From Computer Business Review, a sister publication.
Call it the ‘Dell factor’. Call it the warm up for the internet economy. But over the past six months, the world’s major vendors of personal computers have been completely rethinking the fundamental basics of their business: how they make and sell PCs. The distribution and manufacturing models that most have favored since the industry’s inception in the early 1980s – a combination of internally built products and outside distributors, dealers, resellers and retailers – is being unpicked. In its place: a fluid model under which manufacturing is spread across outside contractors, distributors/dealers and the company itself, with much more emphasis on selling directly to the customer. The evidence is everywhere. IBM Corp, Hewlett-Packard Co and others are off-loading the complete manufacturing of many of their consumer and low-end PC models to outside contractors. Furthermore, a number are establishing direct sales forces and telesales centers to offer machines straight to the corporate customer. Two main catalysts are behind this epic upheaval: one reactive, the other proactive. The first is the wild success of direct PC vendor Dell Computer, the $7.76bn Austin, Texas-based company whose PC sales are growing at 62% and which has grasped the number three slot in the global PC market. The other factor in the revolution in the PC business is more forward looking. Companies viewing the inevitable explosion of customers buying PCs across the internet are taking the first step towards transforming their channel strategies – by adopting an increasingly direct sales model.
By Kenny MacIver
In both cases, it has involved companies scrambling to catch up with and imitate Dell Computer. Since founding the company in 1984, aged 19, chief executive officer Michael Dell has pursued a single goal: to build a personal computer company that side-steps the industry middlemen, the ‘margin-diluting’ layers of distributors, dealers, value-added resellers, and retail outlets that populate the mature distribution channels of rival companies such as IBM and Compaq. By not building a PC until its tele-sales or corporate sales teams have taken a customer’s order – and, in most cases, their cash – Dell can undercut the price tags of the main competition by between 10% and 40% and ship the finished order directly to the customer within a week or two. By having what Michael Dell calls ‘real-time demand’, Dell can keep its inventory of PC components at levels unthinkably low for companies with ‘build-to-stock’ or ‘build to forecast’ business models. Such a model sets the output level of any given product line by anticipating market demand, then feeding the finished product out to a tier of distributors, dealers, resellers and retail outlets. That chain ties up a lot of stock. Today, a PC component spends on average just 13 days on Dell’s books, a fraction of the 40 to 50 days that is typical of indirect PC vendors who use the extended distribution channel. Not content with that, Dell has been taking it further, even suggesting that it can dispense with the stock warehouse altogether. The company encourages its key outside suppliers to set up satellite factories and warehouses within yards of Dell’s production facilities, and to supply the company on demand. When customer sentiment switches to larger disk sizes, larger screens or away from older processors, Dell knows instantly and can change orders to its suppliers within hours. On a wider perspective, several changes in the industry itself are playing into Dell’s hands. As business customers’ buying habits have matured, many more buyers are in the market for a second or third time to renew their company’s computers. Typically, they know what configuration they need and they are much more willing to buy PCs unseen. Michael Dell talks of his company already doing sales of $1 million-a-day via the web, something that would not have been possible without the established direct operation. It is only now that Dell’s rivals are adopting a radical agenda for change. Perhaps the greatest will is evident at Compaq Computer Corp. The company is scrapping its policy of distributing exclusively through the channel, and is establishing direct sales teams and call center telesales operations that will ship systems directly to customers. For many of its business customers, it will move towards a build to order model. By no means is Compaq abandoning the channel, says the company’s vice president of manufacturing strategy and technology, Bill Ramsey, but if it is to fight back against Dell and other direct PC vendors – especially in the small and medium enterprise market – it must have the same advantages and mirror many of their business practices. It is a calculated risk, because it must do so without upsetting the established channel. As Ramsey points out: the direct model can only cover so much of the market. The Dell model, for all its efficiencies, can’t touch all of the customers, maybe only 30%. You need the channel if you get to them all. Compaq is following IBM and Hewlett-Packard and looking at channel assembly – transferring a large part of the assembly of their PCs to a select group of distributors and dealers. Compaq has not engaged with the channel yet in manufacturing or appointed anyone, says Bill Ramsey. We think there is room for the channel to configure products. At the same time, Compaq needs to provide greater flexibility to meet customer needs.
Not without risk
Dell’s success is clearly at the forefront of his thoughts. Our goal is to be competitive with the Dell model, to come close to the Dell model through the channel. The disadvantages of an indirect model today is that you have a lot of computers out in the channel and the value of that inventory drops quickly over time. When Intel cuts the cost of a microprocessor, someone like Dell can take advantage of that because they don’t have channel inventory. So they get the value to the customer quicker, says Ramsey. Clearly, the strategy is not without risk. Some vendors will find it difficult to keep control over the out-sourced part of their manufacturing process. Others will find it tricky maintaining the fine balance between direct sales, the authorized assemblers and the traditional channel. How, for example, will PC companies price their direct offerings: lower or equal to those PCs being produced by distributors under the same logo? What, for example, happens if one or more of the assemblers hits financial trouble? Michael Dell said in 1995: We are like a baker that doesn’t have to forecast what type of bread people will want. We just hold the flour. For those companies trying to emulate parts of his company’s model, there are several years ahead when they will wonder if they have got the recipe right.
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