MEMO
Date: February 7, 2015
Re: Observations from Matching Dell case
History of low average profitability of the PC industry
Prior to 1980, there were several startups offering pre-assembled personal computers but it was not until 1981 when IBM entered the market that any one firm held significant market share. IBM gained almost half of the market quickly but during that time, they had not been able to gain much efficiency. They were purchasing many components and selling through retail stores. They published all the specifications for their pc system for others to develop compatible peripherals. Within a few years, demand exploded and other companies created clones fairly easily with the IBM specs that were posted. Throughout the 1980s and 1990s performance improved and prices fell. Hardware components were readily available and lines between competition blurred. PCs were sold through retail stores, distributors, integrated resellers and to a lesser degree direct distribution. Profit margins were low as a result.
Dell’s Success
Dell entered the market with direct sales and very little overhead, just in time delivery, almost no inventoried machines and very high profit ratios. This left every other manufacturer scrambling to keep up since they had significant distribution costs to deal with. Several competitors attempted direct to the public sales but did not price their product appropriately for fear of upsetting their distribution channels. It appeared as though Dell forgot their competitive advantage in 1990 when they entered into the retail channel. By 1994, they quickly withdrew due to losses on their retail division. Over time, the price differential between Dell and its competitors disappeared but their advantage in inventory turnover remained large.
Dell’s Competitive Advantage In 1996, Dell’s competitive advantage over Compaq is due to Dell’s ability to produce a less expensive PC than Compaq. As a result Compaq must charge a 24% higher price to compensate for 21% higher costs, spread amongst cost of goods sold, SG&A and R&D expenses. Specifically, the total cost per pc are an average of