For years, Dell flummoxed its competitors with a direct sales model and a method for making PCs and servers more customizable than ever before, allowing it to produce quality systems at lower prices. Not anymore.

Rivals have closed the gap on Dell's supply chain advantage, leaving founder and chairman Michael Dell to acknowledge its vaunted model is no longer enough. In its place is Dell 2.0, Dell said last week. While it will still sell direct, this new strategy focuses on growing Dell's services business, increasing system sales in emerging markets, improving customer service, and lowering costs by outsourcing more functions, even product design.

Dell 2.0 "signifies a very exciting time in our company where we are re-examining everything we do," Michael Dell said. Such self-contemplation is overdue. The company last week said it will delay filing its quarterly report because of a Securities and Exchange Commission investigation to determine if previous financial reports included misstatements. Dell's $502 million net income for its second fiscal quarter ended Aug. 4 is down 51% from a year ago. Revenue was $14.1 billion, up 5% from last year's second quarter, but down slightly from $14.2 billion in revenue for this year's first quarter.

The delayed filing puts Dell at risk of being delisted from Nasdaq, Michael Dell acknowledged, adding that the company is confident it could file before the delisting process concluded. And Dell also has been dealing with recalls of more than 4 million Sony-made batteries that run the risk of bursting into flames when used in notebook PCs.

All of this leaves the company vulnerable to archrival Hewlett-Packard. "We're looking for some compelling service that differentiates Dell," says Charlie Orndoff, VP of infrastructure services at Crossmark, a provider of sales and marketing services. Crossmark is renegotiating its HP services agreement and met with Dell to consider its services offerings. Orndoff says he hasn't yet decided which vendor he'll go with but is leaning toward HP. It's hard to differentiate on services for commodity hardware, he says. Crossmark uses HP's PCs, servers, and storage systems.

Dell has spent several hundred million dollars on improving IT services in the past few years, CEO Kevin Rollins says, including the opening of regional IT service centers worldwide. Dell now makes about $5 billion a year in services, about 10% of its revenue.

Upgrading Customer Service

Dell's customer service ratings have slipped in the past year, and part of Dell 2.0 is reversing that slip. "We know we've not done this perfectly in the past," Rollins said at last week's event. Dell hasn't always owned up to its service problem. "That was the clearest acknowledgement that I've heard them make that there have been issues in that space and is a significant step toward recovery," Gartner analyst and event attendee Ron Silliman says. Rollins pointed to Dell's June launch of DellConnect, a service that lets tech support personnel troubleshoot PCs over the Internet. That's part of a $150 million investment to improve customer service, including increasing staff at its tech support center from 1,000 to 4,500.

Customer choice plays a role in Dell 2.0, too. Dell last week began shipping its first PCs running on Advanced Micro Devices processors. The Dimension C521 and E521 PCs are available with AMD Sempron, Athlon 64, or Athlon 64 X2 dual-core processors. It will add AMD servers in coming months. Dell said by year's end it will deliver storage products that use Blu-ray optical disc technology, enabling capacities of around 200 Gbytes.

And it will keep pursuing new types of customers. Dell is focusing on foreign markets with high growth potential, adding manufacturing plants in Brazil, central Europe, and India.

The Dell 2.0 upgrade is the company's strongest acknowledgement that it has lost some of its shine. The coming months will show whether the new model will be as successful as the first one.