The Dead do start slow but they have some big advantages. Their units can get the undying curse trait, which increases their number by 1 for every enemy they kill. Their female units have 50% resistance vs. physical damage. Their terror ability allows them to lock down powerful creatures to be whittled down.
I think the key to playing the Dead is to focus more on troop production in the beginning. Get some cheap troops out fast so they can use their terror ability to help take down powerful monsters. You can easily take down monsters like Ogres, Harridans, and Slags by stunning them with the terror ability. Once you start making female units with the Undying Curse ability, pretty much no one can stand against you. Just send your armies out to find and capture as many death shards as you can and population growth shouldn't be a problem thanks to Morrigan's Call.
Unless you're playing a small map with low magic, monsters, and resources, the Dead will become really powerful when they build up some steam.
Also, if you make custom Dead factions, you can make them Kingdom, so you can cast Sovereign's Call on all your towns. Unfortunately, with a custom Empire Dead faction, you pretty much have to have Gravetouched, which only gives you one more trait if you also have a weakness.
Yes, I am playing them exactly as you suggest--I've probably played about 30 hours this week with the Dead as I've had some time off. You *can* have some success with them if everything plays out well, but I find, especially on harder levels, the Dead unit advantage is not that great because the AI can put out better units faster so by mid-game your skeletal army crumbles to the better equipped units of the AI. If you get really lucky and start with a town with several essences, a death shard, you can overwhelm early, but it is very much dependent on the map (too dependent, really). I generally play on Expert or higher, and the Dead are really difficult to get going--you need the perfect map.
A big problem is the difficulty/delay in getting Dead towns to level 2, even if you build every possible building that provides a growth bonus. Getting the bonuses of the level 2 "cities" is very important. Allowing for other "living" mobs to give population to the Dead would help early on when there are no enemy sovereigns around. Also, perhaps the population gained from mob kills should be distributed evenly among the Dead cities?
I'd also suggest making pioneers more difficult to build across the board--I do think they are far too easy to spam with non-Dead factions. Pioneer and city spam by the AI also makes life difficult for the Dead.
Finally, a big problem is the AI sucks at using the Dead faction. On all the games I've played the AI has not been successful with the Dead at all.