Dell: What happens when component cost rise?

Dell: What happens when component cost rise?

Summary: Dell's most recent quarter benefited from falling component costs. The rub: It isn't passing those benefits on to you.


Dell's most recent quarter benefited from falling component costs. The rub: It isn't passing those benefits on to you.

A few months ago, Apple got a huge bump on cheap component prices. It pocketed most of the gain. And it can because it's a premium brand.

Dell, however, may be a different story. For the second quarter, Dell reported net income of $733 million, or 32 cents a share, on revenue of $14.8 billion.

Not passing those cheaper costs to you may become an issue. Component costs, which are on the rise, are one of the main reasons analysts are skeptical about Dell's future quarters. Of course some audited results and comparisons to the restated historical results would be nice too.

Dell's gross margin last quarter was 19.9 percent and Merrill Lynch analyst Richard Farmer sees something more like 18.5 percent in the long run.

Friedman Billings Ramsey analyst Clay Sumner details the environment in a research note:

"Revenue was modestly ahead of the consensus, but gross margins were once again higher than any since mid 2000...We believe that margins were so high because of an unusually favorable component cost environment and because of changes in Dell's behavior on two fronts. First, we believe Dell is no longer smoothing its EPS results with accruals, so we expect margins to be more volatile in relation to changing component costs. Second, Dell appears to have changed its pricing strategy toward capturing more of the benefits from falling costs, rather than passing them on to customers in an attempt to stimulate demand. We hope that the first change is lasting, but we suspect that the second could prove more temporary. Whether or not Dell gets more price aggressive, however, we expect 3Q margins to fall due to rising costs for displays, batteries, and, to a lesser extent, memory. Heading into 2008, we expect margins to continue falling as Dell ramps its retail PC distribution."

Sumner raises a host of issues. Let's break them out:

  • The component landscape. Prices are going up so Dell won't have the wind at its back in the second half. Meanwhile, Dell's effort to bolster its retail presence will negate some of its supply chain prowess.
  • What happens when component prices go up? Dell has two choices when component prices increase: Pass on increases to preserve profit margins or eat a bit of the costs. If it passes on increases perhaps it reflects a bit of a truce between Hewlett-Packard and Dell, the two largest PC players. A lot will depend on HP, which is the stronger company. If HP decides to squeeze Dell on pricing it can. Meanwhile, the bulked up Acer may limit the ability of Dell and HP to pass on cost increases.
  • Dell's retail adventure. Since Dell hasn't held quarterly conference calls with Wall Street color on its retail partnership with Wal-Mart isn't available. Sumner is on target though when he writes that Dell's retail moves won't come cheap.

Topic: Dell

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  • Costs go up as well as down

    While you can have a great quarter when some costs fall you still
    need to protect your price points against increases in component
    price increases. That is what it appears both Dell and Apple are
    doing. They will be able to absorb increases in component costs
    while avoiding a price increase (or profit drop) without increasing

    Computers are unique in that most customers do not believe
    computer prices should increase. We accept price increases in
    other products, like cars, but expect computer prices to stay the
    same or fall.

    I think that Dell is wise to protect themselves by maintaining
    price points as much as possible and protect themselves for cost
    • Source of expectations

      "Computers are unique in that most customers do not believe
      computer prices should increase."

      Yeah, this is a result of Moore's law combined with economics - as chip manufacturers keep pushing technology, demand falls for older technologies, pushing prices down.

      Since this has been happening so long, it's essentially created the expectation that prices will always fall.
    • I agree

      Dell, Apple, and anyone else has no choice but to maintain their price points. It's a
      catch22 for them due to people's expectations that computer prices should never
      increase, but if anything, decrease. But Apple does have a little more leverage with
      their loyal fanbase and the fact that they sell a premium product. Dell has always
      been about their computers being a good deal for a cheap price (I have
      recommended them to people before). But I wouldn't recommend Dell computers to
      people wanting a troublefree experience that are willing to pay more. So Dell will
      probably be in a tighter spot when the component costs rise.
    • Sure, costs go up as well as down...

      but prices tend to be on a one-way street. This is the perception most people have of the marketplace. What Dell risks by not passing on savings to consumers is being viewed in the same light as the nice petroleum companies who posted record profits while the country was paying more than it had ever paid on average for gasoline. Sure, some people will whine about how unfair that is being to the petroleum companies and others will whine about how unfair it is lumping Dell in with them. The bottom line is that perception is reality, and reality isn't fair nor does it think twice about being right.
      • But Energy costs alway ratchet up

        Yes, we see spikes up and down. But the trend is that the curve has alway risen when it comes to energy. I hear nothing but record compensation numbers and record quarterly profits when it come to energy. Runaway Capitalism has had it's effect on the economy for over 20 years; Enron is just a symptom of that illness. M$ is a symptom too. We have de facto monopolies now; they dictate prices, innovation and R&D. That is reality.
        The industry will probably hit the wall on Moore's Law; we did 20 years ago at Cray. We experimented with small architectures and came up with some interesting results.
        What happens when Moore's law runs into the hard physical laws?
        Computers will fall into line with the rest of consumer goods.

        We are addicts; what happens when the pusher cuts you off?
        Old Timer 8080
  • Eat Crow

    Michael Dell and Larry Craig both need to come out of the closet. In Dell's case he
    needs to admit that Steve Jobs has it right: profits trump market share.
    • well Yin Steve knows he has morons that will pay out the nose it does not

      well Yin Steve knows he has morons that will pay out the nose it does not matter how much component prices fall he can all ways charge more for the same hardware. why because he has drones that believe anything that comes out of his mouth. and will pay the price for the case with the apple on it. he knows most don't even know they are buying the same hardware that go's into the dell hp compaq gateway and so on.

      and the ones that do know they don't care for some reason.

      you got to give him that
      SO.CAL Guy
  • Optimise your value ...

    Buy Vista!
  • Mike knows what to do!

    "Sell the company and return the money to the shareholders!"
  • Microeconomics

    It's way too easy for reporters to look at the P/L for one or two quarters and speculate on how any of the large computing providers profit. When they have those sorts of profits, the pass-along to the consumer may be in the form of rebates. The actual accounting for those decreased costs don't show up for a quarter or even two quarters because of the other factors in costs and expenses.

    When component prices rise, the cost for equipment will go up, but again it will probably lag by a quarter or so unless the cost increase is so drastic that the company has to make an immediate adjustment.

    Headlines such as this without taking into account the long-term effects of the business costs are knee-jerk reporting and cause mild hysteria or "entitlement" on the part of the consumers.