Dell's earnings warning last week amounts to a public goodbye to the days when it could rely on its superb logistics and supply-management controls to undercut competition and simultaneously maintain profits.
The question now is what the company should do, and whether Dell's problems, which caused shareholders to hammer its share price, is shared by other manufacturers such as HP. Dell will be issuing its quarterly financial report this week, and company watchers will get a better picture of how the company plans to tackle market-share and pricing pressures.
Dell said it expected revenue of $US14.2 billion for its fiscal first quarter, compared to its original forecast of $US14.2 billion to $US14.6 billion. Earnings per share are now expected to be $US0.33, compared to the earlier forecast of $US0.36 to $US0.38. Before the revision, analysts polled by Thomson First Call expected a profit of $US0.38 cents a share on sales of $US14.52 billion. Dell said its decision to lower prices was a main reason for the lowered forecast.
The core problem is that Dell has lost its edge in logistical controls as demand has weakened for PCs. To squeeze out profits in the commodity, mass market for PCs, companies need superb inventory and supply chain management because profit margins are so slim. Dell is the acknowledged master of the logistics game. It has been so efficient that it has been able to keep prices low to ward off competition, without suffering big setbacks in profits. No longer.
Other manufacturers have been catching up. While Dell used to have, for example, an 8 per cent to 12 per cent advantage in inventory costs compared to other PC makers several years ago, it now enjoys only a 3 per cent cost advantage, according to an analyst with Citigroup, Richard Gardner.
Dell is signalling that it is willing to cut prices and slice margins to razor-thin to maintain sales levels. Dell's business model is not broken, but for it to work the company needs to maintain sales volume and its market leader position to continue to achieve economies of scale. At the same time, analysts like Citgroup's Gardner are calling on the company to invest more in services, as a way to maintain the strong relationships with customers that its direct sales model has nurtured over the years.
"It would be preferable for Dell to reduce margins and even short term growth, rather than destroy brand equity and 20 years of customer trust," Gardner said in a research note.
In addition to investing in services, Dell needs to expand its presence in areas such as China, India, Brazil and part of Eastern Europe, where PC demand will be above the global average.
While Dell's price cuts and lower profit may be necessary, shareholders are being scared off. Dell's share price the day after its announcement dropped $US1.26, to $US25.17 and has continued to slip, along with other PC makers such as HP.
Dell needs to paint a clear picture of how it plans to invest in services and fast-growth markets. Meanwhile, watch for pricing moves by competitors. While end users might enjoy lower prices now, a price war could bring share prices down further and weaken manufacturers over the medium term.