Matching Dell
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Question 1:
During the 90s, the PC industry came to have low profitability. For example, IBM PC division, which represented 23% of IBMs total revenue, lost over $1 Billion between 1996 and 1998. This was the situation of other major PC manufacturers such as HP, Compaq and Gateway. Unfortunately for the last two, unlike IBM and HP, they had no other lines of business to cover the loss.
In order to analyze the industrys profitability, we use Porters 5 forces model:
Rivalry among established firms:
When IBM launched the first PC in 1981, it published its specifications in order to make it an “open architecture” so that software developers would push the industry forward. Since the architecture was public knowledge, many companies developing “IBM clones” entered the market. By the end of the 90s many strong players were in the market, most of which held less than 10% of the market (See Ex.1). This competition led to a severe price war and damaged the industrys profitability.
Bargaining power of buyers:
Currently there are 4 major markets for the industry (See Ex. 2): Large/midsize businesses & government (42.3% of the total $ sales), small business and offices (23.7%), home consumers (28.7%) and educational institutions (5.4%). Each of the groups had an advantage over the industry. The first group was the most powerful: although we can see in Ex. 2 that the $ share of this segment was higher than the unit share, which means that the prices for this segment were higher than for other segments, the manufacturers had to commit for a long term of warranty, spare parts and so on. In the home consumers segment we can see the reverse situation in which the unit share is larger than the $ share. Those clients were price sensitive. Moreover, they had no shifting costs nor did they have loyalty to a special brand. In 1998, 30% of this segment was first time buyers.
Risk of potential competitors:
The entry barriers were very low. An investment of only 1 million dollars could provide an efficient PC assembly line, which was capable of producing 250,000 PCs a year. With the development of the Asian market and its discovery by the big companies, the production costs declined dramatically by 25%-30% a year. Many small manufacturers entered the market each year and were capable of gaining a decent market share.
Threat of substitute products:
As a product, the PC had and still has few substitutes. One substitute is the MAC (We are aware of the fact that in this assignment MAC is considered a PC but in real life it is actually a substitute for the WinTel PC). Apple kept the MAC as a “closed architecture” product which led to small compatibility and eventually a decline in sales. Another substitute is the mainframe with its terminals. This was an old architecture with low capabilities compared to the PC. The last substitute is the mainframes terminal successor, the NC, which is a small box that has the connectivity to a Windows server which provides the client with the entire work environment he needs. This substitute has not widely penetrated the market since it has lower performance compared to the PC and requires a strong server that changes the balance for the customer. Of course, there is always paper and pen
Bargaining power of suppliers:
We divide the suppliers into two parts:
Production – there are two major groups of suppliers to the production process:
Microsoft and Intel which controlled 85-90% (1991) of the computers made. These two companies had a huge bargaining power over the industry.
Suppliers of components other than CPU and operating systems such as hard drives, Ram, Rom etc. – There were many factories in the Far East which tried to sell their products. These suppliers were at a disadvantage compared to the PC manufacturers.
Distribution channels – Most of the sales were through distributors and resellers. The distributors had a mark-up of 5-7% which raised the price of the computers. The distributors had strong connections with the large account clients which relied on their advice regarding which brand to buy. These connections gave the distributors power over the manufacturers and led the manufacturers to guarantee buy-back of inventory and price protection which cost 2.5% of the revenue. The manufacturers had also funded advertising and marketing for the distributors. Those activities cost another 2.5% of the revenue.
In conclusion, we can see that excluding threat of substitute products, the PC industry was inferior to all the other powers in the Porter model, which can explain the low profitability of the industry.
Question 2:
Dell has been so successful despite the low profitability of the industry because it was able to create value and enjoy a competitive advantage over other firms. A firm is said to have a competitive advantage in an industry if it earns a higher rate of economic profit compared to the average economic profit in the industry. Between 1994 and 1998 Dells stock price rose by 5600% and the profit increased by 1000%. According to Michael Dell, since Dell had no technical advantage over the competitors, nor did it have a dealer network advantage, competitive advantage must have been gained through a new distribution and marketing strategy. According to the Value Bar Model, Dell “attacked” both ends (See Ex. 3):
On one end, elevating the customer perceived benefit with fast supply time, for example 8 servers to the NASDAQ within 36 hours in the East-Asia crisis, the ability to customize a variety of machines, etc. In a survey conducted in 1998, Dell was rated at the top according to ~1500 corporate managers.
On the other end of the bar, Dell cut the costs significantly in a few areas:
Direct distribution only with 7% of sales through resellers. This saves a 5-7% mark-up.
Since every computer was built upon order, less inventory days needed compared to competitors – 7 days vs. average of 50 days.
Direct delivery – computers were sent to the clients directly from the factory without making several shipments – from the factory to the warehouses and then to the clients.
Direct shipment from the supplier to the client (Monitor from Sony).
Less SG&A/Salas ratio –