Dell's plan to cut prices has analysts warning of a potential PC price war.
Dell appears poised to spark another PC price war.
But analysts say that offering lower prices alone isn't likely to help the world's largest PC maker end a run of lackluster financials. While Dell's decision to use an AMD chip for multiprocessor enterprise systems dominated the headlines, the day after for the PC giant brought worries about a price war.
Following the release of the Austin, Texas, company's first-quarter earnings on May 18, Dell CEO Kevin Rollins said that Dell had resolved to cut prices—and some reductions have already been made—in a tri-fold effort that also involves increasing product quality and bolstering service and support. The company reported earnings of 33 cents a share on revenue of $14.2 billion, in line with lowered Wall Street estimates.
"Our history tells us—and we're setting the examples—that it will accelerate growth. It does come at a margin bump. So we're prepared to take that," Rollins said, speaking during a conference call with analysts on May 18. "We believe we'll see sustained growth that will allow us to move back into profitability long term."
Dell has consistently grown its unit shipments at a more rapid pace than the market at large. But it saw that trend reverse itself in the first quarter, when its shipment growth of around 10 percent fell below the market's figure of about 13 percent, as measured by Gartner Group and IDC.
By combining more aggressive pricing with improvements in quality as well as service and support, Rollins said Dell will stimulate demand for its products and return the company to what executives deem a more normal pattern of growth over the long term.
"We think with a combined effort there … that we'll be in better strategic shape and over the long run our profitability will be better."
But Dell's chief financial officer, Jim Schneider, stopped short of calling the effort a brewing price war.
"The way we look at it now, it's not like trying to ignite some price war, but to see where we can get the best combination of price and profitability for the long term," Schneider said during the conference call. "We're trying to find the right spot where we can get growth of higher than six percent."
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But, given that Hewlett-Packard and other PC makers have become more aggressive in recent times, lower PC prices in many respects no longer offer the same pull that they did in the past, analysts said.
"If [Dell executives] nuke the price, they're also going to nuke their own margins and they can't afford to do that right now," said Roger Kay, president of Endpoint Technologies Associates in Wayland, Mass. "It'll have to be a combination of price and supply chain management."
Unless it wants to fight a price war all the way to the bottom, Kay said, Dell must also take a new approach
"Up until now, it's been, 'We'll give you everything that everyone else has at a much better price,'" he said. Now, "What Dell needs to do is market differently—it needs to take a page out of HP's marketing playbook and emphasize the benefits of the features [its PCs] offer rather than the fact that they have a great price. It needs to tell customers why they should care."
Next Page: Price war is likely to erupt.
Even so, a price war is likely to erupt, numerous Wall Street analysts believe.
"We believe that Dell is entering a new phase in which growth will be tougher to achieve than it has been historically. We have some concerns that Dell will struggle to regain consistency over the next six to nine months," wrote Kevin Hunt, an analyst at Thomas Weisel Partners in Boston, in a May 19 report. "In addition, Dell's comments seem to suggest that a price war may be a real possibility in the PC space over the next six months."
Rollins and Schneider said during their conference call that a Dell focus on increasing profit margins gave competitors room to maneuver and that it would thus need to re-establish itself using its tri-fold plan, which includes beefing up tech support while accelerating its cost savings plan with the aim of attaining $3 billion in savings this year.
"Our conclusion from all this is that Dell might be reinvesting this savings to become more price-competitive, which is not a very good sign for the overall industry," Hunt wrote.
Given that it could take anywhere from several quarters to several years for Dell to sort out its service, support and product quality, the immediate impact of Dell's plan may be muted, Richard Gardner, an analyst at Citigroup in San Francisco, wrote in a report.
"It appears that price cuts will be focused mostly on U.S. and European small-to-mid-sized business [and] high-end consumers, but only selected relationship bids," Gardner wrote. "While we understand management's decision to price more aggressively, we are concerned that the cuts may not produce the level of near-term revenue growth necessary to achieve [second quarter] revenue and EPS guidance."
To be sure, Rollins said that Dell's plan is designed to work over time.
"We're planning to be able to move to a position to grow," Rollins said. "I don't think we have a timeline. We're going to stick with the pricing moves as long as we deem it's necessary to strategically light the business up and create a change in the overall market dynamic. We're prepared to make price cuts this year, next year."
However, he said, "I think all we're saying is we believe our growth has slowed because we kept margins too high. We need to accelerate that growth. Price is one catalyst, but we'll have to do other things. It really is a multi-pronged activity."
Still, "Dell's earnings call left us with more questions then answers on many levels," Andrew Neff, an analyst at Bear Stearns in New York, wrote in a May 19 report. "Dell's strategy seems to be contradictory—i.e., [it] plans to expand warranties and scope of services but also reduce warranty costs; announces efforts to accelerate cost improvements while simultaneously increasing investments in customer service/support and new products/technology."
In addition, "the company noted that it will implement 'selective yet across-the-board' pricing actions to reassert its brand and value proposition," Neff wrote. "At the same time, the company insisted that it is not launching a price war, only using price as the first lever to pull. From a larger perspective, what is concerning to us is lack of a clear direction or strategy coupled with a change in the underlying industry conditions that appear to be less favorable to Dell's model—i.e., 1) PC growth is being driven by strength in international markets (channels are largely indirect) where Dell's direct model has less reach, 2) strength has primarily come from consumer where Dell has limited focus, and 3) component pricing has been declining at a less rapid pace."
But not everyone was concerned by Dell's plans.
"We believe Dell missed [its original first quarter earnings projections] largely because it focused for the first 2/3 of the quarter on futilely trying to sell expensive dual-core chips to U.S. consumers," Clay Sumner, an analyst at Friedman, Billings, Ramsey & Co in Arlington, Va., wrote in a May 19 report. "HP won the U.S. consumer battle by simply selling cheaper single-core product at competitive prices."
That means Dell might not have to slash prices on its PCs. Instead, it has to deliver a mix of lower-priced machines, Sumner wrote.
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