For Dell, will luxury PCs boost profits?

Dell, the low-cost king, may be trying to fatten up its margins by going after the top end of the PC market.

The Round Rock, Texas-based company on Wednesday unveiled its XPS brand, a luxury line of computers that will compete head-on with high-end PC makers like Alienware and even Apple Computer.

Some analysts interpret the move as an indication that Dell, which rocketed to the PC industry's top spot by building an efficient manufacturing operation that enables it to sell computers for less than its competitors, wants to feast on the fatter margins that come with selling snazzier gear. Prices for the XPS systems start at $1,099, while prices for the long-running Dimension PC line can go as low as $400.

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What's new:
With its new XPS line of PCs, Dell is taking a shot at the high end.

Bottom line:
Considering that PC components are already at rock-bottom prices, the Texas company is hoping to pump up its margins with the luxury brand. But can it lure style-consious consumers away from Apple Computer?

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But why bother? After all, Dell's margins seem to be holding up. In its most recent fiscal quarter, which ended July 29, Dell said its operating margin was 8.7 percent of total sales, up a tenth of a percentage point from a year ago. And sales were up 15 percent to $13.4 billion.

Still, in an industry whose customers expect prices to keep on dropping, even the most efficient of companies, at some point, will find that it's becoming difficult to maintain a healthy profit.

"There is probably no other business on earth in which buyers continually expect more for less," said Roger Kay, president of the tech analysis firm Endpoint Technologies Associates.

Moore's Law, which argues that the number of transistors in a silicon chip doubles about every two years, has held up for many years and still has some life left in it, Kay said. Moore's Law also means that the cost of producing that better performance inversely drops--and it has over the years. But costs of other basic components, such as cases, fans, frames, power supplies, and a multitude of diodes and resistors, are already at rock bottom and aren't going much lower, Kay said.

"It's pretty clear that (Dell) needs to go after those high-margin markets if it wants to maintain its profits," said Nicholas Carr, author of several tech industry books, including "Does IT Matter? Information Technology and the Corrosion of Competitive Advantage."

The solution: Go upscale with some of your products, where margins are always higher. It's a strategy similar to what big car manufacturers have been doing in recent years: Big trucks don't cost too much more to make than sedans, but they cost a lot more on the sales lot. Customers are willing to pay a premium for that size and power. That's money the carmakers can pocket.

It's the same thing in the PC market. More power, more features usually mean more profits for the manufacturer on each item sold. And Carr argues that, like car buyers, some consumers think of their PCs as statement items and are willing to

pay for that luxury. How else can you explain an Apple laptop with a titanium casing? Or the growing popularity of so-called rugged laptops?

In another move that some analysts also think is aimed at shaving costs and preserving margins, Dell, in a pilot program starting Oct. 10, will stop free shipping of some lower-end PCs, particularly cheaper configurations of the Dimension product line. Customers can still get free shipping for the low-end PCs by picking them up at a local post office, and free shipping will continue for higher-end systems, depending on promotions.

The breakdown
There is a subtle science to how companies like Dell make money off their PCs, Kay said.

"Let's say that a consumer could buy a basic system for $500 that cost Dell $450 to deliver. Dell's gross profit on the sale would be $50," he said. But adding more features, like better speakers, more power, or a better graphics card, could take that theoretical price up to $1,000. Dell's cost for that bundle could be $850. Even if Dell gave the customer a $75 discount, it would make $25 more off that PC than off a cheap one.

"By increasing the value to the customer at each small step up the product line, the company encourages the buyer to stretch a little and take the next package up," Kay said.

That Dell's competitors are also becoming more efficient may also be prompting Dell to introduce its luxury line, said Moors & Cabot analyst Cindy Shaw.

"We think Dell's main rival, Hewlett-Packard, will improve its cost structure over the next few years," Shaw said. "Lenovo's purchase of IBM's PC business could result in a more competitive cost structure for that organization" as well.

Shaw said she expects new HP CEO Mark Hurd to be very focused on cost and execution, which could diminish Dell's cost advantage.

In addition, Lenovo could slow Dell's progress in Asia, particularly in China.

But selling the luxury line could be a challenge for the company that's best known for affordable computing. Buyers seeking style above all else will continue to favor Apple, Shaw said, noting that "Dell's new XPS PCs feature color choices and lights, but in our view, Apple still holds a wide lead over other computers when it comes to style."

CNET News.com's Jim Kerstetter contributed to this report.