Consumer demand, laptop growth leave Dell behind

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To understand why the world's largest personal-computer maker is facing its worst crisis in years, consider how Chris Conroy recently bought his new laptop computer.

Mr. Conroy, who works at a publisher of scientific journals in Washington, D.C., first logged onto Dell Inc.'s Web site to browse personal-computer offerings online. But because his old laptop was dying quickly, the 31-year-old figured buying a PC on the Internet and getting it shipped home would take too long.

So in late June, Mr. Conroy went to a Circuit City Stores Inc. store, which doesn't stock any Dell computers. There, he checked out several laptops before snapping up a $1,200 Hewlett-Packard Co. model. "Most importantly, I could get my hands on it right then, without having to worry about it being shipped," he says.

Mr. Conroy's experience signals a fundamental problem facing Dell. For years, Dell -- famous for selling products directly over the phone and the Internet -- was a dynamo thanks to bulk sales to corporations, mostly of desktop computers. Its direct-sales business model made the Round Rock, Texas, company a widely admired paragon of efficiency as it underpriced rivals such as H-P and Gateway Inc.

But in the past few years, buying behavior in the PC world has changed. Much of the growth has come from consumer demand rather than the business market on which Dell focused. What's more, people looking for a new home computer are increasingly turning to laptops. There Dell is particularly weak: Its models lack the pizzazz and features of rivals. For laptops especially, consumers prefer to hold and test models in a store, but Dells aren't sold there. According to NPD Group, 56 percent of laptops sold to consumers in the first quarter of this year were bought in a store, up from 50 percent two years ago.

Dell has largely ignored the consumer boom although it says it still considers consumers an important market. For a while it had part-time workers with an annual turnover rate of 300 percent taking calls from customers who wanted to buy a PC. The company has poured money into corporate products such as printers, storage systems and computer servers. It nixed some overtures from retailers to sell its wares in stores. At a conference in 2004, Dell Chief Executive Kevin Rollins declared, "We have never focused on the consumer as a company."

At the same time, rivals such as H-P, Gateway and Apple Computer Inc., have charged ahead in the consumer PC market. In particular, H-P cut costs to become competitive with Dell, began working more closely with retailers and redoubled its marketing efforts. As Dell cut prices, H-P invested in consumer-friendly features in its notebooks. H-P computers, using a laser, can write a label on a specially coated music CD with artist and title so users don't have to use a marker. And people can watch movies on H-P laptops without booting up the computer, a feature that Dell now offers too.

Dell has missed sales or earnings projections three times in the past five quarters, most recently posting a 51 percent drop in quarterly profit. The company took another hit two weeks ago when it announced the recall of 4.1 million laptop batteries because they can overheat and catch fire. Earlier this year, Dell expanded more slowly than the overall U.S. PC market for the first time in more than a decade. In the most recent fiscal year, while consumers made up about 30 percent of H-P's $86.7 billion in annual sales, according to Sanford C. Bernstein & Co., Dell's consumer business constituted just 15 percent of its $55.9 billion in revenue.

Dell's stock is down more than 60 percent from its peak closing price of $58.13 on March 22, 2000. By comparison, H-P is up about 30 percent over the same period. The weak performance is a huge comedown for Dell, whose stock was the No. 1 performer in the S&P 500 index in the 1990s.

Dell is now scrambling to contain the damage. It is overhauling its Web site and streamlining its pricing, and it has introduced a new consumer advertising campaign with the tagline "Purely You." It has also opened a retail store for the first time and plans to open another later this year. Overall, it's pumping $150 million into improving its image. In May, it released a host of new products to target U.S. PC consumers.

Mr. Rollins, who took over from founder Michael Dell as chief executive in July 2004, calls the consumer business volatile, and says it remains a secondary focus for the company. But privately, he has admitted to some mistakes. At a May meeting with 50 Dell employees in Round Rock to discuss a change in direction for the company, the CEO conceded that "historically we didn't pay enough time and attention to our customer experience. Some of our competitors did."

Despite Dell's troubles, Mr. Rollins's tenure as CEO seems secure. Mr. Dell, who as of June owned a 9.88 percent stake in the company valued at nearly $5 billion, remains chairman. He has batted down suggestions that Mr. Rollins be replaced. Mr. Dell has said he shares the responsibility for the company's problems and called Mr. Rollins an excellent chief executive. A company spokesman notes that Mr. Rollins won the support of 98 percent of shareholders at a shareholder meeting in July.

Still, some on Wall Street are pushing for Mr. Dell to take a more hands-on role. Investors applauded Dell's recent acquisition of Miami's Alienware Corp., a maker of high-end videogame PCs, for an undisclosed sum. The company has said that deal, which boosted its offerings for consumers, was personally pushed by Mr. Dell.

The desktop market began cooling a few years ago as many companies slowed the pace of upgrading their computers. Desktops represented 65.5 percent of world-wide PC shipments last year, down from 78.8 percent in 2000, according to IDC.

Meanwhile, consumers gravitated to laptops as prices fell and new wireless technology made them more useful at home and on the go. While corporate demand focused on replacing the desktops employees already had, consumers were adding second, third and fourth computers at home as mom, dad and the kids listened to digital music, shared digital photos and played games.

Consumer laptop shipments more than doubled to 65.3 million world-wide in 2005 from 26.4 million in 2000, says IDC. By 2010, consumers will likely be buying more laptops than corporations, predicts the research firm.

Even as these shifts took place, Dell stuck to its roots. Created in 1984 in Mr. Dell's University of Texas dorm room, the company barreled through the 1980s and 1990s tech boom using its direct-sales model. Mr. Rollins, who joined the company in 1996, advised Dell in 1993 while he was a Bain & Co. consultant to get out of retail because there is less profit in selling computers through stores.

As the tech downturn ended around 2003, Dell continued cutting costs and focused on being efficient. Around that time, Dell executives decided to hire temporary workers to man their five U.S. call centers, rather than recruit more-expensive full-time staff. By 2005, 75 percent of Dell's call-center staff -- those who take calls from customers wanting to buy a PC -- were temporary workers. Three years earlier, the majority of those staffers were full-time employees.

The move backfired. By late 2005, Dell noticed its U.S. consumer sales were flattening. Ro Parra, a Dell senior vice president who was asked to look into the problem, pinpointed call-center problems as one cause. He discovered that the temporary call-center workers who wanted full-time jobs weren't being promoted. Turnover in the centers had soared to 300 percent a year from 30 percent in 2002.

"We were very efficient, and we made those decisions that work with the short term, but they were really damaging to us over the long term," says Mr. Parra.

In late 2004, the profitability of Dell's consumer business began deteriorating. Dell told Wall Street its competitors were cutting prices to gain market share at the expense of profit, and said its focus was the high-end PC consumer. But Dell was also participating in a price war, dropping its prices as low as $299 for desktops.

The stirrings of trouble at Dell coincided with a revival at H-P. After buying Compaq Computer Corp. for $19 billion in 2002, H-P realized it had to cut costs to compete with Dell. Larry Wuerz, vice president of manufacturing and supply chain for H-P's consumer desktop PC business, says H-P reduced the number of contract factories that build its PCs to 10 from 24 between May 2002 and 2003.

In early 2005, H-P's board ousted Chief Executive Carly Fiorina, who had engineered the Compaq deal. Her replacement, Mark Hurd, quickly devised a plan to cut costs further. He separated H-P's printing business from its PC business and hired Todd Bradley, the former chief executive of handheld computer maker palmOne Inc., to run PCs. H-P played chip makers Advanced Micro Devices Inc. and Intel Corp. against each other, wringing out cheaper chip prices. (Dell recently said it too will begin using AMD chips.)

H-P worked to build a stronger partnership with retailers. In May 2005, H-P teamed with Wal-Mart Stores Inc. to create a build-your-own-PC program inside Wal-Mart's Rogers, Ark., store, a program that has since been expanded to other stores. H-P for the first time also dispatched 55 of its district managers to roam retail stores and help customers during the 2005 back-to-school season.

As Dell's consumer business sagged, the company discussed displaying its computers in retail stores as a way of luring customers to its direct-sales operations, according to a person familiar with the matter.

In late 2004, Dell met with retailer CompUSA Inc., this person says. The two got close to signing a distribution deal for Dell to sell its computers in CompUSA stores. Executives discussed both selling the computers directly through kiosks in the stores and CompUSA keeping Dell inventory in the stores, says this person. But the discussions ultimately broke down over the size of the margins CompUSA would get, this person says.

Dell confirms it has had talks with retailers, but says it didn't consider keeping inventory in any stores. "We've not found an approach yet that serves our customers better than the direct model," says Jess Blackburn, a Dell spokesman. A CompUSA spokeswoman declined to comment.

Dell also rolled out some new products to woo consumers. In October 2004, it released its first plasma-screen television sets, a digital music player and a new photo printer with a built-in display to preview photos. But some consumers were wary about buying some of those products sight unseen from a company not known as a consumer-electronics maker.

In November 2005, Dell reported shrinking consumer revenues. Aiming to cut costs further, Dell announced it was merging its U.S. consumer business into its overall Americas business.

Several Dell executives left the company. Randy Mott, Dell's chief information officer, joined H-P in July 2005. Mike George, general manager of Dell's U.S. consumer business, left in October. He is now chief executive of Liberty Media Corp.'s QVC shopping network. William Amelio, head of Dell's Asia-Pacific and Japan business, left in December to head Lenovo Group Ltd. Mr. Rollins has said people left for better opportunities that weren't available at Dell.

In November 2005, Dell took a baby step toward changing its consumer strategy by selling through retailer Costco Wholesale Corp. for the first time. Dell says it worked with Costco because it was coming to the end of a product cycle and could shed a small number of units to sell in Costco stores. Dell calls the in-store presence a one-time deal. Ginnie Roeglin, a senior vice president at Costco, says the retailer would like to do more business with Dell if it is interested.

Last month Dell opened its own first retail store in NorthPark Center, a Dallas mall. Customers can check out models and place an order for delivery later but they can't bring home a computer right away. It's the furthest the company has gone in retail, although it already operates more than 170 kiosks in malls around the country where consumers can see and order a selection of Dell products. Jim Skelding, Dell's sales director, says the company decided to open full-scale stores this year -- another one is to open in New York later this year -- because it had run out of places for kiosks. He says Dell executives now realize consumers want to see laptops and other products in action before buying.

In May, the company pledged $100 million to improve the "customer experience," including hiring more than 2,000 new U.S. sales and support staff. Of those, 1,300 will be full-time sales people hired for its call centers. It has since added another $50 million to the effort. Internal Dell data show that its efforts are reducing call volumes and call transfers for customers.



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