Dell – Don’t call it a come back

In technology circles, the innovator’s dilemma is a well documented phenomenon. A company that builds its business around a pioneering idea is faced with a conundrum when market demand changes: does it stick to what it knows and what made its fortune or move on with the pack?

For the past six months, that dilemma appeared to be getting the better of computer manufacturer Dell. The company that once threw the traditional PC industry into disarray with its direct sales channel began, in mid-2005, to resemble a victim of its own success. Competitors such as Hewlett-Packard (HP) and Lenovo created a hybrid of Dell’s direct sales technique and third-party reselling, eventually growing their market share to the point where HP overtook Dell as the world’s leading PC maker.

The attempts Dell did make to rectify that position – a renewed focus on services, the re-instatement of Michael Dell as CEO and, finally, a tentative move into the reseller channel – were hard to judge. The company did not publish net income in its financial reports for the third and fourth quarters of its fiscal 2006.

Normally, this would have been grounds for delisting from the NASDAQ stock exchange, but the Securities Exchange Commission granted Dell exemption while ordering an investigation into the company’s accounts.

When, in May 2007, it did reveal net income for its first quarter of fiscal 2008, the $687 million figure was down 33% from the same quarter the year before. The findings of the SEC investigation – that misleading account reporting had been sanctioned by senior executives, and that its previous filings are ‘not to be relied upon’ – added to the dark cloud gathering over Dell.

So it came as some surprise when, in August 2007, the earnings report for its second quarter of the financial year painted a rather sunnier picture. Profits rose by 47% to reach $733 million, beating analysts’ expectations. That jump would have been greater had it not been for the $59 million cost of its internal investigation. Total revenues were $14.7 billion, up 4.8%.

Two factors helped this rebound. Firstly, the cost of the components Dell sources has been steadily dropping during the past year, helping it strengthen its margins on hardware.

And secondly, the retail channel, which includes US retail mega-chain Wal-Mart, helped the company to grow shipments of PCs by 5.7% – the first significant increase in PC shipments at the company for a year, according to IT analyst Gartner. It derived revenues of $5 billion from desktop products during the quarter.

Dell also maintained its leadership in the US server market, with its revenues of $1.6 billion up 14% on the year-ago quarter and its market share rising to 32.7% (according to its calculations).

Is this the beginnings of a comeback? Some believe so: stock markets across Asia rose as Dell’s new-found recovery was seen as a positive indicator for the technology industry in that region where Dell sources most of its components. But others are more cautious, including Dell itself, which warned that the cost of components could not continue to fall for long and may begin to put pressure on margins in the second half of the financial year.

Contrasting fortunes

Analysts were in agreement that although this is a good start, Dell has a long way to go. That impression was compounded by the glowing set of results produced by arch-rival hp, which turned in its strongest financial performance in seven years during the third quarter of 2007. Crucially for Dell, it was once again HP’s PC division that drove year-on-year revenue growth of 16%, reaching $24.5 billion. Sales at HP’s Personal Systems Group grew 29% to reach almost $9 billion.

Meanwhile the printing division – HP’s most profitable enterprise – enjoyed a 76% boost in sales of multifunction printers and total revenues of $6.8 billion. The company’s software division grew by 74% to revenues of $554 million, thanks mainly to the company’s acquisition of systems management software vendor Mercury last year.   

Profitability was also strong. Net income at the company grew 29% to reach $1.8 billion. On top of the falling component prices, HP has also reduced operational costs with data-centre consolidation and real-estate rationalisation; it has also made over 15,000 job cuts during the past two years.

So secure do HP’s financial fortunes appear that even its expectation-beating third quarter results failed to affect its share price significantly. "It's a very strong quarter [for HP] but not much of a surprise. A lot of this was already baked into the stock price," said Anders Bylund, analyst with financial trading advisory Motley Fool.

And while Dell might at last be on the road to recovery, it will be a long time before investors have as much confidence in it as that

Sun microsystems, which sits in third place between Hewlett-Packard and Dell in worldwide server market share, according to Gartner, reported perfectly flat revenues in August 2007. It took $3.85 million in its fourth quarter of fiscal 2007, exactly as much as it did the year before.

But despite the static revenue, profits improved dramatically. While in the fourth quarter of last year, the company suffered a $301 million loss, this year it made a $329 million profit.

Keen to preserve that upward trend in profitability, the company announced that it is to reduce head count and, in a less conventional move to boost its attractiveness to investors, the company changed its ticker symbol from SUNW to JAVA.

Pete Swabey

Pete Swabey

Pete was Editor of Information Age and head of technology research for Vitesse Media plc from 2005 to 2013, before moving on to be Senior Editor and then Editorial Director at The Economist Intelligence...

Related Topics