How and Why Did the Personal Computer Industry Come to Have Such a Low Profitability?
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How and why did the personal computer industry come to have such a low profitability?
Historically the personal computer (PC) industry has sold its products at reasonably high prices yet garnered only small profit margins. One reason for this is the high competition in the PC industry which led to competitive pricing among producers. Analyzing the competitive environment of the PC industry, it is evident that there is very little barrier to entry in this market. PCs have very low physical uniqueness and are made of standard components that require very little expertise to assemble.
Capital requirements to set up an assembly line to produce PCs are also relatively low, estimated at roughly a million dollars (Rivkin & Porter,1999 pg. 5) which means that virtually any firm can enter the market easily. Despite sky rocketing demands for PCs, PC producers are unable to capitalize due to increasing number of competitors. The PC industry is also affected by environmental turbulence due to price fluctuations of its components. Constant innovation in PC technology causes older components to be rendered obsolete and prices of older versions to plummet. PC producers who are stuck with inventory of obsolete products incur high costs of dumping these components.
PC manufacturers who limit their inventory to reduce the impact of price fluctuations are at a cost disadvantage by failing to reduce costs through economies of scale in purchasing components. Therefore PC manufacturers face high risk when stocking components and essentially loose out on profitability due to changes in technology.
The existence of many large manufacturers in addition to the continuous entry by smaller manufacturers results in limited differentiation and decreased competitive advantage among PC manufacturers. All manufacturers have access to similar suppliers and therefore have the same buying power especially for processors which are sold at the same price to all manufacturers. It is clear that the competitive advantage in the PC industry is not sustainable as easy replication by competitors promotes price wars which lower profit margins for the industry as a whole. Ultimately, high competition and price fluctuations have led the PC industry to low profitability.
Why has Dell been so successful despite the low average profitability in the PC industry?
Dell has been successful due to its differentiated strategy compared to its competitors.
The Direct Model that Dell adopted has been highly successful in reducing its bottom line costs. Comparing the margins in 1994, Dell retail had 7% gross margin and Dell direct 19%; despite higher operating expense in the direct channel overall income was higher through this channel. By reducing the costs of using resellers and distributors, Dell was able to sell at lower prices which were attractive consumers.
Through its direct interaction with customers, Dell was also able to understand the needs of its customers better than the competitors. With this key information Dell subdivided its customers into categories where it could target them with specific products and services which ultimately boosted sales. This market focused initiative with customized products differentiated Dell from its competitors. Dell also tied up contracts with large companies and institution which placed large orders, and through its relationship with Dell placed repeat orders as well. By investing heavily in technology, Dell further reduced its operational costs with the launch of its website where customized purchases could be done online.
The after sales support of Dell had built up an excellent reputation in the industry, as proven in the customer surveys done in 1998. Customer problems were solved using diagnostic software with 90% cases resolved over the telephone. This reputation increased the brand value of Dell which encouraged sales and repeat buyers through brand loyalty.
Dells unique capability was not only through its direct selling but also its efficient manufacturing