Does Dell have a sound strategy?

A consortium headed my Michael Dell is trying to take Dell private. Before the recent surge in share price the company was down 64% (under-performing index with 57%) since Michael Dell took over as CEO in February 2007. Taking the recent bid from the consortium into account, the company is down 44% (under-performing index with 49%). A cynic would argue that Michael Dell ran the company into the ground, just to be able to buy it back at a cheaper price.

Corporate strategy. Dell has tried to develop its corporate strategy in the direction of becoming an information technology services company; gradually moving away from its focus on selling personal computers. However, to succeed Dell has to get each business unit strategy right. Dell's segment reporting is focused on customer groups and not products so it is not so easy to assess the quality of its business strategies.


Dell's businesses. A first cut analysis would split the revenue into hardware (including services and warranty directly related to get the hardware to work) and more general IT services (including software):

• Hardware (82-87% of revenue). Hardware has been and remains Dell's main source of revenue (91-95% in 2007). Dell makes its money selling to companies and not to consumers. It is likely that most of the money is made selling rather complicated solutions as opposed to just selling the hardware. Maybe most of the profit is made from medium sized companies that require more hand-holding. 
• General IT services (13-18% of revenue, 5-9% in 2007). Dell has grown this segment mainly through acquisitions (e.g. Perot Systems) during Michael Dell's tenure as CEO. Dell is a latecomer to this market dominated by companies like IBM, Oracle, SAP, and Accenture. The small share of total revenue shows what a difficult market this is to get into for Dell (cf. Hewlett Packard's problems entering the same market). 

General IT services, business-unit strategy. Unfortunately, Dell is not very forthcoming in describing exactly what services they offer. This makes it difficult to assess the consistency of their strategy. It is possible that the general IT services business will be profitable even after taking acquisitions into account; it can certainly be a high margin business. However, the business is unlikely to generate a large organic revenue growth or profit in the next ten years. The segment's track record in terms of growth is not great. New core competencies will have to be developed and integrated with the main organisation. In terms of valuation, maybe we can consider the business a real option, but not much more.

Hardware, business-unit strategy. Absolutely critical for success is Dell's performance in the hardware business. This is an area in which Dell has built up formidable core competences; both in production as well as servicing of corporate clients (to paraphrase the old IBM slogan You can't go wrong buying Dell). However, today Dell has two key weaknesses. Both are due to the fact that personal computers are a mature 30 years old. First, the industry is getting commoditised. Dell (and HP) is likely to pursue a differentiated strategy by providing more support services to companies. However, the price premium that companies are willing to pay is declining because the industry is maturing. Lenovo pursues a low cost strategy and provides basic, but good support services. That is sufficient for more and more companies. In terms of margins, Dell will do okay, but the growth will not be there. Second, personal computers is just one maturing product category and Dell has been unwilling to expand into other product categories (e.g. mobile phones, handheld computers). This is the second factor that reduces revenue growth.

Michael Dell's tenure as CEO. During Michael Dell's tenure as CEO the core business has been hardware and Dell's share price has gone down 49% more than index. When the buy-out consortium states that the financial market has been unwilling to accept massive changes in Dell's strategy, it is unclear what they mean. The consortium could mean that the financial market does not like a revamp of the hardware business. If this is their view, I think they are wrong. The stock market has not punished Dell for doing too many changes to its hardware business. In fact, the stock market would probably have liked to see further changes. The consortium could also mean that the financial market would not like a stronger shift towards general IT services. If this is their view, I think they are correct. The stock market is probably afraid that Dell's strong cash flow would be used on an ultimately unprofitable expansion into general IT services.

The strategic challenges for the buy-out consortium are enormous and I wonder why they have chosen Michael Dell to oversee these changes. Maybe their argument would be that Dell's share price has been beaten down to such a low level that they can make money with the disruption of changing CEO. If this is the case, however, one has to wonder why the current CEO (and board) has allowed the share price to drop to such levels. From a corporate governance perspective it does not look good; somebody has failed in stewardship of a once-great company.

What will happen? It is still an open question whether the bid will be successful or not. Given the voting rights, the alternative to a bid is probably more of the same with Michael Dell at the helm. Since that is not in the interest of shareholders, they are likely to accept the extant bid (after pushing for a higher bid). I do not think the consortium will be successful in turning the company around (share price 13.81 15/3/1013).