Dell's Effect on Profit Margins of the Computer Industry
Length: 1137 words (3.2 double-spaced pages)
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Historically the personal computer (PC) industry has sold its products at reasonably high prices yet garnered only small profit margins. One reason for this is the high competition in the PC industry which led to competitive pricing among producers. Analyzing the competitive environment of the PC industry, it is evident that there is very little barrier to entry in this market. PC's have very low physical uniqueness and are made of standard components that require very little expertise to assemble.
Capital requirements to set up an assembly line to produce PC's are also relatively low, estimated at roughly a million dollars (Rivkin & Porter,1999 pg. 5) which means that virtually any firm can enter the market easily. Despite sky rocketing demands for PC's, PC producers are unable to capitalize due to increasing number of competitors. The PC industry is also affected by environmental turbulence due to price fluctuations of its components. Constant innovation in PC technology causes older components to be rendered obsolete and prices of older versions to plummet. PC producers who are stuck with inventory of obsolete products incur high costs of dumping these components.
PC manufacturers who limit their inventory to reduce the impact of price fluctuations are at a cost disadvantage by failing to reduce costs through economies of scale in purchasing components. Therefore PC manufacturers face high risk when stocking components and essentially loose out on profitability due to changes in technology.
The existence of many large manufacturers in addition to the continuous entry by smaller manufacturers results in limited differentiation and decreased competitive advantage among PC manufacturers. All manufacturers have access to similar suppliers and therefore have the same buying power especially for processors which are sold at the same price to all manufacturers. It is clear that the competitive advantage in the PC industry is not sustainable as easy replication by competitors promotes price wars which lower profit margins for the industry as a whole. Ultimately, high competition and price fluctuations have led the PC industry to low profitability.
Why has Dell been so successful despite the low average profitability in the PC industry?
Dell has been successful due to its differentiated strategy compared to its competitors.
The Direct Model' that Dell adopted has been highly successful in reducing its bottom line costs. Comparing the margins in 1994, Dell retail had 7% gross margin and Dell direct 19%; despite higher operating expense in the direct channel overall income was higher through this channel. By reducing the costs of using resellers and distributors, Dell was able to sell at lower prices which were attractive consumers.
Through its direct interaction with customers, Dell was also able to understand the needs of its customers better than the competitors. With this key information Dell subdivided its customers into categories where it could target them with specific products and services which ultimately boosted sales. This market focused initiative with customized products differentiated Dell from its competitors. Dell also tied up contracts with large companies and institution which placed large orders, and through its relationship with Dell placed repeat orders as well. By investing heavily in technology, Dell further reduced its operational costs with the launch of its website where customized purchases could be done online.
The after sales support of Dell had built up an excellent reputation in the industry, as proven in the customer surveys done in 1998. Customer problems were solved using diagnostic software with 90% cases resolved over the telephone. This reputation increased the brand value of Dell which encouraged sales and repeat buyers through brand loyalty.
Dell's unique capability was not only through its direct selling but also its efficient manufacturing line. Through collaboration with suppliers, Dell coordinated its supply chain and manufacturing line to reduce its days of inventory to 7 days in 1998. Co-location of suppliers' facilities to Dell manufacturing sites and electronic communication links made replenishment of inventory easy and quick. Limiting inventory and efficient manufacturing processes resulted direct cost advantages over its rivals. This efficient use of resources which Dell perfected over time meant that it was able to be much more profitable compared to the competition.
Dell's extensive sales, service and support network as well as its superior supply chain and manufacturing process flow are critical factors in its success in a low profitability industry. This competitive advantage was unrivaled in the 1990s which was the basis for Dell's profitability.
How effective have competitors been I responding to the challenge posed by Dell's advantage? How big is Dell's remaining advantage?
Based on 1998 data of comparison of major PC manufacturers, it is clear that Dell is way ahead of its rivals with an impressive 62.9% of return on equity. However, due to the transparency of competitive advantage that Dell possessed, the likelihood of imitation by its strongest competitors was extremely high. For example, Gateway which operates on a similar strategy as Dell did surpass Dell briefly in 1994.
Major PC manufacturers could not effectively challenge the dominance of Dell despite the fact that the direct business model was regarded as easy to imitate. This was due to the fact that the challenge was deriving value out of the business model itself. The complexity of building an efficient supply chain and production system could not be met immediately by Dell's competitors. Costly changes in infrastructure and relocation of facilities is an economic deterrence to competitors. Imitating Dell's model requires investment in technology and hiring of experienced work force. Dell also created a very strong brand value and loyalty, which other firms can only acquire very slowly at high expense. However this will not deter the competition in the extremely volatile PC industry.
2003 data shows that there is a small risk that Dell's remaining advantage will be eroded due to imitation by its rivals. Dell's rivals have been effectively improving their sourcing, production and distribution system with mixed results. Notably, Gateway has managed to reduce its days in inventory to 10 days. Dell's capabilities are durable and difficult to imitate but Dell must continue to innovate in order to maintain its market leadership in the future by leveraging its economies of experience.