To keep Dell afloat, going private isn’t enough

In a rational world, Michael Dell would have no reason to take his company private. Investors should prefer a strategy that works in the long run, and if a decision hurts quarterly sales or profits, they’d shrug it off.

But no matter how much drivel you hear about the wisdom of the markets, the stock market is not rational. Too many investors are locked in to a short-term outlook that fixates on “making the numbers” every three months, which hinders the radical actions needed to mount a turnaround. That’s why Dell’s reported plan to pull his company out of the Wall Street circus makes sense. But it’s not the solution to Dell’s problems.

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Dell’s problems run very deep, so getting Wall Street off management’s back alone won’t solve them. Going private won’t break the company’s dependence on the fading market for PCs. Going private won’t suddenly earn a return on the billions of dollars the company has poured into buying software companies. What’s more, going private won’t fill the black hole that is Dell’s mobile strategy.

Taking Dell private is a necessary but hardly sufficient condition. Dell needs radical surgery — and it won’t be pretty. The company must redeploy its resources, which means thousands of people who work there and in its supply chain will lose their jobs.

Dell needs to break its chain to the PC

Dell was one of the first companies I covered when I started my career as a business writer in the early 1990s. I visited the outfit back when its headquarters was still in Austin, and I well remember my surprise when I asked a top executive about how much the company spends on R&D: Basically nothing, he told me.

That wasn’t exactly true; Dell has always spent money on product development. But when it comes to research, you’d be hard-pressed to find a spare dollar at Dell. That hasn’t changed since my visits to Dell 20 years ago.

That no-research strategy made sense when the company was all about PCs. Founder and still-CEO Michael Dell understood that lightning-fast, cost-efficient manufacturing of standardized products, coupled with an iron grip on the supply chain, was the route to success. It worked. Dell was the right company for the PC-centric world of the 1990s and 2000s, but not for the the 2010s’ mobile-centric world of tablets, smartphones, the cloud, and BYOD.

Michael Dell knows that of course, and he is struggling to reshape the company he started out of his college dorm room. Faced with the steady decline in the PC market — in the third quarter, worldwide shipments of PCs plunged more than 8 percent from a year earlier, while Dell’s shipments fell 14 percent, according to IDC — he’s rightly pushed to lessen the company’s dependence on it.

Just a few years ago, roughly three-quarters of Dell’s revenue came from the sale of PCs. Now it’s about 50 percent, a real improvement in terms of making Dell less dependent on that diminished product category — but it’s still far too high. Dell knows that, which is why it has spent billions of dollars acquiring a bevy of companies in software, storage, and networking.

However, the results of all those acquisitions have been far from stellar. Revenues in each of Dell’s other product categories declined from a year ago. Sales for storage products dropped 16 percent, software and accessories fell 11 percent, and services were down 1 percent. Sales were off across all of its customer segments as well. There was one exception in that sea of decline: Dell’s server and networking business grew 11 percent over the last full quarter.

I wouldn’t say Michael Dell is in the panic mode, but it’s no surprise that he’s floated the idea of going private.

Software is key to Dell’s future viability, but it’s currently starved

A measure of Dell’s problem is its software division. Despite huge expenditures, the software division accounted only for $1.5 billion, or 2.4 percent, of the company’s revenue in fiscal-year 2012. That’s all the more startling when you consider that software is the linchpin of Dell’s recovery strategy.

Software, says Ovum chief analyst Carter Lusher, can be a source of high-margin revenues, as well as a driver for business hardware and services deals. Succeeding in that business requires significant investment in R&D — but Dell doesn’t do the “R” in R&D.

Dell’s overall R&D spend in 2012 was just 1.6 percent of revenue last year. According to Ovum, other major blended hardware, software, and services vendors spend significantly more. IBM, for example, spends an average of 6 percent of revenues. Oracle spends 12 percent. Even Hewlett-Packard under its cost-cutting-champ former CEO Mark Hurd averaged 2.8 percent. Dell’s R&D spend becomes downright embarrassing when compared to pure software companies, which typically shell out 15 to 20 percent of revenues on R&D.  

Despite the insufficient R&D spend at Dell, Lusher says its software acquisitions were well thought out. “You can’t expect these companies to produce significant revenue overnight,” he tells me. Wall Street lacks patience and won’t want Dell to divert profits to R&D because their stock returns could be hurt, which is why he believes going private makes sense.

Even if Dell gets out of Wall Street’s myopic view, Dell will have to increase R&D significantly to make the software strategy work. Based on his conversations with Dell executives, Lusher expects software R&D to rise sharply, even as R&D in other areas will stay flat.

Six things that could go wrong Dell is not trying to become another IBM or an SAP; it’s focused on the midmarket. But winning there will be tough. A lot could go wrong, Lusher says:

• Branding: Dell’s brand is both a strength and a weakness. It is a strength because Dell is well known among IT buyers. It is a weakness because the current brand image of value-priced PCs and servers is not aligned with Dell’s software strategy. Dell will have to invest heavily in sales and marketing to change the perception of its brand, Lusher says.
• Competition: IBM and other vendors focusing on the midmarket represent a significant competitive challenge.  
• The cloud: The cloud could make Dell’s vision of converged solutions a moot point. Midsize companies do not need Dell’s software and hardware converged solutions if they decide to move to a cloud-based approach to IT infrastructure and applications.
• Mobile strategy: Does Dell even have one?
• The culture: Turning around a $62 billion company means a seismic shift in thinking that requires significant retraining and new blood, a process that could alienate key employees.
• Investors. Finally, there is the possibility of an investor revolt. Accustomed to short-term results, investors and Wall Street analysts may simply freak out as the company is restructured and short-term results take a hit. That’s why the idea of going private makes so much sense.

If Dell goes private, there’s at least a chance it will make the wrenching changes needed to once again become a high-flying force that matters.

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This article, “To keep Dell afloat, going private isn’t enough,” was originally published by InfoWorld.com. Read more of Bill Snyder’s Tech’s Bottom Line blog and follow the latest technology business developments at InfoWorld.com. For the latest business technology news, follow InfoWorld.com on Twitter.