Case Study: Matching Dell

Index of contents

Index of appendices

Index of tables

1. Introduction

2. The Industry

3. Dell's business model

4. The Competitors

5. Recommendations

List of literature

Appendix

Index of appendices

Appendix 1: Dell's Sales by Customer Category

Appendix 2: The competitors' relative growth rate of the U.S. market share from 1995 - 1998

Appendix 3: U.S. PC Industry - Sales by Customer Segment (market share by $ value) in 1996

Appendix 4: Dell's CAGR compared to its competitors from 1994 to 1998 in value

Appendix 5: Dell's net income performance

Appendix 6: Calculation of Dell's competitive advantage in dollar value

Index of tables

Table 1: Dell's margins in direct and retail channels in 1994

Table 2: Average prices of comparable PCs for the consumer market from 1996 -

Table 3: Dell's competitive advantage in dollar

Table 4: Direct to customer vs. indirect channels

1. Introduction

In 1984, after generating $80.000 revenue per month from upgrading and selling computers out of his dorm room, 18-year-old Michael Dell dropped out of College and founded Dell Computer Corporation. The start-up company was faced to established industry giants like International Business Machines, Compaq and Hewlett Packard. To be competitive, Dell implemented an innovative business model which made the company grow and achieve the status of the one No. 1 PC provider in the U.S. (www.dell.com). Between 1994 and 1998, Dell Corporations revenue increased from $3.5 billion to $18.2 billion, its profit from $149 million to $1.5 billion and its stock price by 5.600%. This meant a twice as fast growth as Dell's major competitors and a triplications of its market share (Rivkin/Porter 1999, exhibit 11).

This paper deals with the questions how Dell Corporation was able to enter the PC market, managed to get that successful and which actions should be undertaken to improve its position in the future.

After this brief introduction, the PC industry will be analyzed. The third part deals with Dell's business model and the resulting competitive advantage. Followed by that the reactions of Dell's competitors due to Dell's business models will be discussed and finally some recommendations to ensure and improve Dell's position in the PC market will be given.

2. The industry

IBM was the first to launch its PC in 1981 and soon held 42% of the market. The growth of IBM was short lived when the company failed to take any proprietary competitive advantage and ceded out the rights of microprocessors and operating systems to Intel and Microsoft. Due to that low priced "IBM clones” produced by Compaq, HP and Dell entered the market. Nearly all of the PCs at that time used Microsoft operating systems in combination of Intel microprocessors which was known as the "Wintel” standard. Most of the companies relied on resellers and retail stores to reach customers and built their PCs on forecasts which resulted in high inventory costs.

To get a closer look on the PC industry the Five Forces of Porter will be applied. According to Michael E. Porter, the profit potential of an industry depends on five competitive forces: Threats of new entrants, threat of substitute products, bargaining power of suppliers & buyers and the rivalry among existing firms (Porter 1980, p. 4).

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New entrants to an industry typically bring new capacity and the desire to gain market share from the existing companies. The threat of entry depends on the presence of entry barriers (Porter 1980, p.7).

A new entrant in the PC industry has low to average costs of investment. On the one hand manufacturing facilities do not require large financial resources but on the other hand the technologies (except of the operating system and microprocessor) need investments in research and development to stay up to date.

The brand loyalty in the PC market can be seen as low, because the "Wintel” standard limits the opportunity of differentiation. The homogeneity of the product also lowers the switching costs. If e.g. a PC user switches from IBM to HP he/she will not have many problems handling the new PC.

Realizing cost advantages in the PC industry is very difficult since inputs are available at fixed prices. Cost advantages could be realized by low cost entrants who enter the market without using advertisements addressed to the end consumer.

All in all the PC industry was not able to build up entry barriers which would protect the existing firms.

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A substitute is a product that appears to be different but can satisfy the same need as another product (Wheelen/Hunger 2006, p. 85).

According to the PC industry PDAs and mobile phones could be seen as potential substitutes. However, PDAs and mobile phones in the 1990's could not be identified as serious substitutes for PCs but the industry should have an eye on them.

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Proprietary standards and customer desire for compatible PCs strengthened the dependency of the "Wintel” standard and catapulted Microsoft and Intel in a dominant position which enabled them to suck up the profits from the industry.

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A lack of differentiation set up by the "Wintel” standard and high market transparency are responsible for low switching costs in the PC industry. These factors are valid for end users as well as for resellers and retailers and increase the bargaining power of buyers. In addition to that the growing end user knowledge is another aspect which lowers the brand loyalty of that buyer group.

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The degree of competition depends highly on the strength of the other four competitive forces. Since no high entry barriers exist, an increasing threat of substitutes is present and suppliers & buyers control the market, the rivalry among existing firms is high.

The "Wintel” standard complicates to differentiate, hence the only way to separate from competitors is the price.

In sum it was figured out that the PC industry has a below average profitability considering homogeneity among the competitors which is not sufficient for all players and potential entrants. To differentiate from its competitors Dell invented a new business strategy which would enable the company to gain cost leadership in the PC market.

3. Dell’s business model

Dell was the pioneer in implementing the direct model in the PC industry. This meant that while its competitors sold computers to distributers, resellers and retail stores, Dell sold directly to the customer and eliminated the other channels. The middleman was removed. The direct model which is nowadays also known as Dell Direct was used for all the consumer segments Dell was serving which are shown in appendix 1.

According to appendix 1 the B2B segment including business and government institutions was the most important segment by being responsible for 77% of Dell's sales. Dell divided this big segment in relationship and transactional buyers depending on the recurrences and volume of orders. On the one hand Dell did business with relationship buyers who were large companies and institutions that could be counted on to place repeated orders for multiple PCs. These Buyers were served by intern and extern sales reps. On the other hand transactional buyers including small-to-medium businesses and home computer users were able to place orders using a phone number which connected them to intern sales reps.

The first and most notable benefit of the direct model was that Dell was able to realize higher gross margins than its competitors by saving channel advertising and channel mark-up. In late 1990 Dell tried to deal at the retail channel but after four years it shunted the idea due to lower margins compared to the direct channel which can be seen in table 1.

Table 1: Dell margins in direct and retail channels in 1994

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The second benefit from the direct model is that it allowed Dell to employ a made to order production strategy. Since Dell is receiving orders directly from the customer, the company begins production on demand whereas its competitors had to produce on forecasts. This resulted in two big advantages for Dell.

The first one was that Dell was able to customize more easily. The deeper customer relationships to the customers resulted in better service, savings, convenience and efficiency which was proved by industry surveys in which Dell is ranked in top positions according to sales, service and products (Rivkin/Porter 1999, exhibits 8, 9). The strong relations to its customers also enabled the opportunity to gather information about customer needs, habits and their evolution. The second benefit of the produce to order strategy was that Dell was able to arrange just in time delivery with its suppliers. To perfect this Dell has reduced the number of its suppliers and strengthened their relationship with remaining ones. Dell remained in close electronic contact with suppliers, often communicating the need for parts on an hourly basis. The close contact also enabled Dell to safe costs by directing some supplier shipments such as monitors from Sony directly to customers. Another important aspect of Dell's logistic system was that suppliers were encouraged to locate warehouses and production facilities close to Dell's assembly operations to ensure smooth flow of materials across the value chain. All in all, Dell was able to reduce its days of inventory from 32 days in 1995 to 7 days in 1998. This means that the average part is in Dell's possession 7 days before it is put in a PC and shipped to a customer. Reducing inventory is very important in the PC industry because they are the highest liabilities of a firm, out of date parts loose their value very quickly and cutting costs is important in this very competitive market.

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