Christmas Dell-light?

19 Dec

After a difficult year, Dell has shown signs of recovery. Investors’ confidence has returned, but Dell’s ability to relive its past glory is still doubtful

In his traditional Sunday blessing last year, Pope Benedict XVI criticised that consumerism had polluted the true spirit of Christmas. But for Dell’s nearly 79,000 employees, consumerism is exactly what they need to stay employed. Dell’s glory has passed; this time Dell needs Christmas magic to boost its sluggish sales.

Starting as a one-man show computer supplier in 1984, Dell has grown into a multibillion-dollar business empire by staying close to its core business model: a combination of direct selling, low price and ultra-efficient supply-chain management. Using this formula, Dell weathered the dot-com bubble burst in 2000 and had even captured more market share while its rivals were struggling to get back on their feet.[1] For that, Dell was rewarded handsomely by Wall Street. Three years after the burst, Dell’s share price was almost double its initial price.

But as the rivals improved, in 2005, Dell’s earnings started to fall behind. Dell’s CEO, Kevin Rollins, tried to convince the investors that the $80 billion medium-term sales target set in February 2005 was still achievable[2]. But Wall Street, so used to Dell’s five-star performance, was not forgiving.

Dell’s inability to satisfy investors’ expectations is clearly reflected by the share price movement. Currently trading at around $26, Dell’s share price is 10% lower than five years ago, as shown in Figure 1. In 2002, this was unthinkable; Dell seemed unstoppable. It expanded its PC business and ventured into other more lucrative markets like notebooks, servers and printers. Indeed, the shareholders enjoyed two significant rises before the shares took a nosedive.

The first happened in 2003 when Dell’s revenue growth hit 17%. By late 2003, the price jumped up by two-quarters to $35. It was then stagnant for a year because investors were holding back as the overall technology market was declining. At the end of 2004, Dell’s strong performance again sent the shares up, to $43, its peak performance since the dot-com bubble burst.

Figure 1 Five years share price

Source: Big chart 

Yet, this was short-lived. In mid 2005, Dell’s failure to achieve targets caught investors by surprise, and the share price slumped back to $35. Dell blamed it on a pricing error made in the PC price war. “We drove it too hard,” Mr Rollins said. However, Dell still failed to lift the profits in the next four quarters. Predictably, the share price took a dive and halved to around $20, a five-year low.

However, the third quarter of 2006 has yielded more positive results. It has been seen as a turning point for Dell that boosted shareholders’ confidence and the shares rose by one-fifth to $25. Still, compared to five years ago, Dell’s share value has dropped to minus 5% while Hewlett-Packard scored a 80% rise and the NASDAQ has enjoyed a 20% increased. These figures suggest that Dell’s problems are more complex than a wrong price tag.

Dell’s problems can indeed be seen in its financial returns. As shown in Figure 2, revenue rose at more than one-tenth in 2002 after the negative growth during dot-com burst. During the next three years, Dell kept growing at a two-digit rate. But Dell could not maintain the momentum. In 2005, the revenue growth was down to 15%. It was almost double the growth of Hewlett-Packard (HP)[4] but still below investors’ expectation.

Figure 2 Year-to-year Revenue Growth Rate – Dell Inc

Source: Dell financial report Even so, Dell was reluctant to change its strategy. In March 2006, after missing the earnings target for the second time, Mr Rollins still proclaimed, “I believe we will prove the model is intact and successful and better than anything in the industry over the next several quarters.” It was proven to be a disaster. The shareholders had enough when Dell’s sales fell short by $20million of the predicted $14.2billion. Earnings-per-share dropped to 22 cents, almost one-third lower than the expected 32 cents.[5] Dell also lost its leadership in global PC sales – Dell’s main source of revenue – to Hewlett-Packard in August 2006.  

In the last quarter, however, Dell changed its focus to maximising profit margin, rather than increasing market share. The net profit was up by almost 10% compared to last year but sales growth dropped even further to disappointing 3% – only one-quarter of the previous year’s.[6] Surprisingly, however, Wall Street had lowered its expectation and took the news positively.

Some market analysts upgraded the share status. Investment bank Goldman Sachs upgraded Dell from its “sell” list to “neutral” citing Dell new pricing strategy as the reason. More confident analysts, such as Bear Stearns and Needham & Co, suggested that the shares were worth buying.[7]

The confidence was on the rise, but does Dell have what it takes to make a comeback and rule again?

Dell’s main problems lay in a few key areas. Firstly, Dell’s cost advantage has been reduced as rivals has improved their process efficiency and reduced their operation cost. Richard Gardner, an analyst in Citigroup, estimated that the previous 10-15% cost advantage over rivals has now narrowed to 5-10%.[8] Dell has been forced to lower its prices further without substantial reduction in cost, thus squeezing its profit margin.

Even so, the low prices did not increase the sales substantially and has been inadequate to sustain growth. Its limited product variation, upgrade incompatibility and unsatisfying customer service have also driven customers away. Consumers shifted to rivals’ various models and price-competitive products. 

Another hitch came from Dell’s inflexibility in direct selling. Customer’s growing preference for retail shopping has left a big hole in Dell’s sales strategy. Furthermore, direct selling is not suitable for developing countries, where the market is growing faster. Despite the rising popularity, the percentage of internet users is still small. In
China, for example, only one-tenth of the 1.2 billion people use internet. It leaves nine-tenth of the market untapped.

In the longer term, Dell income sources may be further squeezed as its sales have relied on the saturated markets: the PC market and in the
US region. Even though it has been venturing into new markets, such as printers and servers, two-thirds of Dell’s revenue is from a combination of PC and notebook selling which have lower profit margins and more saturated market.
[9]

Furthermore, more than two-thirds of its sales depend on the slowing Americas region, especially
North America. As shown in Figure 3, although Dell’s sales in
Asia have doubled in the past four years, the amount is still less than one-eight of total sales. This includes 63% revenue growth in Indian market, indicating slow growth in other countries. Without increasing the proportion from the more profitable markets, Dell may face a bleak future.

Figure 3 Net Revenue by Regions

Source: Dell financial reports  On the bright side, the global PC market is predicted to keep growing at 12% next year, while the US market will grow at 9%, says the IDC’s Worldwide Quarterly PC Tracker published in June.
India, where Dell has captured almost half of the corporate market, is expected to increase by two-thirds to nine million PCs sales next year.
 Also, IDC predicted that in more mature markets, there will be opportunities in notebook sales and new systems sales supported by launch of new operating systems, namely Microsoft Vista and Apple Leopard. Indeed, there is a trend of shifting from PC to notebook computer as people are getting more mobile. This will recreate new demands in the saturated markets.  

To take the opportunity, Dell must place itself in the faster growing sectors and in the untapped regions with the right strategies. As a result, Mr Rollins and Mr Dell have been experimenting with new strategies.

One of them is the no-inventory showroom. It allows customers to try the products while maintaining minimum inventory cost by shipping the products directly from the warehouse. Mr Rollins claimed that the showroom performed better than expectations. Dell is preparing to export this idea overseas, starting with
Britain. If overseas customers like this new way of shopping, it will open new access to the market Dell initially ignored.  

Sales strategy aside, Dell is now refocusing its attention on its product. It has increased the product mix, and now includes products with AMD processors. New computers also allow better compatibility and easier upgrading, including to the upcoming Microsoft Vista operating system. It is also moving up-market to target less price-conscious computer users. Moreover, Dell is expanding its market to more lucrative software and server sectors. In the LCD market, which is growing at 22%, Dell is still the leader, holding around a 17% global market share even after 3% drop in sales last quarter.[10] 

Dell is also hoping to increase its presence overseas. The new factory in
India opening next year will cut cost of the production, inventory and taxation.
[11] It is said that Dell is trying to buy
China’s second largest computer maker, Founder Technology Group. If the deal is successful, Dell may be in better position to penetrate the Chinese market.

      

There is a growing confidence that Dell is on the right track. After the last quarter results were announced, Bear Stearns analyst, Andrew Neff said, “Following Dell’s results, we sense a heightened focus on striking a better balance of profitability and revenues.”[12]

However, shareholders should be aware that the results of the new strategies are still unclear. If they work, Dell may be able to live up to its reputation as a robust company which has again survived market downturn and competition. But under current fierce competition, unless Dell understand its potential buyers better than the rivals, its glorious days as the super-achiever may be difficult to recreate.


[1] Cnet News. 17 January 2002.

[2] Computer Shopper. 11 February 2005.

[3] Financial Times. 26 August 2005

[4] www. morningstar.com.  Accessed on 16 December 2006

[5] Dell 2006 2nd Quarter Financial report

[6] Financial Times, 22 November 2006

[7] Yahoo News, 10 December 2006

[8] Financial Times, 1 November 2005

[9] Dell Financial report

[10] Digi Times – 18 December 2006 http://www.digitimes.com/displays/a20061218PR203.html

[11] BBC News – 14 September 2006

[12] Associated Press, 22 November 2006

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2 Responses to “Christmas Dell-light?”

  1. Richard Acacio March 10, 2007 at 6:16 am #

    This blog is pretty cool. Just wanted to say hi!

  2. kabababrubarta March 26, 2007 at 11:53 pm #

    Cool! kabababrubarta

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