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As Lenovo Moves Into the Market, Will Things Get Worse for Dell?

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What made Dell great no longer does. Lenovo's strengths may one day become weaknesses, too.

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The moment of truth came in early 2007. After bleeding market share for two years, and losing more than a third of its shareholder value, Dell Inc. (NASDAQ:DELL) forced out CEO Kevin Rollins and brought back the man who, two decades earlier, had founded the company. Changes followed quickly. In May, Dell announced that it would begin selling PCs at Wal-Mart (NYSE:WMT), and before long other retailers were carrying the brand. Over the next three years, plants were closed in Texas, North Carolina, and Ireland, and production was outsourced to Asia. The two things that once defined Michael Dell's company -- a direct-to-customer sales model, and a build-to-order supply chain -- didn't survive his return.

This isn't the story of a PC manufacturer struggling in a post-PC world. Dell's troubles began eight years ago, when the computer was king; the company stagnated while its market grew 60%. Rather, this is the tale of a PC assembler that got out of the assembly business.

Once upon a time, Dell was an innovator. It never invested much in R&D, and its products were unexceptional -- it simply bought parts and put them together -- but the company's business model vaulted it to the top of the industry. PCs were expensive at the time, and those who bought them demanded performance. It was a market driven by enterprises and power users -- and Dell shook it up by offering to build customized hardware at assembly-line prices. Avoiding retail meant that inventory was unnecessary. Parts rolled in from nearby suppliers' warehouses, were assembled, then shipped directly to customers, with the result that Dell generally got paid long before its suppliers did.

Then prices fell, and kept falling. More consumers could afford a personal computer, and in turn, PC makers began targeting a demographic that preferred portability over power. The market for cheap, mass-produced laptops began to displace the one for custom-built, gray boxes. At this point Dell did what countless other companies were doing, and what conventional wisdom dictated. It closed factories, standardized its product line, outsourced manufacturing to China, and its customer service to India -- and the company that got its start by cutting the middle man, now became one.

The same year that Dell's fortunes turned -- 2005 -- IBM (NYSE:IBM) sold its PC business to Lenovo (HKG:0992), a small, Chinese computer maker. In a lot of ways, Lenovo was the anti-Dell. It cultivated close relationships with distributors and retailers, manufactured in-house, and drove growth by selling cheap products at an even cheaper price. After acquiring IBM's respected Thinkpad line of laptops, Lenovo became something terrifying: a low-cost manufacturer of high-end PCs. Asian firms like Acer (TPE:2353) were already driving Dell and Hewlett-Packard (NYSE:HPQ) from the budget PC market; Lenovo would begin the same process higher up the food chain.

Today, the two companies present a stark contrast. In less than eight years, Lenovo has grown its global market share from 6.9% to 15.5% last quarter. Over the same period, Dell's take fell from 16.8% to 10.2%. Perhaps Lenovo's experience in China leaves it better adapted to emerging markets, where its gains have been strongest. It could also be that the company's willingness to accept low margins -- less than a third of Dell's -- gives it an advantage over American competitors, whose shareholders demand profitability rather than market share. The most telling distinction, though, is probably the simplest one. Lenovo makes PCs. What does Dell do?

There's something tragic about the company's move to the cloud. It's a run for cover, a last stand. The only way Dell will maintain $60 billion in annual revenue is by selling hardware. It believes it can leverage cloud services into the purchase of Dell servers, and with any luck, Dell monitors and thin clients, too. It's a strategy that worked for IBM -- until Dell began eating IBM's lunch with its lower-priced, commodity servers. Will things end any better for Dell, now that Lenovo is moving into the market? If a company as innovative as Apple (NASDAQ:AAPL) has struggled to maintain share with this kind of proprietary hardware/software model, how will it fare for a firm whose R&D budget is just one-tenth of its selling/general/administrative expenses?

As stories do, this one has a moral: Successful business models are a function of time and place. What made Dell great, no longer does. Lenovo's strengths may one day become weaknesses. It's a point made more poignant by what Michael Dell said 15 years ago about Apple -- that Steve Jobs should shut the company down and return the money to investors. Dell's buyout is essentially that; and with time, the company's privatization will likely prove to be a "far, far better thing" for shareholders.
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