Matching Dell

Final Exam

lvaro de la Garza Musi

Questions:

1. How and why did the personal computer industry come to have such low average

profitability?

To understand why the personal computer industry is having such a low average profitability we

need to analyze it through Porters 5 forces, analysis that can be found below:

Bargaining power of customers: The bargaining power of the customer is qualified as

medium to high. The whole industry, except Dell, had retailers and resellers as its direct

customers. It can be seen that, retailers and resellers face net margins of 0.6% and 1.3%;

these margins are not caused by a low negotiating power with the manufacturers; they are

driven by the bargaining power of the end customer which has a wide variety of choices

(both retailers and manufacturers) and is mostly persuaded to buy products due to its low

prices. In regards to their relationship with manufacturers, they do possess some

bargaining power. In the case it is presented that manufacturers offer price protection and

buy back policies to the retailers and consumers which represents 25 cents on every cent

of revenue for them. They also spend large amounts on advertising towards them; both

indicating bargaining power.

It is important to also talk about the bargaining power of the end consumer as they will

also affect the PC manufacturing industry profitability. End consumers are divided as

follows:

o Large and midsize business: These consumers buy in bulk and can ask for

discounted pricing, so bargaining power is medium.

o Small business: Very educated customer. All the following characteristics

influence their decision: Reliability, performance, support, service, service, price,

brand, and channel recommendations. Due to this and the crowded PC market

from manufacturers; small businesses do have some bargaining power.

o Individual consumers: Decision is based heavily on the evaluations of

independent organizations, with small knowledge about PCs and their

performance; the individual consumer only looks for the price and this creates a

high bargaining power on their part.

Bargaining power of suppliers: The two main inputs to manufacturers are: operating

system and microprocessors. Currently, most PCs use the common standard Wintel and

by 1991 between 85% and 90% of the computers use these standard. This fact makes

Windows and Intel control the entire industry of OS and microprocessors respectively.

Therefore, bargaining power of suppliers is high.

Threat of new entrants: The threat of new entrants is extremely high in the PC

manufacturing industry because the barriers to entry are really low and do not pose a

serious challenge to anyone who is willing to enter the market. A new PC manufacturing

would only need an initial investment of roughly $1M to start manufacturing 250,000

PCs. Also, most of the current manufacturers do not possess any brand recognition or

loyalty from its consumers; as a consequence their willingness to change is only driven

by any brand (old or new) that offers better quality or pricing.

Threat of Substitutes: The threat of substitute products is low, because at this time the

only new technology being developed was to improve the performance of computers.

One substitute could be said to be Apple computers because they were so much different

than all the Wintel computers. Nevertheless, still Apple only controlled around 10% of

the market and it was rare for consumers to change to Apple at this time.

Rivalry among existing competitors: Rivalry is very high, there are several facts in the

case that show us that the competition is fierce among the manufacturers:

o Between 1975 and 1981, there were various firms that began to offer increasingly

integrated, pre-assembled personal computers such as Texas Instruments,

Hewlett-Packard (HP), Zenith, Nec, Toshiba, IBM, Xerox, Sanyo, Sony, Olivetti,

Wang, and DEC. All these firms crowded the market, moreover; with low

differentiation, they could only compete in price. This would little by little eat up

on manufacturers profits.

o Personal computer sales crested in 1990, just when the United States was facing a

recession; in response to this Dell Computer ran advertisements showing that its

prices were much, much lower than Compaqs list prices. In response, Compaq

slashed its prices by as much as 32%, introduced 41 new products in 1992, and

added new distribution channels. These factors led to a vigorous price war.

Summing up, because both the bargaining powers of the suppliers and the consumers are high;

the PC manufacturers profit margins are pushed down, which decreases profitability.

Furthermore, threat of new entrants and rivalry among competitors are very high and these leads

to price wars, low-product life cycles, etc. which also decrease the profitability of the sector.

This is why the PC manufacturing industry is not a good one to start a business at.

2. Why has Dell been so successful despite the low average profitability in the PC industry?

There are several factors that created a competitive advantage on the cost side for Dell which

helped it being so successful with respect to its competitors. They are presented below:

Just-in-time delivery: On behalf of Dells suppliers, this fact reduced raw material

inventory in a considerable way. This, in turn, helped out Dell in being a company that

was not capital intensive.

Customization: Dell sold directly to consumers and provided tailor-made solutions for

each one. This helped the company in two ways:

o First, the company only produced based on customer orders; reducing its days of

finish goods inventory to a negligible 7 days. Again, supporting the strategy of

making Dell a company with low capital requirements.

o Second, no single customer represented more than 2% of the companys sales;

lowering the companys risk and adding bargaining power to Dell.

Communication with its consumers: Dell created both an inside and an outside sales

team, this way the company could understand his customer needs better. Furthermore,

being a first-mover on the customization strategy, Dell was able to get close to the end-

consumer and create a little-bit of loyalty to the brand.

Close relationships with suppliers: Dell was a strong supporter of Co-location, in other

words, the company would incentivize suppliers to locate its respective production

facilities and warehouses close to the manufacturing plant. This reduced transportation

costs for Dell and also WIP inventory.

High Services-level: Dell offered after purchase services to its customers; these services

included:

o 50,000 pages of customer supported information.

o Installation of off-the-shelf software and even software the customer already

owned.

o 24 hour hotline for technical support (which was successful 90% of the time).

Centralized production: The meaning of a centralized production is not that they had

only one facility; on the contrary, Dell had manufacturing plants in Asia, Latin America,

the US and Europe. Nevertheless, the communication among these plants was very

centralized and in this way Dell was able to eliminate all the inventory buffers all of these

individual plants could have.

3. Prior to the recent efforts by competitors to match Dell (1997-1998), how big was Dells

competitive advantage? Specifically, calculate Dells advantage over the team of Compaq

and a reseller in serving a corporate customer.

To calculate the competitive advantage of Dell over Compaq the computer model 97Q1 will

be used. For the analysis the following information was used from exhibit 6: average COGS=

21%. Assumption of inventory carrying cost is taken to be 25%.

Dell Compaq Source

Price to customer $ 2,231.00 $ 2,546.00 Averages of Exhibit 10b

Cost differences

Price to channel $ - $ 2,418.70 Page 5, paragraph 3

COGS $ 1,751.34 $ 1,826.69 Exhibit 6, page 2 and 3

Inventory Carrying costs $ 72.97 $ 329.82 Exhibits 6, 13.

Adv. To Channel $ - $ 63.65 Page 5, paragraph 6

Operating margin $ 406.69 $ 198.54

Dell's Comp. Adv. $ 208.15

4. How effective have competitors been in responding to the challenge posed by Dells

advantage? How big is Dells remaining advantage? Why has it been so hard for rivals to

match Dell?

I believe competitors responded fast, but not in the necessary extent to compete against Dell yet.

All competitors still rely high on their retailers and resellers and not on the direct channel. From

the analysis from question 3 it can be seen that most of this competitive advantage comes from

eliminating that part of the value chain. I believe Dells competitive advantage is still very big

because most of what competitors did was reduce days of inventory which is not a very big

saving for the company. They also added the direct channel through different ways such as sales

force and a website; nonetheless I do not think they have attained the reach the want to.

I think it has been very hard for competitors to match Dell for two reasons:

- Big corporations are slow to change and it will definitively take some time to transition

from your current strategy which relies on retailers and resellers to a direct one.

- Most competitors are unwilling to adopt the customization or pull strategy, they stick

with the push strategy which is their mayor disadvantage.