WHERE DELL IS GOING NEXT
After eating everyone's lunch in the U.S. PC biz, they're now aiming at printers, storage--and the world. Is anybody scared yet?
By ADAM LASHINSKY

(FORTUNE Magazine) – A LITTLE OVER A YEAR AFTER Dell dropped the "Computer" from its name, it's becoming apparent why. The company that Michael Dell founded 20 years ago had always focused on one thing: selling PCs directly to businesses, consumers, and government agencies in the U.S., and doing it more cheaply than anyone else. The numbers tell the story: market value of $90 billion, expected revenues this year of $49 billion, 20% revenue growth in its most recent quarter, and operating margins consistently above 8%, compared with slim to no operating profits on PCs for HP, Apple, and IBM. The company has been so successful in the PC business, in fact, that it has actually been able to raise prices (see box).

But with PC growth slowing, the company has been forced to look elsewhere to keep up profitability. So Dell is upping the ante. It's firing aggressive salvos against the competition on multiple new fronts, including the $43-billion-a-year worldwide printer business and the $14-billion-a-year storage business--taking direct aim at printer king Hewlett-Packard, not to mention IBM and Sun. Quite simply, it's trying to change the game for printers and storage the way it did for PCs. Meanwhile, Dell is increasingly pushing beyond the U.S. in an attempt to boost its less-than-hefty market share overseas. Can Dell pull it off? It's looking good. These initiatives, which Dell has been working on for several years now, are picking up real momentum. Competitors aren't trembling yet. But if history is any guide, they ought to be.

Michael Dell, the company's chairman, says that by the time Dell decides to branch into a new market, the decision is obvious. "We don't go searching for technology as if it were some new compound on the element chart that hasn't been discovered," he says. "Instead, we listen to our customers. That information tells us where we should go innovate on their behalf. So you don't get a lot of these exciting products that don't actually sell very much."

What sells, the company knows perfectly well from activity on its own website, is printers. Dell has been offering a variety of printers along with its PCs since the mid-1990s. But back then it was just reselling other companies' brands--including HP's--and extracting a tiny profit for doing so. Then, in 2002, HP bought Compaq and immediately became a bigger threat to Dell in PCs than before. That galvanized Dell. The company knew that most of HP's profits ($2.5 billion last year on $72 billion in revenues) come from printers--which HP uses to subsidize its PC business. So Dell went from being an HP partner in printers to a rival. That decision serves two purposes. "Any strategist is going to try to develop a strategy that is going to help them and hurt competitors," says Kevin Rollins, who became Dell's chief executive in July. "Our whole vision here was to do both: improve the revenues and profits of our own business, and at the same time put our competitors at a disadvantage."

Since the company began selling Dell-branded printers in March 2003, it has succeeded in growing printer revenues to a projected $1 billion in the current fiscal year. Dell says it's on track to sell about five million printers this year. And it has snatched 19% market share in the first segment it targeted: all-in-one inkjet printers, a low-end product bought primarily by consumers and small businesses. (Dell offers a model that costs around $70, about $20 cheaper than the least expensive HP.) Some Dell printers even include genuine innovations. One example: a laser printer that shuts off color when it isn't needed, thus saving money.

That's pretty good for a company whose spending on research last year was only about 1% of sales, compared with 5% for HP, 6% for IBM, and 21% for Microsoft. But Dell hardly did this alone. For the first time, Dell is turning to partners that are powers in their own right in the products Dell is targeting. That gives the company a fast footprint in a new business without having to make an acquisition, build significant new infrastructure, or invest heavily in R&D.

The first partner in printers was Lexmark International, which has been putting a Dell label on its printers since last year. More recently, Dell announced that it is collaborating with Fuji Xerox, Samsung, and Kodak on new printers. "We've got access to more intellectual property than any single competitor out there by leveraging a network of partners who have technology, but didn't necessarily have customer relationships or an understanding of what features needed to be in the products," says Michael Dell.

Supplying Dell could be like playing with fire, albeit a slow-burning one. Eventually Dell may get big enough in printers that it doesn't need to work with a company that has a competing brand. Gary Morin, Lexmark's chief financial officer, says he isn't worried: "So long as we advance the technology, we'll stay multiple years ahead of anybody else's capability to get ahold of old intellectual property [to compete with us]." Besides, he argues, developing new technology "just isn't Dell's model."

As for HP, its printer chief, Vyomesh Joshi, contends that Dell is having "absolutely no impact." He points out that HP has had eight quarters of profitable growth since Dell entered the market. Still, HP's U.S. printer market share (in units, not dollars) has fallen over the past year as Dell's has risen (see chart). Says Robert Semple, an analyst with Credit Suisse First Boston: "I do think they will be successful in disrupting HP. All Dell has to show is slow progress. As soon as HP starts having any profitability problem with printers, HP's model is broken."

DELL HAD BEEN a bit player in storage computers--the complex, often multi-unit systems that businesses use to store corporate data. That's because storage hardware typically runs on various proprietary systems, the antithesis of Dell's approach. But storage works with servers, an increasingly commoditized product that Dell sells. So the company needed to find a way in. The solution was to work with $8 billion (projected 2004 revenues) storage leader EMC, which itself was trying to focus more on software and less on hardware. In 2001, the two companies signed a five-year partnership, recently extended to seven, for Dell to sell co-branded mid-tier EMC/Dell storage boxes, which can cost from $5,000 to several hundred thousand dollars each.

So far, the relationship has been good for both companies. EMC, whose customers historically were high-end corporations, recorded 40% second-quarter growth in its mid-tier Clariion storage line, roughly one-third of which is sold by Dell. For Dell, which sells lots of equipment to big companies but relatively little to their central data centers, revenue in storage area networks--a collection of storage devices--grew 36% in the same quarter. "A lot of [those sales] I probably wouldn't have done if I didn't have the distribution capabilities and market knowledge that Dell has," says Joe Tucci, EMC's chief executive, who meets twice per quarter with Rollins to make sure the partnership stays on track.

A bigger presence in storage also helps Dell build up its services business, another relatively new market. Unlike IBM, whose Global Services unit is the company's primary growth engine, and HP, which has focused on large-project outsourcing contracts, Dell's services are unabashedly about selling more Dell hardware. "We sell services around the boxes that we sell," says Joe Marengi, who oversees sales and marketing for Dell's U.S.-based customers. "Everything we do is lined up around the hardware. We don't make any bones about it." Getting into the data center with EMC helps spur those sales. It also gives Dell an opportunity to sell its low-cost approach to EMC's customers. "Deploying a storage area network used to take eight days and many, many thousands of dollars," says Marengi. "Over the last couple of years, we've been able to cut that down to a relatively inexpensive deployment and cut the time down by a factor of four."

The result: As in printers, Dell could one day prove a headache for its partner in the storage business. In the third quarter, Dell started manufacturing a co-branded low-end storage box, the AX-100, with EMC technology. List price: $5,999. But EMC, like Lexmark, says it isn't scared. "We spend about 11% [of sales] on R&D," says Tucci. "So we'll keep pushing into new things."

WHEN IT COMES to expanding internationally, Dell isn't seeking any partners. It's doing fine on its own. The company's non-U.S. sales accounted for 37% of the second quarter's $11.7 billion in revenues--up three percentage points in a year--and Dell's share of the PC market abroad is 10.5%, behind only HP (see chart). The opportunity is rich, with PC and server penetration rates lower in Asia than in the U.S. Dell's server shipments in China, for example, grew 41% year over year in the second quarter. In the Americas, revenues overall are growing around 16% a year.

For all its success, Dell doesn't always get things right when it comes to entering new markets. The company caused a commotion this summer when it was reported that it had pulled out of the low-end PC market in China. Not true, says CEO Rollins--but the company did scale back its business there, essentially stopping active marketing of low-end PCs, because "everyone jumped into it and made no money," says Rollins. And in 2002, Dell garnered headlines for introducing switching products that were supposed to take on Cisco. Those products still exist, but Dell doesn't talk much about them anymore. Switches, it turns out, are a market where proprietary technology counts for a lot. Thus Cisco's comfortable lead.

Dell prefers to enter big, established markets that are tangential to its PC business. (Its consumer electronics products like LCD and plasma televisions, handheld PDAs, and MP3 players are mere specks in Dell's $49 billion revenue pool--and they have required little investment because Dell lets others design its products.) It simply won't get into some new products, even to satisfy an important partner, if it doesn't think there's enough money there. For example, Microsoft has been after Dell to manufacture a tablet PC, Microsoft's walk-around notebook computer concept that it hopes will revolutionize electronic notetaking. HP, Gateway, and Toshiba all have answered the call. But the market's size--currently about 100,000 units per quarter--simply doesn't impress Dell. "We haven't said no to the tablet; we just haven't entered the market yet," says Marengi, whose job would be to sell the computers. "We have other things we'd like to offer into the market. We'll make the decision when it makes sense for us." Microsoft declined to comment.

So how are these initiatives affecting Dell's bottom line? PCs still account for a whopping 73% of Dell's revenues and the lion's share of profits. Printer sales will account for about 2% of revenues this year--impressive in such a short time--but profits, if there are any, are minuscule. (Dell executives, reading from the same script, often talk about how "early" the market is.) The story with storage is much the same. Analyst Semple thinks it will be difficult for Dell to make "tons of money" in printers, largely because the technology in printers doesn't lend itself to standardization as well as in PCs.

But here's the thing about Dell. Some of its probes into new markets work brilliantly; others fade into the background. Few, however, cost very much, and the company is ready to dial up and dial down its approach accordingly, always looking for the next growth driver. "We never lose sight of the discipline of what we're about as we get into new product categories," says Rollins. Even if printers and storage never prove to be as profitable for Dell as PCs, Dell can still make life quite difficult for rival equipment makers. And that's why some respectfully suggest that HP and the rest should be just a teeny bit afraid.