The Dell Model: How Well Will It Travel?

Is Dell doing everything right?

 

In a sluggish PC market, the Round Rock, Tex., computer company is miles ahead of the pack. Where global PC shipments only rose by 2.7% in 2002, according to research firm Gartner, Dell reported a 21% revenue growth year-over-year in the fourth quarter.

 

“There were no areas of weakness. All regions, product revenues and customer segments grew revenues double digits” in Q4 2002, Credit Suisse First Boston analysts Kevin McCarthy and Robert Semple said in a report on February 14.

 

Meanwhile, Dell’s number-one competitor, Hewlett-Packard, continues to lose market share. Although HP is still the world’s number-one PC maker, the company’s global market share fell from 18.5% to 16.1% during Q4 2002 – while Dell’s jumped from 13.2% to 15.7%. And Dell’s a solid number one in the U.S., with 29.2% of the market.

 

Flawless execution of the well-known ‘Dell model’ has a lot to do with Dell’s success, Wharton professors say. But the model is now being tested in new ways, as the $35 billion company jumps into new markets – both geographically and product-wise.

 

“In the U.S., the model is, in essence, perfect. But the question becomes, how extensible is it?” asks Martin Kenney, a professor at the University of California at Davis who has studied Dell.

 

The China Challenge

The Dell model relies on several factors that none of its competitors have quite been able to match. Dell’s build-to-order system lets the company hold essentially no inventory (four days, according to Wharton professor Morris Cohen) and take advantage of a negative float: Its customers pay Dell before parts are ordered from suppliers, but Dell doesn’t have to pay its suppliers for another month or so.

 

Bob Barr, Dell’s director of product management for e-business in the Americas, adds four other factors to the Dell mix. Dell’s “most efficient path to the customer” means direct sales, whether through the Internet, sales teams or online – but not through channel partners. A “single point of accountability” helps quality control and gives customers a sense of reliability. “Industry standard technology” is cheap and commoditized, and “low cost leadership” keeps overhead down.

 

Other companies, most notably Gateway, have tried to copy the Dell model. But none has matched Dell’s “operational excellence,” says Wharton professor David Croson. (Gateway, in particular, has also never matched Dell’s power in the enterprise market or its leadership in notebook computers, analysts point out.)

 

“It’s not simple to streamline your supply chain to have reliable sources of high-quality parts, to have very efficient manufacturing techniques, to have very tight quality control tolerances and to be able to communicate this to customers so they’re willing to pay a premium all at the same time,” Croson says.

 

One of Dell’s challenges now is to export that model, especially to the fast-growing China market, where Dell is currently the #1 foreign PC firm with 5.8% of the market. China is projected to surpass Japan as the world’s #2 market for PCs within the next few years, so Dell has been aggressive. The company has set up a manufacturing plant in the coastal city of Xiamen, just across the Straits of Taiwan from parts suppliers and within easy reach of Beijing and Shanghai.

 

At first glance, China seems like a harsh place for the Dell direct-sales model. It’s got low penetration of the Internet (although a very high penetration of cell phones), and distribution to the interior of the country is truly challenging. So Dell is targeting primarily enterprise customers and China’s major coastal cities, where most of the money is anyway.

 

“Most people live near the coast and the infrastructure outside of Hong Kong, Shanghai or Beijing probably rivals New Jersey at this point,” Cohen says. “Dell can adapt its model. In fact, it can do even better in China than in the U.S. because it’s closer to its suppliers.”

 

Dell faces some intense competition in China – not least from Legend Computer, the home-team player which practically owns the Chinese PC market. Mark Margevicius, research director with the Gartner Group, also points out that Dell’s brand “means next to nothing” in China. But Dell’s well-regarded name in the global business world should help, and the quality of its products has been serving the company well, he says. Besides, the Chinese market is growing so quickly that even a relatively small slice could be a strong profit center.

 

“If they do one-third as well in China as they did in the U.S., it will be a remarkable” performance, says Bruce Kogut, a professor at INSEAD.

 

Service Sells

The second prong of Dell’s expansion sends the company aggressively into the enterprise market. Dell’s server and NAS (Network Attached Storage) businesses have been growing great guns: Enterprise revenues grew 28% in Q4 2002, according to CSFB.

 

“The main strategic areas we are pushing are servers, storage, and services for large- and medium-sized corporations,” Dell spokesman Bob Kaufman says.

 

In that business, reliability matters more than anything else, Croson says. So it’s not a major jump for Dell to become a server name, considering it built its reputation on reliability and service in the home market. “It’s precisely the right strategy for Dell to try to leverage its brand name in the domestic household market to try to get more currency in the business market,” Croson adds. The company has been “doing a good job of bringing up its perceived quality.”

 

And business services are one major way around the slowdown in the U.S. PC industry. “Last year Dell, like everybody else, figured out that their products were rapidly becoming more and more commoditized, so they came up with an idea: There’s money and margin to be extracted in service,” Cohen says.

 

So now Dell offers not only differentiated tiers of service (such as ‘priority phone support’ that costs more) but also differentiated order fulfillment, charging more for a guarantee that systems will arrive (or even be installed) at a specific date and time.

 

“They’re gaining some margin on their ability to sell service along with the product. The trick is to ration your resources so you give priority to those you get money from, and they’ve figured out how to do that profitably,” Cohen notes.

 

Making Money Off Red Ink

Dell isn’t just extending their model across the world. They’re also expanding their product lines – most notably into printers. Although Dell hasn’t fully disclosed their desktop printer strategy, it’s widely understood that the company will start by rebranding printers from their current partner, Lexmark.

 

Dell’s Barr says printers (and PDAs, which Dell introduced in 2002) are a good fit for the company because they have “moved far enough down the cost/commoditization curve to standardize.” And the $21 billion global inkjet business is not just a very visible new consumer area, it’s a direct challenge to one of the major profit centers of rival HP.

 

The inkjet printer business uses a ‘razorblade strategy’ to make money: Manufacturers sell hardware at or near cost, and then reap profits on proprietary ink cartridges (similar to what Gillette has always done with cheap razors and expensive blades). Because Dell’s game is to play the low end of existing margin spreads and make its money back on efficiency, there is speculation that Dell will undercut rivals’ ink prices just enough for consumers to notice.

 

“If they go into the printer space, there’s a ton of margin to be made there. Instead of selling [ink cartridges] for $36, they’ll sell them for $28. They’ll make a ton of money but still undercut the competition,” Margevicius says.

 

According to Kogut, the Lexmark partnership is Dell’s one potential area of weakness. Lexmark has a weaker reputation for quality than HP and Epson – and quality is a key element of the Dell equation. “The interesting question is whether or not Dell can bring Lexmark up to the same quality standard in the market which it is acknowledged as having for its PCs,” he says.

 

Even if Lexmark printers aren’t up to Dell’s snuff, Dell may be using the partnership to get a foothold in the printer business from which to launch larger forays, Margevicius suggests. And if there’s one thing the past year should have taught rival PC makers, it’s that when Dell enters a market, it’s time to watch out.

 

“It’s not unfathomable to think that at some point in the future they will do their own product,” says Margevicius. “They’re learning the business.”

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