Dell strategy draws mixed reaction from industry watchers
Bloomberg News Service
AUSTIN, Texas For Michael Dell, the economic slowdown is a time to fall back on an old strategy at Dell Computer Corp.: Cut prices on personal computers and take business from rivals.
This is what Michael Dell, 36, has relied on since he started what is now the biggest U.S. PC maker in his Dobie Center dormitory room at the University of Texas in Austin in 1984.
"It's definitely a flashback to the original strategy," says Tim Ghriskey, a portfolio manager for Mellon Financial's Dreyfus Corp, owner of 22.6 million Dell shares.
So far, investors agree. Shares of Austin, Texas-based Dell, the biggest U.S. PC maker, have climbed 48 percent this year on predictions that Dell will fare better than its rivals.
Dell said that fiscal first quarter net income slipped about 1 percent to $462 million because it didn't cut costs fast enough as PC prices plummeted.
First-quarter worldwide PC sales declined to 32.5 million units from 37.9 million, market researcher Gartner Dataquest said. Consumers and businesses are less willing to spend money on new PCs, and the machines themselves are faster and sport more memory, meaning they don't have to replaced as frequently.
Dell, who made $2,000 selling stamps at age 12 and became a top subscription salesman for the Houston Post newspaper in high school, began his computer business as a mail-order shop, receiving parts and assembling them in his dorm room. Then, as now, he controlled inventory and kept costs lower than bigger PC makers such as Compaq Computer Corp.
"From day one when he started the company, that's the system they used," said Alan Loewenstein, portfolio manager for American Fund Advisors, owner of 1.17 million Dell shares.
Seventeen years later, the company still operates much the same way. Now, inventories are monitored by suppliers via the Internet. Intel Corp., for example, knows exactly how many microprocessors are installed, and how many more it will need tomorrow. This monitoring enables Dell to keep its stock of parts to a few days worth, compared with weeks for most of its rivals. As a result, suppliers bear a larger portion of the costs.
"In a tough economic environment, the low-cost model wins," Dell Vice Chairman Kevin Rollins said in February.
In the first quarter, Dell overtook Compaq as the No. 1 PC unit seller worldwide, according to Dataquest.
But in January, Dell cut sales forecasts for the fourth time in a year as investors fretted that the company's annual sales growth was slipping to 20 percent from more than 30 percent.
That capped the worst year ever for Dell's shares, which plunged 66 percent. Just two years earlier, in 1998, Dell was the best-performing stock on the Standard & Poor's 500 Index, rising 249 percent for the year. By last year, sales growth had slowed, Dell was struggling in new markets such as servers and storage systems, and competitors such as Compaq, started luring more customers.
Now, Michael Dell has recaptured the support of some investors by stressing the market share strategy. But persistent price cuts may erode earnings.
"If the company takes shares at any price, that will severely retard long-term earnings growth," Christian Koch, a senior technology analyst for Trusco Capital Management in Atlanta, which owner of 4.5 million Dell shares, said.
Analysts already are predicting Dell will lower its fiscal second-quarter earnings forecast.
"We've seen this behavior before," said Jim Poyner, an analyst with CE Unterberg Towbin, who has a "neutral" rating on Dell. "It always ends badly."