Dell fights its sobering midlife crisis

In real life, the picture isn't so pretty for Dell (dell). It was the single best-performing stock of the 1990s, with a 97 percent average annual price increase. This year, its stock is down 22 percent. Powered by a revolutionary system for selling personal computers directly to consumers, it used to grow three or four times faster than the rest of the industry. For the quarter ended July 28, Dell's unit shipments of desktop PCs just squeaked past the industry's 12 percent rise. The quarter's 25 percent revenue gain was less than Wall Street's and Dell's projections, the third time in the past five quarters that it has fallen short of expectations.

For Dell, it all adds up to a sobering midlife crisis. A sharp, sudden slowdown in growth in the PC industry has hit Dell hard. Just as the company has become the biggest seller of PCs in the U.S., the PC market appears to be on the wane. The box that made Mr. Dell a billionaire has become a commodity product no longer technologically innovative and no longer in need of replacement every 18 months.

In response, Dell has an ambitious new strategy to regain its edge: a push into Internet server computers and high-end data storage. Both are largely terra incognita for Dell, bringing it a new set of powerful rivals.

The shift comes as Dell's management is changing, too. Since December, it has brought in a new chief financial officer and a new senior operations executive. Mr. Dell, the company's 35-year-old founder, has turned over most day-to-day oversight to the two vice chairmen, Kevin B. Rollins and James T. Vanderslice.

Mr. Dell doesn't see much of a transformation. "We are doing the same things we have been doing for a long, long time," he says. "Picking our spots to focus our energies, and driving the organization behind them."

Yet life for Dell is clearly different. Slower PC growth hurts all companies, but maybe none more so than Dell. Its success over nearly two decades has come from using a steady rise in unit sales to drive down margins and gobble market share. Yet many rivals have folded or sold out, leaving the market with a few powerhouses that will be harder to unseat. Take away the volume gains and all that's left are razor-thin margins. Meanwhile, international sales have lagged, and the company has faltered in low-priced consumer PCs.

Investors certainly notice a difference. Mutual funds have trimmed their Dell holdings, dropping it from the 14th most widely held stock at the end of 1998 to 22nd at the end of June, according to Morningstar Inc. It had fallen to as low as 29th at the end of last year.

Dell's finances are still strong: Projected revenue this year of $33 billion would be a 30 percent increase. While the U.S. market is maturing, Dell is more like an adolescent in Europe and Asia, Mr. Rollins says. "Our opportunity and challenge is to grow each of those while managing them slightly differently," he says.

Mr. Rollins and Mr. Vanderslice, a recent recruit from International Business Machines Corp. (ibm), now jointly manage operations. Mr. Rollins, 47 years old, is widely seen as Mr. Dell's heir. "It's very much the Kevin Rollins show," says a former Dell executive.

A onetime Bain & Co. consultant to Dell and a classically trained violinist, Mr. Rollins is considered a brilliant if aloof strategist, responsible for hiving off growing divisions into dozens of smaller units. Under Mr. Dell's tutelage, he has assumed the challenge of keeping a company that has doubled in size in the past two years hewing to its low-cost model. "Our advantage is the same no matter where you go," he says.

Worries about desktop PC growth are misplaced, Mr. Dell argues, because corporations are shifting to notebook PCs, a business where Dell has recently grabbed the lead. Dell this year should add nearly $7.6 billion in new sales, he notes, more than the $7 billion last year and the $6 billion of two years ago. What's more, Wall Street estimates this year's profit will rise 38 percent, to $2.56 billion from $1.86 billion last year.

Mr. Dell is placing a big bet on the company's ability to drill deeper in the world of "big iron," or large systems and computers. He believes that the same low-margin, high-velocity strategy that propelled Dell's PC sales can work in high-end computing and data storage, a higher-margin, fast-growing world where Dell will have to battle Sun (sunw), Compaq (cpq) and EMC (emc) with more than just a six-shooter.

By using the lean production it has developed over the years, Dell hopes to underprice rivals and gain market share. "We're going full-steam ahead, running at Sun and EMC, and we'll take Compaq out along the way," Mr. Dell says confidently.

Dell is targeting small servers for Internet start-ups and corporate Web sites, with plans to move into bigger, more complex computers. And Mr. Dell promises a new Dell data-storage system that will deliver the same amount of storage for a fraction of the price of a product from EMC, a Hopkinton, Mass., storage-equipment maker. "I think EMC stands for Excess Margin Corporation," Mr. Dell says.

An EMC executive says Dell has little to offer in data storage. "The only storage associated with Dell is onesy (simple) disks in PCs," says Ken Steinhardt, EMC's director of North American marketing. Data storage is rapidly becoming more software-intensive, an area where Dell has no experience, he says.

Picking fights with companies with whom he doesn't yet even compete is vintage Michael Dell. Venture capitalist John Doerr, in the early days of Amazon.com, once asked him to meet Jeff Bezos, calling him "the Michael Dell of the Internet." Mr. Dell's tart response: "I thought I was the Michael Dell of the Internet." Dell and Amazon.com, despite an early alliance to link each other's Web sites, later severed the ties.

While publicly leading the charge, Mr. Dell concentrates on such marketing and development initiatives as a new wireless division. With his wife, Susan, the owner of a women's boutique, he has also become a major backer of Austin children's and arts institutions. A private-equity company he started two years ago has become either sole owner or a major investor in companies ranging from the maker of Sweet & Low artificial sweetener, Internet start-ups, and much more. An executive office building that Dell is renovating will put the founder's office closer to his 33,000-square-foot estate in Texas's Hill Country, west of Austin.

Insiders say Mr. Dell continues to set a gung-ho tone at the company. His 2 a.m. e-mail messages and notes scribbled on pages torn from magazines remind employees that their boss works as if he is running a start-up. "If Michael weren't as involved, I'd worry. There's no one who can make that company run like Michael," says Doug MacGregor, a former Dell vice president who is now a researcher at Harvard Business School.

But moving into corporate middle age has raised a whole new set of challenges for Mr. Dell and his company. Many of the key managers responsible for its hyper-growth have retired early or moved to smaller companies. Of the 15,000 employees expected to gather at the University of Texas last night, more than two-thirds weren't at Dell in 1998.

Lacking the rocket-like stock-price growth that helped draw workers for many years, Dell has had a harder time landing and keeping top talent, recruiters say. Dell says that turnover among midlevel and upper-level managers is below industry levels. While more potential hires are refusing offers, the company says between 75 percent and 80 percent of job candidates do accept its offers.

Other factors have trimmed the staff. By the time the industry's slowdown became apparent in late 1999, Dell's heavy spending in anticipation of faster expansion had caused its expense growth to outstrip revenue gains. Managers were told to slash hiring and to present plans that would get revenue growing faster by the next month's meeting. Any new hire would need the approval of a senior executive.

This year, Dell reduced its revenue target to about 30 percent after concluding it couldn't stretch employees further, Mr. Rollins says. The server-computer group tore up its hiring plan and eliminated a large-scale server project after concluding it would have required too much effort for modest unit sales. The decision leaves Dell out of an area where Unisys, Compaq and IBM are building big computers with as many as 32 Intel processors linked together.

Instead, Dell decided it had to bore in on more promising markets. Shortly after the beginning of this year, a team led by Senior Vice President Michael J. Lambert pinpointed a fast-growing slice of the business where rivals weren't yet entrenched: Internet servers. The target customers had the same traits as Dell's early PC buyers -- a need for custom-designed machines and the tendency to buy 10 to 50 units at a time. In April, amid the dot-com explosion, Dell announced its plan as a way to supply the infrastructure needs of corporate Web-site designers and e-commerce start-ups.

At the rollout announcing the Internet plan, Mr. Rollins called it "probably the largest thing that's happened to our company since we reformatted the business back in 1993" to abandon retail sales.

Yet as Compaq learned years ago, any push into computers that run entire corporations demands big-company organization, service and support. In PCs, Dell's lean culture is part of what made it such a success. Selling servers and data-storage machines will demand a more complex and costly organization.

"These big solutions aren't done on price" as the PC business was, warns Barry Jaruzelski, head of the U.S. computer and electronics practice at consultants Booz Allen & Hamilton. In some ways, by pushing profit margins in PCs down so low, Dell has become "a victim of its own success," he says.

Dell is relying on outsiders for help on service and support. In the past year, it has turned to IBM, Lante Corp. and Andersen Worldwide's Arthur Andersen for installation and service.

At the same time it moved toward servers, the company clamped down on hiring and shook up its sales force. In the corporate-PC market, Dell cut sales costs by removing its own salespeople from handling routine desktop-PC orders, funneling customers to an online system, says Joseph A. Marengi, senior vice president in charge of U.S. corporate sales. The move recognizes that "the large corporate business will grow at a slower pace than small business," he says.

The company also rethought a line of home PCs for novices, a market Dell has long shunned. In early 1999, Mr. Dell had decided the company could no longer remain on the sidelines as low-cost PCs became the fastest growing part of the market. He called on John K. Medica, the scrappy hero of Dell's laptop PC revival, and gave him the task of crafting its first PC intended solely for home use.

Mr. Medica's team of hotshot engineers and marketers charted a collision course with Gateway, a longtime rival that embraced low-cost PCs with a vengeance. He culled employees from Dell's successful laptop and online businesses, telling them: "We're launching a multi-$100 million business within Dell."

Mr. Medica's crew pored over Gateway's business and products, right down to analyzing the number of clicks needed to purchase on its Web site and how its shipping containers opened. It conducted side-by-side tests of prototypes in Gateway's backyard for consumer reaction. By the November launch of Dell's WebPC, he boasted that it came fully assembled and sitting upright in its box. A Dell buyer could be cruising the Internet in seven minutes to eight minutes, whereas Gateway's PC required two laborious flips to unpack and remove, and extra fees for Internet service.

But this year, as it revved up its Internet-server push, Dell pulled the plug on the WebPC. The product had arrived late to market, amid an industrywide component shortage. Mr. Medica, who planned to make the WebPC the starting point for a broad array of low-cost Internet home "appliances," is back developing laptop PCs for Dell. Mr. Dell says the WebPC struggled because consumers weren't interested in a machine without old-style peripheral connections. He says he hasn't given up on the emerging market for low-cost Internet computers with software for specific tasks. "If we see a business there, we'll go after it," Mr. Dell says.

On the international front, Dell has a lot to do just to match rivals. For all its renown in the U.S., Dell is still laying the groundwork for PC sales in many markets. Much of the PC industry's growth this year has come from outside North America, yet Dell gets just 18 percent of its revenue outside its home market. Sun, by contrast, gets 46 percent of sales from outside North America.

Dell has exported its direct-sales strategy first to Europe, then to Asia and Latin America. But it often has been a tough sell. Dell has replaced its European management three times in the past four years. In Latin America, its growth has been below the industry's rate all year.

Of course, with $4.32 billion in cash on its balance sheet, Dell could broker or buy its way to growth. Through its Dell Ventures unit, it has poured $1 billion into 100 companies ranging from Internet commerce to storage software. The idea? Figure out what the next Dell Computer might look like.