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WEB: Managerial Economics: Principles and Worldwide Applications, 7

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Chapter 2: The Education of Michael Dell


Introductory Comment: The following selection illustrates most of the concepts presented in PART
I of the text, and thus it serves as an excellent integrating case study. It clearly shows the nature and
scope of managerial decisions in a current real-world situationthe industry for personal computers
(PCs). In addition, it illustrates the theory of the firm in actual operation and the importance and
function of profits in providing the signal for the efficient allocation of societys resources. It also
shows the firms optimizing behavior as it attempts to minimize costs and maximize profits.


He dropped out of college to start his company. His business model conquered the PC industry. Now,
at age 40, Dell takes his place among the nations most respected executives. The company turned 21
years old in May 2005, and it is now one of the nations most prominent and respected corporations.
Michael Dells company has run through the competition like some kind of sports team from
Boston. Lets quickly review the recent events of the PCindustry: IBM, the company that practically
invented the desktop computer, has exited the business by selling out to the Chinese firm Lenovo.
Gateway has seen its business crashits stock, which traded above $80 five years ago, now fetches
$4 and change. Compaq wisely sold out to Hewlett-Packard, which unwisely doubled down in this
market, giving Dellas one wag puts ita bigger butt to kick.And of course it was HPs bet on
Compaq that ultimately cost Carly Fiorina her job. Truly, this is an industry under assault, and in
every instance the guy at the other end of the gun is Michael Dell. You have to just say he has done a
hell of a job, says former GE CEO JackWelch. No one has pulled the levers of cost, quality, and
service better than Dell.
Dell has thrived as downward-spiraling prices and commodification washed over the PC
industry, benefiting the companys customers and bashing its competitors. Instead of battling the tide
by attempting to erect proprietary systems, as HP and IBM often did, Dell used its low-cost, direct-
sales model to ride the wave. Today, by nearly every unit of measure in the computer hardware
business Dell is irrefutably the No. 1 company in the U.S. Be it in desktops, notebooks, and servers, or
in profits, growth, and margins, Dell is the leader. And it isnt slowing down either. At its mid-
February (2005) earnings conference call, Dell announced that technology research firm IDC had
determined that it had surpassed HP to become the worldwide leader in PC market share, with 17.6
percent.
Success brings unexpected challenges. For years Michael Dell and company CEO Kevin
RollinsDell remains chairman but turned over the CEO reins to his right-hand man last year
cultivated a chip-on-the-shoulder mentality at their company. But now, with all the accolades and
soaring market share, that could ring hollow. I suggest as much in an interview with Rollins.

Fortune: Youre not an underdog anymore.
Rollins: Well, we think we are.
Fortune: Youre deluding yourself.
Rollins: Ill tell you why we think were an underdog, and that is, we had been a PC company.
Weve been migrating the last three or four years out of being a PC company. Weve moved into
servers and storage, mobility products, services, software peripheral categories, and printers, and
became a diversified IT company. If you look at those other categories, were not the leader, were not
the biggest. So as weve built out a diversified IT portfolio, were a small guy again, and it keeps this
notion of the underdog, gotta struggle, gotta change, gotta do things for the customer.
Salvatore & Srivastava Managerial Economics, 7e
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Sure, its pep-talk stuff, but Rollins is describing a fundamental shift at Dell. Until recently
the companys business model was to be the worlds most efficient assembler and distributor of
Wintel technology. In other words, if a customer wanted a PC with an Intel chip and Microsoft
software, Dell was the optimal machine to purchase. The idea may seem basic, but remember that
companies like IBM and DEC spent hundreds of millions of dollars developing alternative operating
systems and hardware that didnt pan out.
Obviously, being the premier Wintel vendor has worked like a charm for Dell, but lately
growth in the PC business has been slowing down, particularly in the huge but mature U.S. market.
Between 1996 and 1999, PC sales in the U.S. climbed on average 16 percent annually. Between 2000
and 2004, sales grew only 3.6 percent per year. True, Dell can still make big market-share gains
unlike Microsoft and Intelbut the graying of the U.S. PC business is nevertheless critical, because
Dell derives some 50 percent of its revenue from this market. Looking ahead, Dell and Rollins
understood that their company would need new growth drivers, which is why they have pushed into
servers and storage, andin a direct challenge to HPs golden gooseprinters.


Michael Dells Rise
By now you are probably familiar with Michael Dells star-spangled bio. He began his business
tinkering with machines in his University of Texas dorm room, and a mere eight years later cracked
the Fortune 500, making him, at 27, the youngest Fortune 500 CEO ever. Doubters said his company
would never challenge the big boys, that his model wouldnt work overseas, that he couldnt sell
serversand he has proved them wrong every time. Today the 9.6 percent stake he holds in his
company is worth some $10 billion, making him one of the richest men in the world.
There is one key point in Michael Dells story that is overlooked, however, and that is the
extent to which he is almost completely self-taught. Unlike CEOs such as GEs Immelt, Home
Depots Nardelli, and 3Ms McNerney, for instance, Michael Dell didnt do time at GEs famed
Crotonville, N.Y., training center, soaking up management acumen at the knee of Jack Welch. Dell
never went to Wharton or the Harvard Business School either. He didnt even stick around at the
University of Texas long enough to collect his undergraduate degree.
Initially the man and his company were perceived as geek and gimmick. Dell knew how to
cobble together PCs on the cheap and sell them on the phonehardly a threat to the technology
orthodoxy. After early success, though, it was acknowledged that the man and the company had
become players in the PC industry. Dell understood not just the guts of a computer but also what made
IBM tick andmore to the pointhow to skewer Compaq and why its not wise to compete with
Sony in consumer electronics. And today the man and the company have become global business
paradigms, analyzed by management consultants, studied by old-school companies like GM and
Lockheed Martin, and naturally the subject of case studies at the Harvard Business School. Sure,
Michael Dell has surrounded himself with mentors and consultants when he needed to, but thats not
always easy for a founding CEO. Michael never had an ego problem or a not-invented-here
mentality. He had no problem going outside the company to find talent, says Mike Kwatinetz, a
general partner with Azure Capital in Silicon Valley who, as a former analyst at Sanford Bernstein,
was one of the first on Wall Street to recognize Dells potential 13 years ago.
The companys ride has not always been smooth, and of course its mistakes have contributed
mightily to Michael Dells business education. In 1989 the company developed a family of high-end
products code-named Olympic, which customers rejected out of hand. Dell killed the products hastily
rather than allow engineers to convince him that they could be tweaked.
Four years later poor quality derailed Dells notebook line. Michael Dell brought in John
Medica, the man behind Apples PowerBook, to fix the mess, and at his urging the company focused
on the one notebook that worked best and scrapped the rest of the line.
Salvatore & Srivastava Managerial Economics, 7e
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More recently Dell and Rollins discovered that their subordinates perceived them as cold
technocrats. Now Dell, Rollins, and the rest of management are working hard on the fuzzy stuff.
Employees rate their bossesincluding Michael and Kevinevery six months in Tell Dell surveys.
If youre a manager and youre not addressing [employee] issues, youre not going to get promoted,
youre not going to get compensation, says Dell. And if you consistently score in the bottom rungs
of the surveys, were going to look at you and say, Maybe this isnt the right job for you.
Just to give you an idea of how far Dell has come: 21 years ago (when the company was
founded in 1984) IBM and HP were voted No. 1 and No. 3, respectively, on Americas Most Admired
Companies list. (At that point if you had asked the voters, Whats a Dell? they probably would have
told you it was a small, secluded, wooded valley.) As for PC market share, of course, Dell wasnt on
the radar screen, while Commodore, with about $1.1 billion in PC sales, was the industry leader with a
27 percent U.S. market share. IBM was No. 2, and Apple and Tandy came in at No. 3 and No. 4.
(Atari and Kaypro were big back then, too, remember?) Fast-forward to today (2005) and youll
notice that HP and IBM are no longer in the Most Admireds top ten, though interestingly IBM ranks
higher than Dell on the industry list (perhaps because Dells competitors didnt want to vote for a
company thats eating their lunch). As for market share in the U.S., Dell is just above 33 percent,
which means that today one in three PCs shipped is a Dell. (Worldwide its one in six.) Besides the
U.S., Dell is now the No. 1 brand in Britain, Canada, and Ireland (all top-ten markets).
Dells market-share gains would be impressive enough, but the company also has the growth
and profitability throttles open all the way. Its worldwide revenues are growing 19 percent now
thats seven percentage points higher than the rest of the industrywhile profits are growing even
faster. Dells margins are revealing, in that its gross margin of 18 percent is actually lower than IBMs
and HPs. Thats because Dell is generally selling lower-margin machines. But a funny thing happens
on the way to the bottom line: Dells net margin checks in at 6 percent, while the others are close to 1
percent. Why is that? Because Dells operating expensesi.e., selling, general, and administrative
are so low, a direct result of the cost-effectiveness of selling directly to customers rather than through
a middleman.
Dell also spends less on research and development than HP, IBM, and the others, a point that
makes the folks at Dell a little prickly and defensive. Dells competitors say it is evidence that Dell
doesnt innovate. The folks at Dell beg to differ. Recently I had dinner in Austin at a place called
Kenichi with Jeff Clarke, senior VP of products and head of R&D at Dell. As we order, I point out
that Dell spends less than $500 million a year on R&D, or less than 1 percent of sales, while HP and
IBM lay out upward of 6 percent. It means theyre spending a lot more money than we are, says
Clarke, whos been at Dell for 18 years. One has to measure effectiveness. One has to measure the
value. We tend to be a very efficient and a very effective spender of our dollars. Clarke argues that
Dells R&D effort is focused solely on open-standards-based computing (read Wintel), while the
competition spends much of its R&D resources on proprietary systems that often dont cut it in the
marketplace.

Dells Move into Printers
The latest great battle in the PC business isnt in computers but in printers. Dell is now waging war on
Hewlett-Packards vaunted imaging and printing division, which produces some 70 percent of that
companys operating profit. To destroy this business would be devastating to HP. Printing is whats
known as an installed-base business, much like the famous Gillette razor-blade model. You sell the
customer a razor, or in this case a printer, but the real margins are in the blades or, in the case of the
printer, the cartridges, and you now have a captive customer who will buy from you for years. Dell
began selling printers, both inkjet and lasers, two years ago, and Michael says that so far the effort is
coming along fine. Our goal this past year was to sell five million printers, and we did that, he says.
We now have about 20 percent of the inkjet-printer market in the U.S., which I think is pretty
remarkable. That suggests to me that five or ten years from now this is going to be a very significant
business for us in terms of revenues and profits. For now, Dell admits that margins are not as great
Salvatore & Srivastava Managerial Economics, 7e
Oxford University Press 2013. All rights reserved
4
as the other businesses, but he insists that his machines lower price will erode HPs business. (He
maintains that a Dell color laser is roughly half the price of an HP and that the toner is 45 percent
less.)
Vyomesh Joshi, head of printers and PC business at HP, counters by saying that Dell
succeeded in PCs because that business was commodifying, while printers arent. He also believes
that Dells partners (Dell outsources the making of printers) wont let it get big. Told of this, a Dell
executive responded, Go back and see what HP said about us in servers five years ago. Im sure they
were saying the same kind of thing. Yes, its true that Lexmark, Fuji, and Kodak are manufacturing
Dells printers, but Dells engineers are digging into this business to make the machines work
seamlessly with Dell PCs, servers, and notebooks. Dell has an ever-improving feature that will alert
the customer when hes getting low on ink. Just click to reorder one of those high-margin cartridges!
And of course there is no middleman to take a slice of the profit.
Whether or not Dell is an innovator or will reign supreme in printers, what is unassailable is
that this company is a manufacturing marvel. A fundamental difference between Dell and the
competition is that at Dell, every single machine is made for a specific order. The others are producing
machines to match a sales forecast. The advantages that Dell derives from this model on the factory
floor are tangible and enormous. For instance, industry sources say Dell now carries only four days of
inventory, while IBM has 20 days and HP has 28. Obviously, low inventory frees up mountains of
cash for Dell that is otherwise tied up at IBM and HP. Dells manufacturing prowess doesnt stop
there. The company urges its supplierseveryone from drive makers to Intelto warehouse
inventory as close to its factories as possible. Any cost that can be shared with (read transferred
to) those suppliers, is. (Does that remind anyone of a certain large retailer headquartered in
Bentonville, Ark.?) Pay a visit to a Dell plant and you can watch workers unload a suppliers
components almost right onto the assembly line.
All this is reflected in one eye-catching statistic: In 1998, Dell produced $745,000 of revenue
per employee. Now, seven years later, the company does $900,000 of sales per employee (HP comes
in at $540,000).
You would be correct, then, if you guessed that Dells factories are running full-tilt boogie
right now. We challenged our manufacturing guys to triple the throughput, and they did it, says
Rollins. Adds Dell: We need capacity. The plants here are running flat out, seven days a week. But
Dell and Rollins saw that coming, and in late 2003 the company began searching for a site for a
massive new plant. Where was the most cost-effective location? Taipei? Mumbai? Kuala Lumpur?
Would you believe, Winston-Salem?
The notion of building a giant new computer-assembly plant in the U.S.east of the
Mississippi, mind youis, to put it mildly, counterintuitive. Can Dell really make money
manufacturing computers in North Carolina? Our business in North America continues to grow in
increments of $6 billion to $7 billion a yearbut where are you going to make all the stuff? asks
Dell. With our business model, it just does not make sense to go off-shore. The value equation is
better building close to the customer.
While the number of employees at the Winston-Salem plant is fairly modest, the state of
North Carolina hopes the factory will attract dozens of other businesses to serve Dell and turn into
something really large. Might be a pretty good bet. When Michael Dell first appeared on the business
horizon a little more than a decade ago, you could see the potential of his business in the same way
you can see an 18-wheel truck coming at you ten miles across the Bonneville Salt Flats. You know its
going to take a while, but theres no question its a big rig and no question its coming. If there are
still any questions, let it be said that Dell, the big rig of the PC business, has arrived.

Source: Adapted and reprinted with permission from Andy Server, The Education of Michael Dell,
Fortune(March 5, 2005), pp. 7382. @ Time Inc. All rights reserved.


Salvatore & Srivastava Managerial Economics, 7e
Oxford University Press 2013. All rights reserved
5
Fast Forward

In 2006, Dell had 18 percent of the world PC market while HP had 15 percent. Since 2006, however,
Dell has faced declining market share and falling profits as a result of stiff competition from other PC
companies and the shift in growth in the PC market toward consumer sales instead of corporate sales
on which Dell now relies upon for close to 80 percent of sales. In early 2007, Michael Dell returned as
CEO trying to revive the company, but results have been inconsistent and Dell lost its spot as the
worlds second PC vendor (after Hewlett-Pakard) to Taiwans Acer. In 2010, Dell share of world PC
shipments had fallen to 12.3 percent as compared with HP's 17.4 percent and Acer's 14.0 percent. We
live in a very competitive world and firms' fortunes can change rapidly.


Source: Back Against the Wall The New York Times (December 16, 2008), p. B1; Dell Profit
Plunges 48%; Firm Pans Further Cuts, The Wall Street Journal (February 2009), p. B1; Dell
Playing Keep-up with Rival H-P, The Wall Street Journal (November 19, 2009), p. C1; and
http://www.onlinemarketing-trends.com/2011/07/hp-dell-lead-netbooks-marketshare-as.html
Salvatore & Srivastava Managerial Economics, 7e
Oxford University Press 2013. All rights reserved