'Craptops' and the End of Dell

Years of putting market share ahead of quality has spurned consumers and driven profit out of PCs. Microsoft needs to act fast. It may already be too late.
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In its most recent SEC filing, Dell explains the various reasons why it wants to go private. Among broader points about the merits of fewer shareholders in tumultuous times, the company makes one thing clear: it believes the Windows PC business is a dead end. The filing states:

  • “Decreasing revenues in the market for desktop and notebook PCs and the significant uncertainties as to whether, or when, this decrease will end”;
  • “The overall difficulty of predicting the market for PCs, as evidenced by the significant revisions in industry forecasts among industry experts and analysts over the past year”;
  • “The ongoing downward pricing pressure and trend towards commoditization in the desktop and notebook personal computer market”; and
  • “The increasing usage of alternative PC operating systems to Microsoft Windows.”

The PC market has looked better. In 2012, sales declined for the first time since the bursting of the dotcom bubble (by 1.2%; from 352.8 million units to 348.7 million units). Despite the poor omen, the decline is hardly large enough to be fatal. Surely it’s possible for Dell – public or private – to stake out a sustainable future in some corner of the market. After all, Apple’s Mac division saw unit growth of 9% in 2012 (up 33% versus 2010) and made more than $6.5 billion in gross profit, despite holding less than 5% share of total PCs shipped. Yet Dell may yet be right, which begs the question: How did it come to this?

In its quest to monopolize the global computer market, Microsoft actively encouraged its partners to offer increasingly inexpensive PCs. Low prices, the company correctly hypothesized, would drive adoption, which would drive ubiquity and in turn, the level of standardization that has entrenched the company’s products since the early 1990s. The unfortunate consequence of this ‘race to the bottom’ (which the vendors readily accepted) has been continued damage to customer experience and customer expectations – to the point that both the Windows and PC vendor brands seem irreparable. Few PC customers would claim any of the big consumer brand names – Dell, Acer, HP, Gateway – make great, reliable or high quality computers, let alone innovative ones.

This is because most of these customers have been suckered into what many affectionately call “craptops.” Earlier this year, prominent Windows journalist Paul Thurrott covered a Best Buy ad telling readers to “Upgrade to the latest technology”. Featured alongside the tagline was a $370 Toshiba with considerably outdated specs – but Microsoft’s three-month old operating system, Windows 8. Unfortunately for buyers, the laptop did not support touch, upon which the OS is essentially (but not critically) based. A quick look in this week’s flyer tells a similar story: a $330 Lenovo and 6-pound $280 “top deal” HP. Not only do these laptops have even worse specs, they, of course, have no touch support. For years, consumers have been buying underpowered, albeit cheap Windows PCs full of preloaded software that simply cannot run smoothly. It’s no wonder none of these companies, Microsoft included, aren’t seen as innovative. Consumers literally cannot use their products.

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At the same time, Apple has been promising and delivering a tightly controlled user experience that guarantees a leading and consistent experience on any of its lines and with any configurations. When the company expanded iPhone availability in the United States to two carriers, it ran nationwide ads showing two identical iPhones, one on AT&T and one on Verizon, performing all of the same tasks identically. You can bet neither company was pleased, but the message was of paramount importance to Apple.

Despite the slow but very steady rise of Apple and its methods, Microsoft continued to reinforce price competition in the Windows market by releasing ever-cheaper, low-end editions of its Windows operating systems. Naturally, these had fewer features and rarely supported newer hardware or specifications. If a PC vendor wanted to support a cheaper Windows edition, the computer’s components better be budget too.

Blog2-01This culture permeated through the vendors, affecting far more than their low-end units. Here, HP is a great case study. Despite the catastrophe of HP today (and his ignominious resignation), former CEO Mark Hurd’s reputation remains shockingly intact. Under his reign from 2005 to 2010, the company displaced Dell to become the world’s largest PC vendor and saw its share price increase more than 110%. However, during this time HP also reduced its R&D budget by 18%, despite a 37% increase in revenue. As a result, the company’s R&D as a percentage of sales plummeted by more than 40%. During this same period, Apple’s R&D spend almost quadrupled, while sales grew 250%, resulting in a 75% increase in R&D/sales. By 2010, HP was spending 15% less on R&D per year than Apple – despite having a dramatically larger portfolio of consumer products and an enterprise services division offering network and information security solutions, enterprise hardware, network switches, routers and more. While the metric is by no means a sufficient condition for innovation, it’s not hard to see why HP’s products failed to ignite consumer interest. What is less obvious is how Dell thought its products might magically improve year-over-year (until a few months ago) Today, Macs are estimated to make up between 75%-90% of the $1,000+ PC market.

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There are signs that Microsoft is starting to understand that it must go beyond simply selling Windows licenses by enforcing rigid standards on its vendors. For the Windows Phone, which it released two and half years ago, the company set minimum hardware requirements and even mandated hardware button layouts to ensure consistency. However, it has yet to bring this approach to its PCs. It needs to. And step one should be rich, multitouch capabilities on any new Windows 8 computer.

Even still, it may be too late. Many customers upset about their most recent ‘craptop’ purchase may not consider the brand for their next purchase. Alternatively, they may simply defer the purchase of a new laptop due to doubts that the “latest technology” will be any better and get a new smartphone or tablet instead (which is likely not made by any major PC vendor and runs an OS other than Windows). Furthermore, Microsoft may struggle to compel vendors to follow new standards, having previously betrayed them by releasing its own PC, the Surface (a product the company claims to have released as a result of the lack of innovation coming from the partners).

Microsoft and its partners need to act fast. However, it took American car companies many years and sales cycles to recover from a reputation for poor quality. Unfortunately for Dell, it seems even tomorrow isn’t soon enough.

Please find my follow-up and responses to reader questions here.


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