Dell Revamps Blade-Server Strategy

On a sunny, breezy spring day in Austin, Texas, Dell painted a rosy picture of a company that's expanding its market share, cutting costs, and staying ahead of target on its long-term revenue goals. Dell has tripled in size since 1997 and continues to aggressively buy back its stock using large cash reserves. Still, the company faces its share of challenges in the coming years as it works through some customer-support problems and revamps a blade-server strategy that got out of the gates quickly but soon fell behind those of rivals Hewlett-Packard and IBM.

At an analyst conference Thursday, chairman and CEO Michael Dell said his company is renewing its efforts in the blade-server market and that within the next several quarters Dell will deliver a new generation of blade servers with standardized components that will make today's blades obsolete. "There are not enough industry-standard components for this next generation of blades yet," he added.

The new standards Dell is banking on will come in the areas of system-management software, cooler-running processors, and a backplane that uses a PCI Express bus to attach blades regardless of vendor. "Today's blade servers are suboptimal in that regard," Dell said.

Not everyone is sold on Dell's ability to pull off this next generation of blades anytime soon. The company's timetable is too aggressive, given the lack of standards needed to realize its vision and its inability to develop a blade that runs on anything other than an Intel Pentium chip, says Mark Stahlman, managing director of equity research for Caris & Co. "Dell's selling Pentium blades, but people want Xeon blades," he says. Stahlman contends that Dell isn't investing enough in R&D to successfully accommodate the heat and power requirements of more powerful chips--a problem that likely will be exacerbated by the market's eventual embrace of 64-bit Intel-based processors.

But Dell's quiet presence in the blade-server market isn't to be overlooked. "Dell has to do something in the blade market because it's part of selling into the larger enterprise," Stahlman says. One strategy would be for Dell to expand its blade lineup to include Advanced Micro Devices Inc.'s 64-bit compatible Opteron-based servers. That way, companies would have a 64-bit migration path, even if they're running only 32-bit apps today.Dell's blade-server challenges remain a footnote in the short term to the company's ability to effectively manage its supply chain and costs. Dell said Wednesday that it will beat earlier predictions for first-quarter sales by $200 million. It projects quarterly revenue of $11.4 billion, up 20% from the same quarter a year ago.

"We're still seeing declines in overall commodity costs," senior VP and CFO Jim Schneider said Thursday at the conference. "This is one of the competitive advantages that Dell continues to have." Schneider pointed out that Dell has been able to lower the cost of materials by cutting down on 30% of the parts used across its product lines.

Dell is able to cut spending on materials by having different server and PC models share the same chassis and by excluding high-cost components during the product design phase. "We don't control the component manufacturing industry," president and chief operating officer Kevin Rollins said. "We're just better at managing it than others. Dell shrinks the profit pie for all vendors and takes the largest piece." Dell has done this with PCs and servers over time and now has its sights set on storage and printers. While a storage area network installation cost $17,000 a few years ago, it now costs $9,000, Rollins said.

This ability to cut costs helped Dell finish fiscal 2004 with $11.9 billion in cash and investments. Dell used a portion of this reserve to buy back 63 million shares of stock in fiscal 2004. The company this year plans to invest $600 million per quarter to continue buying back its stock. Financial analysts see the stock buyback program as a good investment--as long as the company can continue to increase market share and profits.

Michael Dell continues to hold his $40 billion company's size and performance up to the $800 billion overall market for IT products and services. Dell said he sees another $40 billion in profit opportunities in peripherals, printers, services, software, and storage outside the company's core PC market.The company has sold more than 2 million printers worldwide since entering the market a year ago. Dell's plan is to continue to lower the cost of not only the printers themselves, but of the toner and ink supplies that it ships directly to customers. The company ships 100% of its replacement supplies to customers with a 24-hour turnaround. "People thought this would be an impediment to our business," Dell said.

Services pose a different challenge for Dell, particularly in the area of support for its consumer products, says Brooks Gray, an analyst at Technology Business Research. Gray attributes these problems to a lag in training classes for offshore companies that provide Dell's warranty-support services and the need for better communication between these offshore service providers and Dell.

In November, Dell returned technical support for large-business users of its Optiplex PCs and Latitude notebook computers to U.S. call centers from its company-owned facilities in India, where the computer maker ran support operations for the past three years. The move came after some customers complained about poor service. Gray says the ability to cut the cost of services to the customer is a challenge that Dell could also face with its small- and midsize-business customers as it continues to lower prices on the products themselves.