With shrinking margins, is selling PCs just a volume game?

With shrinking margins, is selling PCs just a volume game?

When even PC vendors with efficient supply chains fail to sustain profitability you know something is amiss. Late last year Dell announced that, in spite of increased revenue, its profits are declining. General manager of Dell New Zealand, Deborah Harrigan, says while she would like to offer more detail, she cannot comment on margins or profitability.

“I would imagine Dell is the most efficient way of procuring, manufacturing and delivering a PC anywhere in the world, and yet they’re struggling,” says Paul Plester, general manager of sales and marketing of distributor Express Data.

Elsewhere in the industry, system builders and other channel members say their margins are being squeezed by a number of factors. Currency exchange fluctuations, inherent product risks, the rate of obsolescence and the commoditisation of the PC are all determining factors in calculating appropriate margins.

A staff member at one large distributor who asked not to be identified says the setting of margins is just one aspect of the business that’s under the influence of market dynamics. “Everybody has an opportunity cost regarding what products they buy and sell and how much they try to sell them for. They can be greedy, but not too greedy. It depends on the product, the level of complexity and the number of distributors representing that particular agency.”

Unsurprisingly, system builders and vendors are cagey about margin calculations, and many won’t even be drawn on a ballpark number. “In effect, we would be divulging our competitive advantage in a public arena and it could then be used against us,” says our anonymous distributor.

Dispassionate observers might suggest the IT industry hasn’t proven itself to be especially skilled in retaining margins. Plester says this is because the entire supply chain is being led by vendors. “Right from the source of all our products, there’s a perception that there is a lot of room to move on pricing. Other industries wouldn’t sell $100,000 worth of products for 1 or 2 percent margins. How can end user sales be sustained with 1 or 2 percent margins?”

Vendors justify slimmer margins by playing up other opportunities for the channel to add value; what’s described in the industry as blended margins. “The blended margin doesn’t come from the product sale, it comes from the professional services and the services around that product sale,” says Plester. “That’s where systems integrators and value added resellers actually make their money.”

He says that in the current economic climate, resellers and system builders need to make a three-pronged attack on profitability, as it’s no longer logical to focus exclusively on the margin in one area of a sale. “Businesses need to make money on the product sales upfront and be very careful to add additional services to those product sales. Then they need to make money on professional services at the back. Companies that disregard any of those three are going to be pressured.”

The commoditisation of PCs has largely removed their competitive advantage – most of the advertised productivity gains have already been exploited, with a subsequent impact on sales. “A lot of businesses around New Zealand bought PCs because it was going to mean everybody would be able to do more,” says Plester. “That was maybe true initially, but over the years those efficiencies and performance improvements have died away.”

While Jan Paterson, general manager of specialised system builder Insite Technology, agrees that commoditisation has caused margin tightening, she also notes some positive downward movements in component pricing. “Memory dropped in price considerably over the second half of last year, and LCD panels are still moving down. The pricing I’ve observed in the market is all over the place because some suppliers may have secured shipment at a good rate and it’s taken a while to land.

“You’re starting to see some good lower pricing out there, but it’s opportunistic.”

Paterson won’t reveal Insite’s margins, except to say she tries to keep them competitive; these days that means slim. “There are a lot of factors out there at the moment that’ll be affecting pricing. Our intention is to try and hold our margin as much as possible.”

Another company says it aims for margins of around 7 percent, though the reality leaves a lot to be desired. “Probably, we’d be lucky to be making around three percent,” says Victor Ho, managing director of Morning Star, a distributor that also builds systems to resellers’ customer requirements.

But Ho says he is prepared to turn his back on a sale if it’s apparent there’s no money to be made. “You have to consider the fact that some of these components have a three-year warranty, and I’ve got to cover that cost. We weigh up what we think is appropriate and then if people are just undercutting for the sake of undercutting, I’ll walk away from it.”

While component pricing is dictated by original equipment manufacturers, Morning Star retains enough flexibility on margin calculations to win repeat business. “We price it up based on what we think our margins should be, which are quite small, quote it to the customer and, more often than not, customers come back.”

The market has changed considerably over the past five years, says Ho, with the loss of volume players such as PC Direct and the PC Company having probably benefited specialist builders. However, lower costs for new, mass market products are beginning to eat into the profitability of the desktop PC, he says.

“Laptops are getting cheaper. You can pick one up for $699 or $799 and most people just want the basics.”

Richard Morgan, managing director of Christchurch’s Cyclone Computers, agrees with Ho that lower-priced laptops are affecting desktop profitability. “When people make a buying decision between notebooks or PCs, notebooks are increasingly coming out on top. It’s something we’re seeing especially in the school market, where we’re selling a lot more netbooks to students.”

Cyclone’s core business is what Morgan describes as “good, run-of-the-mill PCs with standard configurations”. He says the market has been aggressive for many years, with strong competition between multinational vendors and local assemblers putting pressure on margins. “Dell would be our largest competitor in tertiary education. They’re very, very aggressive with their margins,” says Morgan. “If all the customer wants is a box drop, then Dell is very hard to compete with because it drives its margin very low.”

Morgan won’t speculate on why Dell’s profitability in particular has fallen, but says that any company making 3 or 4 percent on hardware needs to supplement that with the sale of services. “I can’t see that margin being sustainable, unless it was on significantly large volumes.”

Morgan refuses to divulge Cyclone’s own margins, but maintains they have been reasonably stable over the past five years. “There’s been a slight drop in the last year, but not significant.” He concedes the company has been put under some pressure by component pricing and exchange rate fluctuations, but says these can be managed like anything else.

“If component prices have gone up, we’ve just had to manage our stock. Certainly there has been some hits taken on business won before the US dollar price dropped, but supplied after.”

One contrast between IT and other industries is a low barrier to entry, says Morgan. “Anyone can open an account with Dove and Ingram Micro, buy the components and put a $700-$900 PC on TradeMe or open a web front and pretend that they can sell it, and they can. Where they fall over is the lack of delivery of support, or realising that they have to look after the product for the next one to three years.”

Higher landed costs have pushed up Insite’s component prices over the past three months, Paterson says. “Quite regularly over the last two months, we’ve been going to our suppliers and trying to squeeze their pricing because we don’t like the way landed costs are looking. Our supplier margins are really being affected. We have items that may be landing for 25 percent more than they were before Christmas.”

But Paterson says Insite’s resellers are given the opportunity to value-add and bundle its hardware with their own offerings. “I would hope our resellers aren’t being affected by what we’re doing in terms of pricing changes, because they still have the flexibility to set their own prices,” she says.

In the current economic climate, even for volume PC players, the channel is likely to become increasingly important. In 2007 Reseller News reported on Dell’s announcement of a ‘global’ strategy to expand its reach into retail and value added resellers.

At the time, there was no news about the company’s New Zealand channel plans. When approached about this article, a spokesperson for Dell would only say it still doesn’t have a New Zealand channel programme.

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