Although Dell is growing far faster than any other major PC maker, the company must live with lower profit margins. Dell began a campaign to deliberately undercut competitors through discounts and PC price cuts. While the plan garnered market share, it also hurt margins, necessitating further cost reductions and possible layoffs, Piper Jaffray analyst Ashok Kumar said.
"The competitive pricing pressure has stepped up, particularly from Compaq," Kumar said. "So we expect for the July quarter Dell's gross margins will come under pressure," trimming profits by about 2 cents a share.
"To offset that, Dell will have to trim operating expenses to the tune of $100 million a quarter," Kumar said. "That works out to a 3,000 to 3,500 (work force) reduction."
Dell spokesman T.R. Reid would not discuss the layoffs, saying, "We don't comment on rumors or speculation."
Dell announced in February that it would eliminate 1,700 jobs--about 4 percent of its global work force of 40,200--as the PC industry sank deeper into a prolonged sales slump. While Dell protected its market share during the crunch, economic pressures took a toll on profits.
Dell's PC shipments jumped 34.3 percent worldwide and 30.7 percent in the United States, according to market researcher Dataquest. By contrast, U.S. PC shipments were down 3.5 percent year over year, while IDC reported a 9.5 percent decline. During the first quarter, Dell ranked No. 1 in both the U.S. and worldwide PC markets.
But the price of those impressive gains could be reduced margins, forcing the Round Rock, Texas-based company to cut costs to meet profit goals, analysts say.
IDC analyst Roger Kay said cost-cutting was inevitable in the current environment.
"I find it chilling...that things are much worse than we thought," Kay said. "It's not possible to increase market share in this economy without affecting profitability--and thus laying off people."
Robertson Stephens analyst Eric Rothdeutsch said Monday that he expects more than 3,400 jobs to be cut in the coming weeks.
"We expect the company to announce additional layoffs in the next few weeks, which should be two to three times larger than the 1,700 full-time employees from the first round," Rothdeutsch said in a research note. "We look for the company to restructure its U.S. operations and to close down nonperforming businesses."
UBS Warburg analyst Don Young saw similar signs. "We are also picking up signals of additional streamlining and expense reductions at Dell," he wrote in a research note last week. "These signals confirm our thesis that Dell is hunkering down for a battle."
Salomon Smith Barney analyst Richard Gardner said the cuts would likely be concentrated in divisions outsides Dell's core computer hardware business including its DellHost Web hosting service. He said an official announcement may come by the end of this week.
Signs of rough times
Technology Business Research analyst Brooks Gray said signs of trouble could clearly be seen in the fourth quarter, when Dell margins dropped suddenly. While gross margins remained constant in the third quarter at 21.3 percent, they dipped to 18 percent in the fourth quarter, Gray said. More dramatically, operating margins--minus expenses--dropped to 5.6 percent in the fourth quarter from 9.9 percent in the third quarter.
On the product side, Dell's desktop PC margins fell to 12.7 percent during the fourth quarter from 16 percent in the third quarter, Gray said. During the same period, notebook margins dropped to 18.7 percent from 22.4 percent.
Desktop PC operating margins dropped to 2 percent in the fourth quarter from 5.1 percent in the third quarter, while notebooks dropped to 7 percent, from 10.6 percent during the same period last year.
"Pricing pressure continues to increase in the PC market, and Dell may have to make further head count reductions to support product margins," Gray concluded.
Despite Wall Street's love affair with Dell, the cost-cutting is not surprising, said ARS analyst Toni Duboise.
"I have never seen Dell so aggressive in terms of pricing and promotions," she said. "And I can't believe that won't cost them some profitability. I don't doubt they have to cut costs somewhere."
Dell began cutting prices late last year in an effort to grab a greater share of the PC market. The strategy has worked, helping boost the company to the No. 1 spot in global PC sales, but Dell has held the line in recent weeks to protect its dwindling profit margins.
Duboise emphasized that even reaching a pricing plateau, Dell was keeping prices below competitors'. Dell's entry-level Inspiron 2500 notebook, with 700MHz Pentium III processor and free DVD drive upgrade, sells for $1,049.
The company also is aggressively positioning Pentium 4 consumers. A 1.4GHz model with 128MB of RAM, 20GB hard drive, free CD-RW drive upgrade, and free 17-inch monitor upgrade sells for $1,299. A similarly priced system from Compaq Computer with a 15-inch monitor goes for about $350 more.
Additionally, Dell is engaged in an end-of-the-quarter promotion blitz to drive sales. Customers who purchase a new Dimension PC and recommend a friend to buy "can each earn $100 to spend anywhere online," according to Dell's Web site. Other promotions include free DVD and CD-RW drive or monitor upgrades. They all end when Dell closes its quarter May 2.
IDC's Kay believes the aggressive pricing only continues to cut into profits.
"Dell may have won the crown, but the price they will pay could be high given the economic uncertainty and falling PC volumes," he said.
News.com's Ian Fried and Michael Kanellos and staff writer Richard Shim contributed to this report.