Has the Tide Turned Permanently Against Dell?

If an investor had bought Dell (DELL) and Best Buy (BBY) prior to 1980 and avoided competitors like HP (HPQ) and Circuit City (CC), the investor clearly would have done much better. Much, much better is actually the answer to this question. However, the story is not quite the same for the past two years. HP has more than doubled the returns of Dell. And surprisingly, Circuit City has topped all of them, beating HP by a shade and even coming slightly ahead of Best Buy.

Dell’s troubles are well known. The company took cost cutting to new heights in the process hurting service. It gained huge market share, but there are serious questions whether it can hold onto it as its service has declined in quality because of outsourcing. Service is definitely a downer but it is correctable. Michael Dell already has taken the steps to repair this problem. The real issue is that Dell's plain vanilla, white bread appliances do not stack up on the pizzazz and design test to those of Apple (AAPL) or even those of HP.

The consumer market, not Dell’s strength, is hot, not the business and institutional market where Dell traditionally dominated. Differentiation is the name of the game in this market, not low cost, and with Dell’s culture so single-mindedly focused on the latter it is seriously out of sync.

However, Dell has been known to come back in the past, and it still has formidable strengths. The problem, though, that it faces now is the very size and girth it has been so resolved to achieve. Dell’s business model is based on rapid percentage growth in revenue but now that it is a $50 billion company this growth is not going to come that easily. In the last quarter, it has been growing at an anemic five percent pace, less than almost all its rivals. Forays into super upscale computing (>$3500 for a PC) and super downscale computing (<$350 for a PC) leave Dell in the horns of a dilemma as to what kind of company it is going to become.

Can it afford to continue to try being all things to all people? Its global movement into Asia inevitably will be stymied by Lenovo (LNVGY), whose local connections will prove a huge advantage. So the low price strategy of continued market share expansion may have reached its peak for Dell.

Dell’s future depends on a revival of the Wintel brand. It will not come from large screen televisions, as people are not likely to buy their home entertainment systems in large quantities over the Internet. There is hope, however, that with Window’s new software and Intel’s new processors that Dell can be the diffuser par excellence of these innovations to the business and institutional market. That is the old role that Dell is used to playing and it remains something it is still very good at it.

However, Dell may not be able to repeat the vast successes – the total dominance -- it enjoyed in the late 1990s and early years of the new millennium simply because the market has shifted from plain vanilla boxes that take up space in businesses and other institutions to the home market, at least for the moment.

Dell’ s core competency is not built around an ability to take advantage of this market. You do need a place to kick the merchandise when you buy these things for your home and Dell will never again risk selling its devices in storerooms. CEO Kevin Rollins sees this as an absolute and he probably is correct in doing so.

Here is where HP, Circuit City, and Best Buy shine. And though Circuit City actually has done better than Best Buy the past two years in terms of returns to investors, Best Buy has not fallen off the carpet by any means. The unholy alliance of these companies, along with Apple, whose stock has gone through the stratosphere because of the hype associated with the iPod, a market it 90 percent owns, have been the major powerhouses. The question is will the dominance of these firms continue or have they peaked?

The performance of these companies is based on their ability to keep costs low through better than average logistics -- they are not in Wal-Mart’s (WMT) league -- while at the same time being reasonably cool places with the latest technology. For the longest of time, Best Buy has done a great job at this, with its superb mix of commodity items to draw you in the store and myth items to prop up the profit margins. Circuit City’s success has been built on its ability to copy Best Buy’s model, once it realized what a good one it was, and to follow up on what Best Buy has done in a rather ferocious way in the last five years since it ditched CarMax and the selling of large home appliances like fridges.. It has innovated a bit too. Its alliance with Amazon has been a strong one, one of the best examples of the integration of clicks and mortar.

While Best Buy, as the leader, has had to take risks, bumpy ones at that, like its customer-centricity campaign, Circuit City has been remodeling, relocating, and smoothing out the rough edges so that it can perfect its business of being a strong second comer to Best Buy, which now is the undisputed leader in retail electronics. HP has benefited from being a major supplier of both of them. In this space it has less competition than it used to now that HP has fully absorbed Compaq.

All of them together have gone after the burgeoning home office and small business market, and with the fading of stores like CompUSA, they have been successful with their moves in this direction. While Best Buy's acquisition of Musicland was a total disaster, its acquisition of the Geek Squad has been a huge success, propped up in large part from the added service that Best Buy can provide to small businesses and home offices.

HP also has not stood still. Under Current CEO Michael Hurd, Wall Street’s darling until recently, it has cut costs and stolen its main IT person from Dell and its main marketing and design person from Apple. Its products are much better than they used to be as well as its logistics. The distance between itself and Dell with respect to the direct model that Dell pioneered is not as great as once was.

The HP, Circuit City, and Best Buy trinity seems to have some room for continued upward momentum. In the short term, they could continue to do very well. But in the long term Dell could stage something of a comeback. It will not reacquire the near total dominance it once had, but if the Wintel brand shows signs of new life the Dell brand should be able to make something of resurgence behind it. Dell’s fortunes are still closely tied to Microsoft and Intel. As Microsoft and Intel go, so goes Dell. Dell's gains are a lagging indicator of the fortune of these two firms.

The long term problem that HP, Circuit City, and Best Buy face is that once the novelty of certain devices wear off, these devices become nothing more than commodities, worthy only of being sold at bargain basement rates in a Wal*Mart. The innovations for the home and small business markets keep coming but if history is going to be any guide this market never will have the same absolute bulk as the business and institutional market that Dell serves. In the long run, all four firms could prosper but for different reasons and not at the levels that any of them, especially Dell, previously achieved.

Comment on this article

Comments

[Ronald J Riley:]

HP started as a true innovator but their glory days are long gone, as in more than a decade. Today HP is just another mercantile company. Dell has never been much of an innovator, more like a parasite feeding on other's work. Today both are members of the Coalition for Patent Piracy, otherwise known as the Coalition for Patent Fairness.

HP, Dell and other members of this Coalition are on the same path which destroyed the auto industry. They cannot invent anything significant themselves and in their arrogance prey on and have alienated those who do invent. Because of their reputations inventors shun them and take the best to other companies. It is inevitable that these companies will continue to stagnate. In another decade or two they will be in the same state as the auto companies are today.

Ronald J Riley, President
Professional Inventors Alliance
PIAUSA.org
RJR"at"PIAUSA.org
Change "at" to @
RJR Direct # [phone]

2006 Sep 28 06:34 PM

[M T:]

This article is a mess. Let's start here.

<i> Forays into super upscale computing (&gt;$3500 for a PC) and super downscale computing (


This is an odd and invalid observation. Majority of well known global companies carry many brands to cater to wallets of varying size. Take Toyota and Lexus brands, VW and Audi or Hilton and Hampton Inn brands for example. Are these businesses in the horns of a dilemma as to what type of a company they are going to become? I think not.

Next, you make this comment...

<i> The consumer market, not Dell’s strength, is hot, not the business and institutional market where Dell traditionally dominated.</i>

And, continue to negate your earlier comment with...

<i> Dell’s future depends on a revival of the Wintel brand. It will not come from large screen televisions, as people are not likely to buy their home entertainment systems in large quantities over the Internet.</i>

You are correct. In fact, the majority of the money spent on PCs comes from business and institutional markets where systems are ordered in large quantities. This is where Dell shines and most companies that start working with Dell's direct model, will have a difficult time reverting back to the channels. The difference between a direct model vs. channel is similar to having a tailor made suit vs. buying off the rack.

<i> The distance between itself and Dell with respect to the direct model that Dell pioneered is not as great as once was.</i>

As you know Dell did not invent the JIT model. To this day, Dell is adhering to the JIT model and HP is still operating in a pre-Deming era. This is not a gap that can be closed--you are either JIT or not. What HP is doing right now is one, to compete in pricing by using cheaper packaging, meaning everything aside from the core components like the CPU, RAM, HDD that are identical between all vendors and acquired at market prices. Two, to subsidize the PC business through money from their successful printing and high-end server business. That is a battle the new HP believes it can afford to fight, but for how long? No one knows. It was not until Lenovo's acquisition that we found IBM's desktop/notebook business was costing them $1.5 billion annually to run.

2006 Oct 05 01:28 AM

[Wainwright8:]

I disagree with Ronald J. Riley. HP is just beginning to lead the PC world into the next phase of technology. New management and patented technology will allow HP to stay far ahead of the competition for many years to come. Just visit any computer retail store and you'll see HP desktops and laptaps are the most popular computers and the best value for the money.

2008 Jun 15 11:46 AM