Dell Net Drop May Be Payback

Dell manufacturing plantDell's stock price has taken a small hammering as its margins have slumped. So far I've seen this attributed to expanded marketing expenses (probably associated with its move into Asia) and to a slowing economy. But I wonder to what degree falling margins and the need for the ongoing "turnaround" are results of previous feasting too heavily at the profit trough while pushing its partners out of the way.

About four years ago, I was writing a profile on Dell and interviewed the then research director of iSuppli, a company that closely follows the electronics industry and how it runs. Here's what he said:

A lot of people deal with Dell because they have to and can't afford not to, not because they want to. The moment they start dealing with Dell, it's going to impact their margins. We have had some cases where people declined to bid on Dell projects because the margins were at such a point that they didn't see any reason to go ahead. [--] [Contract manufacturers'] normal margins are only in the very low single digits. Then Dell comes in and they'll set a target price point which makes margin non-existent or negative. The most public case was when Dell first got into the PDA market. Three companies were bidding, and then when two saw the way the business was going to pan out, they walked away, and walked away very publicly in that case. We're sure there have been others.
For years, Dell had margins approaching 10 percent. Certainly the company operated efficiently, but was it so good that it could triple the net of other highly experienced and savvy PC manufacturers?

Probably not. Dell absorbed margin from its suppliers and, according to my sources, they would heavily rely on the manufacturing and engineering of partners, which let the company keep prices low and margins relatively high. Dell pushed hard on its suppliers with the concept that the added volume would let them hit higher scales of efficiency and greater buying power, so they could make more money on their other customers.

But as I understand it, that eventually started to backfire. Other companies didn't want to effectively subsidize Dell's profits, and so the suppliers couldn't justify the pricing. Now, a customer like Dell can find lots of willing vendors -- for a while. But eventually the strategy comes back to nip.

Back in 2003 and 2004, I was telling people that I gave Dell no more than five years before the "Whatever Happened to Dell?" stories started to hit the business press. If anything, I was optimistic, as Slate ran such a story in 2005. Sooner or later it was bound to happen.

There's only so long you can dump on the people who help make you successful before they get tired and walk off. When that happens, and you're starting to see the types of margins that you might expect given the nature of the industry, going after new markets and trying to tighten the belt at home isn't necessarily going to do a bit of good.

Dell manufacturing facility photo courtesy Dell Inc.