The Year Dell Fell? »
Wednesday, April 26, 2006 | Wayne MulliganRating:
Could this be it? Could this be the year that one of America's biggest modern day success stories comes to an end?
Could this be the year that Dell Inc. (NASDAQ: DELL) - the Round Rock, Texas computer maker that was founded in its namesake's college dorm - will fall from grace?
If you're listening to some of the analysts on Wall Street, especially the folks over at Citigroup, you might believe that this prophecy will come to pass.
You might believe that the world's largest computer maker has somehow lost its edge. You might believe that its direct-to-consumer model and efficient supply chain no longer make a difference.
You might even believe that the other PC manufacturers in the world somehow figured out how to make a better PC through all their investments in R&D over the years. And that Dell PC's - even though they contain the EXACT same components - are somehow not as good.
Now you might even be asking, "Well Wayne, what do you think? Do you think people will look back on 2006 and say that this was the year that Dell fell?"
In my opinion, HECK NO!
Now let me tell you why …
Dell's Strategy
Let me take a step back for a minute. I don't want to focus on what's currently happening in the US and World PC markets.
What I'd like to do is focus on Dell's fundamental strategy.
Picture watching a football or basketball game. Every coach has a particular strategy. Maybe he's more defense oriented, or maybe he's more into a strong offense.
Either way, he sticks to that strategy if it's been shown to consistently win, regardless of who the other team is.
Businesses operate in the same way.
Dell, for instance, has always been operating as the lowest-cost provider of Personal Computers.
Dell keeps its costs low in two ways:
- Direct to consumer marketing
- Efficient supply chain management
Let me tell you what this all means:
Direct to Consumer Marketing
This is too simple for words, and it amazes me that the larger PC manufacturers took so long to catch on. It could've been pride, denial or a combination of both, but at the end of the day this strategy has proven to work.
Think of it this way:
If you made a commonplace product (commodity-like product), e.g. rubber bands, how would you go about selling them?
A) Would you use distributors like Eckerd and Walgreens to sell your rubber bands? If you used distributors, these distributors would take a percentage of your sales. This in turn would increase your costs. But because your product is so commonplace, you wouldn't be able to raise prices … higher costs mean lower profits.
B) Or, would you try to figure out a way to sell directly to the end user? This way, you cut out the middleman, and can sell your product even cheaper while still maintaining equal profit margins with your competitors.
If you're smart you probably chose Answer B - Selling directly to the consumer.
This gives you two clear advantages. First, you can be more profitable than your competitors that use distributors to sell their products, simply by selling your product at the same price they do. The only difference is, you're not splitting your earnings with any middlemen.
Secondly, if you wanted to gain market share, you could price your rubber bands lower than your competitors. This in turn would force your competitors to cut prices and operate at a loss.
They can only do that for so long, and eventually will have to give up market share to you.
This is exactly how Dell became the largest direct computer systems company in the world!
Supply Chain Management
Not only does Dell market directly to the end-user, the company also does everything it can to make sure its inventory and supply chain systems are as efficient as possible.
Due to the fact that the company has direct access to its customers, it knows how many new monitors to build, how many mother boards to order, etc.
It would be as if you ran a bakery in town. By having direct access to your customers you'd know if any big weddings were coming up, or graduations. This way you'd prepare extra cakes or cookies.
And if you knew a lot of folks were going on vacation, you might not stock up on a ton of ingredients for that month.
What Does this Mean for Dell?
Well, right now it may seem like this strategy doesn't mean much.
Dell seems to be losing some market share in the domestic and global PC markets. It's not showing the robust growth of the last several years. Could this strategy be failing?
Certainly not!
Right now we're in the middle of a bull market. Interest rates have been so low for so long that people can afford to be a little less thrifty when shopping for a new PC.
Companies can also go the extra mile when they're purchasing new servers.
But what happens when the economy begins to slow? Interest rates are on the rise after all.
I'm not making any predictions as to when this could happen, but as sure as the sun rises, this market and this economy will begin to slow down and possibly turn in the other direction.
This is when a strategy like the one Dell employs will make a heck of a lot of sense.
By cutting prices on its PC's and forcing its competitors to operate at a loss, it will gain back its market share losses in spades.
From there, Dell just needs to wait until the next market upswing, raise prices, and watch its margins go through the roof.
"So What Should I Do?"
If you've been listening to the collective wisdom of Wall Street, you may feel like going right out and shorting the stock.
That would be a huge mistake.
Now, I'm not saying run out there and buy Dell stock right now. The chart is looking weak and its stock is probably headed downward, at least in the short-term.
It probably has a few more weak quarters ahead of it.
But long-term investors may definitely want to get ready to pounce, as Dell will come out of this current situation stronger than ever, and will prove (as all low-cost producers always have - e.g. WalMart) that their strategy is the only strategy for a business that sells commodity-like products.
So if you already have Dell in your portfolio, no need to worry. You might even consider adding more to your position as the company's prospects begin to improve and the share price levels out.
Until next time …
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Wayne Mulligan
Contributing Editor
The Tycoon Report
