News & Insights August 24, 2006, 8:20PM EST

Dark Days at Dell

The tech industry's lean, mean direct sales machine is on the fritz, and there don't seem to be any easy fixes. What gives?

By Nanette Byrnes, Peter Burrows and Louise Lee

Story Tools

These are the dog days of Texas summer, with grass bleached yellow and the mercury hitting 100 by noon. But nowhere is the heat being felt like it is inside Dell's (DELL) no-frills compound outside Austin. For company founder and Chairman Michael Dell and Chief Executive Kevin Rollins, this summer has been one mishap after another: a massive recall of potentially self-igniting laptop batteries, a dismal earnings report, and an announcement that the computer maker is under Securities & Exchange Commission scrutiny for the way it counts revenues. By mid-August, Rollins was being asked on CNBC about how long he would occupy the tandem corner office he shares with Michael Dell.

Rollins looked to be the picture of calm in the face of the rebuke. But make no mistake, this is a pivotal moment for a tech icon. Dell may not have hit a wall in quite as dramatic a fashion as did Eastman Kodak (EK) or IBM (IBM). For all its problems, it is still expected to make nearly $3 billion this year. Yet its predicament may be intractable. Dell remained slavishly loyal to its core idea of ultra-efficient supply-chain management and direct sales to consumers, even as rivals have stepped up their game and markets have shifted to take away some of Dell's key advantages. Instead of adapting, critics say, Dell cut costs in ways that compromised customer service and, possibly, product quality.

ONE-TRICK PONY.

Says one top tech executive in reference to Dell's lean, mean direct-sales machine: "They're a one-trick pony. It was a great trick for over 10 years, but the rest of us have figured it out and Dell hasn't plowed any of its profits into creating a new trick."

The same operational focus that made Dell and Rollins so formidable when they were on top may get in the way of finding another big idea. "Dell's culture is not inspirational or aspirational," says Geoffrey Moore, a tech consultant and author of Dealing with Darwin: How Great Companies Innovate at Every Phase of Their Evolution. "This is when they need to be imaginative, but [Dell's] culture only wants to talk about execution."

And Dell's execution isn't what it used to be. The company will make about $900 million less in net income this year than it did in 2005, analysts estimate. It has slashed prices to maintain PC market share (19.2% in the second quarter) at the expense of operating margins, which slid to just 4.3% in the quarter ended Aug. 4 from 8.7% the year before. With the stock trading around 22, off its 2000 high of 58, blue-chip investment houses have fled. Fidelity Investments (FMR) and Goldman Sachs (GS) are among those that have cut their Dell holdings by a third or more since Jan. 1 (see "Insider Trades in 2006").

Dell is spending $115 million to improve service, and its scores have improved recently. Still, some buyers have jumped ship. Peter Shoesmith, the network operations manager at 74-attorney firm Cummings & Lockwood in Stamford, Conn., once spent $300,000 a year on Dell PCs and servers. Today, he uses Hewlett-Packard (HPQ) almost exclusively. For Shoesmith, Dell's products proved too hard to maintain and operate. "They grew too fast and tried to produce too many products at the same time," says Shoesmith. He would consider using Dell again but says "it'll take a lot for us to jump back."