Dell Guilty of Fraud: How Not to Make a Name for Yourself

Sometimes it's tough to top a factual roundup of what is happening to a company, and in this case, Dell's latest circumstances say a lot. Being found guilty of fraud? Just how badly does a major company have to behave when a court can rule its business practices fraudulent? It came down to deceiving people - promising technical support that it didn't delivery, and apparently didn't intend to deliver, if my understanding of the law behind fraud is accurate at all:

• The company effectively tried causing customers so much pain that they wouldn't or couldn't use the support services they purchased.


• It often didn't provide the on-site repairs it was contractually obligated to.


• People who purchased "next day" support sometimes had to wait ... an entire year to get a problem resolved.


• The company and its financial services affiliate would advertise no-interest financing and then deny it to almost everyone. It would sometimes charge people interest rates as high as 30 percent even when those people actually did qualify for the special financing.

Here's Dell's response, according to the IDG News story:

The court laid out plans for investigating how many people have been affected as a way to determine restitution. Dell hopes that the court will find that only a few people had bad experiences. "We're confident that when the proceedings are completed, the court will determine that only a relatively small number of customers have been affected," Dell said in a statement. "We believe that our customer service levels are at or above industry standards."

I know that computer companies generally have pretty bad technical support - at least, that's what I've found with a number of them. But this actually makes most of them look good. The problem is that Dell apparently sees customers as cattle waiting for slaughter. A few years ago, at the height of the company's reputation among investors and a fawning press, I predicted that one day magazines would run the major story, "What Ever Happened to Dell?" However, I was thinking in terms of how the company has tried to drain dry the money from its own supply chain. This is even more extreme.

Dell Not Well After Knell

A death knell usually means the end of something. Sometimes it happens after a long illness. In the case of Dell, the bell tolls for for conditional listing, for having to restate four years of accounting records, for being unable to predictably deliver products on time. It's the end of Dell as everything thought they knew it.

I'm generally suspicious when praise of anyone or anything gets too loud and continues for too long. It was perhaps three or four years ago that there were some obvious signs that Dell was traveling down a dark path. They were insanely profitable compared to other PC vendors, and while Wall Street rejoiced, investors should have been scratching their heads. As the saying goes, when a deal seems too good to be true, it probably is. Given the thin margins and massive supplies of products, pricing dropping faster than a stone through a clear sky, how could they have been managing profits that were triple those of companies like HP?

One part of the answer came from electronic component analysts who said that they were squeezing suppliers tight enough to suck out virtually every penny of savings the vendors could get from economies of scale. "We're making you efficient," said Dell, according to these analysts. "Get your profits from your other clients." Those other companies - sometimes even competitors of Dell - naturally took offense that they should be underwriting that company's earnings. So a growing number of suppliers began to walk away.

No problem for Dell: suppliers were a dime a dozen. But management forgot that there's more cost in a supply chain than the incremental expense of parts that you buy. There's reliability and service. Bottom feeders eventually get down into the muck, and if things go badly, their low-priced friends don't have enough capital to pull things back up into cleaner waters. Then there was the other strategy: reduce customer service, outsource technical help, anger customers, leave them on their own to solve their problems. All of these actions happened to lower Dell's costs - and another way of putting that is the company wanted to take even more money out of customers' pockets, only without being obvious about it.

And now we see that Dell had yet another strategy: stretch the truth. (It's something most of us grew up calling a lie.) Here's how the Reuter's put it:

Dell Inc. said on Thursday it would restate four years of financial results, reducing net income for the period by as much as $150 million, after a lengthy audit found that top executives sought accounting adjustments to reach quarterly performance goals.

It wasn't enough to keep trimming corners and tick off customers. To keep the stock price up, managers were prepared to play with the numbers to get the results they wanted.

It was perhaps in 2003 or 2004 that I began telling some people I knew that I expected to see front page stories, titled, "Whatever Happened to Dell?", in BusinessWeek within five years. Maybe I was a year or two optimistic. As the Reuters story further stated:

Dell, based in Round Rock, Texas, said it did not expect the restatements to have a "material" impact on its current balance sheet or on cash flows during the restatement period, which covered fiscal 2003, 2004, 2005, 2006 and the first fiscal quarter of 2007.

Not material? Of course management is going to say it's not material. Once you use the M-word, you're really SEC fodder, because the CEO and CFO are now personally responsible for having signed off on misleading financial reports. Right now the analysts are saying that the adjustments look "minor." I'm with Larry Dignan on SeekingAlpha that these reactions are annoying and, to my mind, at least, misleading:

While the restatements were small, Citigroup analyst Richard Gardner notes that Dell would have missed estimates during its first fiscal quarter of 2003, second quarter of 2003 and fourth quarter of 2005 without the accounting hijinx. That’s hardly meaningless.

What company misses multiple quarters and then sees analysts say, "Oh, that's OK, it's the thought that counts?" And that doesn't address the really big problems in supply chain and in customer service and, ultimately, customer retention. What is Dell doing? Saying everything is fine and looking for a new advertising agency. Obviously the company needs a new story. Let me suggest a lead:

After evaluating how we've treated business partners, customers, and investors, we've decided that we have to completely change the way we do business and act with respect toward the people and organizations that hold our future in their hands.

It may not be catchy, but it might actually work.

Strange Sitings from the PC Wars

The PC market is an obviously competitive one, but some stories (via Slashdot.org) show a number of odd things happening right now. For example, Microsoft is apparently in a sales jam, because it has launched a "fact rich" program to convince customers that they should adopt Vista now, according to The Investigator blog at APCMag.com:

"Some customers may be waiting to adopt Windows Vista because they've heard rumors about device or application compatibility issues, or because they think they should wait for a service pack release," the company said in a newsletter.

"To help partners and customers get the real story, Microsoft has created a comprehensive set of fact-rich materials illustrating how Windows Vista is ready today and tomorrow."

However, a link in the newsletter leads customers to a place only available to computer makers that will sign a non-disclosure agreement - which pretty much means that they can't tell you what they just read, and so, theoretically, can't pass on any of the information they just learned. But then, the story proceeds:

What we do know, however, is that Vista service pack 1 is, in the company's own words, designed to address "deployment blockers and high impact issues", suggesting that until the release of SP1, you will have to contend with ... deployment blockers and high impact issues. Hardly the basis for proceeding with confidence.

Maybe the facts are a little too rich for customers. But this puts Microsoft into an awkward position. They clearly released the system before it was ready to use - probably because of pressure of hardware manufacturers and, possibly, demands from those corporate clients that had already paid for the product through site licensing of Windows.

Money has to be a big issue. Yes, Microsoft got a big financial boost earlier this year and was claiming market success with Vista. But what many journalists covering the story missed was that the company does a lot of this site licensing. By accounting standards, although they collect the money, they don't get to treat it as income until they ship a product. Lack the income, and your stock looks bad. But now it's gone through that initial wave and needs the next chunk of money, which generally means the smaller purchases and consumer sales.

But people aren't adopting the way management wants and needs because Vista has received such bad press about the "deployment blockers and high impact issues." In other words, if your computer isn't pretty new, it won't work, and even if you do have a new machine, the system can run incredibly slow, as I've heard from people I know who are using it.

So what might happen is maybe another quarter of "good" results but then a pot hole when the continued sales don't continue. It sounds like Microsoft was hoping that people would buy anyway because, well, they always have. But I think users are tired of paying for complete and total crap. That's why Dell has started selling XP on systems again and why Linux continues to expand, particularly with Ubuntu offering what is supposed to be a more user-friendly version.

This all makes the second story sound even odder: Dell refuses to sell a system with Ubuntu to a business. So why won't it? Is there some licensing agreement with Microsoft or someone else that makes it impossible for them to do so? Or do they want to upsell into a more expensive model with an operating system that adds a bit of additional margin dollars?

What is going on with these companies? They seem to have lost sight of how important customers are. To play such games - because that's what they are, playing with people for your own ends - is essentially is the essence of the con job. You may not get caught, but when you do, it's painful. Better to forgo some profit today and keep your customers than to pump up your numbers for one quarter and find that no one likes doing business with you.

Dell to Sell in Wal-Mart - Future Profit Hell?

Dell is going to start selling two sub-$700 model multimedia computers through Wal-Mart. According to the New York Times story, and other analysis I've seen, this is the first step to Dell reforming its sales strategy so that it's not entirely dependent on direct sales.

I think it's also the beginning of the end for the theory that Dell can do no wrong. The PC business has extremely tight margins. Dell has been able to keep it's profits about three times that of its competitors. According to electronics market analysts I've spoken with, it has done so by beating up on its suppliers. From what I've heard - and I've tried talking to Dell about this in the past, but they wanted no part of the story I was writing at the time - the company pushes prices down so far that the vendors essentially have no profit, and then says that the manufacturing volume will give the vendors the economies of scale to make bigger profits from their other customers. In other words, the manufacturers are supposed to have other customers essentially subsidize Dell's business.

Some have pushed back. When Dell was coming out with its first PDA, for example, there were three firms bidding. Then Dell said what it wanted to pay and allegedly two of the Asian manufacturers walked away from the business because it didn't make any sense to take it. In an industry used to margins of just a few percent, that would have had to be a low number, indeed. Also, some of Dell's suppliers have been hearing from their other clients who have said, "Don't expect us to fund your work with Dell."

There is probably little to no room to move on the price of components. So, from where is the margin for Wal-Mart going to come? It will have to be Dell's margins. Now consider the volume of business the retailer does. This is going to change the overall margin that Dell sees, and that's even before the additional sales support demands that will drive Dell's already over-burdened and under-performing technical support function to needing life support itself.

Eventually companies come across the realization that growth isn't infinite and that high industry margins may not be sustainable. Hopefully for Dell its investors will be understanding, but that's even less likely.

Michael Dell Says Changes Are Necessary

According to a Financial Times article on April 28, 2007 (sorry, no free link), a leaked memo from Dell has the company's founder and current CEO stating that the company is “a defining moment in its history and in [its] relationships with customers.” Dell replaced his former hand-picked replacement, Kevin Rollins, in January because of disappointing results. The memo suggests some pretty significant changes in direction:

He said their plans were to simplify IT for business and the consumer and to innovate beyond its traditional hardware business. They would also work to fix
their core direct-selling business. “The direct model has been a revolution, but
is not a religion,” he said n the e-mail. “We will continue to improve our
business model, and go beyond it, to give our customers what they need.”

The company apparently wants to "radically simplify IT' for corporate customers and go beyond its direct sales model for consumers, which has done well but that is a limiting factor in growth.

I'd like to suggest that these changes are not what the company needs. Consumers aren't moving to HP because of store sales. Dell has developed a recipe for atrocious customer service. (Disclaimer, I once got so frustrated in trying to get a PC from the company on a timely basis that I cancelled the order.) Trying to chase expanding sales before management really fixes this problem is setting up the conditions for business calamity, because customer service that functions poorly now is only going to get worse with greater demands. And the idea that the company will change IT for companies is a level of arrogance that smart corporations won't tolerate - because they don't have the time, money, or inclination.

Then the Dell memo discussed how the company would "take our supply chain and manufacturing to the next level of efficiency." I've done some pieces on Dell's supply chain in the past and have heard from analysts who closely follow electronic manufacturing that Dell is already pushing so hard on its vendors that some are walking away from doing business with the company.

The amount of efficiency increases in the past could not explain the company's profit level growth compared to the rest of the industry. What seemed far more likely, according to the experts I've interviewed, is that it was beating up suppliers and pulling out every last penny of increased profit it can and telling suppliers to use the increased economies of scale that Dell can offer to make more money off their other clients. But those clients are reportedly starting to balk, because essentially they pay for Dell's ability to make more money.

The short prediction: within the next three to five years, major business magazines will be running "What Ever Happened to Dell?" stories, because you can only push your clients and vendors for so long, and then, as the poet W.B. Yeats noted, things fall appart.