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Last updated: May 9, 2006 3:05 pm

More than price behind Dell’s fall

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Shares in Dell hovered near a 12-month low on Tuesday, a day after the world’s biggest computer maker said its results would fall short of expectations for the third time in four quarters.

For investors who have followed Dell from its modest beginnings in Michael Dell’s University of Texas dormitory, the past 12 months have been a shock.

Shares in the company – long considered the wunderkind of the PC industry because of its ability to generate consistent revenue growth in the high double digits – have fall more than 40 per cent since July.

The shares sank 4.3 per cent on Tuesday to $25.30, just above a 12-month low of $25.10 set last week. Most analysts said Monday’s profit warning was not a complete surprise.

But Toni Sacconaghi, an analyst at Sanford Bernstein, reflected the widespread concern that Dell’s latest earnings shortfall means that the company’s business model “appears to be increasingly less competitive in the marketplace”.

Falling prices, cost improvements at Hewlett-Packard, its chief US rival, and competition from low-cost producers in Asia, such as Lenovo and Acer, which have begun to grab market share from US computer makers, they argue, appear to be eroding Dell’s edge.

“We need to see a sense of urgency that has been lacking,” says Andrew Neff, an analyst at Bear Stearns. “Given that Dell has reported disappointing results . . . over the past four quarters, [its] problems are not new, and not simply a result of an escalating competitive environment.”

When pricing mistakes led the company to miss earnings targets in the second quarter last year, Kevin Rollins, chief executive, indicated the problem would be solved quickly.

Now, after Dell blamed “pricing issues” for its latest disappointment, some analysts have begun to wonder whether the company’s problems run deeper.

Five years ago, Dell computers cost 20 per cent less to make and 25 per cent less to buy than those of its rivals. Today, Dell’s cost advantage stands at just 10 per cent, while its price advantage has narrowed to 5 per cent, according to Richard Gardner, an analyst at Citigroup.

Customer service has also stumbled. Mr Rollins says the company is investing to improve customer service, a move Mr Gardner applauds.

“Dell has been under-investing in ‘customer experience’ for some time in an effort to prop up margins, but is now realising that it is preferable to sacrifice some margin near-term in order to protect 20 years of brand quality,” he says.

But investing in service alone may not be enough to solve Dell’s problems.

On Monday Dell said it expected earnings in the first quarter of 33 cents a share, below its initial guidance of 36-38 cents a share. It now expects first-quarter revenues of $14.2bn, at the low end of its earlier guidance of $14.2bn-$14.6bn.

Those numbers suggest that further declines in operating margin – the chief measure of a company’s profitability – may be in store when Dell reports its first-quarter results on May 18.

Dell blamed its miss on “pricing decisions”, suggesting that it lowered prices to make up for lower margins by boosting sales.

Although Dell says that its pricing moves should contribute to higher revenues in the future, Mr Sacconaghi at Sanford Berstein suggests the moves may have been ill-conceived.

“While price has proven to be an effective weapon for Dell historically, conditions in the marketplace today are different . . . and we view Dell’s pricing action as hasty, and potentially risky,” he writes.

Such criticism must be frustrating. After all, in spite of its recent troubles, Dell’s profit margins and revenue growth are still among the best in the industry.

But as rivals such as HP, Acer and Lenovo fine-tune their own business models, the wide gap between Dell and its competitors has narrowed. Those competitors may yet feel the strain as Dell’s aggressive price moves force them to lower their prices, eating into margins. Whether that strategy can restore Dell’s reputation as one of the world’s best growth stories remains to be seen.

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