On a Roll, Dell Enters Uncharted Territory
By STEVE LOHR
The New York Times
August 25, 2002
When they met with industry analysts in New York in April, Michael Dell and his management team were curiously buoyant, playful, swaggering a bit. The computer industry's worst slump in memory? It was a cloud with a shining silver lining for the company, they said — a splendid opportunity for Dell Computer, the hyper-efficient predator of the personal computer business.
Kevin Rollins, the president, spoke of doubling annual sales to $60 billion within four or five years. The remark had the whiff of corporate megalomania, yet he presented it as "a vision of where we think we can go," and if anything, an understatement. "We'd love to see it happen sooner," he said.
In his address, Mr. Dell, 37, the chairman and chief executive, offered a matter-of-fact explanation for why his company was certain to move inexorably beyond the desktop into corporate data centers, selling more large computers and attacking the business stronghold of I.B.M., Hewlett-Packard and Sun Microsystems. And, as he does when things are going well, Mr. Dell peppered his comments with dry, caustic humor. At one point, he observed that 8 of the 10 largest corporations in the 2001 Fortune 500 bought Dell data-serving computers — the machines that power corporate networks and the Internet.
The two noncustomers, Mr. Dell added, were I.B.M., an archrival, and Enron. "I just love that," he said.
Since spring, the outlook for the computer industry has darkened further, as hopes have faded for a recovery in the second half of the year. Yet Mr. Dell and his team seem even more upbeat.
Dell is, indeed, rolling. In the last two weeks, it reported improved profits and solid gains in the PC business and declared its intention to enter three new markets by the end of the year: printers, hand-held devices and unbranded, or white-box, PC's. And its campaign to move up the computing food chain into corporate data centers appears to be gaining traction.
The plan is ambitious and risky, but Mr. Dell betrays no qualms. "We're gaining market share, our profits are growing and we've got new products — yeah, we feel good," Mr. Dell said in an interview on Thursday.
Dell is building on its base of success in the PC industry. Its share of the worldwide PC business has increased two percentage points so far this year, to 16 percent, with shipments rising sharply even as industry shipments are falling. Dell's goal is to grab 40 percent someday — an aim that, if attained, would change the balance of power in the PC industry, giving Dell much more influence with all its suppliers, including Microsoft and Intel.
The Dell strategy is not only striking in its breadth, but it also amounts to drawing a bull's-eye on Hewlett-Packard. Just as Hewlett-Packard grapples with the distraction of digesting Compaq Computer, Dell is zeroing in on H-P's highly profitable printer unit and its solid corporate computing business. At the same time, the Compaq merger increases H-P's stake in the PC industry, where no one has yet matched the efficiency of Dell's low-cost operations.
Dell, however, faces daunting risks. The biggest is that as it moves more and more into industrial-strength corporate computing — the "enterprise" business — and into new product lines, Dell may have to stray from its tried-and-true formula. Its central ingredients include direct sales by telephone or over the Internet; direct relationships with customers, without middlemen to intercept customer information or take a slice of the profits; a build-to-order manufacturing system; and stingy spending on research and development.
By entering the white-box market, for example, Dell will be selling unbranded machines to middlemen — white-box dealers who typically sell PC's, specialized software and support services to small businesses. It is a big market, with an estimated $3 billion a year in sales in the United States alone. But it seems a departure from the direct-sales model.
In the printer market, Dell is taking on a leading company in Hewlett-Packard, which controls the crucial technology in its printers, the ink cartridges. In the PC business, by contrast, Dell has been largely a distributor of the fundamental technologies produced by other companies — microprocessors by Intel and software by Microsoft, which are not Dell's competitors.
Dell is not saying, but it is expected to line up a partnership with Lexmark or perhaps Epson to supply the cartridge and ink-jet technology for Dell-brand printers. Printers have high profit margins, and there may well be room for Dell to cut costs, lower prices and still do well for itself. But so far, Hewlett-Packard has done a good job of limiting the gains of today's price-cutters — Lexmark and Epson.
But the big question for Dell, and the industry, is whether its business model can be a winner in mainstream corporate computing. "The enterprise business — servers, storage and services — has a much higher revenue and profit potential than printers and hand-helds by far," observed Mr. Rollins. "The enterprise market is where the meat is."
When a desktop PC crashes, an office worker may be irritated, but the damage is limited to an individual. But data centers, housing clusters of big machines, are the computing engine rooms of the corporate world, handling companies' manufacturing, procurement, marketing and customer data. They must run constantly and be secure, reliable and versatile.
The computer companies that have traditionally done well in the data-center market stand behind their machines with armies of skilled people and hefty research budgets. These vendors must understand complex, diverse computing environments — requirements magnified by the Internet, which links all manner of technologies. So corporations increasingly want to buy packages of hardware, software and services to solve business problems, like streamlining procurement or tracking customer behavior, instead of buying computer products à la carte and then trying to figure them out.
I.B.M. has been the master of this "solutions" strategy; the successful execution and marketing of that approach fueled its comeback in the 1990's. The logic behing the H-P merger with Compaq was similar — to create a company with the technology, skills and breadth to tackle the full range of requirements of large corporate customers.
Its competitors say that this is a very different business, where Dell must change the way it operates — or stumble. "Dell is seeing the limits of its direct business model and violating the tenets of its model to try to get growth," said Michael J. Winkler, an executive vice president of Hewlett-Packard. "You can argue that Michael Dell is becoming an H-P wannabe, because he's going after the markets where we're strong and entrenched. We're facing an interesting set of battles ahead."
SUSAN WHITNEY, a general manager in I.B.M.'s server computer unit, said Dell might be reaching beyond itself. "In the data center business, you have to make investments in technology, expertise and services," she said. "That requires a different culture and skill set. Dell is trying to get there, but it will be a significant transition for the company."
Mr. Dell, who started the company at 19 in his University of Texas dormitory room, regards such criticism with bemused disdain. Whenever Dell has entered a new market — notebooks, work stations or server computers — rivals have predicted that it would get its comeuppance. They were wrong. "I've seen this movie before," Mr. Dell said. "Hey, order the popcorn. I'm going to enjoy it."
The expansion plan, according to colleagues, reflects his personality — relentlessly competitive, focused and disciplined. His self-confidence has never been in question, but he is not flamboyant or given to excess — at least not for someone worth nearly $10 billion. Mr. Dell, his wife, Susan, and their four young children live in a 22,000-square-foot modern house of glass, steel and limestone on a hill overlooking Austin, Tex.
But Mr. Dell rises early, drives himself to work and tries to get home in time read to the children at night. At Dell's headquarters in Round Rock, Tex., he has no reserved parking space and no door on his office. Over the years, he has sought the advice of mentors, including Morton L. Topfer, a 23-year-veteran of Motorola who joined Dell in 1994 and recently retired, and James T. Vanderslice, a 33-year veteran of I.B.M. who joined the company in 1999 and is vice chairman.
Today, Mr. Dell heads a senior management committee of two dozen people, mostly in their 40's, who have been with the company five years or more. "I don't want to understate the challenges we face, and overextending ourselves could be a formula for disaster," Mr. Dell said. "But I really don't think we're overextending ourselves."
Dell has suffered setbacks when it overreached. In 1993, for example, it took a big charge against earnings when it temporarily pulled out of notebook computers. Its notebooks were riddled with defects, with a tendency to expire amid a puff of smoke and the scent of fried semiconductor chips. But Dell recovered quickly, led by an executive recruited from Apple Computer who helped develop the early Powerbook lines.
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Recently, Dell has switched course a few times in the market for data storage systems — advanced computers, often linked in networks, for storing and managing important corporate data. It tried developing systems in-house, reselling systems made by others, and in 1999 acquired a network storage specialist in Silicon Valley, ConvergeNet, for $340 million. (It has since folded.) In October, Dell signed a five-year partnership deal with EMC, a big maker of computer storage systems. Dell will resell EMC's mid-range Clarion storage systems, ranging up to $200,000 or so, and license some technology from Clarion. Sales from the partnership are rising quickly — 65 percent in the second quarter — though rivals scoff at this as a "P.O.N." figure, for percentage over nothing.
But the computer industry has learned over the last decade that underestimating Dell is a grave mistake. The company has almost single-handedly changed the terms of trade in the PC business. The efficiency of its direct-business model has set the standard that others strive to match. Analysts estimate that Dell's operating expenses, 10 percent of revenue, are about half those of most competitors.
Dell has brought a wave of intense competition, lower prices and consumer benefits to the PC market, as the Japanese did in automaking or Wal-Mart did in retailing.
Dell is known as a "fast follower" in the industry. "Dell doesn't pioneer markets; it milks them," said Martin Reynolds, an analyst at Gartner.
Still, Dell has bet its entire strategy on a single technology trend. Over time, Mr. Dell explained, all technology — whether in transportation, telecommunications or computing — moves toward low-cost standards. Then the winners in an industry are determined less by technology and more by factors like operating efficiency and closely catering to customer needs. That is the trend Dell has exploited in the PC business, and Mr. Dell says the rest of the computer industry is next.
What process is unfolding in the server computer business, where Dell is gaining ground. But how far and how fast Dell can go depends crucially on how quickly the standard technologies of the PC industry — Intel's processors and Microsoft's Windows operating system — become powerful enough to replace computers running the Unix operating system and mainframes in corporate data centers. Dell also faces plenty of competition from the likes of I.B.M. and H-P, which make servers powered by Microsoft and Intel technology, as well as their other large computers.
Yet both the market-share figures and the anecdotal evidence point to Dell making solid gains in servers, especially for machines priced below $25,000. A few months ago, Rackspace Managed Hosting of San Antonio decided to buy several hundred server computers. Rackspace runs data-processing and Web sites for companies from data centers in Texas and London, where it has 6,000 server machines.
Rackspace wanted the computers for a new service that ran on the data-center version of Microsoft's Windows operating system. Its technical people initially leaned toward Compaq, part of H-P, as the preferred supplier of larger Windows-based servers because of its track record in data-center computing.
But after a close evaluation of Dell's new machines and service offerings, Rackspace went with Dell instead of H-P. "Dell had a hard battle to overcome, but they did," said Morris Miller, managing director of Rackspace, who added that the decision was not based on price.
Such gains, Mr. Dell said, are proof that his company's tightfisted approach to research and development is shrewdly tailored for an industry that is increasingly adopting standardized technology. He bridles at the notion that Dell does no technical innovation. The company, he notes, employs 3,200 engineers and spends $500 million a year on R and D, and both numbers are rising.
Dell's investments, he added, tend to build on the foundation laid by the $8 billion that Microsoft and Intel spend on R & D, delivering tangible benefits to customers. By contrast, he said, much of the R & D spending by Dell's rivals is to develop their home-grown technologies and lock customers into their proprietary products. "I think the idea that our competitors have an advantage because they spend more on R & D is complete nonsense," Mr. Dell said.
Dell is likely to face a tougher time, though, in markets where it is not riding on the familiar coattails of Microsoft and Intel. In storage systems, for example, those two are not the dominant technology suppliers, and standardization is just getting under way. And computer services is labor-intensive, with skilled people being the vital assets.
DELL says it is taking a focused approach to services, building capability where service offerings will assist hardware sales. Yet it is also fielding a team to provide "professional" services, which includes training, planning and specialized software development.
"Professional services are where Dell is going to run into trouble," said Julie Giera, an analyst at Giga Information Group, a research firm. "It is a very different model for Dell, not like a product market at all, a very different business. And I.B.M., E.D.S. and H-P are already fighting over that business."
As it becomes stronger and expands further, Dell has more power over rivals and more independence from partners. In 1998, Mr. Dell, testifying before a Senate committee before the government filed its antitrust suit against Microsoft, said that Dell's business practices were determined by what its customers wanted and what was good for its shareholders.
Under questioning, he conceded that his company did not offer Netscape Communications' browsing software on its home PC's because it was not in the best interests of Dell's shareholders to do so. His answer gave many people the impression that Dell was firmly under Microsoft's control.
Things are different today. The browser wars are over, and Microsoft has won. Dell computers run mainly Windows, but the company is also aggressively promoting server computers running GNU Linux, a variant of the Unix operating system that is distributed free. Linux represents a direct competitive threat to Microsoft. And last week, Dell said it was loading Corel's WordPerfect Office on some of its PC lines, an offering that is a direct competitor to Microsoft Office software.
"Sure, our relationship with Microsoft has evolved," Mr. Dell said. "We like Microsoft. But we do things for the benefit of our customers and our shareholders. If Microsoft doesn't like some of those things, they can go jump in the Pacific Ocean."
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