Dell's dilemma--it's about pricing

The Round Rock, Texas-based PC manufacturer announced that revenue for the current quarter would be lower than expected. The problem was blamed on costs associated with replacing faulty capacitors with some business PCs as well as lower-than-expected sales to consumers in the U.S. and U.K.

But the hiccup in the consumer market, in part, can be attributed to price. Although often tagged as a low-cost PC manufacturer, Dell has managed for the past several years to largely keep out of the bargain segments of the PC market in Europe and the U.S., allowing it to garner more revenue and profits than its competitors.

Bargain PCs, however, have become quite sophisticated, and competitors such as Hewlett-Packard and Acer have gained market share by touting low-priced desktops and notebooks. Gateway also has come back to life, emerging as one of the fastest-growing brands, thanks to discount PCs.

A look at the average selling prices for consumer PCs in the U.S. underscores the phenomenon. In 2002, the average selling price for a consumer PC from Dell was $1,084, according to research firm IDC. HP's average selling price for the same year was $1,009, or $75 lower. The average for all manufacturers was $1,030, $54 less than Dell.

In three years, that gap hasn't shrunk. Instead, it has widened. Dell's average selling price for U.S. consumer PCs for the first three quarters of this year was $854, more than $200 above HP's $651 average. The average selling price for the market as a whole was $744, or $110 less than Dell.

Now with the price gap so large, Dell's sway with the upscale PC buyers it usually courts has weakened slightly.

"In the past, the attitude of consumers was, 'Of course you buy a Dell," said Richard Shim, an analyst at IDC.

For Dell, snaring customers who were willing to buy higher-priced PCs was doubly hurtful to competitors. Not only did it mean more revenue for Dell, the company's direct selling model gives it lower operating costs.

The current problems, though, may not spread. When business PCs are added to the mix, Dell's average prices are lower than HP's, making HP the party vulnerable to higher pricing.

Dell edged under HP in 2004. Then, Dell's overall average selling price for the U.S. was $1,016, while HP's was $1,037, a $21 gap. So far in 2005, Dell's overall average for the U.S. has been $963 compared with HP's $986, a gap of $23. While it ships many consumer PCs, most of Dell's sales are to businesses.

Additionally, Dell has already taken action to try to segment its high-end consumers from average ones. In October, the company said it would offer more models in its upscale XPS line of computers. If branding segmentation succeeds, Dell can cater to its traditional consumer base with XPS and fight on price with Acer and the rest with standard Dimension desktops and Inspiron notebooks.

However, Dell also has been dogged by complaints about service. Back in February 2004, Consumer Reports and Technology Business Research reported that customer satisfaction among Dell customers dropped. Although the company ranked higher than most competitors, it was a stinging criticism for a company that can be obsessive when it comes to customer service. Founder Michael Dell himself occasionally dons a headset and fields customer service calls, according to sources close to the company.

Dell took immediate action and improved customer service by December, according to the TBR surveys. But consumers this year have become more vocal about complaints. Dell customer service stories are now a staple of many blog sites.

Although Dell made its earnings warning on Monday, signs of a slowdown were already out there. Earlier in the month, Gartner pointed out that in the third quarter, Dell's PC shipments grew at 17.6 percent, about as fast as the market on the whole. It marked the first time that Dell had grown only as fast as the market in seven years.