DARK DAYS AT DELL.

By: Byrnes, Nanette, Burrows, Peter, Lee, Louise, Hafkin, Gregory, Business Week, 00077135, 9/4/2006, Issue 3999 Database: Business Source Elite

DARK DAYS AT DELL

Contents Section: News & Insights The tech industry's lean, mean direct sales machine is on the fritz, and there don't seem to be any easy fixes. What gives?

These are the dog days of Texas summer, with grass bleached yellow and the mercury hitting 100 by noon. But nowhere is the heat being felt like it is inside Dell Inc.'s no-frills compound outside Austin. For company founder and Chairman Michael S. Dell and CEO Kevin B. Rollins, this summer has been one mishap after another: a massive recall of potentially self-igniting laptop batteries, a dismal earnings report, and an announcement that the computer maker is under SEC scrutiny for the way it counts revenues. By mid-August, Rollins was being asked on CNBC about how long he would occupy the tandem corner office he shares with Michael Dell.
"THEY'RE A ONE-TRICK PONY"

Rollins looked to be the picture of calm in the face of the rebuke. But make no mistake, this is a pivotal moment for a tech icon. Dell may not have hit a wall in quite as dramatic a fashion as did Eastman Kodak or IBM. For all its problems, it is still expected to make nearly $3 billion this year. Yet its predicament may be intractable. Dell remained slavishly loyal to its core idea of ultraefficient supply-chain management and direct sales to consumers, even as rivals have stepped up their game and markets have shifted to take away some of Dell's key advantages. Instead of adapting, critics say, Dell cut costs in ways that compromised customer service and, possibly, product quality. Says one top tech executive in reference to Dell's lean, mean direct-sales machine: "They're a one-trick pony. It was a great trick for over 10 years, but the rest of us have figured it out and Dell hasn't plowed any of its profits into creating a new trick." The same operational focus that made Dell and Rollins so formidable when they were on top may get in the way of finding another big idea. "Dell's culture is not inspirational or aspirational," says Geoffrey A. Moore, a tech consultant and author of Dealing with Darwin: How Great Companies Innovate at Every Phase of Their Evolution. "This is when they need to be imaginative, but [Dell's] culture only wants to talk about execution." And Dell's execution isn't what it used to be. The company will make about $900 million less in net income this year than it did in 2005, analysts estimate. It has slashed prices to maintain PC market share (19.2% in the second quarter) at the expense of operating margins, which slid to just 4.3% in the quarter ended Aug. 4 from 8.7% the year before. With the stock trading around 22, off its 2000 high of 58, blue-chip investment houses have fled. Fidelity Investments and Goldman Sachs are among those that have cut their Dell holdings by a third or more since Jan. 1 (table). Dell is spending $115 million to improve service, and its scores have improved recently. Still, some buyers have jumped ship. Peter Shoesmith, the network operations manager at 74-attorney firm Cummings & Lockwood in Stamford, Conn., once spent $300,000 a year on Dell PCs and servers. Today, he uses Hewlett-Packard almost exclusively. For Shoesmith, Dell's products proved too hard to maintain and operate. "They grew too fast and tried to produce too many products at the same time," says Shoesmith. He would consider using Dell again but says "it'll take a lot for us to jump back." At Dell's suburban Round Rock (Tex.) headquarters, many employees who once used Excel spreadsheets to track the rising value of their stock option grants now find Dell's hard-driving culture too much of a grind. Richard Snyder, an alum of Dell and HP and now CEO of Austin-based Forgent Networks Inc., gets a stream of disaffected workers applying for jobs. "They don't feel

they're part of something at Dell, and they generally leave because they feel frustrated," says Snyder. "Dell is not a fun place to work, and it's less fun now than it used to be." These various defections have the technorati buzzing about whether Rollins will be next to go. Dell turned down BusinessWeek's requests to interview Rollins and Michael Dell, and it wouldn't respond to specific questions about the business. But many who are close to the company doubt that Rollins will walk the plank anytime soon, if only because the two executives have been in lockstep since Rollins came from consultancy Bain & Co. in 1996. Michael Dell shows no signs of backing off: He has spent $70 million to buy 2.9 million shares on the open market since Jan. 1 and holds 10% of the company. In a conference call with analysts on Aug. 17, Dell said his execs "are confident we're making the right long-term decisions for our customers and shareholders." While Dell's problems may seem to have sprung up only recently, Rollins may have revealed the limits of its model in an interview with BusinessWeek back in 2003. "There are some organizations where people think they're a hero if they invent a new thing," he said. "Being a hero at Dell means saving money." But it was clear some time ago that Dell's model was not keeping pace and was not going to be such a big advantage in the future. It's becoming harder for Dell to run one of its most profitable plays: luring customers to its Web site with cheapo models and then getting them to buy a $2,500 box with all the bells and whistles. Now, PCs are so powerful that most consumers are fine with preconfigured models in stores. Some of Dell's other operational advantages are fading, too. Notebook PCs are becoming a far larger percentage of the market, but the Asian contract factories that make them for Dell also make them for other companies, eroding Dell's build-toorder advantage. And while experts believe Dell got the best prices on components when it was outgrowing all of its rivals, these days newly ascendant HP and Asian rivals Lenovo Group and Acer are offering plenty of growth themselves. Even Dell's decision in May to end its exclusive deal with Intel Corp. by using chips from Advanced Micro Devices Inc. could cause short-term pain. The move was cheered by investors, but it comes just as Intel is introducing chips that close AMD's technology lead. "This may not be such a bad thing [for Intel]," says one Intel insider. "Exclusivity was great when Dell was growing faster than the rest of the world. But being tied to the hip to a company that is struggling isn't necessarily a good thing." This source thinks Intel may now tighten its links to Apple Computer Inc. and HP. So why hasn't Michael Dell -- clearly a brilliant guy -- changed tactics? For starters, say rivals and Dell alums, shifting gears would upset investors who expect hyper-profitability from Dell's hyperefficiency. And having stuck to his guns in the past, he can't risk letting customers think that "Direct from Dell" is no longer the cheapest, smartest way to go. That message isn't just a slogan, either: Inside Dell, ideas that break from the model are discouraged, say former Dell managers. Notes one: "You had to be very confident and thick-skinned to stay on an issue that wasn't popular. A lot of red flags got waved -- but only once." Now the cost focus may be making it harder to bring in fresh blood. Three respected headhunters contacted by BusinessWeek said they would rather recruit from Dell than for it because working with the company is so difficult and unprofitable. About two years ago, says one, Dell began an online bidding process for determining which firms would get its recruitment work. "They're trying to extend the process they use for buying memory chips and LCD screens to professional services," says the headhunter. Dell insiders point to one small example of the pressure to maintain performance. In its efforts to diversify, Dell jumped into televisions back in 2003. TVs, like all electronic products, have to meet regulatory standards limiting how much electromagnetic interference (EMI) they produce. Dell, wanting to do better than meet the government standard, set an EMI level well below the legal limit, say two former Dell employees. Those first models made a splash, and management wanted to keep momentum for the fall 2004 launch of LCD and plasma models. But in testing

they didn't meet those higher goals, according to internal memos, copies of which were obtained by BusinessWeek. Redesigning the TVs to lower emissions would have taken weeks or months, and forced Dell to miss the launch dates. After ordering suppliers to work around the clock and hiring contract engineers to try to fix the problem, Dell lowered its standards, according to the former employees. The memos indicate that some TVs would ship without meeting the company's EMI goal, though they still would meet legal standards. Other attempts to expand beyond PCs have come up dry. Dell dropped its DJ music player in January after tepid sales. Its stolid brand image doesn't help it in fast-growing consumer markets, and a tightfisted approach to R&D stunts new-product innovation. While Dell sells straight-up TVs, for example, HP just introduced a big-screen TV that can wirelessly grab whatever music, movies, and photos you have on your PC in the den. As hard as things look, Dell is nowhere near as bad off as it was in 2001, when the tech bubble burst and companies stopped buying. Today, Dell is still adding new employees. Maybe they'll bring some bright ideas with them.
Dell: An Icon's Two-Year Slide

JULY 2004 Kevin Rollins is promoted to CEO; founder Michael Dell remains chairman. FEBRUARY 2005 Rollins sets a goal of $80 billion annual revenues in three to four years, from $49 billion. NOVEMBER '05 Rollins sticks to $80 billion goal, but now won't say when he'll reach it. DECEMBER '05 An exodus of top execs continues as Asia chief Bill Amelio takes the CEO post at competitor Lenovo. JANUARY 2006 Dell discontinues its DJ music player due to slow sales. MAY '06 Dell quits giving quarterly earnings guidance and says it will miss first-quarter goals. JUNE '06 Web pictures show a Dell laptop burning in Japan. JULY '06 The stock hits a nearly five-year low of 19.91, down from 58 in 2000. AUGUST '06 Dell recalls 4.1 million notebook batteries at risk of overheating. Quarterly earnings fall by half, to $502 million.
Down on Dell

Some big institutional investors have sold Dell shares this year

NO. OF SHARES SOLD SINCE JAN. 1 (MILLIONS)* Fidelity Investments Sands Capital Management Wellington Management T. Rowe Price Associates Goldman Sachs Asset Management AllianceBernstein Grantham, Mayo, Van Otterloo Columbia Management Advisors 29.7 23.5 20.3 12.5 11.2 9.8 9.5 9.3

PERCENT CHANGE 32 100 56 31 36 65 49 77

* As of most recent quarterly filing with Securities & Exchange Commission

Data: Thomson Financial via Capital IQ and company filings

A Bad Spell for Dell. By: Corcoran, Elizabeth, Forbes, 00156914, 6/19/2006, Vol. 177, Issue 13 Database: Business Source Elite

A Bad Spell for Dell

Contents

Section: Out front COMPUTERS Lots of little changes are in store to halt the swoon of this famous model of efficiency

Kevin Rollins had a lot of explaining to do on Friday, May 19. The chief executive of Dell had just announced the company's most disappointing quarterly revenue growth in four years, and its stock had hit yet another 52-week low. Rollins went from a boardroom where he briefed senior managers on plans to regain momentum to leading an hour-long "town hall" meeting called earlier to field employees' questions. Over the course of the day he answered 250 e-mails, including this one from a once disgruntled customer: "Kevin, Thank you for your concern and assistance with my request. I was contacted by the Care Resolution Center, [who] apologized for his team dropping the ball on a response to my inquiries and recommended a satisfactory solution to my problem. My confidence in Dell and product loyalty are strong again." Rollins has pulled Dell out of jams in the past, but personally solving customers' problems one by one is an impractical way to run a company with sales of $56 billion. Dell has lost $40 billion in market value since last July. Until early May its executives had refused to say publicly what investors knew all along: Dude, you've got a problem. The law of large numbers has caught up with Dell. Once worshipped for consistent performance, Dell has had seven quarters of declining revenue growth and missed its own revenue predictions in three of the last four quarters. It finally gave up giving quarterly guidance (arguing that its competitors don't do so, either). Its competition is on its back: HP, now nimbler, is gaining share in the U.S. and is improving its profitability. Lenovo continues to gain share in fast growing China. In Round Rock, Tex. Rollins impatiently waves off criticism. "We're still gaining share, we're still growing faster than our competitors, we're still more profitable by a long shot," he says in an interview. "Still, we're human. We tripped. And we're not happy about that." Dell has grown faster than HP in businesses where it is smaller, such as services--but lost share in its biggest segment, desktop PCs. Although Dell executives are loath to be pinned to a timetable, neither the company nor its founder, Michael Dell, who still holds 9% of its stock, is known for patience. "I believe the things we're doing now will be successful, and a year from now we'll be able to talk about how they've been successful," Rollins says. The changes being made are medium-size but manifold. In a first, Dell will abandon its Intel-only policy and begin offering corporate customers high-end servers running microprocessors from Advanced Micro Devices, an option Hewlett-Packard has been offering for years. But more deals with AMD could be down the road. Dell began cutting prices on PCs and servers in earnest in early spring, but Rollins pledges he won't jeopardize the entire business by setting off a price war. In the last few years, Dell simply got greedy and tried to grow profits and ultimately sacrificed revenue. Now that's changing. In its most recent quarter, Dell's operating (Ebitda) margin sank to 7.7%, while HP's climbed to 10.7%. "This isn't an excuse for why the margins are down--it's an explanation," Rollins says. "We are going to take [prices] down to ignite growth. So it wasn't a mistake. And we'll stay with it for the foreseeable future." Rollins is accelerating the construction of a new assembly plant in India, due to be operational by next year. Dell also struck a deal with Google, reportedly worth hundreds of millions of dollars

over three years to Dell, to install the search giant's software on nearly every PC. Dell also recently said it will open its first retail stores, in Dallas and New York, where people can configure PCs for delivery a few days later, an idea that the company says has worked well at the 160 kiosks Dell now operates in shopping malls. Retail stores can go either way. They flopped for Gateway but have added sparkle to Apple Computer. Then there are the big fixes, like improving customer service for U.S. consumers. To save money Dell had moved toll-free service and tech support to India in 2001. Consumers started grousing, but executives downplayed the complaints, pointing out that corporate clients, who provide 85% of Dell's business, were happy. (Dell did shift customer support for business clients back to the U.S. in 2004.) "The consumer business was having some trouble," says Rollins, "but we thought that was in containment." He got a splash of cold water to the face last November from Dell's own employees. In the semiannual "Tell Dell" survey, workers bluntly signaled they were losing confidence in their leadership. "They felt we might not have been listening enough and that they didn't think we were positioning the company for success," Rollins recalled. "We felt terrible. We thought we could do better." Late last year Dell hired 2,000 people in its U.S. call centers and stepped up its training programs for 5,000 other reps. The company will spend an additional $100 million this year to improve customer service. It is already seeing some gains, with call-wait times down 50%. "We get it," Rollins says. Dell has always been at its best when under attack. Alone among PC makers, it grew through the industry slump that began in 2000. It is still extremely profitable. Last year it netted $3.6 billion, to HP's $2.4 billion. And Dell's efficiency remains tough to match. It takes under an hour to assemble a laptop or desktop PC. This year Rollins wants to whittle down $3 billion in costs without laying off employees, in part by scraping a few dollars off the material costs of every PC. But Dell no longer has the benefit of an archrival distracted by merger drama. HP now builds laptops in its China plant in under three hours. It is capitalizing on the extensive network of partners it has in Asia, where it was the number two PC vendor last year, with 11.6% of the 41 million units shipped. Dell is third with 8.2%. (Lenovo holds 18% of the market but is in perilous shape outside of China. It snared Dell's Asia boss William Amelio as its new chief executive late last year.) "HP understands Asia," contends Ann Livermore, an executive vice president at HP. "We've passed our twentieth year in China. We have 4,000 partners in China and 2,000 retail centers," she says. Those partners help introduce HP's newest technology and provide service. In India HP has retail outlets in 100 cities, as well as extensive support and service centers; 200 shops carry only HP's gear. Equally critical: the deep expertise in setting up and running computer systems. HP brought all those elements into play when the Bank of India was looking for a partner to put computers into 900 branches. "We needed a partner with experience in hardware, software, implementation, as well as training in banking and services--and competitive pricing," says D. Krishnamurthy, general manager of information technology for the Bank of India. HP beat out 21 other bidders and is now two years into the ten-year program, which it is using to showcase its work with Asian banks. Rollins has been looking for such service deals to help fuel Dell's growth. And for the past few years they have grown: Even in its tough first quarter, Dell's services business rose 28% to $1.4 billion. Dell uses its affordable hardware as its calling card, then offers services along with storage and networking.

Boeing and DaimlerChrysler are leaning on Dell to manage and update thousands of their PCs and printers both in the U.S. and worldwide. TRW Automotive standardized all of its 24,000 PCs in 165 sites using Dell. "We decided that the PC was a commodity and we could get the best price from Dell," says Joseph Drouin, a vice president at TRW Automotive. Dell also put together a service package for TRW that includes software updates and a server network that runs cheap open-source software. Dell executives say they find plenty of business without channel partners. "Every time we went into a new market, people would say, 'Oh, the direct model won't work,'" says Rosendo Parra, who now heads Dell's Americas group. "When we first went to Japan [in 1991] we actually listened to what the market said. Our initial implementation wasn't a pure, direct model. And we failed," he says. "We actually had to hit the reset button and began to apply the elements of our model." For consumers Dell's "buy direct" model means you have to place an order over the phone or via the Web. For businesses Dell's "direct" means you get to hear from Dell's sales force and then order PCs off a customized Web page. Direct sales are always the best way to get to know customers, points out Stephen Felice, who now runs Dell's operations in Asia. Even so, if necessary Dell will deliver its products through another company, something that happens to about 20% of Dell's products in China, where Dell has been actively selling since 1998. Felice is trying to reduce that number. "We're adding infrastructure," Felice says. "You won't see costcutting here." Dell managers concede that growth comes hard to giant firms, which is one reason why they might consider splitting the company into autonomous chunks. One possibility is to operate its brands more independently, just as Toyota does with the high-end Lexus and budget-priced Scion. Dell took a step in this direction by acquiring Alienware, which makes expensive PCs for gamers. Dell will leave that brand alone. Rollins is staying mum about other plans. "Dell is a very dynamic company," Rollins says. "So if anyone says, 'Well, that's not what you said a month ago,' I'll say, 'You're right.' And I'm not going to apologize for that. We'll change things the minute we have new data."
By the Numbers

Turn of the Tide

HP has put its merger drama behind it and is trimming Dell's long-held lead in worldwide PC sales.

Dell

HP

WORLDWIDE PC MARKET SHARE IN 1Q06 18.18% 16.52% ([down] 0.39%) ([up]1.41%) PC UNIT GROWTH IN 1Q06 (MARKET OVERALL UP 13%) 10.2% 23% PC UNITS SHIPPED IN 2005 37.8 mil 32.6 mil PC UNIT GROWTH IN 2005 19% 16%

Source: IDC PC Tracker.

It's Dell vs. The Dell Way

Contents Section: Information Technology Computers How the PC maker's once-revolutionary sales strategy may be holding it back

DURING A CONFERENCE call on Feb. 16 to announce quarterly results, Dell Inc. executives unleashed a torrent of impressive numbers. Earnings grew 52%, to $1 billion. Sales rose 13%, to $15.2 billion. And the company said it increased market share, already tops on a global basis, in every region around the world. "Our promise to you is that we intend to grow and take share, as we have historically," said Chief Executive Kevin B. Rollins. Yet Dell's investors keyed in on another number: Sales growth for the coming quarter would be just 6% to 9%, the company said, a far cry from the 16% Dell posted a year earlier. The following day, Dell shares slid 5%, to $30, bringing the decline over the past year to 25%. On Feb. 22, Dell said it would postpone an annual analyst meeting scheduled for April until September, a move that gives the company more time to improve its performance before the public affair. For the past 22 years, Dell has laid waste to mighty rivals with one of the most groundbreaking business innovations of the past half-century: selling technology products directly to customers via the telephone, and later the Internet, instead of going through retail stores or resellers. But now the remaining competitors, such as Hewlett-Packard Co., have narrowed the gap in productivity and price. That leaves Dell in a tight spot. Rollins and Michael S. Dell, founder and now chairman, must either come up with another breakthrough innovation or face a future of slugging it out on nearequal footing with rivals. "Michael broke the paradigm about how to run a computer business, but they haven't been so great at finding the next paradigm," says David Yoffie, a professor at Harvard Business School. "That's the big challenge for Dell the company and for Michael." This looks like the year Dell will be pushed harder than ever to reinvent itself. Rollins wasn't available to comment for this story. But he and his top managers are weighing several steps that would represent sharp breaks with the past, including loosening its relationships with Microsoft Corp. and Intel Corp., the two companies most responsible for Dell's dominance in the PC business. Dell is in talks to install key search software from Google Inc. on its computers in exchange for payments of as much as $1 billion over three years. Such a deal is sure to antagonize Microsoft, which has been trying to gain ground against Google in search.
CONSUMER PRESSURE

Dell has also reopened negotiations with Intel rival Advanced Micro Devices Inc., according to one well-placed source. Dell is considering offering PCs and servers built on AMD processors, a move that would mark the first time Dell has bought processors for its machines from a supplier other than Intel. The source cautions that talks have been serious in the past and failed, and they could falter again. Yet analysts say what's different this time is the rising pressure on Dell to offer AMD chips, since AMD is swiping market share from Intel. "Customers want AMD," says Charles Wolf, an analyst with Needham & Co. "If Dell doesn't offer their chips, it has less ammunition in the war." Dell has long been known for its strict financial and operational discipline. But some in the industry say what's needed now is a willingness to experiment, perhaps with larger acquisitions, perhaps with selling through retailers or resellers. "Dell is still singing the same old song," says analyst Mark D. Stahlman of Caris & Co. "It's time for them to change." The world is clearly changing around Dell. The once-torrid growth in sales of personal computers has slowed, to about 5% a year. More surprising, consumers seem less enamored of buying their tech wares over the Web or phone. According to researcher NPD Group Inc., the percentage of PC sales done via the phone and Web fell last year, and the share of sales through U.S. retail stores

rose, as people flocked to shops to fiddle with new gear such as digital-music players, digital cameras, and slick laptops. Consumers' buying habits are a reflection of a broader shift in the technology world. People are mesmerized by new digital gear with unique features and style. Commodity technologies, such as plain-vanilla PCs, are passe. That's a difficult development for Dell. It spends less on research and development ($463 million) than Apple Computer Inc. ($534 million), despite being four times Apple's size. "Not investing in R&D works great in the commoditized PC world," says Vinnie Muscolino, general partner with Babson Capital Management. "It doesn't work as well in other areas." That's not to say Dell is broken. It's the global leader in PC market share, with 17.2%, and most analysts expect it to continue to gain share even without any significant changes to its approach. One reason is that Dell has room to expand in fast-growing markets such as China. And Dell is making progress in offering basic computer installation and maintenance services to businesses as well as in reselling back-office storage gear from partner EMC Corp. But Dell is losing its reputation as a must-own growth stock in the tech field. With its inconsistent financial results over much of last year, several big shareholders have headed for the exits. Citigroup, insurer AXA, and Nicholas-Applegate Capital Management have each slashed their holdings in Dell by 80% in recent months, according to filings with the Securities & Exchange Commission. Dell's market cap has dropped below that of Hewlett-Packard, with HP worth $92 billion and Dell at $70 billion. Dell's greatest difficulties are related to one of its biggest opportunities: consumers. Operating margins for Dell's consumer business were an estimated 3.8% in the fourth quarter, despite an attempt to reduce reliance on low prices. While Dell remains a leader in selling home PCs, it hasn't made inroads in selling more lucrative gear like portable music players. "Innovation is now front and center," says analyst Stahlman. Can Dell get back on track with consumers? Job One is to fix its poor reputation for customer service: The Better Business Bureau saw complaints more than double last year, to 1,533. Dell has already boosted its support staff in North America by 20% and is planning another call center in India. Dell may have to do even more. Some analysts say it's time for the company to invest more in R&D to spice up products. That's not happening so far. Dell recently axed one research group assigned to examine and prepare for future trends. Putting more money into R&D. Selling through retail stores. Breaking with Intel. None of these steps sound anything like Dell. The fact that analysts are raising these ideas underscores how dramatically the times are changing. If Rollins and Dell want to keep up the company's image as one of the great stock market performers of all time, they may have to think different.

A Paradigm Loses Its Punch Dell remains the world's largest PC maker. But it's nowhere near the revolutionary force -- or hot stock -- it once was. The reason may be that key assumptions of the Dell Way no longer hold true. DIRECT WILL DOMINATE: Dell has long assumed that its major innovation, selling directly to customers over the phone or Net rather than through middlemen, would become even more important as people grew more comfortable buying tech products. But sales in retail stores grew faster than direct sales last year.

WINTEL RULES: Among PC makers, Dell has had the tightest partnerships with Microsoft and Intel, the creators, respectively, of the Windows operating system and Pentium chips that defined the PC. But Microsoft is losing ground to Linux software and Intel to Advanced Micro Devices. Dell may loosen its ties to the tech giants. COMMODITIZATION IS KING: Dell has never done much of its own R&D, and it recently eliminated a research group assigned to examine and prepare for future trends. But rather than settling for plain-Jane PCs and servers, many customers are looking for more innovative products. WIN WITH COST-CUTTING: Dell's ruthless efficiency allowed it to underprice rivals and pump up its own profits. Critics have said the company is not spending enough on customer service or new products.