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Will Dell be next victim of price wars?

Dell has thus far managed to sidestep the PC price wars which have gouged the profits of other major computer vendors.

Although Dell has thus far managed to sidestep the PC price wars that have gouged the profits of other major computer makers, analysts say it is only a matter of time until the Austin, Texas-based manufacturer has to cut its prices to remain competitive.

At that point, the company may begin to face a decline in profitability and its stock price, which has gone from the low 20s to close to 100 in the past year.

It's likely that Dell will continue to enjoy manufacturing and distribution cost advantages over traditional PC companies such as Compaq Computer. Nonetheless, its profit-per-computer will steadily fall, forcing the company into the high-volume, low-margin soup the rest of the industry is swimming in.

"The [low-price] undertow is eating the entire cliff off the PC industry," said Roger Kay, a computing analyst with International Data Corporation. "No matter how much concrete they pour, Dell may find themselves in the sea anyway."

Compaq, IBM, Hewlett-Packard, and Intel have all reported or warned of lower-than-expected earnings due to declines in PC prices. Unit sales and revenues are up, but incessant price-cutting has drained much of the profit. A year ago, sub-$1,000 PCs were rare. Now all three of these manufacturers have several models at, near, or below that price.

By contrast, Dell has been able to sustain its prices. The company does not have a series of sub-$1,000 PCs and has stated that it may not move toward that market until the end of the year, when the next-generation of Intel's Celeron chip, code-named Mendocino, is due to ship. (For its part, Intel has significantly revamped its lines and pricing of PC chips to address the low-cost phenomenon.)

Dell's mainstream PCs have floated above the fray as well. The average selling price of a Dell business PC is close to $500 more than the average price of an HP business PC, according to Kay.

That will invariably fall, he and others say, because any technological advantages Dell might bring to the table can't justify the difference. Dell maintains that its customers are from the high end of the market, but even these sophisticated buyers are demanding lower prices.

A Dell spokesperson stated that the company maintains relatively high selling prices for its systems because that's what customers are buying. The average selling price of a consumer model from Dell is $2,200, said Bill Robbins, a Dell spokesman.

"They want the latest technology," he said, adding that orders for cutting-edge technology spike whenever new processors come out.

Demand is also softening among corporate users, which will lead to less growth this year than last. Partly as a result of these trends, BT Alex Brown dropped its rating on Dell from buy to market perform in March.

But some argue that Dell will continue to avoid the low-price pressures because of the cost advantages it enjoys by building computers on an as-ordered basis and selling them directly to customers, avoiding middlemen. Compaq and others have said they will reduce this advantage but haven't yet done so.

Dell's entire inventory cycle lasts eight to nine days, Robbins said, a much shorter period than traditional PC makers.

"It has been a year since the other computer makers said they would narrow Dell's advantage, and it hasn't happened," said Jeff Matthews, a partner in RAM Partners, a Greenwich, Connecticut-based investment firm. "To really compete with them, someone else is going to have to sell direct."

Dell has also moved to shore up its services and support capabilities, Kay pointed out, announcing major service and support agreements with Unisys and Wang earlier this week. Services are increasingly becoming a significant profit source for IBM and HP. Under these agreements, Dell will earn revenues and profit from work performed by Unisys or Wang, the company has said.

Still, low prices and the potential problems they can bring seem inevitable.

"Realistically, at some point, business customers are going to say, 'Explain to me why I am spending $2,500 bucks for a PC when a slightly less robust version sells for less than $1,000,'" Matthews said.