Dell and the Deep Blue Sea

 
 
By Eric Nee  |  Posted 2003-01-17
 
 
 

Dell and the Deep Blue Sea


Every so often, industries undergo jarring upheavals as innovators forge breakthroughs in technology and new ways of doing business. Companies that once towered comfortably over their rivals are toppled, and new ones rise up to take their place. Thats exactly whats happening in computers as Dell Computer continues to turn the hardware business inside out. Yet the scary thing for Dells competitors is that the turmoil has just begun.

The results are already clear in PCs, the business Michael Dell tackled first when he started the company in 1984. Today, Dell ranks number one, with 15.8 percent of the world market in the third quarter of 2002, just ahead of the newly merged Hewlett-Packard, which held 15.7 percent, according to Gartner Dataquest. Even more telling, Dells shipments in the same quarter grew 20.7 percent over last year, while HPs shrank 3.1 percent.

Dell is also having success selling servers, a business it began going after seriously in 1996. Dell has a solid hold on second place, with 19.2 percent of the worlds server market in the third quarter, compared with HPs 30 percent. But again, Dells unit shipments in the quarter were up 18.1 percent over last year, while HPs slumped 4.8 percent, and IBMs were off 1.3 percent.

Dell has no plans to stop with PCs and servers. It is marching through the rest of the hardware business as well. The company began selling external storage systems in 1998 and introduced a line of networking switches in 2001. In November, Dell introduced its first handheld computer, and just recently the company announced plans to start selling its first line of printers by the middle of 2003.

Dell is not a technology pioneer. It shakes things up by doing business differently from the rest. Dell waits until a market has gotten large enough and settled on technology standards before it joins the fray. This allows the company to rely on such partners as Intel and Microsoft to supply the technology. While Dell spent just 1 percent of revenues on R&D in its most recent quarter, Sun Microsystems, a technology pioneer, spent 16 percent in hopes of developing something new.

Once Dell has identified a new market, it uses the same highly efficient manufacturing system it developed for PCs to make its new products. By selling directly to customers instead of through retailers and other third parties, Dell cuts costs and maintains close contact with its customers.

As Dell brings this model to such markets as storage, communication gear and printers, buyers of technology stand to benefit. But traditional computer firms are left scrambling. The question companies like IBM, HP and Sun face: Can they compete with Dell in hardware markets where standards are already determined? Or should they move entirely into specialized hardware, software and services where Dells unique approach doesnt have much leverage?

Up in the Air


Up in the Air

The upheaval in the computer hardware industry is not unlike whats happening in the airline industry. Think of the old carriers—United Airlines, American Airlines and Delta Air Lines—as the legacy vendors of their industry: high-cost firms providing a multiplicity of products and services for a premium price, as if the airline business were stuck in its past as a luxury enjoyed by the few. Then along comes Southwest Airlines, with a low-cost business model, significantly undercutting the major carriers on price while offering benefits such as better on-time performance. Southwests advantages didnt matter so much during the high-flying 1990s, when the price of an airline ticket meant little. But the failings of the old model became glaringly obvious when the economy turned down and the Sept. 11 terrorist attacks slowed air travel further.

Today, the major carriers are scrambling to find a way out of the mess. United declared bankruptcy in early December, American is cutting prices on regular flights, while Delta has plans to imitate Southwest by establishing a low-cost carrier of its own, something it has tried before, with miserable results.

If this sounds familiar, it should. Dells competitors have tried similar tactics, with little success. So change they must. IBM has been the most successful. Over the last decade, Big Blue has all but exited the desktop PC business—a bold move considering the company started that industry. Instead, IBM is focusing on hardware markets where it can offer unique technology, like laptops, or leverage its strength in services and software, like servers. Today, hardware comprises just 36 percent of IBMs revenues.

Meanwhile, IBM has steadily expanded its software and services business, to the extent that it now makes up 60 percent of total revenues, by far the most of any of the old-line computer companies. Software revenues totaled $3.1 billion in the third quarter, while services totaled $8.9 billion. The recent acquisitions of PwC Consulting and Rational Software only add to the companys strength in these areas.

Unlike IBM, HP decided to tackle Dell head-on, first by building PCs to order. But the company was unwilling to give up its retail channel or its extensive R&D budget, and its refusal to go all the way into made-to-order PCs doomed its effort to compete on Dells terms.

Then it bought Compaq. But thats the same failed strategy American Airlines employed when it bought Trans World Airlines in 2001. The deal helped American lay claim to the dubious distinction of being the largest carrier in the world, but did little if anything to help American compete with Southwest. Like American, HP has spent the last year laying off thousands of employees in an attempt to reduce its cost structure.

Losing Market Share


Losing Market Share

Yet investors seem to be taken with HPs strategy, betting that in the short term it can cut costs faster than it loses business, resulting in higher profits. That appears to be working for now, but the bigger problem HP faces is that it is still losing market share to Dell in computers.

Consider what happened to HPs PC business. For a brief moment after acquiring Compaq, HP was the number one PC seller in the world, but Dell quickly passed HP, probably for good.

HP now looks like the mirror image of IBM, with hardware comprising 65 percent of revenues, and software and services just 18 percent. (Hugely profitable printing supplies make up much of the remainder.) But without a strong portfolio of software or enterprise services, all HP has to offer in servers is price/performance, a game it cannot win against Dell. And looming ahead is Dells plan to take on HPs golden goose—printing.

Sun Microsystems believes it can fight on all fronts. On the one hand, it is trying to be the Singapore Airlines of the computer industry: a boutique provider of special-purpose computers and software—such as powerful engineering workstations and servers—that some customers will pay more for. At the same time, Sun thinks it can compete directly against Dell with low-priced, general-purpose Linux servers. This is the same mistake the airlines made: thinking they can run both a high-priced and a low-cost airline at the same time. Its as if Singapore Airlines were to try to compete against Southwest on the Houston-to-Phoenix route. It cant be done.

Like Southwest, Dell has dramatically altered the landscape of the computer industry. To compete against Dell in computers, and increasingly in other parts of the hardware business, older firms are being forced to become more efficient, or get out and find other ways to meet their customers needs. IBM is the one firm that has figured this out. The question for HP and Sun is whether they will follow suit, or go the way of United Airlines.

Eric Nee, a longtime observer of Silicon Valley, has served in a variety of editorial positions at Forbes, Fortune and Upside magazines.

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