InformationWeek

November 15, 1999

Dell Finds Success In Its Custom-Build Strategy
Vendor looks to enterprise-systems business to continue its high rate of growth

By Paul Korzenowski with additional reporting by Paul McDougall

ell Computer was expected to end its third fiscal quarter last week on a high note, with analysts predicting revenue growth to $6.7 billion, an increase of about 40% compared with the same quarter last year. But that's hardly surprising news these days for the high-tech bellwether. Dell wrapped up its second quarter with stronger-than-expected earnings, reporting $607 million in net income and $6.1 billion in revenue, and forecasting healthy demand through the second half of its fiscal year. Observers say the company is on a clear path to hit $23.6 billion in annual revenue this year, after seeing 1998 revenue rise almost 50% over 1997, to $18.2 billion.

One striking development for the prominent PC vendor has been the growth of its enterprise-systems business, which comprises servers, storage, and workstations. Revenue in the third quarter was up 85% from the year-ago period, and the company's plan is to decrease its reliance on desktop systems. PCs now make up 60% of its revenue, and Dell wants to cut that to 50%.

The enterprise-storage market is growing rapidly, and Dell wants a piece of it. "Storage is becoming a bigger part of system purchases," said Michael D. Lambert, senior VP of Dell's enterprise systems group, at Dell's DirectConnect conference in August. "The Internet is making online storage more important." Dell, which had never made an acquisition before, in September bought storage systems vendor ConvergeNet Technologies Inc. in a stock swap valued at $340 million. ConvergeNet makes software to control and secure the flow of data between servers and storage systems in storage area networks. Dell plans to fold the technology into its PowerVault storage system.

Dell has also made huge inroads in the Windows NT server market. Dataquest reports that Dell became the second-leading supplier of NT servers in the United States behind Compaq in 1998, and it has retained that rank through the second quarter of 1999. The company has also begun exploring other server opportunities. "To cut operating costs, customers want to use Solaris and Linux on eight-way Intel servers," says Patrick Patla, group brand marketing manager for Dell's PowerEdge line. Dell began offering both operating systems installed on its servers in the last year.

Analysts expect Dell to be one of the first companies to feel the heat from the diminished supply of memory chips, caused by the recent Taiwan earthquake. Because of its custom-build, direct-order model, Dell operates with only six days of inventory, so it didn't have as large a stock of chips on hand as some competitors when the earthquake struck. Dell says it expects to pay up to 25% more for memory. Analyst Brooks Gray with Technology Business Group Inc. says the chip issue will add about $80 million to Dell's third-quarter expenses and cut expected growth in net income for the quarter from 40% to about 35% (about $700 million).

But in all other respects, Dell's direct, build-to-order model has been successful. Dell's operating margin in its second quarter was 11.3%, compared with Compaq's 1.8%, for example. "Because of its superior cost structure, it becomes difficult for other vendors to match Dell on price," says Lorin Olsen, senior manager for IT infrastructure planning at Sprint Corp. in Overland Park, Kan., which uses 70,000 Dell PCs.

By primarily selling direct, Dell also is able to keep better tabs on customers' needs than competitors, say analysts. "Dell has a better understanding of what they need than vendors who process user requests through third parties," says Kevin Knox, a research director at Gartner Group.

One critical customer requirement to which Dell has turned its attention is services. In August, the vendor unveiled an online support program, dubbed OpenManage Resolution Assistant, that provides diagnostic and management services for PowerEdge servers over a secure, virtual private network; it plans to expand that program to all Dell hardware by the end of next year.

And in September, the company inked a seven-year, $6 billion deal with IBM Global Services to provide installation, basic- and extended-warranty, and high-availability services for desktop, notebook, server, and storage customers. The new relationship will help Dell further extend its services reach worldwide through IBM's 22,000 field service technicians. (This deal followed an agreement the two companies reached in April, in which Dell agreed to buy $16 billion worth of components from IBM.)

The services will become available in the United States in early 2000 and to international customers later next year. The partnership with IBM's worldwide technical staff suits Dell's global expansion plans; earlier this month, for example, Dell opened its first factory in Brazil.

The company says the IBM deal is also a key to Dell's strategy to become a serious player at the high end. "As Dell continues to grow up and its enterprise server and storage products become even more aggressive than today," says Gary Cotshott, Dell's VP of services, "customers will want the combined solution of a Dell enterprise product and more choice of who they want their service provider to be."

Photo by Paul S. Howell Dell says it expects to retain the advantage of customer intimacy, even as it expands its services arrangements to include more partners. "We're still the first point of contact for the customer, so we don't expect to lessen our customer contact," says Steve Felice, VP of relationship group services at Dell.

Meanwhile, Dell's PC business remains strategic to its interests. It displaced Compaq as the top supplier of business and consumer desktop PCs in the United States for the first time during the third quarter of 1999, according to Dataquest. Dell's U.S. unit shipments increased by 57%, as its market share grew from 13.4% in the third quarter of 1998 to 17.1% in the same quarter this year. "All of the other PC suppliers are chasing Dell," says Mark Specker, an analyst at SoundView Financial Corp.

The vendor has transferred its desktop success to the notebook segment. Notebook revenue increased from $895 million in the second quarter of 1998 to $1.3 billion in the second quarter of 1999. "It's amazing that Dell has significant market share in the notebook space because it really has only one product line," says Technology Business Group's Gray. The company also signed a five-year deal with Samsung Electronics Co. in October to provide LCDs for its notebooks. Earlier this year, Dell underestimated demand for its notebook systems and wound up having to pay a premium for LCD components.

But that's a small misstep for the company, which is also concentrating on continuing to enhance its Internet business. In the last month of its last quarter, Internet sales to Dell customers reached $30 million per day, representing nearly 40% of the company's revenue. The vendor, which early on developed customized Web-ordering sites for large customers, recently added new features to make it easier to price and order systems from its Premier Pages. Dixon Ticonderoga Co., a writing-instruments company in Heathrew, Fla., says Dell's Premier Pages are a key reason for doing business with the company. "We've found it extremely easy to get product information and order new systems since Dell supplies us with our own portal," says Garrett Grainger, Ticonderoga's VP of information systems.

Dell plans to further expand online ordering capabilities. Next year, it will unveil its Direct Commerce Integration software, which links a company's online procurement of Dell products with its SAP R/3 procurement module. Initiatives like this one, and the IBM services agreement, are designed to position Dell to avoid the perils of a commodity market. "There's a commoditization that continues to shape elements of the product line," says Cotshott, "and in a commoditized world, customer experience is very important."

Photo by Paul S. Howell

Go on to the next story, "Hewlett-Packard's Makeover Starts Turning Heads ."

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