Dell’s dilemma in the post cheap PC age

The low cost, high-volume sales model is no longer the competitive advantage it once was, says David Moschella

The recent burst of bad news from the once all-conquering Dell — disappointing earnings, executive departures, customer service problems, battery recalls, MP3 market withdrawal, SEC inquiries etcetera — brings to mind the huge cyclical swings that have always characterised the global PC business and the historical inability of even the strongest vendors to adjust. Each decade has had its own version of this pattern and its own winners and losers. Is history now repeating itself with Dell?

During the first half of the 1980s, IBM dominated the PC hardware business, especially in large companies, where it enjoyed a market share similar to what it had in mainframes — around 70%. In an industry without any real standards, IBM was the safe choice, and its products were usually good enough. But this heady success soon sowed the seeds of future problems. IBM became overconfident and unresponsive, fell behind in its price/performance ratio and staked its future on ill-conceived ventures such as the PC Jr, PS/2 and OS/2.

These blunders opened the door for a new company, Compaq, which mastered the art of IBM PC compatibility and understood the value of portable (initially luggable) computers. Compaq also understood that it could be a leader in both price/performance and quality, which made it very popular with the then crucial PC dealer community. During the second half of the 1980s and through the early 1990s, Compaq raced past IBM and became one of the fastest-growing companies in business history.

But at the heart of Compaq’s success was a fundamental weakness — a dealer channel that didn’t add enough value to justify substantial price mark-ups. This inefficiency was identified by, among others, a University of Texas student named Michael Dell, who in 1985 began selling PCs directly to consumers under the PCs Limited brand. By cutting out the middleman and using inexpensive industry-standard components, the company (which was renamed Dell Computer in 1988 and more recently became Dell) grew steadily, but it wasn’t until the emergence of the web in the mid-1990s that direct sales exploded, resulting in the US$60 billion (NZ$92 million) giant that Dell is today. Compaq never effectively responded, and in 2001, it was acquired by Hewlett-Packard.

Selling products directly over the web was ideally suited to a time when customers wanted the optimal mix of configuration flexibility, price/performance and ease of ordering. But the enormous, and often unused, processing power and storage capacity of today’s PCs have made these factors much less important. Increasingly, customer buying preferences are polarising in ways that are making life more difficult for Dell.

Today, if all you want is a low-cost, standard PC, you can get a perfectly good one in about an hour down at the local superstore, whose thin margins are much harder for Dell to undercut. At the other end of the spectrum, many customers are now much more interested in fashion than function. As we have seen with cellphones and the Apple Macintosh, a significant portion of the market is willing to pay a premium for superior look, feel, colour, shape, weight and style. Neither Dell’s brand image nor its reliance on off-the-shelf components is well suited to this challenge, and thus it is now scrambling to improve the design of its offerings. Given its vast size, this won’t be easy.

When IBM’s PC division and Compaq first started having market problems few would have imagined that someday both would be acquired. Ironically, Lenovo (which bought IBM’s PC business in December 2004) and a rejuvenated HP are now trying to reclaim the PC market leadership once enjoyed by their previous incarnations. Of course, Dell is a very big and powerful company and will have many chances to get itself back on track. But history says that in most IT markets the first round of bad news is rarely the last and that comebacks, such as those eventually made by IBM, Apple and HP, often take years and result in radically different organisations.

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