1 How and why did the PC industry come to have such a low average profitability

situation?

All the manufactures in the PC industry were operating on very less profit rate due to
the following reasons.

Reason 1.

Due to the increase in customer demand for PCs in the late 90s there is more
competition to capture the market between the manufactures. There were many
manufactures like Dell, IBM, Campaq, HP , Gateway and other small assemblers.
There was a price war between the manufacturers and they reduced the prices by
keeping low margin to capture the business.

Reason 2.

The second reason is the reduction the components price. For example Intels 386 DX
microprocessor was priced at $299 in 1985 and can perform 2.5 million instructions per
second ie a price of $120 per MIPS .But in 1998 it was costing $1 per MIPS .

Similarly the prices of almost all the components used to make PCs had typically
declined 25-30% per year. In 1998, prices declined even faster at the rate of 1% per
week.

Reason 3.

Most of the major PC manufacturers shifted their assembly plant to low cost countries
like China, India, Taiwan and Malaysia so that the operating cost was brought down
drastically in order to sell them at low cost.

For example Dell had plants in Malaysia and china apart from US and IBM had
subsidiary in Taiwan etc

Reason 4

Following the success of Dells Direct Model , almost all the major companies started
selling through their websites thus the cost associated with dealer commission,
advertisement and salesmans incentive all brought down which led the company to sell
at lower price.

Reason 5

Another major reason for low profitability of PC industry is the Customers buying
behavior.
Since there are more choices for the same specification, the customer started buying
from a supplier who offers a lower price. This forced the suppliers to reduce their margin
to capture the business and whoever selling for a low price captured the considerable
share in the market.

This brought down the market share of IBM in PC market who was the leader in the
market until the price war .

Reason 6

The final reason for the reduced profitability is the ease of setting up a manufacturing
plant. With a million dollar capital investment one can easily set up an assembly plant
capable of assembling 250000 PCs per year . This led many companies to start
manufacturing the PCs mostly a clone of IBM but with lesser cost.

Since there are more suppliers offering their product to attract the customers it has
become customers market and customers prefer the product with a lower price . This
led to the price war.

Question 2

Why Dell have been successful despite the such low average profitability in PC
industry?

The success of Dell is due to many reasons and they are as follows.

1Dells segment targeted approach and positioning of its product resulted for its huge
success. Unlike IBM, Dell focused mainly on PC Industry segment and 97% of its
revenue was coming from PC market.

2 One of the important reason for Dells success is the Direct Model approach of
sales. When the competitors sold primarily through distributors , resellers and retail
sales Dell took orders directly from the corporate customers and shipped directly to the
customers. Thus Positioning of the product to customer in a competitive market in a
different way resulted for its success.

3 Dell supplied computers as per the corporate customer specifications and assembly
commenced only after Dell received an order.

4 Since Dell incurred losses on retail sales in 1993 Dell was not keen on retail sales.
Only 5% Dells sales were from resellers. But even for this Dell didnt allow returns and
it didnt give the purchase protection which normally all the major suppliers do.
5 Since Dell made customized PCs based on actual orders and so there is no finished
goods inventory which is very important for a successful company.

6 Dell had manufacturing plants in Ireland, China, Malaysia and Brazil apart from US
where the manufacturing costs are considerably less. All these plants are very much
integrated which eliminated buffer stocks.

7 Dell worked closely with suppliers to arrange just in time delivery of parts. Thus Dell
reduced its raw material inventory from 32 days in 1995 to 7 days in 1998.

8Dell had close electronic link with some suppliers and directed them to supply directly
to the customers. For example monitor supplier Sony was asked to deliver directly to
customers instead of Dell thus reducing transport cost and time.

9 Dell encouraged suppliers to locate ware house and production facilities close to its
assembly operations , a move helps for Just in time delivery from suppliers.

10 Dells after sales service was very good. Nearly 90 % of the customer complaints
were solved over telephone using the diagnostic software .For problems required on
site visit ,Dell contracted out the service and most of the problems were solved within 48
hours.

11 Dell managed the receivables and payables in such a way that it received payments
for its products in 5 days before it had to pay for the suppliers.

All the above reasons made Dell to sell more by reducing the price and making the
customer happy by customized solution and it captured 13% of total US PC sales within
a short period. And unlike IBM and HP Dell focused mainly the PC market and 97 % of
Dells sales comes only from PC market.

3How big is Dells competitive advantage? Calculate the same over Compaq and
reseller?

Dells has a advantage than its competitors by receiving orders directly from customers
and avoiding distribution channels. This enabled Dell to attain cost leadership and
competitive advantage in the PC market.

The decision to eliminate wholesale and retail dealers proved to be a significant cost
cutting measure. It also provided for a less expensive and efficient way of distribution
and production of computers.
Furthermore the direct model also gave Dell a better understanding of their customers,
as their sales team remained in close contact with them, versus their resellers and
distributors.

Dell was able to accomplish this by aligning and integrating their supply chain directly
with customer expectations.
Dells competitive advantage is derived from 3 sources, namely:
1. Just In Time (JIT) purchasing of components (avoiding falling prices)
2. Lower inventory costs (avoiding carrying and inventory costs based on cost of capital)
3. Distribution channel related costs and markups (which increases prices to the
customer).

Competitive Advantages over Compaq , HP & Gateway in the year 1998

Category Dell Compaq HP Gateway

Net income / 7.7% -8.8% 6.3% 4.5%
Revenue
Inventory Days 7 34 70 10
Value of 97% 89% 25% 93%
PCsale/
Revenue
Return on 63% -24% 17% 26%
equity

Question 4 How effective have been the competitors move in responding to Dells
strategy?

Dells strategy:

Direct deal with the customers by supplying tailor made products as per customer
specifications. Production starts only after getting the order.

Supply the product with relatively low price by reducing the inventory by following JIT
method, avoiding distribution channels
Good after sales service enabled it to gain good name in the market.

Competitors Move in response to Dells strategy:

IBM

To counter Dells Direct sales model IBM followed Authorized Assembly

Programme(AAP). In this IBM shipped lightly configured PC known as Model 0 to
downstream partners and the channel partners completed the assembly by as per
customer specifications by purchasing components from IBM.

This move did not yield enough results to IBM because though the customer was
getting the tailor made product the price was high because still it was selling through the
distribution channels and they need to keep some margin at their end. This move
helped to reduce the inventory days of the distributors but not IBM because still IBM
was producing against the forecast from distributors .

So IBM started explored options to start its own direct sales program and launched a
new product under the name of AMBRA , a low cost product but it failed and so IBM
closed it in 1994.

In 1998 IBM opened a website that allowed individual customers to buy through the site
directly and later under the Netfinity direct program allowed large enterprises to
purchase a particular line of IBM servers without going through resellers.

Due to this move the PC operations unit which was under loss until 1998 started making
profit by the end of 1998.

Compaqs Move to counter Dells strategy:

Like IBM , Compaq also was selling through distribution channels and retailers initially.
Further to Dells success , Compaq launched an online catalog in 1993 but abandoned
the initiative in the face of channel resistance.

Again in 1996 Compaq introduced a toll free number that allowed consumers to order
directly from Compaq but to satisfy the resellers Compaq kept the prices higher and so
it didnt give enough results.

Like Dell, Compaq started Optimum distribution model(ODM) in which PCs were built
after an order was received .This is a move which reduced the inventory from 50 days
to 25 days , but still it preferred to sell through channels like IBMs two stage process for
customized solution and so this move didnt give enough results
So in 1998 Compaq unveiled the directplus program where it started selling directly to
customers through internet and telephone.

This move allowed Compaq to breakeven in the first qtr of 1998 to post profit by the end
of 1998.

Hewlett Packard

Like other major players HP also was selling through distributors and resellers till the
middle of 1997.

After seeing the tremendous success rate of Dells customized product solution HP also
offered a program called Extended solutions partnership program( ESPP) like Dell and
compaq. As per ESPP , HP builds PCs in their plant as per customer specification and
deliver it through the resellers. HP tried to take advantage with the channel partners
who were unhappy with Compaq when Compaq launched its Directplus programme.

But latter HP also started Direct sales through its website for individual customers but
still HP requested the Business customers to complete purchases through resellers.

Gateway

Gateway also followed the same principle of Dells direct model and it has become the
second largest direct PC maker after Dell.

Gateways focus was on the home and small officer yielded good results since Dell was
focusing on large business customers.

But still Gateways profit was not as much as of Dell because Gateway didnt follow the
lean principle like Dell and it resulted in excess inventory.

Conclusion

Thus all the competitors of Dell followed Dells strategy of Direct Model in some or other
way to stay in the market and got benefited by following Dells strategy.

What should the major rivals ( IBM, HP ,Compaq , Gateway) In the market place do
now?

In the year 2002 HP and Compaq which had a market share of 7 % and 11%
respectively merged together. But still Dell was leading the market with a market share
of 16% until 2006 which was closely followed by HP-Compaq . In 2007 HP-Compaq
took the leadership and in 2010 HP-Compaq was the market leader with a market share
of 18% and Dell was closely following it with a market share of 13%. IBM and Gateways
markets share fell down further to sixth and tenth position respectively in 2010.