The Tycoon Report

Dell Sells Out

Wednesday, June 6, 2007 | Wayne Mulligan

I’ve written about this company before – in fact, you probably heard me defend it and its strategy several times last year.

While most folks on Wall Street were ready to stick a fork in this technology behemoth, yours truly was saying to be patient and just wait for the company to turn around.

Let me just say that, as of a few weeks ago, my opinion on this Round Rock, Texas company has changed.  That’s right, I’m no longer confident that Dell (Nasdaq: DELL) is pursuing the correct strategy.

If you go back to any of my articles on this PC maker ...

http://tycoonreport.tycoonresearch.com/past_issues/560082483
http://tycoonreport.tycoonresearch.com/past_issues/611825448

... you’ll see that I’ve always been a major proponent of the company’s direct-to-consumer sales strategy.  It just makes the most sense in the world to me – and to some of the savviest investors in the world, but more on that in a minute – because computers are a commodity product now.  That means that there’s no REAL difference between the “stuff” that’s inside of a Dell computer and what’s inside an HP (NYSE: HPQ).

That means that the only real difference is price.

And that’s exactly what Dell capitalized on for years – selling its computers over the phone and eventually over the Internet in order to keep costs low which, in turn, allowed it to charge less money.

That meant that in good PC markets, Dell earned above average profits – and even in down markets, the company was able to stay profitable because it relentlessly cut costs.

But now my opinion has changed dramatically, and here’s why:

Dell is going to start selling its PCs in Wal-mart stores (NYSE: WMT) – can you believe it?

I sure couldn’t!  I couldn’t believe that, after coming out of retirement, Michael Dell was pursuing a retail strategy.

It’s like watching Michael Jordan come out of retirement and warm the bench.

Right now we’re in a very good PC market – demand is high and so are profits.  But when this market slows down and companies have to cut prices, only those with the lowest cost structure will remain profitable.

That’s why maintaining a direct-to-consumer sales strategy is essential for companies in commodity businesses, and I’m not the only one who thinks so – my good friend Warren Buffett agrees.

As I’m sure you know, Buffett, through Berkshire Hathaway (NYSE: BRK), owns GEICO (among other insurance companies).  The unique thing about GEICO is that that company also uses a direct-to-consumer sales strategy – so they really appreciate keeping costs low.

Buffett once said something to the effect that he won’t write unprofitable insurance policies, no matter what his competitors were doing. 

Basically, he was saying that he would NEVER discount GEICO’s prices simply because the market was really good, and the company could “afford” to do it.

Buffett knew that if and when a disastrous event occurred, or the market for insurance went into a downturn, his margins would be squeezed, and those policies would be unprofitable.  He was financially disciplined enough to know that capturing market share in an upturn wouldn’t be worth the financial loss during a downturn.  In fact, if executed properly, the lowest-cost operator in a field SHOULD capture all of its market share during a downturn.

So why is Dell playing this “me too” game with every other PC maker?

Is it out of greed?  Fear?  Lack of financial discipline?

All of the above?

I’m not sure, but what I do know is that this company has deviated from almost all of its founding principles, and that’s why I’m issuing a vote of “no confidence” for Dell.




Wayne Mulligan
Contributing Editor
The Tycoon Report