Dell's success in PC sales sacrifices profit growth
08/19/2001
Bloomberg News
AUSTIN – Michael Dell has proved that his company, Dell Computer Corp., can make personal computers cheaper than anyone. As he's driven off rivals to become No. 1, though, some investors say it's taken too heavy a toll on profit.
Dell, who is founder, chairman and chief executive, used lower prices to win the title of best-selling PC maker from Compaq Computer Corp. Compaq, Hewlett-Packard Co. and Gateway Inc. -- Dell's biggest rivals -- have begun to stress sales of higher-profit services instead.
Dell controlled 13 percent of the PC market last quarter, and wants to push that to 40 percent. Though the company's sales haven't been hit as hard as those of rivals, Dell's gross margins in the fiscal second quarter narrowed to 17.5 percent from 21.3 percent a year earlier. That has led some investors to see the market-share gains as a hollow victory.
"Their strategy is to gain market share, and we think they've been successful," said Raymond Mills, manager of the TD Waterhouse Technology Fund, which owns 2,600 Dell shares. "It remains to be seen whether they can return to higher profit (margins) of the past."
The company's average PC selling price in the second quarter declined 17 percent from a year earlier to $1,850. To preserve profit, the Austin, Texas-based company has said it will fire as many as 5,700 workers, a 14 percent reduction, this year.
Second-quarter loss
Dell on Thursday reported a loss in the quarter ended Aug. 3 of $101 million, or 4 cents a share, compared with net income of $603 million, or 22 cents, in the year-earlier period. It's the first loss Dell has reported since the second quarter of fiscal 1994. Excluding charges of $742 million, second-quarter profit would have been $433 million, or 16 cents a share.
The company reduced targets for third-quarter sales and profit. Earnings will be 15 cents to 16 cents a share on sales of $7.2 billion to $7.6 billion, Dell said, compared with net income of $674 million, 25 cents a share, on revenue of $8.26 billion in the same period last year. The company's shares dropped 9.4 percent yesterday to $23, and have fallen 41 percent in 12 months. They have gained 32 percent in 2001.
The PC industry is slumping because companies have slowed information-technology spending, and no hot new product has emerged to entice consumers to buy PCs.
Michael Dell has used the slump to grab market share, with the idea that customers gained now will buy Dell in the future, bolstering the company's margins in the future.
Dell, who wasn't available for an interview for this story, on Thursday told analysts he doesn't think PC sales will rebound until the second quarter of 2002, when corporations begin a new cycle of upgrading their PCs.
Direct sales
Dell can keep prices lower than rivals because the company's direct-sales method doesn't pay commissions to distributors or retailers, letting it pass along savings from falling component prices quickly. That has put pressure on rivals, whose sales models can't react as fast to price changes or drops in demand.
International Business Machines Corp. has stopped selling PCs to consumers. Compaq and Gateway quit their price war with Dell, saying they won't risk profits to gain sales. Hewlett-Packard also refused to compete with Dell on price.
After three straight quarterly losses, Gateway has said it may leave international markets, and, like Compaq, is focusing on services such as installing and maintaining PCs and networks.
"Dell can be the low-cost, low-priced hardware manufacturer," said Ted Waitt, Gateway's founder, chairman and chief executive. "Our customers want something different, a high level of solution services. Those are where the higher margins, recurring revenue streams are."
Services push
Dell is also pushing more into services to help boost profit and bolster sales of servers and storage devices, Michael Dell told shareholders at the company's annual meeting in July. Second- quarter services revenue rose 30 percent to $773.5 million, accounting for 10.2 percent of total sales.
The 36-year-old Dell also faces challenges from rivals like Compaq in trying to sell more business servers, which are more profitable than PCs. In the second quarter, the two companies tied for the lead in the U.S. server market based on unit sales, according to researcher Dataquest Inc. Both companies garnered 29 percent of the market for the quarter. Dell's share was unchanged from the first quarter, while Compaq's rose from 26 percent.
Dell shares were the top gainer during the 1990s in the Standard & Poor's 500 Index. Last year, they tumbled 66 percent.
Michael Dell was paid a total of $2.6 million in salary and bonus last year, and was granted 1.25 million stock options. His 12 percent stake in the company was worth $7.22 billion as of yesterday's close.
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