Dell: No backing off aggressive pricing plan
By Ken Popovich
eWEEK
February 16, 2001 7:21 AM PT
In good news for PC buyers, but bad news for its rivals, Dell Computer Corp. says its recent aggressive low-price strategy is paying dividends and it has no plans to back off now.
The decision could put a nail in the coffin of some smaller computer makers, as well as turn up the heat on Compaq Computer (NYSE: CPQ), which may lose its title as the world's largest PC vendor this quarter to its cross-Texas rival.
Dell (Nasdaq: DELL) has slashed PC prices in recent months to match cost-cutting moves by its largest competitors, many of which were forced to take the action to get rid of unsold inventory amid a slowdown in demand.
But in a potentially risky move to subsidize its cuts, Dell, based in Round Rock, Texas, reduced its profit margin on each PC sold to historically low levels.
While several analysts predicted the aggressive pricing strategy would be a short-term maneuver, Dell executives yesterday declared it was here to stay.
"I don't think that you are going to see the margins on our desktops and notebook PCs ever climbing back to the levels that they were before," said Kevin Rollins, Dell's vice chairman, during a conference call with market analysts Thursday following the release of fourth-quarter earnings.
Specifically, Dell's gross profit margin fell to 18 percent, compared to 21 percent in the third quarter.
Strategy is here to stay
Highlighting apparent concern over the strategy, analysts repeatedly questioned Dell executives about the decision.
Lower profit margins on PCs were somewhat offset by the company's surging sales of more profitable enterprise hardware, such as servers and storage devices, which were up more than 40 percent compared to the same quarter a year ago.
Rollins also credited the low-price strategy with enabling Dell to further expand its market share.
"We believe we can profitably gain share and really intend to stick with this strategy for the foreseeable future," he said.
Dell's decision could have the greatest impact on smaller PC makers, which are struggling to survive amid the harsh pricing environment.
One such example is eMachines Inc., a low-cost computer maker that is the third most popular brand sold at retail stores. Hard hit by a slowdown in demand and further undermined by steep price cuts by rivals, the computer maker said yesterday its fourth-quarter revenues plummeted 56 percent.
All eyes on Compaq
But Dell's largest rival, Compaq, may also face increasing pressure as it continues to see its share of the PC market erode.
Indeed, a recent report by Morgan Stanley Dean Witter predicted that Dell would overtake Houston-based Compaq as the world's top PC vendor this quarter.
Last month, a Compaq executive belittled aggressive PC pricing strategies, calling gains made using price cuts as "fleeting."
"I think we will continue to be more prudent and reasonable in the pricing world," Mike Winkler, Compaq's executive vice president, told analysts.
But the PC maker eventually may be forced to cut prices further to fight off Dell, said market analyst Ashok Kumar of U.S. Bancorp Piper Jaffray in Minneapolis.
"Compaq cannot continue to afford to take a passive posture and continue to lose market share," Kumar said, "because when all is said and done, PCs are half their revenues."
And although Compaq has taken comfort in the success of its server business, where it's number one in sales of Intel-based systems, Dell is increasingly encroaching in that area as well.
For the fourth quarter, Dell's sales of high-density, rack-mounted servers more than tripled, and the company showed significant improvement in sales of the more profitable eight-way servers, a market niche Compaq currently dominates.
"I don't think Compaq is going to continue to have its full reign over that market as it may have had in the past," Michael Dell, the chairman of the company, told analysts yesterday.
"They are eating into Compaq in the rack-dense servers because their pricing structure is superior," Kumar said, "and now they're making inroads in the high end as well."
The inventory issue
Another factor working in Dell's favor is the recent accelerating drop in component prices.
"In an environment where processor and memory pricing is all falling rapidly, having no inventory gives you a major advantage over all your competitors," said Dan Niles, an analyst with Lehman Bros. in San Francisco.
Companies that sell thousands of computers through retailers, such as Compaq and Hewlett-Packard, must keep several weeks of inventory to ensure store shelves are stocked.
But that puts them at a price disadvantage when component prices fall quickly, since PCs on store shelves were likely made weeks earlier and ultimately cost more to make than a comparable Dell system.
"The environment that Dell operates best under is a very aggressive price environment," Niles said. "If the prices are stable, who cares whether you have inventory or not."
Yet Dell is not immune to the recent economic slowdown and slump in PC sales, as was highlighted by the company's announcement yesterday that it is cutting 1,700 jobs, or 4 percent of its workforce, and will take a charge of $105 million related to the layoffs and consolidation.
"The good news is that Dell is probably the best positioned computer maker for weathering this downturn because of its 100 percent direct model," Niles said. "Having said that, they're still going to feel it."
In fact, Dell lowered its previous projections for the first quarter and is now forecasting an 8 percent decline in revenue from the just-ended quarter.
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