In an expected but remarkable turn of events, Standard & Poor (S&P) lowered its corporate credit rating of Dell from BBB to BB-, rendering the investment status of the world’s third-largest computer maker to junk.
The rating downgrade comes on the heels of a successful bid for a $25 billion leveraged buyout (LBO) by Dell founder Michael Dell with financing from Silver Lake Partners, a leading private equity firm, and Microsoft.
The proposed buyout is to move Dell to a privately held company and shift production focus from personal computing to enterprise-based services, software and cloud computing.
In Michael Dell’s own words: “Under a new, private company structure, we’ll have the flexibility to accelerate our strategy and pursue organic and inorganic investment — without the scrutiny, quarterly targets and other limitations of operating as a public company.”
Dell Struggles Despite Long-Held Dominance
Two aspects of Dell’s business model had contributed to its initial success. Firstly, Dell sold affordable computers at a time when PC’s were expensive. Secondly, a build-to-order supply chain model had meant that Dell was able to circumvent the added costs of retail management.
Unfortunately for Dell, PC prices kept falling and consumer demand shifted from powerful PC’s to portable computing and low-priced entrants like China’s Lenovo began to cannibalize Dell’s market share.
While Dell tried to remain competitive via a lean supply chain management system, the shift in demand from PCs to mobile computing devices and escalating competition put severe pressure on its revenue growth and profitability.
Narrowing PC Market and Sluggish Sales
As an long dominant leader from 2003 – 2006, Dell’s market share has slipped to 12 percent, trailing behind Lenovo at 16.7 percent and Hewlett-Packard at 16.3 percent. In the second quarter of 2013 Dell shipped 8.98 million PCs, compared to 9.35 million in the same period the previous year.
As reported in the New York Times, its second quarter earnings in 2013 dropped by 72 percent compared to earnings in the year-earlier period. While the company’s year-on-year revenue has remained stagnant over the last few years, in 2012 its enterprise solutions and services business grew by 6 percent and contributed 30 percent of their revenue. These figures were a bellwether to the changes the company needed to make.
Shift in Production Focus
Dell’s proposed shift to a privately held company is likely to be finalized over the next couple of months. From a PC-centric business, the company will re-allocate R&D spending to cloud computing, networking, hardware, servers, storage and software to boost its enterprise driven product line. Dell also plans to significantly reduce its costs from the supply chain and sales group over the next three years.
In an aggressive strategy that takes Dell back to its roots, the company is looking at lowering prices, creating a presence in emerging markets to put a squeeze on the profitability of competitors. In a recent presentation, Marius Haas, the head of Dell’s Enterprise business indicated the company’s plans to accept lower profit margins on industry-standard servers, while bundling the offering with higher profit-margin products such as storage and networking.
Although Dell’s profit margins may not change significantly, the proposed strategy is bound to make an impact on enterprise businesses like Hewlett-Packard, IBM and Cisco Systems.
Dell Continues to Expand in Emerging Markets
As Dell consolidates existing global manufacturing facilities, it remains committed to a strategic manufacturing presence in the Asia Pacific region, in particular China. In June 2013, Dell launched a new global operations site in Chengdu City, in Western China with an annual production capacity of 7 million units. It also has an existing manufacturing facility in Xiamen, China.
Dell is an organization that has not been afraid to change the way it does business. When it entered India, it quickly realized that its made-to-order PC sales model where it takes one month for PCs to arrive from its factory in Malaysia would simply not work. To counter competition from established brands such as Hewlett-Packard and Lenovo, Dell set-up a full- fledged operation in the Indian state of Tamil Nadu in 2007 and by 2010 India had become a billion dollar market for Dell products.
Charles Darwin had famously quoted, “It is not the strongest of the species that survive, nor the most intelligent, but the one most responsive to change,”As the business of computing evolves, Dell’s latest move to privatize and shift gears toward enterprise driven products reflects the company’s keenness on surviving well beyond its current relevance. And as the company’s history has shown, it stands a good chance of being successful.