February 16, 2001 4:00 PM PST

Dell to keep cutting prices to gain market share

Can Dell Computer conquer the world?

As PC sales slow worldwide, the Round Rock, Texas-based company has embarked on a broad campaign to gain market share by cutting prices, according to analysts.

In the past, the company focused on keeping profit margins high, leading to strong profitability, robust revenue growth and relatively high average selling prices on its PCs. Now, with the maturation of the PC market, Dell is undercutting competitors in price to rapidly gain market share.

But the short-term cost to Dell could be high: reduced profitability.

"It's very apparent that in the last quarter Dell traded profitability for market share," IDC analyst Roger Kay said Friday. "It was very deliberate."

Dell is currently the No. 2 computer maker worldwide, with 12 percent market share. And it's the No. 1 PC maker in the United States, with 16.9 percent market share.

Analysts now expect Dell will pass Compaq Computer as the No. 1 worldwide PC maker during the first quarter.

The short-term results of the price-cutting are apparent.

On Thursday, Dell missed its lowered fourth-quarter estimates by a penny. At the same time, operating margins fell to 18 percent from 21.3 percent in its third quarter. Dell also lowered first-quarter revenue expectations to $8 billion--an eight percent drop from the fourth quarter--the company's first-ever sequential revenue decline.

During a Thursday conference call with the media, Kevin Rollins, one of Dell's two vice chairs, said the company in the short term would continue to pursue market share over profitability.

"We've seen an opportunity most recently to get more aggressive with pricing and subsequently you've seen our margins change," he said.

Meanwhile, overall demand will remain low. "Many market observers are projecting a double-digit sequential decline in computer systems units in the first quarter, with an even higher decline in market revenues," Dell Chief Financial Officer James Schneider said.

Dell's opening gambit in price began last year.

"Toward the end of the year, I saw Dell step forward to really get aggressive in pricing," ARS analyst Toni Duboise said. "Dell is by far the first to pass on the benefits of lower component prices, and that is important in this heightened state of competition."

Using Dell's entry-level Dimension L series consumer desktop and high-end OptiPlex 300 corporate PC as examples, Duboise showed how dramatically Dell's average selling prices have fallen since June.

Between June and October, the OptiPlex price dropped 40 percent and another 2 percent between October and January, she said. During the same period, the Dimension's price dropped first 18 percent and then another 21 percent by January.

"This came at the expense of gross- and operating- margins," said U.S. Bancorp Piper Jaffray analyst Ashok Kumar.

High-stakes Risk
Analysts described Dell's gambit--trading some profitability for big market share gains--to playing the board war game, Risk. By expanding its lead in more markets--or in Risk controlling enough countries--Dell hopes to overrun competitors.

"What Dell is try to do is use the bad climate to gain share, and from an enhanced share position rebuild the liquidity, profitability, revenue growth triumvirate that is their kind of mantra," Kay said. "They can't abandon that model."

But he warned that Compaq, Hewlett-Packard and other companies that embarked on a similar strategy found it to be a "tried-and-true folly."

By contrast, Technology Business Research analyst Brooks Gray said the strategy could pay off, particularly as Dell looks to sell to a mature rather than growing U.S. PC market.

"Dell could be in a favorable position if it continues to ramp market share around the world, because of its successful customer retention rate," he said. "The risk is that Dell will grow too quickly and the quality of customer service start to decline, which we have already started to see."

Whether or not the strategy works in the long run, Dell's strategy to sell, sell, sell has chalked up some impressive gains during the fourth quarter.

In the quarter, overall shipments rose 43 percent, compared with the same period a year earlier. Server shipments jumped 63 percent, for a worldwide market share gain of 2 percent, according to IDC. Notebook shipments rose 45 percent.

"One in four laptops sold in the U.S. is a Dell," Schneider said.

Making life miserable
Dell's pursuit of market share puts many competitors in a defensive position, according to analysts.

"Dell has a way of making life more miserable for people who are already in a bad way," Kay said. "For example, when Compaq, HP or some other another company has a big inventory of imminently aging equipment hanging in the wrong place, Dell has a habit of dropping prices and making that inventory even more valueless."

Smaller companies will face even greater problems and may have to face the ultimate question of whether to continue to participate in the PC market.

Far worse for competitors may be Dell's determination to undercut them in price in higher-margin products like servers and storage systems.

"The aggressive pricing environment in PCs is now spilling over into the enterprise market with Dell pricing its high-density rack servers at sub $1,000 and NAS (network attached storage) products at 6 cents per megabyte," Kumar noted.

Whether Dell's market share gambit will pay off is uncertain, but many Wall Street analysts like the company's strategy in spite of lowered margins.

"Dell is doing everything right in a bad economy," Morgan Stanley Dean Whitter analyst Gillian Munson said in a research note Friday.

 

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