Dell, HP and the folly of the consumer PC business

Summary:Dell clings to the consumer PC business in the name of the bring your own device movement, but the operating profits are just north of nil. HP is defending its No. 1 spot, but the profit and revenue lines are headed in the wrong direction.

Dell and HP still play in the consumer PC market, but you have to wonder if it's really worth staying in the game.

Of the two companies, Dell's position in the consumer PC market is increasingly hard to justify. In its latest quarter , Dell barely made any money on consumer PCs. The problem: Dell has decided to focus on mid- to high-end systems and has stepped away from the high volume low margin PCs that happen to sell well in emerging markets.

In theory, Dell's move to preserve profit margins in the consumer PC business makes total sense. However, Dell is focused on margins and still not generating much profit. For instance, Dell in its fiscal second quarter had a consumer operating margin of 0.5 percent. Dell’s consumer business made $14 million in operating profit in the second quarter on revenue of $2.62 billion. What's the point?

Consumer notebook revenue was down 26 percent in the second quarter.

In other words, Dell's consumer business is a drag compared to its SMB, public and large enterprise units, which happen to bring in real profits. This consumer portrait is just ugly.

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On a conference call with analysts, Dell CFO Brian Gladden acknowledged that the consumer unit has issues. In fact, the corporate PC market looks better. So why bother? Gladden said that Dell has to play in the bring your own device market. Given that trend, Dell needs to be about consumer PCs too. Gladden said:

Our focus continues to be on mid and high value systems, which contracted at an industry level the second quarter. Our Latitude and OptiPlex products performed well in the commercial space. But we're seeing pressure on consumer and entry-level corporate products. There's particular softness in pricing pressure in key emerging markets like India and China, as well as Western Europe.

In the quarter we saw the channel drawing down inventory in anticipation of the Windows 8 launch. We also continued to see discretionary spending directed to alternative mobile devices like tablets and smartphones. In light of these results and market dynamics I think it's important to reiterate our client strategy. We're focused on continuing to drive our cost out initiatives to maximize operating income versus unit share. We'll continue to deliver a strong portfolio of systems targeting the mid-and high value spaces. We've refreshed our Latitude and XPS portfolios with products that are thinner and more powerful. We're building strong capabilities in security and systems management and have an industry-leading position in thin client solutions. And we're positioned to be a leader in addressing the emerging corporate BYOD trend with our current XPS 13, 14 and 15 notebooks and our upcoming tablets and converged devices. In addition you'll see new Windows 8 Ultrabooks, all-in-one tablets, and converged devices in the fourth quarter and headed into next year.

Dell's PC strategy can work---to a degree. Later in the call, CEO Michael Dell noted that his company is ready for Windows 8, but the corporate PC market, which makes all the dough, is likely to be slow to respond to it.

For HP, the decision to stay in the consumer PC business has already been decided. HP decided to ditch consumer PCs and then keep it for supply chain and other reasons. However, HP is seeing the same pricing competition as Dell. In fact, HP is facing bloated inventory levels because PCs and printers aren't flying off the shelves.

HP CFO Cathie Lesjak said on the company's earnings conference call :

In terms of the market conditions, consumer demand remains soft in PCs and Printing, resulting in elevated levels of channel inventory for us in PSG Consumer and IPG (imaging and printing group). We will look to manage sell-in consistent with the underlying soft demand. Additionally, the pricing environment in our hardware business remains competitive.

Meg Whitman, CEO of HP, noted that the integration of the company's printing and PC units is "well underway." The idea is that HP can combine scale and cut expenses by combining two consumer units arguably in decline.

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HP's PC unit operating margins for the third quarter just reported were 4.7 percent. Simply put, HP's PC business is much better than Dell's on the profit front. Nevertheless, Whitman had to defend the PC business. After all, both revenue and operating profit trends are going in the wrong direction.  In its fiscal third quarter, HP's PC unit delivered operating income of $409 million on revenue of $8.62 billion. That operating profit trails HP's services, imaging and printing and enterprise server storage and networking units.

Whitman said:

Let me just give you a little perspective on our strategy for our PC business because I think that can help shape your thinking about where margins will go. So first is, we are focused on profitable growth and continuing to deliver a very strong return on invested capital in this business. But we are under attack by very strong competitive pressures and we're going to respond and what we're -- how we're responding is really three parts.

One is product lineup. I think we have among the best product lineup we've had in the PC business for a long time. A host of thin and light Ultrabooks, a Windows 8 tablet for the Enterprise. Two sort of tablet, if you will, tablet combined with laptops for the consumer space and we've also done a lot of work on our cost structure.
One of the benefits of putting IPG and PSG together is we have a much more seamless go-to-market. We see very good opportunities for freight, logistics, supply chain and we have got to make sure that our cost structure allows us to compete effectively because we're going to defend our number one position in this business.

HP's PC and printer combination makes sense on paper. Analysts, however, were skeptical and pelted Lesjak and Whitman with inventory questions. If a Windows 8 surge doesn't materialize for HP, the company will be fielding a lot more questions about the consumer business. Meanwhile, Lenovo is hell-bent on being the top dog in the PC world.

Topics: Hardware, Dell, Hewlett-Packard, Laptops, PCs

About

Larry Dignan is Editor in Chief of ZDNet and SmartPlanet as well as Editorial Director of ZDNet's sister site TechRepublic. He was most recently Executive Editor of News and Blogs at ZDNet. Prior to that he was executive news editor at eWeek and news editor at Baseline. He also served as the East Coast news editor and finance editor at CN... Full Bio

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