Dell Consumer Investments Hinder Quarterly Earnings

Dell, in its zeal to expand its nonenterprise market share in Europe and in various IT sectors, may have expended too much marketing energy and cash trying to set up retail outlets and woo consumers over to its laptops, desktops and peripherals.

Dell revealed in its quarterly report on Aug. 28 (link will expire in 30 days) that its fiscal second-quarter profit margins fell more than 17 percent from a year ago to $616 million, from the restated year-ago net income of $746 million. Overall revenue, however, came in at $16.43 billion, up about 11 percent.

The drop-off in profit reflects what is happening in the sluggish macroeconomy. Most companies are seeing a general slowdown in IT buying and spending this summer. Some analysts saw the report as an indicator of things to come in the IT industry.

There was good news on the data storage side, where Dell continues to grow at a strong pace, earning $681 million this quarter, a full $50 million more than Q1.

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Storage, however, still lags far behind the company's main businesses—desktop and laptop PCs and servers—and represents less than 15 percent of the company's income.

CEO and founder Michael Dell told a teleconference of analysts and journalists that its profit margins—which often are in the 30 to 50 percent range—were hurt by efforts to build out its consumer product lines and overseas markets, especially those in the EMEA (Europe, Middle Eastern and African) markets.

Dell himself told me a few months ago that about 85 percent of Dell's overall business was sales to other enterprises, and that the company intended to focus more of its energies on the consumer market. That's what the company is doing, and the upfront investments it made during the last year now are playing havoc with the company's bottom line.

Dell has invested a great deal in developing channels, retail presence and its consumer sales force, which certainly isn't inexpensive. Two years ago, Dell was virtually an all-direct-sales business, with few channel partners.

"Our enterprise business in Europe is doing quite well, but our consumer presence there is, in fact, very small," Dell told the conference attendees. "We know we need to build broader and stronger relationships with our partners there, and we will."

Chief Financial Officer Brian Gladden echoed Dell's comments, saying Dell's earnings were affected by "strategic actions" taken to expand in its global consumer business.

The company also has done this, Dell said, despite losing a total of about 1,500 employees due to attrition and cutbacks during the last year.

Dell stockholders and investors probably shouldn't worry too much about the Aug. 28 report, analyst Brian Babineau of Enterprise Strategy Group told me.

"In this climate, technology companies are trying to grow their businesses with a mind-set of getting as many customers as they can," Babineau said.

"In some cases, that means forgoing profit, as was the case with Dell. I am sure that they will solve the pricing and cost structure issues and get back on the path. In contrast, other companies had a tough time growing but remained profitable.

"And the ones that executed did both and they should be commended. EMC comes to mind as a good example [of getting back on the path to operating leverage]," Babineau said.