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The Education Of Michael Dell


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THE EDUCATION OF MICHAEL DELL

Walk around the headquarters of Dell Computer Corp., an understated glass-and-steel building in Austin, Tex., and mixed in with the abstract art and unassuming, utilitarian furniture are dozens of framed accolades to Michael S. Dell. There are glowing press notices in several languages, laudatory magazine covers, industry awards to both the man and the products he sells, a wall full of bronze copies of Dell's 11 patents, and the hand-soldered guts of the company's first personal computer mounted in the center of a separate "history wall." All fitting tributes to a college dropout who nine years ago, at the tender age of 19, took an idea that was startling in its simplicity--selling computers over the phone--and parlayed it into a $2 billion-a-year business. It is now the fourth-largest PC maker in America, behind IBM, Apple, and Compaq.

Yes, Michael Dell has become one of the most mythic of heroes in an industry full of Homeric figures. And his company's public-relations efforts promote to the hilt Dell's image as the young David doing battle against the Goliaths of the computer business. The name was even changed from PCs Limited to Dell in 1987 to capitalize on the image of the firebrand taking on the graybeards. The thing is, David is now a Goliath himself. No longer a pudgy, bespectacled youth, Dell now speaks with authority at industry conferences, wears expensive suits and contact lenses, eats only health foods, takes management seminars at Stanford University, and tries to be the very model of a proper CEO.

And he has built a Goliath of a company. Today, Dell has 4,654 employees--and is hiring 100 new staffers a month. The company markets 42 different PC designs and also distributes a full line of software and accessories such as fax modems. And Dell's reach is increasingly global: The company sells PCs in 18 countries and entered six new foreign markets in the past year, including Japan (page 88).

TOUGHER CHALLENGES. Dell's formula is elegantly direct: He has cut out the dealers and distributors, designs and assembles most of his PCs from off-the-shelf components, and runs a no-frills operation whose main focus is customer service. That model has won him kudos from across the industry. He may not have the high-tech vision of a Bill Gates or a Steve Jobs, but "it is probably true that Michael is the most innovative guy for marketing computers in this decade," says Philippe Kahn, chairman of software maker Borland International Inc. "He's the quintessential American entrepreneur that does something everyone says is impossible."

The proof is in the numbers. On Mar. 9, Dell reported a stunning 126% gain in sales for the fiscal year ended Jan. 31, to $2 billion. Fourth quarter revenues--despite component shortages that caused shipping delays--rose 117%, the fourth quarter in a row of triple-digit sales growth. Despite a price war, earnings for the fiscal year were no slouch either, doubling to $102 million.

But that was last year. This year, Michael Dell faces new and tougher challenges. Over the past several months, he has suffered the loss of two top executives, an embarrassing and costly flap over currency speculation, quality problems with some Dell computers, and shrinking margins (chart, page 85). Dell recently warned investors that net margins will contract to between 3.5% and 4.5% this year, down from the 5% the company has promised Wall Street in the past. PC price wars, increased capital expenditures, and higher taxes will take their toll.

Investors have already taken notice: Dell's stock plummeted from a high of 49 in January to about 30 a month later. By Mar. 10, it had rebounded to 36 1/2. The decline caused Michael Dell no little pain: He owns 10.8 million shares--30% of the stock outstanding--and has suffered paper losses of about $135 million. More significantly, Dell was forced to postpone a long-planned 4 million-share public offering. On Mar. 8, the company received another jolt: Archrival Compaq Computer Corp. announced price cuts, with IBM following suit the next day. Dell immediately responded with two new models priced below similar Compaq PCs. But now, Dell will face a formidable opponent on its own turf: Compaq will begin marketing PCs through direct sales (page 8753).

`GUTS.' Clearly, life is getting rockier for Dell--and how he responds will be critical. Most entrepreneurs eventually run into a time of crisis that tests their ability to grow, to become managers for all seasons. Some, like Bill Gates of Microsoft Corp., smoothly shepherd their enterprises from startup to sustained growth, while others, like Steve Jobs of Apple Computer Inc. and Rod Canion of Compaq, end up out in the cold. The question is whether the education of Michael Dell will continue, or whether the brash qualities that made him an entrepreneurial boy wonder will now cause him to founder.

True, Dell is widely hailed as a brilliant marketer, but the market is becoming increasingly complicated and competitive. With PCs almost all alike, manufacturers have to rely on price, brand name, and extra features such as 24-hour service or multimedia doodads. Dell was one of the first to realize the importance of service and price, but now everyone does. And the nanosecond changes in this industry have brought down a long list of more seasoned players than Dell. "Dell had the guts to take on the industry and succeed," says Eckhard Pfeiffer, Canion's replacement as CEO of Compaq. "But you can't sit on your laurels. You must keep moving forward, and I think that is where Michael Dell is falling down."

Dell calls Pfeiffer's assessment "total nonsense." His performance, he says, can be judged by the success of the company. "I think the company's report card is pretty good."

BITTER ATTACK. No question that the company has done well. Still, cracks in Dell's success started appearing last November, when Kidder, Peabody & Co. analyst David R. Korus revealed that Dell Computer had been engaging in a highly aggressive and risky foreign-currency hedging strategy that had lost the company $38 million in the second quarter. Dell says those losses were reduced to $1 million by yearend and came out to a profit of $1.1 million if a different type of accounting method is used. Korus' report came only weeks after Dell Chief Financial Officer James R. Daniel suddenly resigned without explanation, after helping to manage two years of phenomenal growth. The two events left investors wondering whether the company was slipping up on the administrative side.

Dell's vituperative reaction didn't calm the markets. He launched a bitter, personal attack against Korus, calling his analysis irresponsible and inflammatory, and even threatened to sue the analyst and Kidder. Three months later, Dell says his response to Korus may have been "a bit aggressive. We probably lent more credibility to his speculation by commenting the way we commented." No matter, he's still attacking. "If I had known that this guy made a regular practice of breeding reports like this, I don't think we would have responded at all," he says. "This is a nonentity. It is not a rational situation here."

Or is it? For all Dell's hue and cry over Korus, his reports are highly regarded on Wall Street. More significantly, for six months last year, Dell did in fact regularly take multimillion-dollar plunges into foreign-currency investments, as large as $50 million a day, until the board of directors ordered it to stop last Aug. 21. Even Dell CFO Thomas Meredith, who came on board last November, says Dell's currency trades were "definitely leading-edge in relation to the size of the company" and will not be nearly so adventurous in the future.

So why not fess up and just admit they were wrong? That's just not Dell's style. He is an extremely competitive risk-taker who has always played close to the edge. "Michael Dell is an aggressive personality, and the people who work for him reflect that," says Joel J. Kocher, president of Dell USA and Dell's No.2 executive. "Our people sleep aggressive. They eat aggressive," says a very intense Kocher, without even a hint of a smile. Which helps explain why employees greet criticism with a counterattack or a dismissive shrug. David Lunsford, the 31-year-old engineering director, voices the typical Dellite view: "I think a lot of people can't stand that such a young guy can totally show them up."

FATHER FIGURE. Dell has been showing them up for years. He first went into business at age 12, when he set up a mail-order stamp auction, complete with a nationwide catalog. The business netted him his first $2,000. By the time he got to the University of Texas at Austin, he was immersed in computers and knew he was destined to be an entrepreneur. His parents wanted him to be a doctor, but that was not an option. "I don't like hospitals," says Dell. "The failure rate is way too high."

He didn't exactly choose a low-risk alternative. Fed up with shopping at fusty electronics stores where he often knew more than the salespeople, he decided to start selling PCs himself. Only one problem--he had to find a cheap source of machines. He started PCs Limited with IBM computers purchased on the gray market. At the time, IBM did not allow dealers to sell PCs to anyone who would resell them. But unsold stock is every dealer's nightmare, so when Dell or his buyers knocked on back doors offering to buy up all the surplus stock at cost, retailers leapt at the chance. "I would go to, say, a ComputerLand store and tell the salesman I needed 10 or 20 computers. He would ask: `Are these for resale?' And I'd say, `No, I'm buying these for my fraternity brothers,"' says one of Dell's former buyers. Dell would then soup up the PCs with graphics cards and hard disks before reselling them.

By 1985, the company was assembling its own PC designs--rather, three guys at a six-foot table were assembling them. There were only some 40 employees, and Dell worked 18-hour days and slept on a cot in his office. Back then, he hung around mostly with the engineers and was so shy that some employees thought him stuck-up because he never talked to them.

The person most responsible for turning Dell into a polished executive, and the company into a powerhouse, was E. Lee Walker, president and chief operating officer of the company from 1986 to 1990. Walker, 51, an Austin venture capitalist who had been involved in numerous startups, provided the managerial and financial experience to implement Dell's marketing ideas. "They complemented one another," says Brian Fawkes, Dell's senior manager of corporate communications from 1987 to 1990. "[Walker] knew everybody's name in the company. He had a fatherly image."

YOUNG TEAM. As Dell's mentor, Walker gave him the confidence to overcome his shyness. After Walker's resignation because of a serious back ailment, Dell turned for advice to Morton H. Meyerson, the former president of Electronic Data Systems Corp. and now a potential candidate to replace John F. Akers as IBM's CEO. Meyerson served as an adviser to Dell for about a year. His assignment: help Dell make the transition from a megagrowth medium-size company to a mature large one. "Dell's management team is very young, but they have a unique sense of mission and dedication," says Meyerson. "Michael in particular is a peculiar combination of technical and business talent."

His management team is youthful: Dell only recently turned 28, Kocher is 36, and International President Andrew R. Harris, the No.3 executive, is 38. G. Glenn Henry, senior vice-president of the product group and a former IBM research fellow, is a seasoned 50, but his main role is product development. So Dell's only elder statesmen are his board members, particularly Bobby R. Inman, former chairman of Microelectronics and Computer Technology Corp., an electronics-industry research consortium, and Teledyne co-founder George Kozmetsky. "These kinds of people have already faced highly complex challenges," says Dell. "They've been to a lot of the movies that we will be going to."

The board is not concerned about Dell's lack of experience. "Michael has never made the same mistake twice. He's a quick learner," says Inman. And there is universal agreement that he has grown in the job. When Harris joined six years ago, Dell was "intense to an extreme. He wasn't a very good public speaker. He wasn't good at running meetings. He wasn't laughing a lot." Now, says Harris, Dell is a changed man. "He's a very charismatic leader, a great speaker." He's also intimately aware of all parts of the business. "He can go into any department and know what hot button to push" to inspire the staff. That involvement has won him intense loyalty from his young work force--average age, 28--and many talk of him in reverential tones.

Driving his Acura NSX, Dell rolls into one of his two offices--at headquarters or the nearby research and development building--about 7 or 8 a.m. But he has cut back on those 18-hour days since his marriage four years ago, with Walker as his best man, to Susan Lieberman, a former commercial leasing agent. He still comes into the office on an occasional Sunday, but now he brings his 14-month-old daughter, Kira, with him.

Any mellowness in his personal life, however, has not tempered his competitive zeal at work. Look at some of his brash advertising campaigns. "His ads are really an extension of his personality," says Michael Massaro, chief operating officer at Goldberg, Moser O'Neill, Dell's San Francisco-based advertising agency. "He frowns on anything that's too soft or too fuzzy."

Dell was the first in the hardware business to use comparative ads, throwing barbs at Compaq machines that the copy said were more expensive than Dell's own, with headings such as "The Lap of Luxury" (Dell) vs. "The Lap of Lunacy" (Compaq). The ads, created by Goldberg Moser, were clever and attention-grabbing. But they were wrong. Compaq said Dell was not comparing the same models or prices, and it sued. In 1991, Dell was forced to alter its ads and to pay Compaq an undisclosed sum to settle litigation that emerged in the U.S. and Europe.

In London, the Royal Courts of Justice ruled that the ads contained "malicious falsehoods" and that Martin Slagter, vice-president of European marketing, knew it. But Michael Dell is unapologetic. The ads were "very effective. We were able to increase customer awareness about value," he says.

QUALITY ISSUES. Yet Dell has another problem that can't be papered over: quality and service gaps. The company came in first in 1991 on a J.D. Power & Associates ranking of customer satisfaction for small and medium-size businesses buying PCs, and No.2 on the same survey last year, behind Apple. But recently, some customers have been complaining about delays in filling orders. "The machines are good, but Dell's idea of just-in-time is not the same as ours," says Jeff Margolies, an account representative with AI Credit Corp., the leasing and financing arm of AIG Insurance. Margolies often buys up to 100 machines a day but says Dell meets the promised delivery schedule of six days only about half the time.

More worrisome may be complaints about product quality. Dell's notebook computers and Dimension line of PCs have been plagued by glitches ranging from broken hinges to bad power supplies. Both are non-Dell designs. SCI Systems in Huntsville, Ala., designs and makes Dell's low-end Precision and Dimension desktop PCs, while its notebooks are designed and built in Asia. Says SCI President Olin King: "I'm not aware of any quality problem."

But others say problems are surfacing. "We've heard a lot about problems, especially with their portables," says Marc Litvinoff, an analyst with Gartner Group, a Stamford (Conn.) consulting firm. Gartner is now investigating those reports, as it does with all PC vendors, and Litvinoff says it is holding off on a decision about whether or not to place Dell on its "Problem Watch" list until it gathers more data.

Kocher's initial response to questions about possible quality problems? "That's pure hype," he snaps. And it's true that every PC maker has some quality slipups. But it's also true that Dell's notebooks were "suboptimized," as Kocher puts it. "We are now making the investments to turn that around. We'll be back," he says, with a new line of notebooks this summer.

Analyst James Poyner of Rauscher Pierce Refsnes Inc. in Dallas says Dell's quality problems have definitely hurt its notebook sales. In the fourth quarter, notebook computers, the fastest-growing segment of the overall PC market, accounted for only 8% of Dell's total unit sales, compared with 25% for Compaq, Poyner estimates.

Dell's competitors, specifically Compaq and IBM, keep arguing that they have more control over quality than Dell because they assemble most of their own machines. For its part, Dell intends to rely upon subcontractors less. Beyond that, Dell has long boasted that his assemble-to-order, direct-response business model is more certain to meet the customer's needs. His strategy avoids the huge costs and inflexibility of building parts in-house that can be easily bought. Instead of building up inventories of finished PCs, his plants in Austin and Ireland only finish machines once a customer specifies which features are needed.

TIGHT MONEY. But his model is losing some of its advantages. The two big draws of direct sales--price and convenience--are now being matched by low-price electronics superstores such as BestBuy and CompUSA. And Gateway 2000, a closely held direct-sales company, is hot on Dell's heels. On Mar. 8, Gateway reported 1992 sales of $1.1 billion, a 76% rise over the previous year. Many analysts say Gateway, based in low-overhead North Sioux City, S.D., will always have the edge over Dell on costs.

Dell insists he's not trying to be the lowest-priced vendor--only the lowest-priced top-tier vendor. And he's willing to adapt: Dell has started selling in superstores such as Sam's Club, Price Club, and CompUSA. "We have not been wedded to one sort of religion as far as our strategy goes," says Dell. "We're constantly reinventing ourselves."

The challenge now for Dell the company and Dell the man is to continue adapting to the rapidly changing nature of the PC business. He has little room to cut already trimmed costs, having embarked on an austerity program last summer. That included a temporary 5% pay cut for top employees. And PC prices are still plummeting. Expansion is critical--Dell has assured investors that the company can still grow by 70% this year.

But money is tight. The public offering has been postponed indefinitely. The company now has cash and investments of $95 million, down from $155 million a year ago. That compares with $357 million for Compaq. CFO Meredith says Dell can easily finance its growth with bank loans, a cheap source of funds thanks to current low interest rates. It recently entered into a $200 million revolving line of credit and has $48 million in long-term debt outstanding. But Compaq and Apple have no long-term debt. "Adding interest expense on top of falling margins adds further net-margin pressure to the picture," says Poyner. "For PC companies, relying on credit financing has been the road to hell."

Perhaps. But Michael Dell has always shown a willingness to change. Take 1988, when he ordered a full-court press to develop an engineering workstation. After spending 18 months and several million dollars, the project still had design problems--and a limited market. Dell knew better than to throw good money after bad. He shifted engineers back to PCs, and six months later a new line of more conventional 386-based machines were on the street.

Dell also is candid about what he thinks he doesn't know. He says he needs help managing the company and has focused much of his energy over the past year on bringing in key aides, such as CFO Meredith and Scott Flaig, senior vice-president of worldwide operations. He hinted that another top executive will be added shortly, probably to replace the former director of manufacturing, who left in August for personal reasons.

BROADER VISION. He'll need the help. Now that Compaq and IBM--"the sleeping bears," as Dell used to call them--have awakened, market share isn't quite so easy to grab. In fact, claims IBM personal-systems head James A. Cannavino, "we are now growing just as fast as Dell."

But Dell insists that he is not particularly worried about the big guys. After all, by getting into direct sales, they're now playing the game his way. "You'd be hard-pressed to find a successful company that has won by copying an innovator's strategy unless the innovator is a bad executor," he says. "I don't think Dell has been a bad executor." Besides, he says, direct sales is harder than it looks. "It's not as easy as a couple of 1-800 lines and picnic tables."

Surely IBM and Compaq know that. For Dell, the question is how he can go them one better. That will take a broader vision. Other entrepreneurs before him have moved to the next level. Microsoft's Gates, a former boy wonder himself, says entrepreneurs have to start questioning their skills not when the company reaches a certain revenue size, but when the number of employees and products reaches a certain breadth. "That's where you say, `Wow, I have to play a different role."' For Michael Dell, that role is just beginning.Stephanie Anderson Forest and Catherine Arnst in Austin, Tex., with Kathy Rebello in San Francisco, Peter Burrows in New York, and bureau reports


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