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