Major Factors For The Low Profitability Commerce Essay

To understand the indispensable elements that contributed as major factors for the low profitability in the computer industry, the group had to apply Porter’s five forces orientation. The main reasons for a low average profitability in the computer market even though there exists high level of output and innovation especially during the last ten years can be attributed to these factors:

Primary, as a weak strategic choice, Stiff Competition (which ultimately led to price competition) was war of attrition between these companies, and of course as a result of this some money was left on the table and average profitability was low. Secondly, product differentiation among the industries was very weak and complementary products that would have made a difference were not as such available. Thirdly, as it can be seen from the business chain, the suppliers had monopoly power over the manufacturers. Fourth, threat of the substitutes was very high since there was no brand loyalty on the part of customers. So, as a result these forces were able to put an undeniable pressure on the computer industry and led to a low average profitability.

2) Why has Dell been so successful despite the low average profitability in the PC industry?

In 1998 the computer industry shared or had the same kind of business strategy. This is more obvious when one sees the similarity in distribution channels. What made Dell distinctive from the competitors was their application of the Blue Ocean strategy. Dell focused on direct orders from customers, offering customer tailored products and meanwhile developed new marketing and distribution strategy. This resulted in low product variable cost and 8% increase in operating profit in comparison with usage of standard distribution channels.

Dell segmented their customers in two main groups – relationship and transaction buyers. This increased the capability of better understanding and responding more efficiently to customer needs. This raised customer satisfaction level and created loyal customers, which affected positively the company’s profitability.

The decision to take orders directly from the internet web page, designed especially through a new CRM model, made it possible for Dell to provide innovative service and products to all customer segments. A crucial key to Dell’s success was the decision to proceed with production only after an order was received.

In the same time focusing on limited number of suppliers and maintaining close relationship with them, allowed Dell to separate delivery of different components of production, thus reducing shipping time and decreasing operating cost by keeping stock at minimum level.

Dell’s successes resulted from implementing an effective and profitable corporate strategy by focusing heavily on direct customers and suppliers.

3) Prior to the recent (1997‐1998) actions by the competitors to match Dell, how big was Dell’s competitive advantage?

The personal computer industry has been one of the most competitive industries in the world. It is typically characterized by rapid innovations, low costs, and in most cases, the demand for updated processing systems has kept this industry very attractive.

The only way companies can be profitable under this set framework was to be operationally efficient. In the 1990s, the growth of the World Wide Web led to an increased demand for PC and thus consequently led to a decline in prices because of its highly competitive nature.

Dell’s efficiency in 1997-1998 came from two key success factors: First, they sell directly to their customers so their distribution channels are simple and cheap (eliminating all middlemen costs, no dealership markup). Second, they adapted the Direct Model, where they only do ‘build-to-order, which kept inventories low. Low inventories mean that, when the competing companies drop the price of its processors, Dell did not have accumulated old expensive processors. It was able to reduce the prices on its computers faster than its competitors can, because the components that made up those computers are the latest and cheapest.

Dell clearly distinguished its customers segments and as part of its strategy, it targeted the corporate customers (relationship buyers) who were volume buyers. As a result, the transactions costs/per PC sale were substantially lower compared to its competitors.

In summary, Dell’s strategy was characterized by:

‘Build-to-order’ and ‘direct-to-customer’ relationships;

Focus on specific market segments;

Low cost distribution;

Manufacturing and strong supplier relationships;

Minimum inventory;

Service and repair through telephone and third parties.

Exhibit 1 shows that Dell as compared with the competitors had a low gross margin. (See annex)

Exhibit 2 shows that Dell’s net profit margin is the same as the market average. We can conclude that the fixed costs for Dell was much lower than for the competitors, which gave Dell an opportunity to cut prices unlike its competitors. (See annex)

Exhibit 3 shows that the company has a relatively low inventory turnover which gives the company a competitive advantage in the fiercely growing market by minimizing losses. (See annex)

4) How effective have competitors been in responding to the challenge posed by dell’s advantage?

IBM

IBM was the first PC maker to recognize Dell’s competitive advantage in direct sales distribution. In early 1990s it launched a series of initiatives to improve the coordination with resellers and distributors called Joint Manufacturing Program that was followed by Integration and Assembly program and Enhanced Integration and Assembly Programs. IBM started to ship heavily configured PCs to resellers and distributors who completed the configuration of the machine for the end users.

In 1995 IBM launched Authorized Assembly Program shipping lightly configured computers (Model 0s) to downstream partners who would complete the assembly with the missing components and ship to customers. The AAP program helped IBM to rapidly deliver customized PCs without holding large amounts of inventory.

In 1998 IBM launched its web site where business customers would refer to authorized resellers and individual customers could purchase standardized PCs directly from IBM.

Compaq

In 1994 Compaq was the world’s largest manufacturer of PCs. Compaq’s initial strategy was to distribute the PCs to customers primarily through retail stores. The company launched several unsuccessful initiatives to sell directly to customers (online catalogue in 1993 and toll free telephone in 1996) which soon had to be shut down because of channel conflicts.

From 1995, Compaq launched new initiatives to reduce the inventory by optimizing its production system and introducing Optimized Distribution Model. This eventually reduced the inventory to 25 days.

Starting from 1998 Compaq launched Direct Plus Program selling PCs directly to customers via internet and telephone. Direct Plus came with additional services such as support service, software modules and leasing programs.

HP

HP sold PCs mainly through distributors and resellers and retail channels. HP was reluctant to sell PCs directly to customers and although in 1997 it started to accept orders on its web site, the PCs were delivered to the customers through resellers.

In 1998 HP extended the scope of HP Shopping Village web service that allowed the consumers to purchase PCs directly from the web site, however like IBM business customers were referred to resellers.

Gateway

Gateway’s business model was very similar to Dell’s, the company took orders from the customers, build the PCs and shipped them directly to the customers. Initially the strategy was very successful but over time Gateway’s competitive advantage declined despite a series of initiatives. In 1998 the company lost its corporate customer segment and refocused on small businesses.

Despite the efforts the competitors made to match Dell’s success, none of them were particularly successful.

5) What should each of Dell’s major rivals (IBM, Compaq, HP, Gateway) do now?

As a short term solution, competitors (IBM, Compaq, HP and Gateway) before focusing on their core competence and increase their market margin they have to imitate Dell’s competitive advantages for some time. But in the long run competitors should;

Pursue sustainable increase in efficiency of the production processes to decrease the operating costs: analyze and revise current supply chain, outsourcing certain tasks to the other geographical location in order to benefit from the lower labor cost and also try to find new market place as a comparative and competitive advantage.

A special attention should be given to premium customers (large companies) through direct sales and sales-force, because these clients make big and repetitive orders, and for the rest of the segments sales can be conducted through Internet or phone. Direct sales help avoid leaving margins in pocket of resellers and distributors.

And most importantly, they should focus on their specialization.

Company

Key Market segments

Key Distribution channels

Business

Dell

Large Business

Direct distribution 86.6%

Assembly (only)

Gateway

Home and small business

Direct distribution 90.43%

Production

HP

Small and middle business 32.6%; Individuals 28%

Distributors – 75%, Resellers, 23%

Production

Compaq

Small and middle business; Individuals

Distributors – 66.6%, Resellers, 24.6%

Production

IBM

Large Business; Small and Medium Business

Distributors – 69.6%, Resellers, 18.4%

Production

Annex

Exhibit 1

Exhibit 2

Exhibit 3