The Tech Slump Doesn’t Scare Michael Dell

In April, as part of BusinessWeek’s "Captains of Industry"
series, Dell Computer CEO Michael Dell sat down with BusinessWeek
Editor-in-Chief Stephen Shepard to talk about Dell and the changing PC business.
Excerpts:

How is the tech slump affecting your business?

If the overall market were growing faster, we would have an opportunity to
grow at a faster rate. I think it affects much more the companies that are
operating with less efficient business systems. In our last quarter, we had 43%
growth in units. That was 4.5 times the rate of the market growth. All the data
that we have so far for this year would indicate that we’re growing
significantly faster than the market.

How do you motivate employees at this time?

What we see now is a more normal business environment: People appreciate
being employed. They appreciate the fact that they have salary and benefits and
incentive compensation plans that actually pay, and bonus plans and profit
sharing plans that are funded based on the success of the business.

Did we get caught up in the romance of technology a little bit too much?

The new technology still has a tremendous opportunity to change businesses.
The change will be more profound for existing businesses, not necessarily new
businesses. A year ago, customers were scrambling to figure out how they were
going to deal with their dot-com competitors. Now what they are thinking about
is, "How do I drive productivity? How do I get my supply chain to be more
efficient? How do we link our customers?" Just fundamental,
blocking-and-tackling, roll-up-your-sleeves kind of work that has very clear and
tangible benefits in the P&L and in the balance sheet.

Where do you see future growth coming from?

The biggest opportunity for us is in the server and storage markets, which
are midway through the commoditization that has occurred in desktops and
notebooks. Then there’s globalization. We have about 22% share in 45% of the
market. We have only 5% in the other 55% of the market. So there’s a big
opportunity to grow outside of the top four or five countries in the world.

What do you think of predictions that PCs are going the way of the
dinosaur?

There is a shift from fixed computers to mobile computers that is quite
pronounced. As we get wireless networks and the next-generation cellular systems
that are higher-speed, those networks allow us to take our computers anywhere.
But remember, the PC is a device that is sold to the tune of 150 million units a
year. Now, will it change form? Definitely, but I don’t think it’s going
away anytime soon.

Many companies have decreased in value tremendously. Is Dell interested in
acquiring in order to expand and diversify? Pick ‘em up cheap, in other words.

Just because it’s cheap doesn’t mean it’s good. Almost all of our
growth has come with organic activity as opposed to acquisition. I truly believe
that will continue to be our major source of growth. We’re acquiring our
competitors, one customer at a time. Not to say that we wouldn’t consider
(acquisitions) as a path for continuing expansion.

You’re 36 years old. Do you expect to be CEO of Dell for the next 25
years?

I think I’ve got at least another good 25 years left. I feel I’ve got a
fantastic job and there is plenty of room for me and the company to grow. So I’m
staying right where I am.

BusinessWeek. Copyright 2001 by The McGraw-Hill Companies, Inc

Looming battle

Those who like software dished up this way aren’t going on faith alone. One
company, VeriSign, shows that offering up software as a service can work
profitably. VeriSign, which sells encryption services for e-commerce sites and
corporate communications, posted $474.8 million in revenues last year, up 460%
from a year earlier. Pro forma net income hit $45.5 million. VeriSign is a
winner because it spotted a technology needed by every company doing business on
the Net, then beat others to the punch by offering it as a service.

That sets the stage for a bruising battle this year. With piddling revenue
streams to be had in the short run, the early ASPs will fight desperately to get
the formula right while next-generation companies pile into the market. And the
old behemoths? Don’t count them out. They, too, want a piece of the action.
"The software business is going to change fundamentally in the next three
to five years," predicts Oracle chief executive Lawrence Ellison.
"Oracle is going to be ahead of that charge."

Some of the pioneers now seem to be on the right track. USi has rounded up
170 customers, and its revenues grew 208% last year, to $109.5 million. Analysts
project revenues this year around $165 million, with the break-even point coming
in the third or fourth quarter. The best news is that USi has finished building
three huge data centers for running the software, which analysts say totaled
more than $300 million. Another leader, Corio, reported revenues of $43.6
million last year, up 650%. Analysts project $75 million in revenues this year
and profits early next year. Both companies are now asking customers to pay part
of the cost of software licenses up front. They have skirted problems
encountered by some of the ASPs that failed, such as Pandesic, which tried to
make money off of fees based on its customers’ e-commerce sales.

No matter how well they tune their engines, though, the first generation ASPs
will have a tough time outperforming the newer entrants. The newbies establish
one super-reliable Web site that all their customers hook into–plugging their
information into simple templates. They don’t have to buy a new set of server
computers for each individual customer, as the pioneers do. If the Young Turks
get it right, the economies of scale could produce gross profit margins topping
90%–dramatically better than the 70% average among traditional software makers
and the 15% to 20% margins that early ASPs have achieved, say analysts. Boasts
Marc Benioff, chairman of sales-force-automation ASP salesforce.com: "We
are going to kill traditional software.’’

Don’t think that big software companies will oblige Benioff. Microsoft, for
instance, is betting its future on an online-service strategy. In addition to
allowing ASPs to rent out such desktop applications as Word, Microsoft is
building a technology foundation upon which other companies can build their
services.

With a market as embryonic as this one, it’s too early to call winners. The
Microsoft of the ASP world might not even be alive yet. But, already, some of
the contestants are promising. Analysts especially like VeriSign’s prospects,
since it has a proven track record and a dominant 75% share of the market for
Internet encryption.

While the notion of software as a service could turn the traditional
packaged-software world upside down, the approach has deep roots in computing.
For decades, companies such as IBM have run other people’s software from their
data centers for a monthly fee. When the Internet came along, Web-hosting
companies managed sites for tens of thousands of companies. USi’s innovation
was to offer the full array of corporate applications–from accounting to
materials planning–as services delivered via the Web. IDC dubbed this an
application service provider.

For a while, the computing world was nuts about ASPs. At the height of the
mania, in the fourth quarter of 1999, venture capitalists pumped $2.5 billion
into these companies. That was half of all the money invested in new software
companies that quarter, according to McKenzie Consulting.

So what went wrong? The biggest obstacle has been inertia. It’s just plain
hard to persuade people to try something new. In interviews with more than 25
corporate customers, BusinessWeek found balky executives. Corporate IT
departments are reluctant to give up control over their computing systems. CEOs
are worried about Net security and fret about handing important business data
over to another company, though those fears have so far proven to be unfounded.

Missing link

For some, the numbers simply don’t add up. The ASPs claim they would have
been cheaper partly because they believe Abraham underestimates the cost of
building and operating fail-safe computing systems like the ones they provide.

When ASPs do manage to land customers, sometimes they fail to deliver the
goods. Even among customers who get satisfactory service, there’s a tendency
to move cautiously. At Hershey, for example, just one tiny portion of the
company, an e-commerce site called Hershey Direct, has gone online with an ASP.
The rest of the company’s computing systems are run through a separate
computing division that sticks to running software the old-fashioned way.

Now ASPs are reconciled to slower growth than they had first expected. That’s
why they’re focusing on profits. ‘’The market is much different than it
was a year ago,’’ says USi CEO Andrew Stern. To cut costs, USi laid off 11%
of its staff in January. Now it’s asking customers to pay at least 20% of the
total cost of a contract up front.

While USi and Corio are struggling to get on a winning track, they’ve got
to be wary of the next generation of ASPs who are coming up from behind. In
little more than a year, salesforce.com has landed 1,700 paying customers and
25,000 companies are participating in free tryouts. NetLedger.com, which
provides small-business accounting services, has 3,000 customers. It’s just a
very different proposition than the one USi and Corio face. Since these newbies
build their technology themselves, they don’t have to pay a software supplier
for programs.

It’s low-risk for customers, too. While second-generation ASPs don’t have
all the bells and whistles of a mature software program from PeopleSoft or SAP,
they make it very easy for customers to sign up and use the services. For
NetLedger’s service, the price is just $9.95 a month to start. A corporate
customer can add more users at any time, and they also can drop them.

Growing payroll

The biggest challenge for the new crop of ASPs will be attracting big
customers. NetLedger doesn’t even try. It’s meant for companies with less
than 100 employees. Salesforce is aiming higher, but so far its largest customer
has just 300 users of the service. Are these upstarts going to snatch away giant
business software projects? Not yet. "Maybe in a few years I would consider
working with them," says Nick Amin, vice-president of information systems
at Cigna in Philadelphia. "They don’t have all the capabilities that I’d
need at this point"–such as sophisticated risk-analysis tools.

That’s already starting to change. The upstarts are quickly adding such
features as sales forecasting. And their deals are getting bigger, too.
Employease, an Atlanta-based human-resources service, has seen its average
customer size increase from 96 employees to 441 employees during 2000. "I’m
supporting 500 people with Employease," says Reed Vickerman, vice-president
of information technology at Copper Mountain Networks in California.
"Adding more would just be a matter of clicking a button."

The software giants can’t turn on a dime like the upstarts, but they’re
quickly becoming forces to reckon with. The furthest along: Intuit, the $1
billion maker of financial and tax software for small businesses and consumers.
Already, Intuit is reaping more than 20% of its revenues from online services.
Every piece of packaged Intuit software, from the QuickBooks accounting program
to TurboTax, has an online counterpart.

While Intuit has the jump on its brethren, other major software makers vow to
excel at delivering their software as services. Software heavyweights such as
SAP, Oracle, and PeopleSoft have a distinct advantage over the first-generation
ASPs when it comes to profit margins. They don’t have to buy somebody else’s
software–they make it themselves. In the past year, Oracle doubled, to 100,
the number of customers using its finance, manufacturing, and customer-service
applications online. With SAP, 16 ASPs are hosting its applications for 150
customers.

Microsoft is going at this market a bit differently. While it offers its
Office desktop applications to customers through a handful of hosting services,
its main goal is to provide a software platform for corporations and ASPs to
build upon–the so-called .Net technology. As part of Microsoft’s $50 million investment in
USi last fall, the upstart agreed to offer customers services based on Microsoft’s
technology. But Microsoft faces stiff competition from Sun Microsystems and
Oracle, which also supply foundation technologies for Net services. Upstarts
such as salesforce.com and NetLedger built their systems on Sun’s heavy-duty
Unix operating system and use Oracle databases. Would they ever retool for
Microsoft? "No way," says NetLedger CEO Evan Goldberg. "We don’t
think Microsoft software is ready for an online service."

Making the transition from the traditional software business to services won’t
be a snap for the established giants. They’ve got to retool their technologies
to run smoothly on the Web. And they’ve got to tinker with their business
models without upsetting quarterly earnings–shifting from their dependency on
huge, up-front license payments to monthly fees.

Rather than mess with what’s working well, some of the established software
companies are opting out of the ASP business–at least, for the time being.
Consider Check Point Software Technologies, which sells firewall software that
protects corporations from intrusions by thieves or hackers. It’s deeply
committed to a network of 1,000 distributors that handled 90% of its $425
million in revenues last year. Offer services directly to customers?

Shwed, however, may be in the minority. Most established companies are
gung-ho for offering software services. "If software companies don’t do
this–maybe not today but somewhere down the line–they are going to
die," says Tim Chou, president of Oracle Business OnLine. That may be too
dire a prediction. However, given the volatility of the software business these
days, it makes sense for them to at least hedge their bets.

Jim Kerstetter with Jay Greene in Seattle–BusinessWeek