(FORTUNE Magazine) –

The witching hour came, fittingly enough, on Halloween: Dell chief executive Kevin Rollins issued an early warning about the company's third-quarter financial performance. He probably wished he could hide behind a mask. Earnings and sales would both be below expectations. The company would have to write off $450 million, the bulk of it because of an embarrassingly basic misstep for a firm that prides itself on operational efficiency: the installation of faulty capacitors in a large number of computers. Finally, the company hinted at layoffs--what it called a "workforce realignment"--a harbinger of retreat that the company had resorted to only once or twice before in its history.

It was not the kind of surprise Dell watchers had come to expect. For years Dell's startling announcements have been on the positive end, posting blowout revenue numbers, climbing market share, and rocketing profits. Beating Wall Street's expectations had become part of the company's persona, and investors were richly rewarded. The little direct seller of PCs that Michael Dell famously launched in his University of Texas dorm room leapfrogged name brands like IBM and Hewlett-Packard to become the largest computer seller in America, and Dell millionaires were minted not only among employees at the company's Austin-area headquarters but also among investors across the country, who have enjoyed explosive share gains of more than 28,000% since Dell went public 17 years ago.

Suddenly, though, it seems that Dell's best days might actually be behind it. The company has experienced stumbles before, most notably in 1989 and 1993, only to bounce back stronger. It certainly felt some pain when the tech market (and Nasdaq) crumbled during 2000. Yet over the past five years Dell had, if anything, extended its mastery over the domestic PC market, defying naysayers by moving strongly and profitably into business servers and continuing to post eye-opening growth gains. Other companies would kill for Dell's "disappointing" numbers--earnings growth in the second quarter came in at 28%; when final third-quarter results were announced on Nov. 10, the company pointed to 12% earnings growth (excluding one-time charges that sent net income down 28%). But this is Dell, and so Rollins's late-October surprise seemed to reflect a new era. Less than three months earlier he had toned down Wall Street's growth projections. The fact that the company couldn't meet its own modified, more modest targets raises an awkward question: Could this be the end of Dell as we know it?

Founder Michael Dell, still the company's chairman, evinces no apparent unease, despite the fact that his stock is down 28% since August: "There is no perfect linear path to success," he told me. "I think the stock market overreacted." CEO Rollins goes further: "No, the sky is not falling at Dell," he says. "We failed to meet our own expectations, which were high. But you'd think we were not growing or were losing money by what you read. We still have an outrageous track record. Our model still works very well." Changes, Rollins admits, are necessary. But, he says, "we are not talking about wholesale upheaval. We are tweaking, making refinements and enhancements, and resetting."

There's no question that Dell isn't the highflying growth company it once was. You can't expect a $50-billion-a-year sales juggernaut to grow like a full-throttle startup. Finding significant new streams of revenue is a huge challenge when a company reaches that size. Revenue growth, while still solidly positive, has declined the past six quarters in a row. It is undoubtedly true that Dell has misfired lately, which has company executives scrambling to adjust levers and pulleys. Says Sanford C. Bernstein analyst Toni Sacconaghi, who has been lukewarm on the company's prospects: "I do think Dell's expectation setting has clearly exacerbated a fundamental problem. Stock prices are driven by earnings results, but are also impacted by emotion and disappointment, some of which could have been avoided by setting more realistic targets." Or as Rollins puts it, "We are now in show-me mode for a couple of quarters."

But even if Rollins and his crew succeed in "tweaking and resetting," Dell's challenges go beyond just executional lapses. Rather, it is a question of math. Decelerating growth isn't an issue that can be "fixed." It's a condition that must be managed. The law of large numbers will ultimately trump any business model no matter how ingenious. "What Dell did was really brilliant," says Phil Asmundson, managing partner of Deloitte's U.S. Technology, Media, and Telecommunications practice. By creating a precision direct-sales structure, with each PC assembled specifically for each customer, Dell eliminated the need for inventory or middlemen and gave itself a built-in price advantage, which it in part keeps as profit and in part passes on to customers. Yet today that alone doesn't seem to be enough to fuel ever-rising growth. "Every company needs to challenge and reinvent itself," Asmundson observes. The question for Dell is, How?

Dell is not the first tech titan to have faced this kind of challenge. Two thousand miles northwest of Austin, just outside Seattle, is the headquarters of the poster child for the growth conundrum, Microsoft. For a time Mr. Softee, as the company is colloquially known on Wall Street (for its MSFT ticker symbol), was the quintessential "it" stock, the ruler of the new economy, the minter of Microsoft millionaires. Thanks to a business model that it dominated--even more than Dell owns its niche--Microsoft hauled in ever-growing profits, and despite continually racheted expectations by Wall Street, inspired only more grand visions of the future for investors.

And then the party ended. It wasn't just the federal government's antitrust suit or the rise of Internet computing. Microsoft's control of desktops worldwide became an accepted fact, taken for granted, and the question "What have you done for me lately?" was posed anew by investors. Since the company already had the most efficient near-monopolistic business imaginable--huge margins, with huge market share--any new business opportunities naturally couldn't compare; even if successful, they would dilute the company's enviable profitability history or be so small as to have no measurable impact on the company's overall bottom line. So Microsoft's stock price--driven down to begin with by the end of the tech bubble--stalled. Bill Gates and his compatriots, from CEO Steve Ballmer on down, have tried gamely to find new corners of opportunity, from the Xbox console to the MSN websites and new Live software initiative. But they all pale in comparison to Microsoft's core business. The company has been redefined, less as a growth stock than as a blue-chip cash cow. Not a bad place to be, perhaps, but certainly a different one, and one that requires a different business strategy and a different mindset for executives and investors.

The situation at Dell is not entirely different. The company was also propelled forward by a business model that competitors couldn't match and is apparently reaching the speed limit its advantages can offer (at least in its core U.S. market). It too has some redefinitions being thrust upon it by investors. Yet Dell also has some advantages that give it options Microsoft does not have. For one, Dell's core business--the manufacture and sale of computers--is a relatively low-margin commodity business, which means incremental business lines that Dell might add or move into could potentially enhance profitability. The market for servers, for instance, which is still relatively new to Dell, has higher margins than PCs; similarly, the printer market (which HP has ridden to great results) offers a profit-rich niche that Dell has yet to fully exploit. And even in its core PC business--the window through which it accesses customers for servers and printers, as well as for system integration and business services, another higher-margin area--Dell still has significant market share it can take from competitors. Overseas, for instance, in the Asia-Pacific region, Dell ranks third in market share, with only 7.8% of the PC business, according to IDC.

The concern on Wall Street is that the hits Dell has taken lately have come in those new areas. Consumer electronics, for instance, which the company entered with much fanfare two years ago (and FORTUNE touted on its Nov. 10, 2003, cover, "Guess Who Wants to Entertain You?"), has proved more difficult to graft onto the company's existing consumer sales model than hoped. In the second quarter Dell was No. 10 in the U.S. in LCD TV shipments, with a 2.4% market share, according to estimates from David Naranjo of research firm DisplaySearch, and No. 7 for plasma-screen shipments, with a 3.3% share. Ford Cavallari, senior vice president in charge of the consumer practice at consulting firm Adventis, thinks Dell's strategy here could be a blind path, unless it can get into what he calls a "multibusiness model." "Selling standalone consumer products is tough," he says. "The successes here are iPod, game consoles, and DVRs that are attached to other recurring revenue streams."

Even the core U.S. consumer business is struggling. While Dellites stress that the segment accounts for only 15% of its business, it was supposed to be a key driver of growth. Yet the business is expected to rise only 4% to 5% this year, to about $8 billion, estimates Sanford C. Bernstein, down from 13% last year and 19% the year before. No wonder the U.S. consumer-sales unit is being folded into its business unit counterpart.

CEO Rollins acknowledges that the company has placed too much emphasis on selling low-end PCs; margins here are the thinnest, contributing nearly negligible amounts to the bottom line. He says that the company won't abandon the $500 PC segment, but that "the key is balance. We need to pay as much attention to the high end as the low end." (While it may seem ironic that upmarket is where the opportunity is for a company known for rock-bottom pricing, the truth is that Dell can no longer lay claim to the title of low-cost PC provider, with the likes of Wal-Mart now hawking cheap Asian imports.)

As for the company's global opportunity, in Britain, where Dell is the No. 1 PC seller, sales have been sluggish, for reasons Rollins likens to Dell's U.S. market trouble: "Tepid government buying in the wake of the Iraq war and pricing that was a bit too low," he says. There have been suggestions that sales efforts in India and China are falling flat, but he strongly disputes the notion: "Those reports are 180 degrees wrong. We have 46% growth in units and a 29% growth in revenue in China. Profit is growing strongly and so is our market share." Still Lenovo, the Chinese PC group that includes IBM's former business and currently commands 20.4% market share in the region, is reported to be making strong gains. HP, too, once given up for dead in the PC wars, is showing renewed signs of strength globally, analysts say. (How about this dirty little secret: While Dell's stock is down 22% over the past year, HP's is up more than 40%.)

Rollins's operational tasks are clear: He must find the right product and pricing mix in the U.S., ensure that overseas growth is on track, and keep his eye on how convergence in device businesses, like set-top boxes and game consoles, will affect the PC arena. His toughest job, though, is to make the world accept and understand that the aircraft carrier Dell can't cruise as fast as the destroyer it once was. Fact: Between 1995 and 1999, Dell's earnings doubled on average each quarter; in the most recent 20 quarters, earnings on average climbed 43%. That's still amazing, but also dramatically slower. "Growth rates will be lower than in the past," Rollins acknowledges. But he also feels that investors are missing a great opportunity: "The last time our stock was $30, our earnings were half what they are now." Of course, investors were willing to pay more back then because they believed--incorrectly, it turns out--that earnings would continue to grow at an accelerating pace. Now they are saying they don't believe profits will continue to soar, and they're probably right.

Last year Dell and Rollins predicted that their company would hit $80 billion in sales within three or four years. That's a longshot. Dell's sales should grow 13% this year; the company would have to maintain that rate to hit $80 billion in four years. Michael Dell is, as always, relentlessly upbeat: "Our model continues to be the best in the business," he tells me. "We wouldn't trade ours for anyone else's! It's also important to have a little perspective. In the past ten years our sales are up about 15 times, earnings and the stock price are up about 20 times. Not too shabby!" Can't argue with that. But as they say, past performance is no guarantee of future results.

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