A value chain
is the linked set of value-creating activities
all the way through from basic raw material sources
for component suppliers to the ultimate end-use
product delivered into the final customer's hands.
Superior value chain architecture is one that,
from the customer's point of view, has slashed
costs and/or greatly enhanced the value. Examples
of companies that have designed far superior value
chain architectures include Nucor, the world's
most efficient steel manufacturer; Ikea, the world's
largest furniture retailer; Wal-Mart, the world's
largest retailer; Amazon.com, the world's largest
virtual bookstore; and the specific example here,
Dell, the world's largest "direct sales"
personal computer company. (Anderson, 1999).
Background of Dell Computer
As of 1999, Dell Computer Corporation boasted
16,000 employees in 33 countries and millions
of customers in 170 countries. Headquartered in
Round Rock, Texas, near Austin, the company was
founded in 1984 when Michael Dell pioneered the
process of selling custom-built computers directly
to customers. Within its short life of 17 years,
Dell has become the number one retailer of PCs,
outselling IBM, Hewlett-Packard, and Compaq. Businesses
of all sizes, government agencies, educational
institutions, and individual customers have ordered
Dell's desktop and notebook computers, workstations,
and network servers by phone or via the Net. (Alexander,
1997).
In 1996, Dell embraced the Web. By late 1999,
more than 40 percent of its sales emanated from
this channel. On the Internet, customers are in
"control." They can use the Web 24 hours
a day, 7 days a week, at their own convenience,
to configure, price, and order computer systems,
get current information on order status and delivery,
and access technical reference materials on hardware
and software. Dell computer systems are assembled
one at a time, as ordered, at factories in Austin;
Limerick, Ireland; and Penang, Malaysia. Dell
outsourced delivery to other firms with far superior
core competencies in logistics to ensure that
custom orders are delivered within a few days.
It also provides an extensive range of value-added
services, including system installation and management,
after-sales service, and technology-transition
planning and execution. Its own on-site system
engineers and consultants as well as employees
of strategic service partners give Dell an army
of more than 10,000 service providers around the
world. (Aldrich, 1999)
Dell has outpaced its competitors in both growth
and profitability. Its market capitalization was
about $700 million at its June 1988 IPO. By 1999,
that had grown to well over $100 billion-an increase
of more than 140 times over an 11-year period,
dramatically above that of Standard & Poor's
500. At age 34, Michael Dell had become the richest
man in the world under 40. His company had created
enormous value for customers and shareholders
by adopting radically different value chain architecture
in the PC industry. (Dell tops Compaq…..1999).
Redesigning of the Value Chain of Dell
The traditional value chain in the personal computer
industry could be characterized as "build-to-stock."
PC manufacturers designed and built their products
with preconfigured options based on market forecasts.
The products were first stored in company warehouses
and later dispatched to resellers, retailers,
and other intermediaries, who typically added
a 20 to 30 percent markup before selling to their
customers. Manufacturers controlled the upstream
part of the value chain, leaving the downstream
part for middlemen. Retailers justified their
margins by providing several benefits to customers:
easily accessed locations; selection across multiple
brands; the opportunity to see and test products
before purchasing; and knowledgeable salespeople
who could educate customers regarding their choices.
Two trends in the 1980s allowed Michael Dell to
radically reengineer the value chain. First, corporate
customers were becoming more and more sophisticated
and no longer required intense personal selling
by salespeople. By the end of the decade, even
individuals--especially those buying their second
or third PCs--had become savvy and experienced
technology users. Second, the different components
of a PC (monitor, keyboard, memory, disk drive,
software, and so on) became standard modules,
permitting mass customization in system configuration.
When Dell developed its "direct" model,
it dramatically transformed the value chain architecture
by departing from the industry's historical rules
on several fronts:
1. It outsourced all components, but performed
assembly.
2. It eliminated retailers and shipped directly
from its factories to end customers.
3. It took customized orders for hardware and
software over the phone or via the Internet.
4. It designed an integrated supply chain linking
its suppliers closely to its assembly factories
and the order-intake system.
Three major benefits ensued from this new architecture:
technology advantage; cost advantage; and customer
knowledge advantage. (Austin, 1998)
Technology Advantage
Dell custom-built its machines after receiving
an order, instead of making them for inventory
in anticipation of orders. Thus, it had very low
levels of components as well as of finished goods
inventory; on average, inventory turnover for
Dell was 7 to 1 days, compared to 70 to 100 days
for other PC manufacturers and their resellers.
Low inventory translated into a huge technology
advantage.
Microprocessors and other component technologies
kept advancing at a relentless pace. Because Dell
essentially had no finished goods inventory in
the pipeline, it enjoyed a first-mover advantage
in bringing leading-edge component technology
to the marketplace. Its components were 60 to
80 days newer than those in IBM or Compaq PCs,
so it could introduce new products faster than
its competitors. (Magretta, 1998)
Cost Advantage
Dell derived cost advantage in three areas: component
purchasing; inventory and working capital; and
selling and administration. First, because the
cost of computer components kept declining, and
because Dell purchased its components on a just-in-time
basis, it enjoyed a component cost nearly 6 percent
lower than that of its competitors.
Second, radical reductions in inventory helped
Dell save on the interest of financing the inventory
as well as warehousing and storage costs. With
its direct channel to customers, Dell eliminated
the need to mark down inventory not sold by retailers,
thereby minimizing the cost of product obsolescence.
And its direct dealings with individual customers
ensured immediate payment by credit card, which
meant a lower investment in accounts receivable
investment and insignificant bad debt risks. Moreover,
Dell enjoyed normal credit terms from its component
suppliers. As a consequence, it operated with
negative working capital: in 1998 it had 36 days
in accounts receivable and seven days in inventory,
but 51 days in accounts payable--for a negative
18 days of sales in working capital!
Third, bypassing the retailer and establishing
a direct interface with customers via phone and/
or the Net eliminated the typical markup and extra
sales force of the middleman, as well as the need
for physical space at distributors' showrooms.
And the Net helped reduce sales costs further
by cutting down on telephone personnel salaries,
toll-free call charges, and the bricks and mortar
for the telephone service center. (Aveni, 1994)
Customer Knowledge Advantage
Direct contact with customers helped Dell gain
a superior understanding of specific customer
needs. Each of its several market segments multinational
corporations (MNCs), medium-sized businesses,
small firms, individuals, the federal government,
state and local governments, and educational institutions--had
unique computing needs and different buying processes.
Global service capabilities were critical for
MNCs; mid-sized companies placed a high value
on presale, product repair, and help-desk support;
and so on. By organizing its marketing and sales
functions around distinct customer groups, Dell
was able to address varying customer needs with
greater precision and speed.
Proprietary information about customers' purchasing
patterns also gave Dell a superior ability to
forecast demand, which in turn helped it maintain
minimum inventory without suffering the problem
of "stock-outs." Those purchasing patterns
helped Dell forge lifelong customer relationships.
For instance, it understood better than its competitors
which customers would benefit most when newer
versions of hardware and software were available,
so it could actively market them to the right
customer segments. By owning these relationships
with customers, Dell not only avoided getting
"filtered" information from third-party
retailers but also insulated itself from poor
service and a lack of product knowledge on the
part of retailers. (Govindarajan & Shank,
1991)
Dell’s Virtuous Cycle
Dell created a "virtuous" cycle (the
opposite of a vicious cycle) by rewriting the
rules of the PC industry, custom-configuring PCs
through direct dealings with end users. Customer
intimacy gave Dell superior forecasting ability,
which allowed it to pursue JIT manufacturing with
very low levels of finished goods and components
inventory and little risk of stock-outs. Radical
reductions in inventory not only lowered costs
but also enabled Dell to be first to market with
the latest products. The net result was that Dell
had the dominant share of the PC market, which
in turn led to more customers contacts-thereby
starting the cycle all over again.
The new value chain architecture also enabled
Dell to globalize faster and more profitably than
its competitors for two reasons. First, Dell's
direct model yielded the same benefits in non-U.S.
markets as it did at home. Second, because of
its direct channel, Dell--in contrast to IBM and
Compaq--did not require access to local distribution
channels and so faced lower entry barriers into
foreign markets. Whereas many MNCs found it difficult
to make money in China, Dell had achieved profitability
within a year of entering the country in August
1998.
IBM, Compaq, and Hewlett-Packard probably found
it difficult to imitate and neutralize Dell's
direct model for fear of alienating their dealers.
The bulk of these companies' sales came through
third-party dealers. If they set up direct channels,
their distributors, retailers, and resellers would
be upset at the loss of market share, and the
companies could not run the risk of angering their
critical constituency. (Magretta, 1998)
Key Ideas for Value Chain Redesign
As the case of Dell Computer illustrates, there
are three principles that should guide the redesign
of the end-to-end value chain architecture. First,
its two central attributes must be redesigned:
(1) the set of activities that will constitute
the new value chain and (2) the interfaces across
the activities. In eliminating the role of middlemen
altogether, Dell redesigned the set of activities
comprising the chain. However, the company did
not stop there. It built deep relationships at
both ends--with suppliers as well as customers.
Such virtual integration without vertical integration
represents a redesign of the interface across
activities on Dell's part.
Second, the new value chain must create dramatic
gains in one or more of three areas: cost structure,
asset investment, and speed of responsiveness
to external changes. Compared to traditional competitors,
Dell's direct model had the following unique combination
of features: significantly lower costs, negative
working capital investment, custom-built machines,
first-mover advantage in offering leading-edge
component technologies, high quality and reliability,
an efficient and convenient purchasing process,
speed of delivery, and excellent after-sales service.
(Dell & Fredman, 1999)
Third, the new value chain must enable the company
to scale up its business model to ensure rapid
growth in market share, high-velocity globalization,
and expansion into related products and services.
On the upstream side, Dell relied totally on third-party
component suppliers; on the downstream side, it
completely eliminated reliance on local distributor
channels; and the Net-based Dell Online channel
allowed it to sell a large variety of PC-related
peripheral products, such as printers and cameras.
As a result, Dell's business model has perhaps
been the most rapidly scalable within the PC industry.
(Govindarajan & Shank, 1991)
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