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Dell looks out for No. 1

The direct PC vendor appears to have a chance at the top spot U.S. market, though the window of opportunity is small.

With its strong market growth, stable margins, and growing brand name cachet, Dell Computer appears to have a chance to take the No. 1 position in the U.S. PC market, although observers caution the window of opportunity will stay open for only so long.

"They are like Compaq was three years ago against IBM. They are the company that can do no wrong," said Scott Miller, an analyst with Dataquest. "The question is how badly do they [Dell] want to be the leading PC company. They will have to spend money to do it. The opportunity is that they are close enough to make it worth shooting for."

But it's the "how badly" part that is the rub. To continue to grow much faster than the market, Dell will likely have to move beyond its Fortune 500 customer base to less lucrative markets such as small office consumers, said Phil Rueppel, an analyst at BT Alex Brown. Dell will also make a push for overseas markets. In the end, unit sales may increase, but average selling prices, and the profit per machine, may come down.

"Mathematically, it is unsustainable," said Rueppel of Dell's current growth and price trends.

Dell, which will report its second-quarter earnings for its fiscal year later this afternoon, seems to be firing on all cylinders these days. The direct PC vendor is expected to report earnings of 45 to 48 cents per share. It also could exceed those figures.

In the second calendar quarter, Dell's unit shipments grew by 72 percent over the same quarter a year ago, more than seven times faster than the market and faster than Compaq Computer, IBM, or Hewlett-Packard, according to International Data Corporation. Although Compaq likely sold more computers to U.S. customers during the quarter, many of those came from inventory at Compaq distributors and dealers. Dell shipped around the same number of new computers as its Texas rival.

Interestingly enough, the company's growth trajectory comes at a time when the average price of a Dell PC is still higher than those from competitors. Dell's average selling price dropped from $2,500 in the first quarter to $2,350 in the second quarter, mostly because of declining component costs, according to Ashok Kumar, an analyst with Piper Jaffray.

Still, that compares favorably to an average selling price of $2,200 for HP and Gateway systems and $1,800 for Compaq, which was effected the most by inventory problems. Other analysts roughly confer on these figures.

Adding insult to injury, Dell's gross margins stands at a relatively high 22.3 percent, Kumar said, because of its build-to-order manufacturing capabilities.

A concerted, albeit expensive, marketing push could vault Dell past Compaq to become the chief supplier in U.S. PCs, said Dataquest's Miller. But is that really a goal anyone wants to aspire to?

"Once you get there, the question is what do you do next," Miller added. "It's real fleeting."

The economics of the PC industry could make this something of a Pyrrhic victory, Miller and others noted. Prices are expected to continue to decline in the PC industry because of component price declines. While component-driven price declines do not impact computer vendors' gross margins, lower-priced PCs mean that vendors have to sell more computers to maintain revenues and profits. Dell, which mostly sells to large Fortune 500 companies, can expect to see lots of competition in these accounts.

Dell also will begin to feel heat in the near future from the build-to-order initiatives from Compaq, IBM, and HP. All three companies have been working on revamped manufacturing and distribution initiatives that will allow the companies to mock Dell's ability to build computers only after customers order them. The systems cut costs by essentially cutting out costs associated with inventory. All three companies are expected to begin to show financial gains from these programs in six to nine months, according to various sources. At that point, some of Dell's current advantages should be shaved.

To get around the pricing issue, Dell will try to shift more of its product mix to notebooks and servers, with an increasing emphasis on high-level enterprise servers, said Kumar. Right now, 80 percent of Dell's unit sales come from desktops.

Still, competition will remain intense. "The pricing pressure is severe. There are no two ways about it," the analyst added. "The music has to stop somewhere."

"I've been a supporter of the Dell business model, but that doesn't mean they are going to be able to segregate their market from the rest of the industry," said Rueppel. "In the future, they are going to have to lower their average selling prices."