What's the Deal with Dell?

Back in the 1990s Michael Dell could do no wrong, at least in the eyes of his early investors. His method of mass customisation in personal computers was, in its own way, as revolutionary as Henry Ford's car factories. Profits followed and Mr. Dell became one of the wealthiest men in the world.

The next decade was not so kind to Dell, whether the company or the man. Competition from Asia and elsewhere reduced his products to commodity status. Profit margins shrank accordingly – and so did the company's market value. By early 2009, a share price that was below $1 (split-adjusted) as recently as 1996 - approaching $60 in March 2000 – dropped all the way down to $8.

Can Dell come back? Maybe, but only by drastically changing its business model. The global economic slowdown isn't the only challenge the PC segment faces. The upgrade cycle that once drove users to buy new machines every 2-3 years is long gone. Hardware sales are driven by software sales, and users are either happy with what they have or migrating to other platforms.

The good news for Dell investors is that the company is drastically changing, as is the marketplace in which it operates. The much-hated Microsoft Windows Vista operating system is giving way to Windows 7, which new features are convincing both businesses and consumers to replace older models. The resulting sales will give Dell some breathing room as it works to meet longer-term challenges. Dell is also aggressively expanding into the Linux market – a smart move that reduces its dependence on Microsoft.

Remember when everyone had to have the newest faster processor and all its accessories? Now much of the heavy-duty processing is done in the cloud, on servers far away from the end user. Personal computers are now far less important than they once were. For most people, a speedy broadband connection matters far more than a lightning-fast CPU chip.

For Dell this is both problem and opportunity. The problem is that the mass PC market is not nearly as dynamic as it once was, regardless of the global economy. The opportunity is that someone has to build the servers that power the web to which all those legacy PCs are connected. Dell is working to improve its position in this faster-growing segment.

A storage-system partnership with EMC Corporation is another key advantage. The corporate server market is closely tied with system design, consulting and other outsourcing services. Dell's 2009 purchase of Perot Systems was clearly aimed at a quick expansion of this business.

Dell's second key initiative, announced last year, is its entry into the worldwide smart-phone market. Devices like the Apple iPhone are quickly supplanting the desktop and even the notebook computer for many users. Called the Mini 3 and still shrouded in secrecy, the Dell phone will be based on Google's Android software and reportedly features a touch-screen interface. Agreements with telecom providers will make the Mini 3 available in the U.S., China, Brazil, Australia and much of Europe.

While Apple obviously has the first-mover advantage in the new generation of smart phones, plenty of growth potentials remain. A Dell-sponsored study found that more than three-quarters of current users would consider new devices from a well-known technology brand. “Considering” is not the same as buying, of course, but Dell has a chance to capture market share if its phone has the right feature set.

Rumors are also floating around that Dell is working on a “tablet” computer comparable to Apple's forthcoming iPad. Does Michael Dell have his eyes on Steve Jobs? From the outside, it surely seems so.

Maybe most important to Dell's renewal will be a return to its roots as an efficient, cost-effective hardware maker – but with a twist. A company that for years shunned outsourcing is now embracing it. Dell is transferring ownership of its plant in Lodz, Poland to contract manufacturer Foxconn, and apparently intends to consolidate European operations. The firm recently closed a facility in Limerick, Ireland and transferred the business to Lodz. Poland's relatively low tax rates and below-average labor costs will give Dell another small edge over the competition. Such incremental savings worked before, and should work again.

Dell's top advantage is still its founder. Mr. Dell returned to active management in 2007 after a failed attempt to transfer leadership to others. He will not make the same mistake again. This doesn't mean he will stay at the helm forever, but Mr. Dell clearly intends to put the company that bears his name back on the map.