In its heyday, DELL, as now, assembled and sold desktops and laptops, primarily to business and government but also to consumers. The desktops were utilitarian, the laptops not particularly stylish and a bit heavier than others. But all DELL’s products were serviceable and they were cheap.
DELL had several advantages over its competition:
1. it dealt directly with the end consumer, assembling machines to order. So it had virtually no finished goods inventory
2. component manufacturers suffered from chronic overcapacity. So their prices were generally falling. DELL took delivery of parts on the day a machine was assembled and sold, rather than having a finished machine sitting on a shelf for three months before purchase. This gave the company a several percentage point cost of goods advantage over rivals.
3. competitors were weak. IBM wasn’t sending its best and brightest to make PCs. A Jobs-less AAPL was drifting. Compaq was very inefficient, as was HP. HP then compounded its problems by hiring Carly Fiorina–a marketer with little manufacturing experience–and acquiring Compaq.
4. DELL uses a negative working capital business model. That is, customers pay for their DELL computers at present on average 36 days earlier than DELL pays its suppliers and workers for making the machines. Also, DELL receives payment for warranty or other service contracts in advance. When short-term interest rates were higher than now, DELL could earn hundreds of millions of dollars in interest income on these “floating” balances.
..where did they all go?
What happened is this:
1. component making became more sophisticated and expensive. Suppliers consolidated or dropped out of the business. Chronic overcapacity abated. We now appear to be entering, if anything, a period of component shortage.
2. IBM sold its PC-making business to Lenovo. Jobs returned to AAPL. Fiorina was shown the door at HPQ, which promptly hired a veteran manufacturing manager, Mark Hurd, from NCR. Acer and ASUS emerged as global players in the PC market with low-cost netbooks.
3. Consumer tastes shifted from heavy and clunky to smartphones, netboooks and sleeker Macs. DELL didn’t adjust, although it’s trying to do so now.
4. Vista arrived, causing consumer disenchantment with MSFT-driven computers and encouraging businesses to stay with Windows XP.
5. The Great Recession developed. Not only did this reduce demand, but it lowered short-term interest rates to almost nothing, all but erasing DELL’s once significant interest income.
Not all the issues were external, however.
6. DELL’s quality control and customer service, at least in its consumer business, slipped badly.
Where to from here?
Michael Dell, the company founder, returned to the helm to right a troubled ship in early 2007.
His initial goals were to reduce manufacturing costs and increase production efficiency, in order to raise margins and reverse a sharp slippage in the effectiveness of the company’s negative working capital model.
DELL has also been trying to rationalize product lines (fewer models) and simplify product design. To this end, it is increasingly turning away from its own manufacturing plants and using contract manufacturers.
I’ve read that Mr. Dell also at least initially wanted to expand the company’s consumer device offerings. But I can see no specific evidence of this desire in company documents on the website. And in any event, it seems to me that this market–which is now iPhone, iTouch, Blackberry, Android, netbook–has pretty much run away from DELL.
(By the way, I’ve found the company website much more open and accessible than it was a few years ago, when it was impossible, even as a professional investor, to arrange to get on the company’s email alert list. The new reporting format this year is also a big step up in delivering relevant investor data.)
International expansion is another theme.
So to is creation of a much larger service business, so that DELL can have more recurring revenue and be less dependent on the PC replacement cycle with large enterprises and government entities. Hence, the $4 billion (cash) Perot Systems acquisition, which has just closed.
A tough row to hoe
To sum up: DELL appears to have decided to start down the same path that IBM began to tread in the late Nineties and onto which HPQ turned two years or so ago. This seems to be the natural evolution of the IT business–from hardware to software and services. Two big issues for DELL: it’s a little late to the game, and the competition is not only ahead of it in this move, but also much less concentrated than DELL is on enterprise and government PCs and servers (about 80% of the company’s business).
Progress so far is hard to assess
This is partly due to the recession itself, partly to DELL having to try to restructure the corporate house during an economic tornado. I’m not sure how the reorganization is faring, but then I’m not an expert on DELL. But I didn’t get the sense from listening to last week’s conference call that professional Wall Street tech analysts have a much better idea than I do. So maybe lack of communication from DELL also plays a part.
Do we as investors need to know?…probably not.
In a case like this, the relevant investment question is: do I need to know this information, or can I make a decision about the stock without it? Here, my guess is it’s unlikely that we’ll get strong earnings acceleration from ongoing cost-cutting. If anything, we may get further unusual losses. So restructuring is probably a neutral or a mild negative.
Things probably can’t get any worse in the consumer business, since results are close to zero now and DELL seems determined to protect margins at the expense of incremental sales. Public will go its own counter-cyclical way. Half of small and medium business customers have already upgraded to Windows 7.
Therefore, the next big potential lift to earnings, I think, will come as and when enterprise customers start to buy new PCs again. This is unlikely to happen before yearend–and possibly not before the middle of next year. So my conclusion on DELL is the best course of action is to watch and wait.
One more post
I have one more post to do on DELL–an analysis of its negative working capital situation and what constraints it potentially places on the company. It will be out in the next day or two.