Dell ponders "free" PC push

To counter the pressures in the PC market, Dell is looking at ways to capture revenue after the sale of the computer. One method Dell is considering is a move to the cell-phone strategy where the cost of the PC is subsidized by selling a contract for Dell-branded Internet service, wrote Merrill Lynch analyst Steve Milunovich in a report today.

"You will be seeing us do more to essentially make to make the PC look like a cable-TV subscription, if you will, in terms of a financial product," Michael Dell, chief executive of Dell Computer, told analysts during a conference call yesterday.

Dell, in essence, was referring to how cable-TV subscribers lease a cable TV box for a nominal fee and charge for access to programs. The benefit for Dell is a greater degree of insulation from sales cycles as the company gets a constant stream of money off of the PC. Plus, they compete with the new PC kids on the block.

Dell isn't the first to consider selling a PC as if it were a cell phone or cable set-top box. A gaggle of start-ups such as Gobi, Free-PC, and Enchilada are offering "free" PCs to customers if they sign up for a combination of advertising and/or Internet service.

Other major PC companies considering such plans include IBM and Compaq. IBM, for one, expects to offer PCs on a similar plan.

Dell said that his company will "expand our efforts to capture more of the ongoing annuity revenue stream that comes from ISP connections as we bring more consumers to the online world."

Yesterday, high-flying Dell reported net earnings of $434 million, an increase of 42 percent over year-ago results. One of the bright spots is the growth in consumer and small-business sales, with revenue increasing 54 percent from the year prior.

But today analysts are sounding warnings about how Dell's profit margins are coming under increasing pressure, even in spite of the company's much heralded advantage in selling directly to its customers. So far today, concerns about how Dell will keep up profits have driven the stock down 10.21 percent to $39.5625 in afternoon trading.

Subsidized model gaining currency
Analyst Dan Niles of BancBoston Robertson Stephens thinks that by July, a major retailer such as CompUSA, Circuit City, or Best Buy will begin offering a brand-name PC for a nominal cost of around $200 when a customer signs up for Internet service.

Anecdotal evidence points to the overwhelming popularity of the "free PC" craze. CNET News.com readers have noted in emails that many of these programs have months of backlogged orders. Dell appears to be readying a plan to cash in on the craze, although executives remain coy about any specifics.

"One of the big advantages we have as a direct company is we're constantly experimenting with different models. We're always testing things," said Paul Bell, senior vice president and general manger of Dell's Home and Small Business Group in a separate interview with CNET News.com.

Dell, he said, tested its current ISP and portal programs before rolling them out, and noted that "We're certainly developing other [programs]."

While he declined to offer specifics on any such programs, he did say issues about how to sell a PC, whether it be a lease or a subscription or some other plan, "are really merchandising questions. The key thing is what services are of value."

Certainly, consumers find Internet service to be of value; a number of market surveys show that access to the Internet to be a primary factor in the purchase of a computer. And that points to a trend that analysts are starting to point out: PCs are increasingly being viewed not as stand-alone boxes but as an appliance that lets a user access another product--the Internet.

Why subsidize the PC?
The news comes as analysts caution that Dell's direct sales model isn't providing as clear an advantage as it once did in. Gross margins declined from 22.4 percent to 21.5 percent; Dell was able to reduce selling and administrative expenses in order to keep profits up.

However, analyst Richard Gardner with Salomon Smith Barney said in a report today that Dell reduced gross margins in order to maintain its price advantage over competitors, whereas in the past it relied on increasing sales of higher-margin products like servers, workstations, and notebooks to offset declines in desktop pricing. Sales of the latter are increasing as a portion of overall revenue, yet "Dell is now being forced to lower overall blended gross margins to maintain a price advantage. This is a clear signal that Dell's competitors have made progress towards closing the price gap," he said.