Dell takes the price war gambit

One day recently, the Dell Latitude L400 ultralight laptop was listed at $2,307 on the company's Web page catering to small businesses. On the Web page for sales to health-care companies, the same machine was listed at $2,228, or 3% less. For state and local governments, it was priced at $2,072.04, or 10% less than the price for small businesses.

The price differences are no mistake. Amid a slowdown that is crunching its own profits, the world's No. 1 PC maker is employing ferocious high-tech tactics to grab an ever-larger share of the PC market. The Austin, Texas, company's more than 5,000 salespeople constantly quiz large corporate customers on their purchase plans -- and on the deals they are weighing with Dell rivals. And the company has begun demanding flexible pricing in its contracts with suppliers, many of which also continually update Dell on their own costs. All that lets Dell adjust prices and incentives immediately in response to changes in its own costs and demand from customers, from one segment of the PC market to another.

"Our flexibility allows us to be [priced] different even within a day," says a Dell spokesman. A Dell telephone-sales representative recently quoted a machine for $50 less than the price touted in an advertisement in the New York Times the same day.

Dell's strategy is collapsing profit margins throughout the PC market, a dire development for rivals who can't keep up. Dell is pricing its machines not so much like lucrative high-tech products, but more like airline tickets and other low-margin commodities. That puts pressure on Dell to push up sales volume to compensate for the thinner margins.

Dell's tough pricing could force slower-moving rivals to retrench. "There will be consolidation -- and I do not expect it from mergers," says Barry Jaruzelski, head of the U.S. computer and electronics practice at consultants Booz Allen & Hamilton. "A large player could be driven out."

For Dell, the strategy is paying off. In the first quarter of 2001, shipments of personal computers world-wide grew by 852,000 units, to 31.6 million, while Dell's shipments alone grew by 957,000 units. Dell's unit sales grew by more than the overall industry's because the company snatched market share from competitors during the period. In the U.S., Dell now accounts for nearly a quarter of PC sales, compared with 6.8% in 1996, according to International Data Corp.

With PC unit sales expected to rise just 5.8% this year, compared with average annual gains of 15% in recent years, the industry is already feeling the pinch. Compaq Computer Corp. has said it will take a $450 million write-down in the second quarter for unsold PCs, while Hewlett-Packard Co. wrote down $100 million in the quarter ended April 30 for overpriced inventory.

Margins slipping
Dell, too, is taking a hit. Its net margin has slipped nearly two percentage points in recent months to less than 6% of sales. And some analysts worry that the company's aggressive pricing could eventually reduce the margin to 3.5% -- a slice only slightly better than that of Wal-Mart Stores Inc., another well-known cost hawk and price cutter.

Still, among the top six U.S. PC makers, Dell was the only one to report a profit for the first quarter. In the current fiscal year, ending Feb. 1, 2002, Dell's profit will decline for the first time since 1993, according to a survey of Wall Street analysts by Thomson Financial/First Call. Earnings last year totaled $2.31 billion. In 4 p.m. Nasdaq Stock Market trading Thursday, Dell stock was at $25.61, down 53% from its 52-week high of $54.67, reached in July last year.

Dell's tactics build on founder and CEO Michael S. Dell's famously fastidious concern with costs and pricing. At company and industry gatherings, the 36-year-old billionaire tirelessly quizzes customers on what they would be willing to pay for new technologies. He once chastised a supplier for bringing cinnamon rolls to a meeting with Dell employees. "Michael walked in and said, 'Take those back and let's knock the price off the next shipment of materials you bring in,' " recalls Jim Cano, a now-retired Dell manufacturing executive who attended the meeting. " 'We don't need food. We want a better price.' "

Even before recent staff reductions, Dell's overhead consumed just 11.5 cents of every sales dollar, compared with 16 cents at Gateway Inc., 21 cents at Compaq and 22.5 cents at Hewlett-Packard. And as it grew into the world's biggest PC maker, Dell made a practice of quickly passing along to customers its own savings from price drops in memory chips, disk drives, modems and other key PC components.

For years, most PC makers have calculated unit costs--and thus margins--by projecting sales, then asking suppliers to submit component bids based on those sales estimates. The PC maker then sets a list price based on the bid costs, its own sales projections and its desired markup. Production is based on projections; the system leaves scant wiggle room for subsequent changes in component costs, customer demand, or others' price cuts. Moreover, prices are very often in the hands of independent PC dealers, free to add their own markups -- a system that gave manufacturers little control over the final retail price.

Direct sales route
Dell's methods have always differed. It builds its machines to order and shuns sales through independent dealers. By selling directly via the Internet, catalogs and the telephone, it maintains direct contact with customers and can regularly gauge their sensitivity to price changes. It also routinely polls customers on their willingness to pay for new technologies, such as whether they would substitute flat-panel displays for bulkier monitors.

More recently, suppliers and others close to Dell say, the company has developed a cost-forecasting system that underpins its fluid pricing. The company won't discuss in detail how it sets prices, beyond saying that its strategy has cut into its rivals' business. "Contrary to what most companies say, it's not necessary to be price competitive," says James T. Vanderslice, Dell's co-president. "It's most necessary to be cost-competitive."

The company's 25 main suppliers and dozens of others provide regular updates on their costs and prices, enabling Dell to forecast prices for each component in its computers several months into the future. Last year, the company set up Internet "portals" for many of its suppliers so that it could share with them regular updates on its own inventories and customer purchases. All this pooling of information provides early warnings of potential material shortages and helps Dell and its suppliers schedule production to avoid overproduction or costly overtime runs.

"They feed forecast changes to me on a weekly basis," said Gil Christie, vice president of operations at video-graphics maker ATI Technologies Inc., Thornhill, Ontario. Christie says that of all the PC companies that ATI sells to, "they are the only one I'm dealing with that have it." Dell's weekly purchasing forecasts, he says, help ATI plan its own production and purchasing more precisely, which holds down costs.

Suppliers say Dell makes it clear that it expects them to push down prices just as hard as it does. "There isn't a standard fixed price" with Dell, says Andrew G. Gort, senior vice president at computer-board maker Celestica Inc. "They change their price to a customer, and we're expected to participate in that," he says.

That gives Dell an edge now, as prices of circuit boards, flat-panel displays, microprocessors and other major PC components are falling. Dynamic random-access-memory chips, or DRAMs, have plummeted to $2 each for a standard 64-megabit chip from $8.65 apiece last August.

Information collected from suppliers and Dell's own factories is grouped into a spreadsheet called a "cost package" that sales managers use to find out precisely what each product costs Dell to make now and to project what it will cost six months into the future. The company now aims to go beyond collaborative planning with suppliers to collaborative design, using the Internet to swap information among its own and suppliers' engineers.

The cost package is available online to all Dell business managers, who set profit goals for all their accounts. The team that collects the information also sends e-mail alerts when costs move unexpectedly. After a late 1999 jump in memory-chip prices hurt profits on sales under existing fixed-price contracts, Dell renegotiated many contracts to incorporate the unexpected increases.

Open access
With open access to cost information, Dell sales representatives can adjust PC prices based on quantity, profit targets and proposed delivery dates. Dell also considers the degrees of competition among computer buyers, so that even on the same day, the company may sell PCs at one price to governments, at another to health-care companies, and so on.

The company's salespeople encourage customers to order far in advance or seek staggered delivery dates. In addition to giving Dell a reliable backlog, these long-term sales allow Dell to squeeze higher profits out of lower prices charged now for deliveries in the future -- for instance, when the company predicts that the price of an Intel Corp. microprocessor is scheduled to decline 10% in several months.

A Dell salesman says he can "set the margin wherever I want as long as it meets the objectives of the regional sales manager." For prices below the target margin, a salesperson can call a "special pricing" team that will evaluate the lower price and provide an answer within an hour.

Dell customers say rapidly changing prices have become a necessary part of the market. "If you go to Dell from two or three directions, you get two or three different prices," says William McCallum, chief executive officer of Integration Concepts Inc., a Hurst, Texas, provider of computer services to health-care companies. But he says the company buys Dell machines because the price is right.

David Krauthamer, computer manager at Advanced Fibre Communications Inc., in Petaluma, Calif., recently switched his PC purchases to Dell from Compaq because of lower prices. "It's a brave new world when people give you their cost and say, 'This is our markup,' " he says.

Peter Panagiotatos, a computer manager at Nova Chemical Inc.'s Pittsburgh office, says he recently bought 700 Dell desktop PCs at 40% off their nominal list price. Nova already had a negotiated discount but found that Dell readily clipped an additional 25% off that when he made the purchase.

Big rivals have embraced to a limited degree Dell's build-to-order assembly and its distribution method, but they still haven't been able to match its pricing. They still tend to follow a system of estimating sales, then drafting a production plan and negotiating long-term component purchases, and the bulk of their sales are still through dealers, with whom they don't share cost information.

Going global
IBM and Compaq say they have begun investigating software that will allow them to adjust their own prices according to demand for certain machines. And some have begun shifting more production to lower-cost overseas sites. Compaq's new PCs for businesses are built entirely by Asian subcontractors, a break from the U.S. company's norm.

At home-PC maker Gateway, Michael J. Ritter, vice president of product marketing, says Dell's price shifts are "keeping people like me on their toes." In response, Gateway just offered to match the price of any comparable Dell PC. It also created a database system to monitor rivals' prices.

Clark Hubbard, president of CSI Data Systems Inc., a Norcross, Ga., computer dealer, says Compaq, IBM and Hewlett-Packard tell him to match any Dell quote, regardless of their costs. "They'll do anything, anything they can, if it's within reason to keep Dell from getting the deal," he says.

Smaller PC makers can't keep up. Already this year, Micron Electronics Inc. has opted to exit from the business and focus on an Internet service business. EMachines Inc., once the largest retail-store PC maker, earlier this month said it is considering a sale of the company.

Dell, meanwhile, remains as aggressive as ever. On May 7, the company said it will take a restructuring charge of as much as $350 million for the fiscal second quarter, ending Aug. 3, to consolidate operations and slash staff by 10%. It said it will use the savings to underpin price cuts.