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Matching Dell Harvard Business School 9-799-158 June 6, 1999 Professors Jan W. Rivkin and Michael E. Porter prepared this case from public sources with the assistance of Research Associate Faramarz Nabavi as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. The case draws on a report prepared by Charlie Bruin, Markus Cappel, Tom Galizia, and Laila Worrell, all MBA 1998. Copyright © 1999 by the President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685 or write Harvard Business School Publishing, Boston, MA 02163. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School. 1 Matching Dell Between 1994 and 1998, the revenue of Dell Computer Corporation rose from $3.5 billion to $18.2 billion, and profits increased from $149 million to $1.5 billion. The company’s stock price rose by 5,600%. During the same period, Dell grew twice as fast as its major rivals in the personal computer market and tripled its market share. In the first half of 1998, Dell reported operating earnings that were greater than the personal computer earnings of Compaq, Gateway, Hewlett- Packard, and IBM combined.1 On Forbes magazine’s list of the richest Americans, Michael Dell, the 33-year-old founder of Dell Computer, ranked fourth with an estimated worth of $13 billion. He trailed only Bill Gates, Warren Buffett, and Paul Allen on the list and was worth more than Gates had been at the same age.2 Dell Computer had pioneered the widely publicized “Direct Model” in the personal computer (PC) industry. While competitors sold primarily through distributors, resellers, and retail sites, Dell took orders directly from customers, especially corporate customers. Once it received an order, Dell rapidly built computers to customer specifications and shipped machines directly to the customer. The success of the Direct Model attracted the intense scrutiny of Dell’s competitors. By 1997, headlines such as “Now Everyone in PCs Wants to Be Like Mike,” “Compaq Reengineers the Channel: Will It Be Enough to Slow Dell’s Momentum?” and “In Search of Greener Pastures, Gateway Moves on Dell’s Turf” peppered the PC trade press.3 By late 1998, virtually every major PC manufacturer had taken some step to match Dell’s approach. The Personal Computer Industry History. Electronic computers emerged from military research undertaken during World War II. In 1949, the magazine Popular Mechanics predicted that “Computers in the future may…perhaps only weigh 1.5 tons.” For the following three decades, large mainframe and minicomputers, produced by vertically integrated firms such as IBM and Digital Equipment Corporations (DEC), dominated the market. As late as 1977, Kenneth Olsen, founder of minicomputer maker DEC, opined, “There is no reason for any individual to have a computer in their home.”4 For the exclusive use of T. Phan, 2020. This document is authorized for use only by Trang Phan in MGMT 449_THUR_Spring 2020 taught by JUNG YEON LEE, Kennesaw State University from Jan 2020 to Jul 2020. 799-158 Matching Dell 2 However, electronic hobbyists were already purchasing mail-order and retail kits which allowed them to assemble primitive computers at home. These kits pieced together components that were either altogether new or newly affordable: microprocessors made by start-ups such as Intel, random-access and read-only memories, power supplies, and so forth. (A Glossary at the end of the case defines technical terms.) Between 1975 and 1981, a series of firms began to offer increasingly integrated, pre- assembled personal computers.5 Start-ups such as Apple Computer and MITS, and midsize firms such as Tandy / Radio Shack and Commodore, led the early market, gaining popularity among hobbyists and educational institutions with easy-to-use machines for ordinary people. Established firms including Texas Instruments, Hewlett-Packard, Zenith, NEC, Xerox, IBM, Toshiba, Sanyo, Sony, Olivetti, Wang, and DEC soon joined the entrepreneurs and began to produce PCs. IBM launched its first PC in 1981 and, two years later, held 42% of the market. With a world- renowned corporate sales force and service organization, IBM commanded 61% of the market for mainframe computers and produced many of the components for its mainframes.6 In launching its PC, however, IBM purchased many components. It commissioned a start-up software firm, Microsoft, to write the operating system for its PC and adopted a microprocessor architecture designed by Intel. Publishing most of the specifications for its PC system, IBM established an “open architecture” to encourage software developers to write programs for the IBM PC and to spur other firms to make compatible peripherals such as printers. Most of the industry rapidly rallied around the IBM standards. By 1983, the major alternative standard, a proprietary system championed by Apple, held only 20% of the market.7 IBM used its huge sales force to sell personal computers to large corporate accounts. Volume discounts encouraged large firms to centralize PC purchases through corporate MIS departments, with whom IBM sales people had strong relationships. To serve small businesses and individuals, IBM turned to retail stores such as Sears and Computerland.8 It also encouraged the development of a network of distributors and dealers known as value-added resellers. These resellers not only sold PCs to customers, but also guided them through the purchase of what was still an unfamiliar product. Resellers commonly handled installation, configured software, pieced together customer networks, and serviced machines on an on-going basis. In small and midsize businesses, employees rarely had the skills to do what resellers did, and few companies had enough PCs to justify hiring trained personnel. As demand for IBM’s PCs exploded, other firms began to offer “IBM clones.” Compaq entered the market with a low-priced portable clone in 1982 and booked $100 million of revenue during its first year, making it the fastest growing firm in American history. A host of other start-ups followed Compaq’s lead and entered the market with IBM clones. Among these entrants was Dell Computer Corporation, incorporated in 1984. During the same period, most established competitors such as Hewlett-Packard shifted from proprietary architectures to the IBM standard. Like IBM, makers of IBM clones relied on resellers and retail stores to reach customers. While IBM initially steered resellers away from the largest corporate accounts, start-ups such as Compaq without internal sales forces encouraged resellers to cater to large customers. In time, even IBM relied heavily on resellers to service large accounts. By 1986, IBM realized that it had set a standard, but in doing so, had spawned a set of imitators while ceding the rights to the most valuable components of the PC—the microprocessor and the operating system—to Intel and Microsoft. In 1986, IBM declined to adopt Intel’s third-generation microprocessor, the 386 chip. In introducing its PS/2 line of computers in 1987, IBM tried to make the PC more proprietary. Compaq both adopted the 386 chip and led a group of nine clone makers in affirming the existing industry standards. Though IBM subsequently accepted the 386, its market share fell from 37.0% in 1985 to 16.9% in 1989.9 For the exclusive use of T. Phan, 2020. This document is authorized for use only by Trang Phan in MGMT 449_THUR_Spring 2020 taught by JUNG YEON LEE, Kennesaw State University from Jan 2020 to Jul 2020. Matching Dell 799-158 3 Throughout the 1980s and 1990s, PC performance improved and prices fell at a rapid clip. Intel’s 386DX microprocessor, introduced in 1985, was priced at $299 and could perform 2.5 million instructions per second (MIPS)—a price of $120 per MIPS. Intel’s Pentium II microprocessor, launched in 1998, was priced at $699 and could carry out 675 MIPS—$1 per MIPS.10 In addition, the range of software available for the personal computer expanded dramatically. Microsoft released its new operating system Windows 3.0 in 1990, and over the next four years, the user-friendly Windows became ubiquitous on PCs configured to the IBM standard. Indeed, the standard soon became known as “Wintel,” reflecting the combination of the Windows operating system and Intel’s x86 microprocessor architecture. By 1991, between 85% and 90% of computers sold conformed to Microsoft / Intel standards, with the remainder using the proprietary Apple operating system and a Motorola microprocessor. The initial surge in sales of personal computers crested in 1990, just as a recession gripped the United States. In newspapers around the world, Dell Computer ran advertisements showing that its prices were much, much lower than Compaq’s list prices. Compaq usually discounted its PCs well below the list price, but the advertising campaign was highly effective. In response, Compaq slashed its prices by as much as 32%, introduced 41 new products in 1992, and added new distribution channels.11 A vigorous price war followed. Demand growth recovered in the mid-1990s, buoyed by strong economic growth and the emergence of new, popular services involving computer networks. Proliferation of electronic mail and growth of the World Wide Web gave customers, especially individual consumers, new reasons to purchase a personal computer. PC prices continued to decline. Compaq offered a powerful personal computer for less than $1,000 in 1997, and other companies rushed to offer similarly inexpensive PCs. By December 1998, the prices of the least expensive PCs had plunged to $499. In the United States, 45.5% of households owned a computer in 1998, and the figure was expected to rise to 49.5% by 2000.12 Household ownership levels were lower but also growing in Europe and Asia. See Exhibits 1 and 2 for market size and share data over time. Products in 1998. PC makers followed well-established standards to piece together modular components of hardware and software. The resulting machines differed widely in their processing speeds, memory capacities, portability, software configurations, modem speeds, and screen sizes, for instance. Hardware components such as housings, keyboards, memory chips, motherboards, disk drives, monitors, modems, and connectors could be purchased in highly competitive global markets served by numerous companies. In contrast, microprocessors were supplied by only a handful of companies. Intel dominated this market, providing 80-90% of the microprocessors for Wintel PCs.13 By 1998, roughly 96% of new PCs followed the Wintel standard.14 Virtually all of the rest employed the Apple standard with PowerPC microprocessors.