company would start selling in stores. Today, Dell needs to worry about retail sales cannibalizing its higher-profit direct sales. An executive at Best Buy Co. BBY -2.86%said recently in an interview that it expects its sales of Dell PCs to take away from Dell's direct sales. Dell doesn't report retail profits, but profit margins there remain slim, analysts say. A Dell spokesman said that "retail has actually enhanced the online business," since it has raised Dell's profile with consumers. Mr. Dell also focused on the consumer-laptop business, which by that time suffered from a troubled reputation. For instance, tech blogs had a field day after Dell and a few other manufacturers' notebooks caught fire due to battery problems. Dell recalled the faulty batteries, which it hadn't manufactured. Mr. Dell hired top executives from outside the company to push into new markets and cut costs. Mobile technology was also to be a promising new foray, since smartphones have recently been a sweet spot of computer growth. Mr. Dell brought in Motorola Inc. veteran Ron Garriques to run the new consumer division. "The phone is a very different animal for us," said Tim Mattox, Dell's strategy chief, in an interview earlier this year. "It's one of the reasons we brought in Ron." Mr. Garriques set up a Chicago office, hiring ex-Motorola employees to develop portable devices, including mini-notebook PCs. In August 2007, Dell acquired Zing Inc., a company founded by an Apple veteran that develops portable music players and software. Dell said it planned to release a Zing music player this year, along with Zing software. Mr. Dell paid close attention to the consumer division. "I'll come down from a meeting, and he'll be in my cubicle," Mr. Garriques said in an interview earlier this year. "Michael knows no boundaries." Early this year, Dell executives discussed entering the phone market in 2009, said people briefed on the matter. But it has held back due to cost and the uncertain market, they say. A Dell spokesman declined to comment on the company's phone plans.

Dell has pushed into the hot market for netbooks -- small, low-power laptops designed mainly for internet access. However, netbooks have thin profit margins and sell for as little as $350. Meanwhile, H-P this year introduced a line of two consumer-oriented smartphones in Europe. It also beat Dell into the netbook market. Dell's biggest transformation may be in manufacturing, which was narrowly tailored to its original direct-sales strategy. The company eschewed inventory, and its famously efficient factories quickly assembled build-to-order PCs. Plants were often located in local markets to speed up delivery times. But Dell stuck to that approach too long, opening new plants in the U.S. while rivals like Apple and H-P shifted to Asia. At a conference in Switzerland early last year, Mr. Dell approached Mike Cannon, a former CEO of a contract manufacturer. On a plane back to the U.S., Mr. Dell told Mr. Cannon that Dell "needs a lot of help," Mr. Cannon recalled earlier this year. Shortly after, he was hired as Dell's operations chief. Mr. Cannon soon began efforts to outsource Dell's manufacturing to Asia and to start the process of selling off factories. On a conference call with analysts Thursday, Mr. Dell said his leadership team has laid "important foundations that position us to be a stronger and more nimble company." Miguel Bustillo contributed to this article.