DELL COMPUTERS STRATEGY

1984, at the age of 19, Michael Dell founded Dell Computer with a simple vision and business conceptthat personal computers could be built to order and sold directly to customers. Michael Dell believed his approach to PC manufacturing had two advantages: (1) bypassing distributors and retail dealers eliminated the markups of resellers, and (2) building to order greatly reduced the costs and risks associated with carrying large stocks of parts, components, and finished goods. While Dell Computer sometimes struggled during its early years in trying to refine its strategy, build an adequate infrastructure, and establish market credibility against better-known rivals, its build-to-order and sell-direct approach proved appealing to growing numbers of customers in the mid-1990s as global PC sales rose to record levels. And, just as important, the strategy gave the company a substantial cost and profit-margin advantage over rivals that manufactured PCs in volume and kept their distributors and retailers stocked with ample inventories. Going into 1998, Dell Computer had a 12 percent share of the PC market in the United States, trailing only Compaq Computer and IBM, which held first and second place in the market, respectively. Worldwide, Dell Computer had nearly a 6 percent market share (see Exhibit 1). And the company was gaining market share quickly in all of the world's markets. The company's fastest growing market for the past several quarters was Europe. Even though Asia's economic woes in the first quarter of 1998 resulted in a slight decline in Asian sales of PCs, Dell's sales in Asia rose 35 percent. Dell's sales at its Internet Web site were averaging $5 million a day and were expected to reach $1.5 billion annually by year-end 1998. Dell Computer had 1997 revenues of $12.3 billion, up from $3.4 billion in 1994a compound average growth rate of 53 percent. Over the same period, profits were up from $140 million to $944 millionan 89 percent growth rate. Since 1990, the company's stock price had exploded from a split-adjusted price of 23 cents per share to $83 per share in May 1998a 36,000 percent increase. Dell Computer was the top-performing big company stock so far during the 1990s and seemed poised to become the stock of the decade. Dell's principal products included desktop PCs, notebook computers, workstations, and servers. The company also marketed a number of products made by other manufacturers, including CD-ROM drives, modems, monitors, networking hardware, memory cards, storage devices, speakers, and printers. The company's products and services were sold in more than 140 countries. Sales of desktop PCs accounted for about 65 percent of Dell's total revenues; sales of notebook computers, servers, and workstations accounted for about 33 percent of revenue. In early 1998, the company had 16,000 employees. Company Background At age 13, Michael Dell was running a mail-order stamp-trading business, complete with a national catalog, and grossing $2,000 per month. At 16, he was selling subscriptions to the Houston Post, and at 17 he bought his first BMW with money he had earned. He enrolled at the University of Texas in 1983 as a premed student (his parents wanted him to become a doctor) but soon became immersed in computers and started selling PC components out of his college dormitory room. He bought random-access memory (RAM) chips and disk drives for IBM PCs at cost from IBM dealers, who often had excess supplies on hand because they were required to order large monthly quotas from IBM. Dell resold the components through newspaper ads (and later through ads in national computer magazines) at 10-15 percent below the regular retail price. By April 1984 sales were running about $80,000 per month. Dell dropped out of college and formed a company, PCs Ltd., to sell both PC components and PCs under the brand name PCs Limited. He obtained his PCs by buying retailers' surplus stocks at cost, then powering them up with graphics cards, hard disks, and memory before reselling them. His strategy was to sell directly to end users;

by eliminating the retail markup, Dell's new company was able to sell IBM clones (machines that copied the functioning of IBM PCs using the same or similar components) at about 40 percent below the price of an IBM PC. The price discounting strategy was successful, attracting price-conscious buyers and producing rapid growth. By 1985, the company was assembling its own PC designs with a few people working on six-foot tables. The company had 40 employees, and Michael Dell worked 18-hour days, often sleeping on a cot in his office. By the end of fiscal 1986, sales had reached $33 million. During the next several years, however, PCs Ltd. was hampered by a lack of money, people, and resources. Michael Dell sought to refine the company's business model, add needed production capacity, and build a bigger, deeper management staff and corporate infrastructure while at the same time keeping costs low. The company was renamed Dell Computer in 1987, and the first international offices were opened that same year. In 1988 Dell added a sales force to serve large customers, began selling to government agencies, and became a public companyraising $34.2 million in its first offering of common stock. Sales to large customers quickly became the dominant part of Dell's business. By 1990 Dell Computer had sales of $388 million, a market share of 2-3 percent, and an R&D staff of over 150 people. Michael Dell's vision was for Dell Computer to become one of the top three PC companies. Thinking its direct sales business would not grow fast enough, in 1990-93, the company began distributing its computer products through Soft Warehouse Superstores (now CompUSA), Staples (a leading office-products chain), Wal-Mart, Sam's Club, and Price Club (now Price/Costco). Dell also sold PCs through Best Buy stores in 16 states and through Xerox in 19 Latin American countries. But when the company learned how thin its margins were in selling through such distribution channels, it realized it had made a mistake and withdrew from selling to retailers and other intermediaries in 1994 to refocus on direct sales. At the time, sales through retailers accounted for only about 2 percent of Dell's revenues. Further problems emerged in 1993. Dell reportedly had $38 million in secondquarter losses that year from engaging in a risky foreign-currency hedging strategy. Also, quality difficulties appeared in certain PC lines made by the company's contract manufacturers, profit margins declined, and buyers were turned off by the company's laptop PC models. To get laptop sales back on track, the company took a charge of $40 million to write off its laptop line and suspended sales of laptops until it could get redesigned models into the marketplace. The problems resulted in losses of $36 million for the company's fiscal year ending January 30, 1994. Because of higher costs and unacceptably low profit margins in selling to individuals and households, Dell did not pursue the consumer market aggressively until sales on the company's Internet site took off in 1996 and 1997. Management noticed that while the industry's average selling price to individuals was going down, Dell's was going uppeople who were buying their second and third computers, who wanted powerful computers with multiple features, and who did not need much technical support were choosing Dell. It became clear that PCsavvy individuals liked the convenience of buying direct from Dell, ordering exactly what they wanted, and having it delivered to their door within a matter of days. In early 1997, Dell created an internal sales and marketing group dedicated to serving the individual consumer segment and introduced a product line designed especially for individual users. By late 1997, Dell had become the industry leader in keeping costs down and wringing efficiency out of its direct sales and build-to-order business model. Industry observers saw Dell as being in strong position to capitalize on several forces shaping the PC industrysharp declines in component prices, rapid improvements in PC technology, and growing customer interest in having PCs equipped with the power, components, and software they wanted.

Michael Dell Michael Dell was widely considered one of the mythic heroes within the PC industry having been labeled as "the quintessential American entrepreneur" and "the most innovative guy for marketing computers in this decade." He was the youngest CEO to guide a company to a Fortune 500 ranking. His prowess was based more on an astute combination of technical knowledge and marketing know-how rather than on being a technowizard. In 1998 Michael Dell owned about 16 percent of Dell Computer's common stock, worth about $10 billion. In the company's early days Michael Dell was said to hang around mostly with the company's engineers. He was so shy that some employees thought he was stuck up because he never talked to them. But people who worked with him closely described him as a likable young man who was slow to warm up to strangers.1 Early in the company's history, Michael's managerial experience was limited, but Lee Walker, a 51-year-old venture capitalist brought in by Michael Dell provided much-needed managerial and financial experience during the company's organization-building years, became Michael Dell's mentor, built up his confidence, and was instrumental in turning him into a polished executive.2 Walker served as the company's president and chief operating officer during the 1986-90 period; he had a fatherly image, knew everyone by name, and played a key role in implementing Michael Dell's marketing ideas. Under Walker's tutelage, Michael Dell became intimately familiar with all parts of the business and turned into a charismatic leader with an instinct for motivating people and winning their loyalty and respect. When Walker had to leave the company in 1990 because of health reasons, Dell turned to Morton Meyerson, former CEO and president of Electronic Data Systems. Meyerson provided guidance on how to transform Dell Computer from a fast-growing medium-sized company into a billion-dollar enterprise.

Michael Dell usually spoke in a quiet, reflective manner and came across as a person with maturity and seasoned judgment far beyond his age. He was an accomplished public speaker. He delegated authority to subordinates, believing that the best results came from "turning loose talented people who can be relied upon to do what they're supposed to do." Business associates viewed Michael Dell as an aggressive personality, an extremely competitive risk-taker who had always played close to the edge. Moreover, the people who he hired were aggressive and competitive, traits that translated into an aggressive, competitive, intense corporate culture with a strong sense of mission and dedication. Developments in Early 1998 Dell's sales were up strongly in the first quarter of 1998, even in product areas where the company had previously lagged, pushing its global market share to 7.9 percent and its U.S. share to 11.8 percent. Unit shipments were 1.6 million units, compared to 978,000 in the first quarter of 1997. In laptop PCs, Dell moved into third place in U.S. sales and fifth place worldwide. And it climbed into second place in higher-margin products like servers and Windows NT-based workstations. Dell announced the formation of an alliance with Data General Corporation to enter the market for data storage equipment. In the first quarter of 1998, about half of the industry's PC sales consisted of computers selling for less than $1,300. Dell's average selling price was $2,500 per unit, down 9 percent from the prior quarter. The company was planning to broaden its product line to include lower-priced PCs equipped with Intel's low-end Celeron chip; Dell's new budget models were priced in the $1,200 range. Competing Value Chain Models in the Personal Computer Industry When the personal computer industry first began to take shape in the early 1980s, the founding companies manufactured many of the components themselvesdisk drives, memory chips, graphics chips, microprocessors,

motherboards, and software. Believing that they had to develop key components in-house, companies built expertise in a variety of PC-related technologies and created organizational units to produce components as well as to handle final assembly. While certain "non-critical" items were typically outsourced, if a computer maker was not at least partially vertically integrated and an assembler of some components, then it was not taken seriously as a manufacturer. But as the industry grew, technology advanced quickly in so many directions on so many parts and components that the early personal computer manufacturers could not keep pace as experts on all fronts. There were too many technological innovations in components to pursue and too many manufacturing intricacies to master for a vertically integrated manufacturer to keep its products on the cutting edge. As a consequence, companies emerged that specialized in making particular components. Specialists could marshal enough R&D capability and resources to either lead the technological developments in their area of specialization or else quickly match the advances made by their competitors. Moreover, specialist firms could mass-produce a component and supply it to several computer manufacturers far cheaper than any one manufacturer could fund the needed component R&D and then make only whatever smaller volume of components it needed for assembling its own brand of PCs.

Thus, in recent years, computer makers had begun to outsource most all components from specialists and to concentrate on efficient assembly and marketing of their brand of computers. Exhibit 6 shows the value chain model that such manufacturers as Compaq, IBM, Hewlett-Packard, and Packard-Bell used in the 1990s. It featured arm's-length transactions between specialist suppliers, manufacturer/assemblers, distributors and retailers, and end-users. However, Dell, Gateway, and Micron Electronics employed a shorter value chain model, selling direct to customers and eliminating the time and costs associated with distributing through independent resellers. Building to order avoided (a) having to keep many differently-equipped models on retailers' shelves to fill buyer requests for one or another configuration of options and components and (b) having to clear out slow-selling models at a discount before introducing new generations of PCs. Selling direct eliminated retailer costs and markups (retail dealer margins were typically in the 4 to 10 percent range). Dell Computer was far and away the world's largest direct seller to large companies and government institutions, while Gateway was the largest direct seller to individuals and small businesses. Micron Electronics was the only other PC maker that relied on the direct sales and buildto-order approach for the big majority of its sales. Dell Computer's Strategy

Dell Computer's strategy was built around a number of core elements: build-toorder manufacturing, mass customization, partnerships with suppliers, just-intime components inventories, direct sales, market segmentation, customer service, and extensive data and information sharing with both supply partners and customers. Through this strategy, the company hoped to achieve what Michael Dell called "virtual integration"a stitching together of Dell's business with its supply partners and customers in real time such that all three appeared to be part of the same organizational team.5 Build-to-Order Manufacturing and Mass Customization Dell built its computers, workstations, and servers to order; none were produced for inventory. Dell customers could order custom-built servers and workstations based on the needs of their applications. Desktop and laptop customers ordered whatever configuration of microprocessor speed, random access memory (RAM), hard-disk capacity, CD-ROM drive, fax/modem, monitor size, speakers, and other accessories they preferred. The orders were directed to the nearest factory. Until recently Dell had operated its assembly lines in traditional fashion, with workers

each performing a single operation. An order form accompanied each metal chassis across the production floor; drives, chips, and ancillary items were installed to match customer specifications. As a partly assembled PC arrived at a new workstation, the operator, standing beside a tall steel rack with drawers full of components, was instructed what to do by little red and green lights flashing beside the drawers. When the operator was finished, the components were automatically replenished from the other side of the drawers and the PC chassis glided down the line to the next workstation. However, Dell reorganized its plants in 1997, shifting to "cell manufacturing" techniques whereby a team of workers operating at a group workstation (or cell) assembled an entire PC according to customer specifications. The result had been to reduce assembly times by 75 percent and to double productivity per square foot of assembly space. Assembled computers were tested, then loaded with the desired software, shipped, and typically delivered within five to six business days of the initial order.

This sell-direct strategy meant, of course, that Dell had no in-house stock of finished goods inventories and that, unlike competitors using the traditional value chain model (Exhibit 6), it did not have to wait for resellers to clear out their own inventories before it could push new models into the marketplace. (Resellers typically operated with 60-70 days' inventory.) Equally important was the fact that customers who bought from Dell got the satisfaction of having their computers customized to their particular liking and pocketbook.

Dell had three PC assembly plantsin Austin, Texas; Limerick, Ireland; and Penang, Malaysia. The company was constructing another plant in Ireland to serve the European market as well as a new plant in China (the company expected the market for PCs in China to soon be huge). Both of the new plants were expected to come into use at the end of 1998. Partnerships with Suppliers

Michael Dell believed it made much better sense for Dell Computer to partner with reputable suppliers of PC parts and components rather than to integrate backward and get into parts and components manufacturing on its own. He explained why: If you've got a race with 20 players all vying to make the fastest graphics chip in the world, do you want to be the 21st horse, or do you want to evaluate the field of 20 and pick the best one?6 Management believed long-term partnerships with reputable suppliers yielded several advantages. First, using name-brand processors, disk drives, modems, speakers, and multimedia components enhanced the quality and performance of Dell's PCs. Because of the varying performance of different brands of components, the brand of the components was as important or more important to some buyers than the brand of the overall system. Dell's strategy was to partner with as few outside vendors as possible and to stay with those vendors as long as they maintained their leadership in technology, performance, and quality. Second, because Dell committed to purchase a specified percentage of its requirements from each of its long-term suppliers, Dell was assured of getting the volume of components it needed on a timely basis even when overall market demand for a particular component temporarily exceeded the overall market supply. Third, Dell's formal partnerships with key suppliers made it feasible to have some of their engineers assigned to Dell's product design teams and for them to be treated as part of Dell. When new products were launched, suppliers' engineers were stationed in Dell's plant. If early buyers called with a problem related to design, further assembly and shipments were halted while the supplier's engineers and Dell personnel corrected the flaw on the spot.7 Fourth, Dell's long-

run commitment to its suppliers laid the basis for just-in-time delivery of suppliers' products to Dell's assembly plants in Texas, Ireland, and Malaysia. Some of Dell's vendors had plants or distribution centers within a few miles of Dell's Texas assembly plant and could deliver daily or even hourly if needed. To help suppliers meet its just-in-time delivery expectations, Dell openly shared its daily production schedules, sales forecasts, and new-model introduction plans with vendors. Michael Dell explained one aspect of the information-sharing relationship with suppliers as follows: We tell our suppliers exactly what our daily production requirements are. So it's not, "Well, every two weeks deliver 5,000 to this warehouse, and we'll put them on the shelf, and then we'll take them off the shelf." It's, "Tomorrow morning we need 8,562, and deliver them to door number seven by 7 am."8 Dell also did a three-year plan with each of its key suppliers and worked with suppliers to minimize the number of different stock-keeping units of parts and components in designing its products. Why Dell Was Committed to Just-in-Time Inventory Practices Dell's just-in-time inventory emphasis yielded major cost advantages and shortened the time it took for Dell to get new generations of its computer models into the marketplace. New advances were coming so fast in certain computer parts and components (particularly microprocessors, disk drives, and modems) that any given item in inventory was obsolete in a matter of months, sometimes quicker. Having a couple of months of component inventories meant getting caught in the transition from one generation of components to the next. Moreover, there were rapid-fire reductions in the prices of componentsmost recently, component prices had been falling as much as 50 percent annually (an average of 1 percent a week). Intel, for example, regularly cut the prices on its older chips when it introduced newer chips, and it introduced new chip generations about every three months. And the prices of hard-disk drives with greater and greater memory capacity had dropped sharply as disk drive makers incorporated new technology that allowed them to add more gigabytes of harddisk memory very inexpensively. The economics of minimal component inventories were dramatic. Michael Dell explained: If I've got 11 days of inventory and my competitor has 80 and Intel comes out with a new 450-megahertz chip, that means I'm going to get to market 69 days sooner. In the computer industry, inventory can be a pretty massive risk because if the cost of materials is going down 50 percent a year and you have two or three months of inventory versus eleven days, you've got a big cost disadvantage. And you're vulnerable to product transitions, when you can get stuck with obsolete inventory.9 Collaboration with suppliers was close enough to allow Dell to operate with only a few days of inventory for some components and a few hours of inventory for others. Dell supplied data on inventories and replenishment needs to its suppliers at least once a dayhourly in the case of components being delivered several times daily from nearby sources. In a couple of instances, Dell's close partnership with vendors allowed it to operate with no inventories. Dell's supplier of monitors was Sony. Because the monitors Sony supplied with the Dell name already imprinted were of dependably high quality (a defect rate of fewer than 1,000 per million), Dell didn't even open up the monitor boxes to test them.10 Nor did it bother to have them shipped to Dell's assembly plants to be warehoused for shipment to customers. Instead, utilizing sophisticated data exchange systems, Dell arranged for its shippers (Airborne Express and UPS) to pick up computers at its Austin plant, then pick up the accompanying monitors at the Sony plant in Mexico, match the customer's computer order with the customer's monitor order,

and deliver both to the customer simultaneously. The savings in time, energy, and cost were significant. The company had, over the years, refined and improved its inventory-tracking capabilities and its procedures for operating with small inventories. In 1993, Dell had $2.6 billion in sales and $342 million in inventory. In fiscal year 1998, it had $12.3 billion in sales and $233 million in inventoryan inventory turn ratio of seven days. By comparison, Gateway, which also pursued a build-to-order strategy, had 1997 sales of $6.3 billion and inventories of $249 millionan inventory turn ratio of 14 days. Compaq had inventories of $1.57 billion at yearend 1997, and 1997 sales of $24.6 billion (thus turning its inventories about every 23 days). Dell's goal was to get its inventory turn down to three days before the year 2000. Direct Sales Selling direct to customers gave Dell firsthand intelligence about customer preferences and needs, as well as immediate feedback on design problems and quality glitches. With thousands of phone and fax orders daily, $5 million in daily Internet sales, and daily contacts between the field sales force and customers of all types, the company kept its finger on the market pulse, quickly detecting shifts in sales trends and getting prompt feedback on any problems with its products. If the company got more than a few similar complaints, the information was relayed immediately to design engineers. When design flaws or components defects were found, the factory was notified and the problem corrected within a matter of days. Management believed Dell's ability to respond quickly gave it a significant advantage over rivals, particularly over PC makers in Asia, that made large production runs and sold standardized products through retail channels. Dell saw its direct sales approach as a totally customer-driven system that allowed quick transitions to new generations of components and PC models. Despite Dell's emphasis on direct sales, industry analysts noted that the company sold 10-15 percent of its PCs through a small, select group of resellers.11 Most of these resellers were systems integrators. It was standard for Dell not to allow returns on orders from resellers or to provide price protection in the event of subsequent declines in market prices. From time to time, Dell offered its resellers incentive promotions at up to a 20 percent discount from its advertised prices on end-of-life models. Dell was said to have no plans to expand its reseller network, which consisted of about 50-60 dealers. Market Segmentation To make sure that each type of customer was well served, Dell had made a speco finer, more homogeneous categories (see Exhibit 7). In 1998, 90 percent of Dell's sales were to business or government institutions and of those 70 percent were to large corporate customers who bought at least $1 million in PCs annually. Many of these large customers typically ordered thousands of units at a time. Dell had hundreds of sales representatives calling on large corporate and institutional accounts. Its customer list included Shell Oil, Exxon, MCI, Ford Motor, Toyota, Eastman Chemical, Boeing, Goldman Sachs, Oracle, Microsoft, Woolwich (a British bank with $64 billion in assets), Michelin, Unilever, Deutsche Bank, Sony, Wal-Mart, and First Union (one of the 10 largest U.S. banks). However, no one customer represented more than 2 percent of total sales. Because corporate customers tended to buy the most expensive computers, Dell commanded the highest average selling prices in the industry over $1,600 versus an industry average under $1,400. Telephone, fax, and the Internet made Dells sales to individuals and small businesses. It had a call center in the United States with toll-free lines; customers could talk with a sales representative about specific models, get information faxed or mailed to them, place an order, and pay by credit card. Internationally, Dell had set up six call centers in Europe and Asia that customers could dial toll free.12 The call centers were equipped with technology that routed calls from a

particular country to a particular call center. Thus, for example, a customer calling from Lisbon, Portugal, was automatically directed to the call center in Montpelier, France, and connected to a Portuguese-speaking sales representative. Dell began Internet sales at its Web site (www.dell.com) in 1995, almost overnight achieving sales of $1 million per day. In 1997 Internet sales reached an average of $3 million daily, hitting $6 million some days during the Christmas shopping period. In the first quarter of 1997, Dell's Internet sales averaged nearly $4 million daily; and the company expected that 1998 sales at its Web site would reach $1.5 billion. The fastest growing segment of Dell's international segment was on the Internet in Europe, where sales were running at a weekly volume of $5 million in early 1998. Internet sales were ramping up rapidly from Asian buyers. In early 1998, Dell's Internet sales were about equally divided between sales to individuals and sales to business customers. Nearly 1.5 million people visited Dell's Web site weekly to view information and place orders, about 20 times more than called to talk with sales representatives over the telephone.

In 1997, 31 percent, or $3.8 billion, of Dell's sales came from foreign customers. Europe, where resellers were strongly entrenched and Dell's direct sales approach was novel, was Dell's biggest foreign market. Dell's European sales were growing at 50 percent annually. The market leader in Europe was Compaq, with a 14.8 percent market share, followed by IBM with 8.3 percent, Dell with 7.8 percent, Hewlett-Packard with 7.6 percent, and Siemens Nixdorf (Germany) with 5.6 percent. In Britain, which Dell had entered in the late 1980s, Dell had a 12 percent share, trailing only Compaq. Sales of PCs in Europe were expected to reach 22-24 million in 1998 and 28.5 million in 1999. Total European sales in 1997 were 19.7 million units. Customer Service Service became a feature of Dell's strategy in 1986 when the company began providing a guarantee of free on-site service for a year with most of its PCs after users complained about having to ship their PCs back to Austin for repairs. Dell contracted with local service providers to handle customer requests for repairs; on-site service was provided on a next-day basis. Dell also provided its customers with technical support via a toll-free number, fax, and e-mail. Dell received close to 40,000 e-mail messages monthly requesting service and support and had 25 technicians to process the requests. Bundled service policies were a major selling point for winning corporate accounts. If a customer preferred to work with his or her own service provider, Dell gave that provider the training and spare parts needed to service the customer's equipment. Selling direct allowed Dell to keep close track of the purchases of its large global customers, country by country and department by departmentinformation that customers found valuable. Maintaining its close customer relationships allowed Dell to become quite knowledgeable about its customers' needs and how their PC network functioned. Aside from using this information to help customers plan their PC needs and configure their PC networks, Dell used its knowledge to add to the value it delivered to its customers. For example, Dell recognized that when it delivered a new PC to a corporate customer, the customer's PC personnel had to