Dell Points to Progress in Consumer Market

By John G. Spooner  |  Posted 2005-11-10

Dell Points to Progress in Consumer Market

Dell Inc. says its back in the groove.

The PC maker followed a second-quarter consumer PC pricing misstep with what amounted to a disappointing third fiscal quarter.

Dell reported on Thursday record revenue of $13.9 billion on shipments of 9.2 million units for the quarter, which ended Oct. 28, but saw slower than expected sales in some segments and took charges that cut its profit to 25 cents a share.

However, Dells top executive said the companys consumer business is in better shape entering its fourth fiscal quarter and the coming holiday season, and its overall business model is solid.

Dell relies on products such as servers and storage systems, which saw revenue jump by 16 and 35 percent, respectively, during the quarter, for the bulk of its quarterly take. But it spent the third quarter fixing its consumer business.

As part of this effort, the Round Rock, Texas, company consolidated its consumer and small business groups in the United States.

It also reworked its consumer PC sales strategy by introducing the XPS brand, a line of new high-end desktops and notebooks that offer premium services, in addition to reworking its pricing strategy on the remainder of its consumer PCs.

Thus Dell enters its fourth fiscal quarter, which encompasses the holiday consumer PC buying frenzy, with a wide range of deals, starting with $299 desktops and $399 notebooks and scaling to multi-thousand-dollar Dell XPS systems which, despite costing more, will offer relatively high value for their prices, said Kevin Rollins, Dells CEO.

"We believe that [the consumer PC] model might have fallen into a bit of disrepair" during the second quarter, Rollins said in a conference call to discuss the earnings with reporters. But, he said, "Weve been focusing this quarter on getting it back, and feel we have."

Still, Dell issued a relatively conservative fourth-quarter forecast of revenue growth of between 9 and 11 percent. The forecasted increase represents a smaller jump than in some years, but Dell said its still on track to reach $80 billion in sales.

"We believe that 9 to 11 percent revenue growth rate is a very healthy growth rate for a company of our size," Rollins told analysts in a later conference call to discuss the earnings.

Despite Dells efforts to get its consumer business back on track, some analysts worry the company could be facing a gathering storm.

After a long period of growth, which saw it boost its PC market share in leaps and bounds and expand its product lines to include printers—a business Rollins said has turned the corner on profitability and will remain so—and consumer electronics devices like televisions, Dell may have been setting Wall Streets expectations too high, one analyst said.

At the same time, the company is facing intense price competition from rivals Hewlett-Packard Co. and Gateway Inc., which also owns the eMachines brand and it continues to have problems with its customer support machinery, another analyst said. Even some of the tools Dell uses to boost revenue, including up-selling customers on components, may have lost some of their oomph, according to a third.

In toto, several of the things that helped make Dell successful in the past may no longer be as effective in the consumer space, the analysts said.

"The Dell model is still quite strong, but management clearly underestimated the negative impact of outside influences, particularly in regard to the developing economic weakness in the United States," Brooks Gray, an analyst with Technology Business Research Inc., said in an e-mail on Thursday night.

Click here to read more about shrinking consumer satisfaction with Dell.

"I believe Dell is a leading indicator for the U.S. IT market, signaling that other technology vendors are likely to experience significant growth contractions in the coming months. With that said, Dell should be able to incrementally gain share during a cyclical downturn," Gray said.

"The company remains well-positioned versus its competitors in the PC market, and is making inroads in services, enterprise products and peripheral devices. The negative sentiment in the market is primarily due to the re-alignment of Dells financial targets to deteriorating IT spending, but it should be clear that the Dell business model is not broken."

But other analysts suggested that parts of Dells third-quarter consumer troubles have to do with its own internal operations.

"Theres been a tremendous well of consumer unrest regarding Dells consumer ordering and services," she said. "I have no statistically valid data on this, but I have enough friends, business colleges, their relatives and so on out there who have had bad buying experiences. And there are a number of people who say never again. We could be seeing that lack of repeat buyer and the bad recommendations percolating out."

Next Page: Convincing customers to upgrade.

Convincing Customers to Upgrade

Selling up customers interested in standard fare PCs has also become more difficult as well, said Steve Baker, an analyst at NPD Group Inc.

Dell has traditionally enjoyed having higher PC selling prices thanks to its ability to entice clients with upgrades, Baker said.

"You go in to buy X and come out with Y, which is a few hundred dollars more than you thought you might pay," he said. "If you manage them well you can make a lot of money by offering people certain kinds of upgrades."

However, problems arise if the upgrades offered become less enticing. Some, such as larger hard drives and DVD players, have been more available on even low-price desktops of late.

"What is the value of moving up on a processor? Not a heck of a lot these days," Baker said. "For most mainstream users, a standard processor is going give you pretty much everything you need. So theres less incentive to upgrade. Its similar with hard drives and optical drives."

Rollins, citing a 3 percent increase in Dells average PC selling price during the third quarter, along with a 30-40 percent growth rate for XPS PCs, said he was confident that Dell can continue to compete in the market as well as sell upgrades to customers.

"Weve been able to compete very aggressively, sell a good balance of low, medium and high" level PCs, he said. "Were very comfortable that the [Dell] models fundamental strategic advantages will remain intact."

Those moves could help offset the lower than expected sales in the U.S. consumer space it saw in the third quarter. The company also said the U.K. public sector hurt sales, leading to a surprise third-quarter earnings warning issued earlier this month.

At that time, Dell said it would miss its original guidance of revenue between $14.1 billion and $14.5 billion. It reset the bar at about $13.9 billion, a figure that it met on Thursday. Its 25-cent earnings per share were pulled down by a $442 million charge.

Layoffs, earnings warnings and missed expectations have been a way of life in the PC industry over the last several years. But they have rarely touched Dell. Part of Dells $442 million third-quarter charge including about 1,000 job cuts, some related to the consolidation of its U.S. consumer and SMB operations, and a program to replace faulty motherboards in a number of business desktops, the company said.

Click here to read about a Dell PC that can potentially run with a Linux desktop.

The company is also hedging its bets in 2006 by refreshing vital business products, including servers, storage systems and notebooks. It will deliver its ninth-generation servers in 2006, based on dual-core chips, alongside a new line of SATA (serial ATA) storage systems and a new line of Latitude corporate notebooks, Dell executives told analysts on the earnings call.

But the XPS brand appears to hold the keys for the future of Dells consumer PCs. Dell will continue to speed the XPS systems, company executives said, hinting at plans to beef up the line with new dual-core chips from Intel Corp. that are expected early next year.

If successful, the brand could help Dell rise above issues such as questions about lackluster service, analysts said.

And, to boot, "The XPS brand gives Dell a way to segment away form the standard PCs into premium models where they dont have to worry as much about people upgrading," Baker said. Thats because "the upgrades are already built in. Youre locked into those higher average selling prices right form the get-go."

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