China Key to Dell's Comeback

Having stumbled at home, the tech giant needs to succeed in the second-biggest PC market.
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BEIJING -- Having fumbled at home, can Dell (DELL) - Get Report make amends with a standout China performance?

As everybody knows, the PC giant has fallen on hard times lately largely due to weakness in the U.S. But to compete with a re-energized

Hewlett-Packard

(HPQ) - Get Report

, Dell will need to shine in its global execution, too.

Dell has traditionally focused more on the home front; last year it drew two-thirds of its $56 billion in revenue from the Americas, compared with only 12% from Asia Pacific-Japan. But China, the world's second-biggest PC market, stands as a key strategic prize. And investors should take note because a big stumble here is likely to have serious repercussions on the tech giant's long-term growth outlook.

On last week's earnings conference call, Dell management flagged what it called an impressive China performance in the first quarter of fiscal 2007, noting its China sales were up 29%. The company's 40% increase in units was almost twice that of the growth of the rest of the industry, Dell pointed out.

Is this legitimate crowing? Well, in some ways Dell deserves to boast. It's gained share, an impressive feat in China's cutthroat PC market. In calendar year 2005, Dell grabbed third place in PC rankings with 8.8% of share, up from 7.4% and fourth place in the previous year, according to IDC. (H-P also gained more share, by the way.)

Dell can claim to be the "top multinational

PC vendor in China right now and they've already made quite a bit of gains, so it's looking good for them," says Bryan Ma, IDC's associate director of PC research in Singapore.

But going forward, Dell faces some serious challenges in China.

Already, PC sales in China's wealthiest cities, like Shanghai, Guangzhou and Beijing, have hit a saturation point. So have sales to big companies in China. Most future sales in both these areas are likely to be replacements.

So PC vendors are now pushing into less-affluent provincial cities looking for growth. They're also trying to tap into China's emerging small and medium business sector (SMBs), which numbers some 15 million enterprises.

Dell has been successful landing deals in the government and education market and in big companies, especially with foreign outfits in China. But much of the growth going forward will be among the SMBs, where Dell hasn't been as strong, says Edward Yu, president of Beijing-based Analysys International, a technology research firm.

The difficulty for Dell is that Chinese competitors like Lenovo and TongFang have extensive retail networks that serve these customers, who are more likely to want to touch and feel before they buy.

Dell has its own corporate sales team -- and Yu says some of its products are quietly resold through distributors, notwithstanding its much-touted direct-sales model. But it's hard to match the breadth of those third-party retailers in reaching far-flung SMBs. "You need a system and feet on the street to directly talk to customers to convince them to buy a product. That's been a weakness of Dell so far," says Yu.

Never one to give up a fight, Dell has responded the way it knows best: with prices rock-bottom enough to thoroughly spook the market. A Citigroup report recently cited Dell when it cautioned against investing in Asia PC stocks, invoking the specter of a damaging, Dell-led price war that could wither profits.

At the same time it's battling on the PC front, Dell must deal with renewed pressure from H-P in the server market. In 2005, H-P managed to tie with Dell as the No. 1 vendor of x86 server units in China, erasing the narrow lead Dell held a year prior.

Meanwhile, H-P and

IBM

(IBM) - Get Report

continue to best Dell in servers as measured by revenue share, because they both sell more high-end -- and more profitable -- fare.

"Over the past 12 to 18 months, H-P has been extremely aggressive in China," says Rajnish Arora, IDC's research director for Asia Pacific servers and workstations. "By aggressive, it's not just about dropping prices but also executing well, streamlining its channels so it has a clear focus, and trying to increase its reach" into smaller cities.

Dell won a reputation based on its insanely ambitious market-share goals and its willingness to plunge headlong into the scariest, skinniest-margin commodity markets. Expect the China market to put both to a serious test.