Matching Dell

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

The personal computer industry has been one of the most competitive industries in the world. The industry is typically characteristed by rapid innovations, low costs, and in general, the demand for better performance systems has kept the market very attractive. If we look at the main players, firstly IBM, which within two years of launching its first PC in 1981 occupied 42% market share set the industry standards. In launching its PC, IBM commissioned Microsoft to write the operating system for the PC and adopted Intel's microprocessor. The computers were sold via its huge sales force, retailers and resellers. By publishing its PC specifications, IBM established an "open architecture" encouraging software developers to write programs for its PC.This largely became the framework of the PC industry. As the demand grew, companies offering IBM clowns at lower prices came into picture. Companies like Compaq, Dell, and HP emerged as a result. Overtime companies started heavily relying on resellers to reach the customer.

IBM realised that in setting the standards, it had firstly conceded the rights to the most valuable component of the PC-the microprocessor (constituting upto 67-75% of the PC cost) and operating system to Intel and Microsoft respectively and secondly it spawned a set of imitators. To act to this fact it tried to make its PC more proprietary by declining to adopt Intel's microprocessor into its PC in 1986. However, IBM lost its market share from 37% in 1985 to 16.9% in 1989.

The only way companies could be profitable under the set framework was to be operationally efficient. One of the interesting features of this industry was that as PC performance improved the prices fell dramatically. To highlight the fact, Intel's microprocessor in 1985 priced at $120/MIPS, was priced at $1/MIPS in 1998.

Dell, which had earlier followed the same framework, could not add any value to its products. More or less the companies looked like assembly line operations.

With Dell's "Direct Sales Model" success, the industry become more competitive and everyone wanted to the go the Dell's way.

In the 1990's the growth of the World Wide Web increased the demand for PC's and hence seeing the highly competitive nature of the market, the prices declined too. To illustrate this fact, by 1998, the prices of the least expensive PC had plunged to $499.

Considering all the events, we can see that why the PC industry has had low average profitability.

PC INDUSTRY= Innovation, new entrants, increased competition, decreased prices.

"If we look at the industry structure in the 1990's, the supplier power was very high (Intel & Microsoft), the PC manufacturers could not control the prices. The buying power of the customers was also high because of the number of choice available in the market. The barrier to entry was very low, since the demand for the PCs was very high and as a result, the whole industry looked very attractive. Threat of the substitutes was very high since there was no brand loyalty on part of the customer .The PC companies in order to gain more and more of the market share priced the computers at a very competitive price (operating at very low profit margins). Hence the whole industry has since been in a highly competitive low profitability state".

Why has Dell been so successful?

Dell's efficiency comes from two key success factors (KSFs). First, they sell directly to their customers so their distribution channels are simple and cheap (no dealer markup). Second, they build-to-order (BTO), which keeps inventories low. Low inventories mean that, when Compaq/IBM/HP drops the price of its processors, Dell does not have many of the old expensive processors sitting around. Dell can reduce the prices on its computers faster than its competitors can, because the components that make up those computers are the latest and cheapest.

Dell clearly distinguished its customers segments and as part of its strategy, it targeted the corporate customers (relationship buyers) who were volume buyers. As a result, the transactions costs/per PC sale were substantially lower than its competitors were.

PAY-OFF MATRIX PC INDUSTRY

Dell's Action

No price change Cut prices

HP/IBM/Compaq Action No price change No change in market share Dell: Gain market share and profitability HP/IBM/C: Lose market share and profitability

Cut Prices Dell: Lose market share and profitability HP/IMB/C:Gain market share and profitability Dell: No change in market share, lose profitability HP/IBM/C: No change in market share, unprofitable

In summary, Dell's direct model is characterised by

* Build to order and direct to customer relationships

* Focus on specific market segments

* Low cost distribution

* JIT manufacturing and strong supplier relationships

* Minimum inventory

* Service and repair through telephone and third parties.

Each customer order may be unique in terms of manufacturing, procurement, packing