Shifting Gears at Dell

Dell Computer soared to the top of the PC industry in the 1980s and '90s by innovating not so much on the machines but on the way they're made and sold. Michael Dell started the company in his dorm room at the University of Texas at Austin, assembling the components and shipping them directly to customers, bypassing the big retail markups of electronics stores. As the company grew and brought in investors, it made its mark with efficient manufacturing, direct Internet sales and good customer service.

Today, Dell is no longer the largest computer maker—Hewlett-Packard took the lead two years ago—and there are signs its old model isn't working. Last quarter, Dell announced a 17 percent drop in profits, and the stock price has fallen significantly. Sales of Dell PCs have been rising lately, but growing costs and slimmer margins have put it on the defensive. A company once seen as perhaps the future of all manufacturing industries has had to change its business model.

The PC maker has abandoned two of its core principles: exclusively online sales and owning its own factories. Dell has long been touted as proof that retail intermediaries can be cut out. Last year, however, in a dramatic about-face, the company ended its Internet-only sales model, joining the other major PC brands on store shelves. J. P. Gownder, a senior analyst at Forrester Research in Cambridge, Mass., says being present in stores is even more important now as manufacturers compete on esthetics. "In the case of Dell," he says, "there was really no outlet for people to get their curiosity sated."

The company's move into retail, says one Dell executive who requested anonymity while discussing company strategy, was a response to "pent-up demand." Now Dell products can be purchased at more than 15,000 stores worldwide, including Best Buy, Staples and Wal-Mart in the United States, and at Gome and Suning in China. Retail has become crucial, as growth in PC sales is increasingly driven by the world's emerging economies. First-time buyers in China, especially, want help from a store clerk.

The firm's manufacturing strategy is also being rethought. In September, Dell executives leaked plans to sell most or all of its factories within 18 months. The company owns factories in Florida, North Carolina, Tennessee, Texas, Brazil, China, India, Ireland, Malaysia and Poland. Dell wouldn't discuss the factories sale, but some analysts say it is a risky gambit to raise cash quickly. (In November of last year, Dell's balance sheet showed $12.2 billion in cash and equivalents; two months ago the figure had fallen to $8.6 billion.) Analysts also say that losing ownership will make it harder to tweak and improve production, previously a Dell stock in trade. That advantage could now go to rivals like Lenovo, which maintains ownership of nine factories. If Dell sells its factories, Dell specialists might still be able to study production at the factories and recommend efficiency improvements.

Dell's desire to relinquish its factories is likely driven in part by the rapidly expanding markets for ultralow-cost mini-laptops, known as nettops. The company built its factories to best handle large corporate orders for desktop PCs; its production of smaller PCs has been less competitive. Nettop sales have been brisk industrywide, especially in Asia, but margins are already razor-thin. Not all PC makers have embraced the devices; Fujitsu, a Japanese company, has decided to stay out of the market altogether, fearing that the PCs would cannibalize sales of bigger-ticket computers.

Dell has entered, at least partially, the ultralow-cost market; in August it launched the mini Vostro PC, which starts at about $440. But other manufacturers make cheaper machines (one Lenovo PC costs half as much). Now Dell must decide if it wants to build an even cheaper model to compete at the bottom of the bottom. T. R. Reid, Dell's head of corporate PR in Singapore, won't say if the company plans to do so. But he does say that the boom in rock-bottom computers provides Dell with an opportunity. As greater numbers of the unwired masses come online, lured by cheap computers, the demand for Web servers will grow ever faster—and Dell manufactures those servers.

It's too soon to tell if Dell's efforts to shift gears will pay off. Either way, the entire PC industry will need to learn from Dell's high-stakes retooling.

© 2008