11 May 2006

For Whom The Dell Tolls

(Apologies for the headline, but I couldn't resist. Although I've seen it somewhere in the last few days, a google search shows it's hardly original. If I could attribute my plagiarism to the deserving originator, I would).

A few weeks ago, I wrote here that Apple was in reality not competing with Microsoft - but with Dell, HP, Lenovo, Sony and the other successful Hardware and Consumer Electronics makers. I had hoped to be writing an obituary to Dell in about a year's time when Apple's Intel transition is well behind it, Vista is achieving only moderate success, Apple's market share has doubled, etc. But, instead Dell has gone and shot itself in the foot well before that time, and Apple has had very little (if anything) to do with it.

Of course, I don't REALLY believe Apple is going to overthrow Dell, nor do I believe Dell would be the major or unique casualty of an Apple revolution. I do think Apple has a chance to inflict pain on Dell by taking away a percentage or so of marketshare which in a slowing PC market would cause Dell some severe embarrassment with Wall Street, but in all honesty, Dell is going to be around for sometime yet, irrespective of what Apple does. I worked out that if Apple doubled its worldwide market share (an achievement it would be happy with over a couple of years) it could do so by taking relatively tiny amounts of marketshare from the other top 8 manufacturers (in proportion to their own marketshare) such that they would barely notice the difference in a growing market. The effect on Dell for instance would be considerably less than 1%. So, while Dell may fear Apple if they radically could overhaul the whole PC market, in reality, Apple is not the company that should be worrying Michael Dell when he gets up in the morning.

To recap, Dell has had a few disappointing consecutive quarters showing slower growth. Dell has typically grown faster than an already fast-growing market. When that market growth becomes slower AND your own growth falls below average, then problems set in. Just this week, Dell gave a profit warning:

"During Q1 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," said Kevin Rollins, Dell's Chief Executive Officer. "We are committed to delivering industry leading value to our customers, which ultimately results in industry leading growth for the company."

What does that mean? Well, Paul Kedrosky - a witty observer of technology and investing - has kindly translated the DellSpeak so we can all understand it:
Paul wrote:

"During Q1 we tried to fix our support problems in hopes that would spike growth in the crummy PC market, but that didn't work so we tried to save the quarter by cutting prices earlier and more than expected. Trouble is, those bastards at HP cut prices too, which made us drop prices further. Now we're left with losing money on PC sales and trying to make it up on volume."

Thanks, Paul (check out Paul's views on Google too).

Of course, Dell represents a classic business case study - and mostly for the right reasons. It has shaken up the PC industry as it commoditised more and more. Dell's innovations are not in hardware but in supply chain. It has been a phenomenal low-cost operator and reaped the benefits of that strategy. But the problem with being the low-cost operator in a market is that it is not sustainable unless you have some unique advantages. In Dell's case, its competition is still of a reasonable size (eg HP) so can get the same economies of purchasing. What the competitors had to learn was to copy Dell as far as possible and perhaps add a bit of their own spice on top. It's a bit like low-cost airlines. Ryanair in Europe has been a leading protagonist of this model. But as it reaches the limits it is left with getting rid of window shades to save weight and fuel (what? 5cents per flight?) - ever decreasing yields for each idea. It relies on the inertia of its outdated competitors to stay ahead. In Dell's case, their competitors have not stood still. Furthermore, Dell is also recognising that in some cases (eg support) it has perhaps taken too much cost out (as witnessed by its poorer customer sat ratings), and needs to put a bit back in.

But Dell's previous strengths may start to become its weaknesses. It does not really have the same sales channels that, say, HP has to business - relying on the direct model primarily. In retail it is lacking partnerships and/or its own physical retail outlets. Just a few years ago, that looked a wise strategy as Gateway failed so emphatically. But Apple has shown that a retail strategy CAN work. And if Apple and others can show that there is more to a computer than just low price, then people will need to experience it before buying. Whether that's PC World, John Lewis, or your own retail store may not matter - you allow people to come and see and play. What Apple has shown with its retail strategy is that Gateway wasn't wrong about retail, just that the way it went about it was wrong. Whether the lack of channels worries Dell or not it is the fact that its competitors have also learned how to operate the direct model too that should be worrying it. So, they may not be THE lowest cost operator, but if they are thereabouts AND with a reassuring retail presence, good customer satisfaction ratings etc. then that maybe enough to tempt the serious buyer. Of course, Dell is the master at advertising incredible prices and at bait and switch tactics. But it is already on the limit of what it can do here.

I honestly think Dell is in a difficult position at this point. And it will take several quarters at least before it can regain its crown. It is too late to switch to AMD chips which some have said it should have done. Right now, Intel is bouncing back with very tempting offerings, and Dell should reap it's loyalty reward from Intel (in both supply and cost). Vista is late and not going to help in the usual wonderful Q4 (in fact it may hinder). In a way, Intel's problems and now Microsoft's have shown how little control Dell has over its own innovation and destiny. Dell, will have to innovate better and to improve it's customer satisfaction ratings again. How it can innovate when it doesn't control much of the hardware or the software is hard to see except through design or customer service. These efforts will take time to do and to feed through to perceptions. It may have to explore alternative channels to market - perhaps with its own branded Dell stores (though I'm not convinced this would work). Of course, the low cost leader can always cut prices more (which it is doing). But this is a dangerous move that not just hurts your competitors but you as well. Dell has few manufacturing advantages over it's competitors - just its supply chain scale. Would Dell risk starting a vicious price war?

Perhaps its best alternative is to buy one of its smaller competitors that has complementary channels and apply the Dell financial magic on it. If it could boost its marketshare above 20% it would be in a unique position in the market again. IBM's business would have been good in hindsight, but I doubt they could get Lenovo off the Chinese. Assuming the Japanese companies are staying put, that leaves possibly Gateway or Acer out of the top 8.

It is far too early to write off Dell as the hardware powerhouse. And it's competitors (including Apple) should be fearful of what a wounded giant could do. But unless it can come up with some new lessons to teach it's competitors, I think it is Dell that's going to be doing the learning for a while, and it's shares are not going to command the heady premium of the past until it can demonstrate it has learned those lessons.

Footnote: There are lots of articles on Dell's predicament over at Wall Street Journal and FT to name just two, with similar musings, but of course, they require a subscription!

Edit/Update 24/5/06: Dell has announced the first two retail stores! However, such stores will be used to allow people to try Dell products and to order. The stores will not carry inventory for take-away purchases. Is this too little, too late?

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