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Dell's Edge Is Getting Duller

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DQI Bureau
New Update

When Dell announced disappointing quarterly sales a few months ago, CEO Kevin

B Rollins explained away the problems as an 'execution issue.' But if

investors were worried then, the company's October 31 news that it would miss

the mark again this quarter is prompting some to ask a question that once seemed

unthinkable: Is the much-feared Dell Way running out of gas?

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It could well be. While Dell still dominates PC-related gear sold to

corporations, it's stumbling with consumers-a critical growth segment that

has powered brisk PC sales in recent quarters. At the same time, resurgent

rivals such as Hewlett-Packard and Gateway are pricing their products more

aggressively and taking advantage of being in thousands of retail stores-unlike

direct-selling Dell. "Dell traditionally has led with the lowest

price," says FTN Midwest Securities Corp. analyst Bill Fearnley Jr.

"Now it's not unusual to see even lower price points than Dell's."

The PC maker has always had mixed emotions about how to target consumers.

While Dell focused on the corporate market, it reaped consumer sales

opportunistically-never entering markets where it thought it couldn't

achieve its profit goals, and quickly pulling money-losing products. For

example, it still hasn't wholeheartedly targeted the vast Chinese consumer

market, believing it too costly to court so many far-flung newbie customers.

Such pragmatism is one reason for Dell's past success. Selling one computer

to a consumer isn't nearly as profitable as signing a contract to sell

thousands to a corporation. Churning out hits for today's tech-savvy consumers

also requires design savvy and the ability to gamble on creating and marketing

new features-both expensive propositions. And selling to consumers means

investing in help desks.

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But the limitations of Dell's consumer strategy are becoming clear. It is

expected to grow only 10% this year, to $8.4 bn, estimates FTN Midwest

Securities, down from 13% last year and 18% in 2003. Dell declined to comment,

citing the quiet period before its November 10 earnings call.

All this creates a major dilemma. To maintain its status as a hot-growth

company-it grew almost 19% in 2004-Dell needs to tap consumer PC demand,

which is expected to grow 8.4% next year and 10% in 2007, according to IDC.

Meanwhile, the corporate market is projected to grow 5.9% next year and 7.8% in

2007. With revenues expected to hit about $55 bn in the fiscal year ending in

January, Dell is now fighting the problem confronting all large, maturing

companies: how to keep growing.

Can Dell avoid that fate? It faces an uphill battle in righting its consumer

business. At least for now, Dell seems to have run out of cost-cutting

efficiencies to enable it to underprice its rivals enough to gain share and

maintain earnings at the same time. Analysts expect Rollins to maintain Dell's

bottom line even if it means losing customers to lower-priced rivals. The goal:

to stem eroding operating margins in its consumer business, which last year fell

to 5.2%, from 5.9% in 2003.

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Dell's rivals, meantime, can accept lower margins without disappointing

investors. HP is spending far more on R&D. Gateway has fought its way back

to profitability, despite low prices for its eMachines brand. And Lenovo plans

to reenter the retail notebook market, using the IBM ThinkPad it acquired last

year.

Dell has two choices, according to Gartner analyst Charles Smulders:

"Follow the consumer market down in pricing and adjust its costs

accordingly. Or focus just on products" and sacrifice market

share and growth rate for profits. Wall Street will be watching.

By Louise Lee and Peter Burrows

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