July 3, 1998    Volume 5, No. 13

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Dell's Make-To-Order System Leaves Competitors In The Dust

The Internet is upending the model for how businesses operate, and companies that don't take advantage of the change will have a difficult time staying afloat, says Michael Dell, chairman, CEO and founder of Dell Computer Corp.

"With the advent of the Internet, process innovation will no longer be measured in minor increments," he told the World Congress on Information Technology in Fairfax, Va. "Instead it will be possible to revolutionize processes in a way that blurs traditional boundaries between supplier and manufacturer, manufacturer and customer. This is already shrinking time and distance to a degree not possible ever before." The Internet, he adds, is "turbocharging" Dell's already turbocharged business.

Dell Computer is a case study of the power of this emerging business model. Sales are soaring, due to Dell's build-to-order manufacturing system which is dependent on the integration of information technologies throughout all aspects of the company's operations. Dell describes his company as being "virtually" integrated, as opposed to vertically integrated.

"In the case of computing technology, vertical integration was necessary in the early years," he explains. "The supplier base was not well established, leaving companies no choice but to design and manufacture product components themselves. In this environment, proprietary technologies, priced at a premium, provided the main source of competitive advantage."

But the vertically integrated companies, like Digital Equipment, are going extinct. Virtual companies like Dell have established direct relationships "that close the gap between customer, manufacturer and supplier," he says. Virtual companies know precisely how to add value and they have established partnerships with best-of-breed suppliers. These suppliers are integrated within their businesses and must perform to the same quality standards and metrics. Virtual companies use the Internet not as an add-on, but as an integral part of their strategies. "Only then can you use it to cross traditional company-to-company boundaries to achieve virtual integration," Dell told the 1,700 attendees from 100 different countries.

Michael Dell, 32, started his company with $1,000 and sold PCs directly to customers. His business model of partnering with suppliers and customers flowed naturally from these humble beginnings. "In this way, Dell obtained the benefits of tightly coordinated supply-chain management that have normally been associated with vertically integrated companies," he explained. "Building a $14-billion business in 14 years like Dell was unthinkable just a decade ago. By integrating virtually with both our customers and suppliers, we have been able to achieve a highly scalable business and grow at five times the industry rate."

The Internet is propelling Dell to even greater heights. The company is now selling $5 million of products online every day and Internet sales are approaching an annual run rate of $2 billion. "But online commerce and the use of the Internet as a sales channel represent only a fraction of the Internet's value to business," he says. "The real potential of the Internet lies in its ability to transform relationships within the traditional supplier-vendor-customer chain."

The Internet is enabling the company to share information from its internal processes with suppliers and customers, "creating true information partnerships," says Dell. The rapid flow of information is saving time and money. "It transforms organizations by eliminating paper-based functions, flattening organizational layers and integrating global operations seamlessly."

Companies that adopt such information partnerships "have the potential to fundamentally change the face of global competition and change our definition of the value we provide to our customers and constituents."

Dell creates individual web pages for its customers that can be accessed with a password through its Internet site. These "Premier Pages" contain detailed account information unique to companies such as Ford Motor and Shell Oil. Information is drawn from the same databases used by Dell's engineers and technicians. "This doesn't necessarily result in major cost savings for Dell," says Dell. "But it HAS resulted in significant cost-savings for our customers, enriching their relationships with Dell."

The company also is building similar web pages for its top 20 suppliers, who provide about 90 percent of the components Dell purchases for its computers. These pages "will allow our suppliers to provide us with rapid information on their capacities, capabilities, inventories in their supply lines, component quality and current cost structures."

This emerging Internet based system enables Dell to provide direct and immediate customer feedback to suppliers concerning quality and reliability of their components, current forecasts and future demand, special technical requirements and pricing. The page Dell has created for Intel "allows us to much more quickly and efficiently manage order and flow and to control just-in-time delivery of inventory," says Dell. The system soon will be tied to all of Dell's suppliers' factories throughout the world.

"By working virtually with Dell, we challenge our suppliers to reach new heights of quality and efficiency," says the young business icon who is worth more than $1 billion. "This improves their process and their inventory control, which creates greater value for them, as well as for Dell."

Thanks to the Internet, Dell soon will be measuring inventory in hours or even minutes, instead of days, "moving from just-in-time delivery to real-time delivery," he explains. "I do not think this vision is that far into the future." The company has reduced inventory from more than 30 days a few years ago to fewer than eight days today.

"No longer can a manufacturer afford to treat a supplier from whom every last ounce of cost-savings must be wrung," he says. "Nor can a customer be treated simply like a market for products and services at the best possible price. Instead, both suppliers and customers must be treated as partners and collaborators - jointly looking for ways to improve efficiency across the ENTIRE spectrum of the value chain, not just in their respective businesses. In the virtual economy, collaboration is a new competitive imperative. It is an imperative I urge you to consider." Dell's web site is www.dell.com.

Shortly after his presentation, Dell sat down with a small group of reporters including Manufacturing News editor Richard McCormack. Here is what he had to say.
 

An Interview With Dell Founder Michael Dell
 

Q: How hard is it going to be for Apple and Compaq to go to a make-to-order manufacturing system similar to yours?

Dell: It depends on whose order they're making it to. Making it to the dealer's order is pretty easy. Making it to the customer's order is a whole other matter.

A lot of these guys talk about build-to-order and what they're really talking about is building to the dealer's order. So when you go into the store and look up at those systems, those were built to order -- built to somebody's forecast of what somebody was going to buy and hopefully they were right. But as we see right now with four or five or six weeks or however much inventory there is in the channel, obviously they have more mistakes than successes.

     
Q: So how hard will it be for them to build to the customers' order similar to your model?

Dell: What you first have to do is extract the dealer from the relationship and the dealer might not like that because they are fundamentally a dealer. They like to deal with things. They sell things and
they make money on them and if they don't sell one company's products, they'll sell somebody elses'. This is the whole issue of channel conflict. It gets back to this idea that the traditional business system was set up for a long series of events that were all strung together and if you just take a web site and stick it on the end of the very last one, it doesn't create all of the benefits a company like ours has; it's just a web site. You have to fundamentally change the way the business works before you get the benefits.

    

Q: Do the OEMs face the risk of becoming commoditized? With everybody using the same types and sizes of hard drives, mother boards, the machines are becoming more and more similar. How do you stand out from the crowd?

Dell: If you look at our results, you'll see that we have stood out from the crowd. This industry started with a differentiation around technology. That never goes away. There is always the hot box and the fastest computer. But that is not the only element. 

There is the issue of cost and this is an area where Dell has differentiated very significantly because we have the lowest cost structure in the industry. We have the most efficient asset management. We have a business system that has a structural competitive advantage.

The next element is the whole area of service and relationships and the fundamental integrity of the whole process from order to delivery to product reliability to service and support. If you look at those areas, quite frankly the industry hasn't done that great as a whole....A lot of these machines fail more than they should.

PC Magazine just did a user service and reliability study and Dell got an A grade for both desktops and notebooks and we're the only vendor to do so. For a second year in a row, we were the only vendor to get that A grade. Some of our competitors got D grades, and I'm not talking about the smaller competitors.

Clearly if you look at Dell's business system and the fact that we're growing five times the market growth rate and had a return on capital of 229 percent, that is not any way indicative of a commodity business. So at least one company has learned how to differentiate itself and do quite
well.

Q: Is the Internet changing your mix of customers?

Dell: About 88 percent of our business is to companies and institutions and about 12 percent to consumers. The interesting thing about the Internet is that it is initially attracted to the consumer. But this whole idea of a "Premier Page" with large businesses is taking off. Customers like Shell Oil are transferring from physical purchase orders to electronic purchase orders. One of the things we do with a lot of companies is we set up employee purchase programs. We set one up with Shell on their same web page and the employees purchased about 6,000 PCs on line, in addition to the PCs the company bought.
 

Q: How important is the release of Windows 98 to your company?

Dell: I'm not sure if a lot of customers would have waited to get their new computer with Windows 98 on it....The beauty of the situation here is we don't have to decide if customers want Windows 98, Windows 95, NT or OS2. The customer gets to decide. We're building machines that don't care what operating system they have. They don't care as long as it has the one the customer wants.

Unlike our competitors on the indirect channel, they have to forecast for 200 megahertz, 300 megahertz, 400 megahertz, Windows 95, Windows 98, Windows NT, 2 Gig, 4 Gig, 8 Gig, 17-inch, 15-inch. This is why you have an inventory problem. If you go into a computer superstore and look up you'll see the failed forecast of some poor guy who has to forecast what people are going to buy when they come to the store. That is a problem our company doesn't have because of our use of information.

Q: Coming up in September, there is a request for a preliminary injunction against Microsoft by the Justice Department that would force Microsoft to allow computer makers like yourself the chance to make substantive changes to Windows 98. Would you welcome that ability to make changes, such as to unbundle the browser or change the startup screen? 

Dell: There are two aspects to that. If you buy a system from us in Windows 98 it installs and sets up very, very quickly because we effectively break the seal of the software, install the system and get it all set up and then reseal it. We do this electronically. There are no people doing this. It's being done in the factory as the systems are being built.

The benefit of that is the user gets that machine and instead of having to go through this long complicated install process, they turn on their computer and enter their name and it's ready to go. So there are things we can do that improve the customers' experience.

One of the concerns we have is that if you start making every component of a system a different product, then you get into this whole problem of what kind of PC do you have? What kind of memory manager do you have? What kind of JAVA do you have? What kind of application interface do you have? Do you have this driver or that driver? You lose the whole concept of compatibility.

We have something in the PC industry that is a beautiful thing. You have 300 million machines and you can buy a piece of software and you're assured that it will work on your machine, so long as your machine is not out of date. You know it's going to work. If the integrity of that gets messed up because there is some type of legislated architecture for computers, then that is not a good idea. This is what [Fed Chairman Alan] Greenspan is referring to in his recent comments [about his misgivings concerning the antitrust case being pursued against Microsoft by the Justice Department].

Q: The House of Representatives passed the Internet Tax bill that holds off on assessing taxes on products sold over the Internet. It looks like you won't have to pay sales tax for three years when you receive orders online. What does that mean for your company and is there pressure from your municipality that sees you as a money bag?

Dell: This is a complicated issue. The reason it's complicated is because if I'm a customer and I buy something off a web site, I don't know if that web site is in Toronto or Singapore, Taipei, Timbuktu, or Tonga Tonga. You get on the web and you don't know where this thing is.

The cost of shipping a small package anywhere in the world in three days is $80.00. The question that local jurisdictions have to deal with is not only state to state, but outside the U.S. because in a sense this is a pretty easy thing for a merchant to overcome, just stick your web site [in another country].

What we worry about is let's say we are selling in the United States and are complying with all the applicable issues and a competitor is selling in a jurisdiction that doesn't have those tax structures and is in another country. How is the U.S. government going to protect the businesses here and make sure there is some type of global competitiveness? That's a big issue, much more complicated than the state-to-state issue. If you just deal with the state-to-state issue, we're really blinding ourselves to the way the Internet works.

We don't have any problem with fair and equitable tax structures, but the challenge is....Toronto is not that far away. It's not that hard for a business to set up in Toronto and with NAFTA you can ship stuff over the border.

Q: Since more of your business is reliant on the Internet, what do you see as the big hurdles for electronic commerce?

Dell: Privacy is a concern that the individual consumer has. Our company has been vocal on this issue. We have a very clear privacy policy in our company and we clarified it again this week. We don't share our information or sell our mailing list and we use the information only to service that customer. We allow our customers to remove themselves from the mailing list if they want. But when you go out and look at the gazillions of web sites not everyone has figured out that they need a privacy policy and we want to encourage everybody to do that.

The availability of high-speed access is another hurdle. I was in New York last week on a panel with [the] FCC chairman and he was talking about the World Wide Wait. In the home today, the average person is getting on the Internet at 28 kilobits and this is just really slow. So until we have megabit speeds, cable modems, satellites -- some broadband communication -- you're not going to have people using Internet to its full potential.

You have standards emerging with regards to commerce, security and the good news is that a lot of these things are being worked out. 
     

Q: One of the big themes of this conference has been the need for companies to take higher regard to the needs of third-world countries by providing them with access to the Internet and PCs. Do you feel any responsibility at Dell to do that?

Dell: Well, we feel a lot of responsibility to helping lower the cost of computing and deploy the technology around the world. However, we are a capitalist enterprise and we have to answer to a number of different constituencies here. But Dell probably more than any other company in the industry -- and I'm not trying to sound too boastful here -- has made a big contribution in lowering the cost of PCs by fundamentally wringing out a lot of inefficiency in the distribution channel and that in itself has made this technology much more affordable.

We're spending a lot of time trying to figure out how we bring our business all around the world. We're building a plant in China. We have a plant in Malaysia. We are going to build a plant in South America and we're at the stage where we are dealing with the next 40 countries. We have the first 40 and that will put us into a lot of emerging markets.

Q: Do you see the $200 computer as a way to reach the masses? Is that a real viable commodity?

Dell: The $200 computer has been around for a long time. I remember having the Sinclair kit computer and you can always build a low-cost machine, but does it really do anything of substance and do people want to buy it? Therein lies the problem.

I know a lot of corporations that have old 386 machines they'd love for people to take off their hands, but the problem is these machines don't run software, so just lowering your price doesn't solve the problem because it gets to the point where it has limited to no utility and it doesn't run the software.

Every time I go to China or other emerging countries, they don't talk about $200 computers. They talk about Pentium IIs running at 400 megahertz. They want the latest technology. They don't want to be treated like second-class citizens from a technology standpoint. 

It would be great if you could have a $200 computer, but it's not like we make them for $100 and sell them for $2,000. The issue is that the cost that goes into developing the products is pretty expensive.

If you want to understand the costs, start with Applied Materials, KLA Instruments and Tokyo Electron -- the people who make the semiconductor equipment. If you want to build a plant that makes semiconductors that go into computers, write a check for $2.5 billion. If you write a check for $2.5 billion, somebody ultimately is going to say, "I want a return on that money," and you can't sell computers for $200 after you've spent $2.5 billion on a plant.

 


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