(Mt) – Read Case 5, “Dell Computer: Back to the Future,”

were generally 40 percent less than IBM’s, Dell grossed The company experienced a number of growing pains Dell Inc., although considered a modern, high-tech com- in the past. The famous “Dell Way” process pany, had the roots of its operational success planted $6 million in his first year of business and $40 million which used just-in-time (IT) inventory management and lean-production philosophies, together with direct sales during its early years, and in 1986, Dell brought in E. Lee form the company from a business operating out of reported sales of $159 million in 1987 and went public in est PC maker in less than 20 years, with a market capital- Michael Dell’s college dorm room into the world’s larg. mid-1988, selling 3.5 million shares at $8.50 a share. ization that at one time exceeded $100 billion. years, a tall order considering that until then, firearms During its early years, Dell also branched out from its direct-sales model to sell personal computers (PCs) Dell’s operational philosophies could be traced back through such traditional retail channels as Staples and to Eli Whitney. Although most famous as the inventor of CompUSA. It ended the practice in 1993, however, due the cotton gin, Whitney also advanced the idea of using mainly to thinner margins and the fact that the company prices. In 1799, he was awarded a contract to produce interchangeable parts to mass-produce goods at lower frequently found itself left with obsolete inventory on 10.000 muskets for the U.S. Army over the course of two store shelves whenever it began selling a more advanced PC through its direct-sales channel. had been produced only by skilled workers.2 In 1990, excess component inventory and the aban- donment of a product line of workstations reduced earn- Although Henry Ford was generally considered the ings by 65 percent, to $5 million, despite the doubling of first industrial-age practitioner of JIT and lean produc- the company’s sales. The recession of the early 1990s ben- tions were more properly attributable to Taichii Ohno tion, arguably Whitney’s and Ford’s contemporary itera- efited the company at the expense of competitors, how- ever, because Dell produced lower-priced PCs and had and his work in creating the Toyota Production System. more flexibility to cut prices because of higher operating The Dell Way, however, was facing challenges from margins. But the price wars eventually took a toll on Dell, increasing globalization, new technologies, and evolving and it reported a loss of $36 million in 1994. market trends. For Dell, these challenges were probably Despite the loss, Dell’s revenues had grown to $2 bil- more daunting than those faced by its competitors because lion by 1994. At the time, Dell was “a struggling second- Dell’s operational success over the past 15 years had been tier PC maker. Like other PC makers, Dell ordered its substantially greater than that of its competitors. components in advance and carried a large amount of component inventory. If its forecasts were wrong, Dell had major write-downs.”9 Dell’s Early History Dell faced several other serious crises in 1994, most Michael Dell entered the University of Texas in 1983. Dur- significantly diminishing sales, declining quality, and a ing his freshman year, Dell began selling RAM chips and growing cash crunch.10 disk drives for IBM computers, which he acquired from the The foundation for Dell’s ultimate success, however, was laid in its response to these issues. Dell found the excess inventory of IBM dealers through newspapers and answer in JIT inventory management and lean produc- trade magazines at a discount of 10 to 15 percent off retail. tion, processes that proved to be the perfect complement By April 1984, Dell’s dorm-room business was grossing to Dell’s direct-sales model in the rapidly changing high- $80,000 a month and he dropped out of college. Dell soon expanded his business to building and sell tech market and that Dell relentlessly improved upon to become the most efficient PC manufacturer on the ing IBM clones. Because he sold directly to consumers rather than through traditional retail outlets, Dell’s prices planet. This case was prepared by Alan Zimmerman, under the supervision of Elliott N. Weiss, Isadore Horween Research Professor of Business Copyright © 2007 by the University of Virginia Darden School Foundation, Charlottesville , VA. All rights reserved. Administration. It was written as a basis for class discussion rather than to illustrate effective or ineffective handling of an administrative situation. C-49 C-50 3. Dell used a “selling what you have” sales and marketing. As Dell implemented the held weekly “lead-time meetings led by Mic system and managed Inventory down over time senior executives sales, marketing, and supply-chain managers to pret trends and short-term supply needs. When found itself with surplus inventory, the sale ally had; if Dell found itself short of needed was provided with incentives to sell what Della quickly and components Sales could steer customers toward makeable JIT and Lean Production JIT inventory management was a fairly straightforward concept. It was an inventory management system in Dell that brought together whach a manutacturer did not acquire components until they were needed in the manufacturing process.” Lean production could be roughly defined as an assembly-line process that sought to produce more goods more quickly while using fewer resources–less factory pace, fewer worker movements, fewer assembly steps, nents, Purchasing would have to and so forth through the elimination of waste by con stant refinement of practices and procedures. The practi- alternative sources for the needed cal application of lean production to different industries, ucts through pricing or incentives, however, could be quite varied.” Once adopted, JIT and lean production proved quite compatible with the desktop-PC-manufacturing process in general and with Dell’s business model in particular. First and foremost, desktop PCs contained many stan- dardized parts, including the chassis and the mother- board. Even the components used to customize a desktop was 36 days; and although Hewlett-Packard H PC (e.g. different processors, sound cards, graphics cards, did not disclose its cash-conversion cycle at the time RAM, hard drives, software configurations, and external with an average of six weeks of inventory, it disc drives) were, for the most part, standardized in terms of assembly or could be made so despite their significantly cycle ranged from 40 days to 44 days.” Dell’s sub different technical capabilities.” stantial negative cash-conversion cycle meant tha Several other unique aspects of Dell’s business proved well suited to the adoption of these operational processes: Dell’s suppliers were, in effect, financing its opera tions. See Exhibit 1 for comparative cash-conversion 1. Dell’s corporate customer base had relatively predict- cycles. able needs that typically rose and fell on a set budget Once it had implemented JIT, Dell’s forecast accuracy 2. Dell’s business customers tended to be high-end repeat cycle, which simplified component-purchase planning. for component purchase averaged 70 percent to 75 per- purchasers who required new technologies as soon as cent and Dell was able to manage remaining inventor possible, a by managing demand. Dell’s component inventory system that emphasized speed and minimized the need perfectly matched with a production which at one time stood at 70 days, was eventuali potential for ending up with obsolete inventory. reduced to zero.18 4. Because most customers paid using credit cards, typically received payment within 4 days, althou it did not typically pay its vendors for 45 days. As result, Dell created huge amounts of cash flow fuel its growth. In 2004, Dell’s cash-conversion de likely positive. 16 By 2006, Dell’s cash-conversion Exhibit 1 Cash-Conversion Cycle for Dell, Gateway, and Hewlett-Packard Dell Inc. (DELL) at 5/5/06 Gateway Inc. (GTW) at 9/30/06 Hewlett-Packard (HPQ) at 7/31/06 30 27 40 5 13 Days of sales outstanding Days of supply in inventory Days in accounts payable Cash-conversion cycle (58) (77) (42) (53) (13) 23 Figures for HPO core the entire company the company did not break out cash conversion data for computer sales separately Days of sales outstanding so Des based on net wade recevables and most recent quarterly revenue for the period and 3 days of customer shipments not yet recognized Days of supply in inventory is based on ending inventory and most recent quarterly cost of sales for the period. Days in accounts payable is based on ending accounts payable and most recent quarterly cost of sales . Gateway’s cash conversion cycle does not include days in supplier receivables. Gateway Dells DSO includes the effects of product cated to customer shipments not yet recognized as revenue that are classified in other assets. DSO consists of 27 days of sales outstand Del computer ure 051 By 1998, just four years after adopting JIT and lean $16 billion, a 50 percent annual growth rate, and the production, Dell’s annual revenue was approximately low on disk drives, a signal goes out. A forklift wheels company held $1.8 billion in cash. When the personal computer slowdown of 2000-2001 hit, Dell was well positioned to undercut its rivals in price. In 2001, Dell and rival Compaq was acquired by Hewlett-Packard.20 became the number-one PC manufacturer in the world pull the part until it has a customer order; it doesn’t take Creating the “Dell Way” Dell distanced itself from the rest of the PC-manufac- Rather, it transferred the risk of holding that inventory strategy, JIT inventory management, and lean produc- also by its prescient recognition of the Internet in the with parts line up at the bays. When an assembly line runs onto a trailer bed, snatches a pallet of disks, and pulls out onto the floor. When the forklift crosses the white line, a scanner records the shipment’s bar code and the parts move from the supplier’s books to Dell’s. Dell doesn’t ownership until it pulls the part. In effect, that thin white line demarcates Dell’s entire supply chain.” ruring At its heart, Dell’s system did not eliminate inventory. field not only by the adoption of a direct-sales from Dell to the component manufacturer. Dell’s busi- ness needs and practices, therefore, did not allow for were regularly reviewed and measured against one both its customers and suppliers, allowing it to manage mid-1990s as an information tool to connect Dell with another, with only the best performers getting purchase contracts. Good performance during a prior review period these processes in real time. The real potential of earned a supplier nothing. Once the Dell Way got going the Internet,” Michael Dell said in 1998, “lies in its abil- and the company grew, suppliers were willing to accept supplier-vendor-customer chain. “21 ity to transform elationships within the traditional this treatment in order to tap into Dell’s huge demand.26 Dell’s need for speed also meant that its adoption of Dell, for example, created individual Web pages for the lean-manufacturing philosophy was a critical element its corporate customers to access account information of its success. Dell created a corporate environment mani- and history, obtain up-to-the-minute pricing, place cus- acally committed to process improvement and the use of tomized orders, and find other information. Dell created objective data to measure that improvement. In this similar pages for its top 20 suppliers, which collectively commitment resulted from the constant crisis atmosphere provided Dell with 90 percent of its components. These that permeated the firm’s operations as a result of pages allowed information to flow between Dell and its JIT inventory management, but it eventually became customers and between Dell and its suppliers regarding ingrained in the company’s operational practices. pricing, capacities, capabilities, order forecasts, and qual- Dell plants, for instance, contained prototyping areas ity feedback in real time.22 Michael Dell observed: where new ideas for improving production were imple- mented and monitored. If the ideas turned out to be good No longer can a manufacturer afford to treat poorly a ones, they were incorporated into Dell’s process.28 In supplier from whom every last ounce of cost-savings must be wrung. Nor can a customer be treated simply addition, Dell factory managers regularly studied video- tape of the assembly (what they called the “build”) pro- like a mai ket for products and services at the best pos- sible price. Instead, both suppliers and customers must be cess. And last but not least, Dell maintained a flat treated as partners and collaborators-jointly looking for management structure so that ideas, when they were cre- levels of management approval.30 the value chain, not just in their individual businesses.23 How did this approach pay off in practical produc- Finally, in Dell’s unique relationship with its suppli- tion improvements? Here are a few examples: ers , speed drove Dell’s supply chain because of the need build a laptop PC by flipping it over two times rather for quick delivery than the usual six times.31 locate close to Dell assembly plants if they wanted to do half the number of times a Dell worker had to touch part, ways to improve efficiency across the entire spectrum of ated, could be tried out without being subject to many of customized PCs combined with lim- 1. In 2002, Dell employees figured out a process to ited inventory. Suppliers, therefore, were required to business with Dell because when an order was placed, the 2. In 2004, Dell factory managers were able to cut in was such that not only could their suppliers not a PC during assembly.32 were assembled) to shave 20 seconds off the build time, reduce long reaches by 50 percent, and decrease turns by employees during the process by 80 percent. By 2004, Dell was producing about 80,000 comput- ers a day. In its Round Rock, Texas, factory alone, Dell into 40 per minute and 23,500 per shift.35 mentality 33 either.24 supplier had an hour and a half to deliver the parts. Dell’s be late, they could not be early with their deliveries 3. In 2004, Dell redesigned its “build table” (where PCs Consider, for example, this description of the opera- tion of a part of Dell’s supply chain: Dell’s clout with its suppliers is epitomized by a set of thin white lines on the floor of its [Round Rock, Texas) plant. The lines form a rectangle that fronts each of the 110 produced 2,350 computers every hour, which translated cargo bays encircling the factory. Tractor-trailers loaded C-52 The Changing PC Market percent, ba 43 the return of Michael Dell to of CEO. In the third quarter of 2006, Hewlett-Packard drew equal with Dell in the top spot for worldwide PC market share. HP overtook Dell in the fourth quarter of that From an operational perspective, the heart of Dell’s challenge resulted from the combined effects of the com- moditization of the desktop computer and the emergence of the laptop and other mobile devices as the industry’s growth drivers, each of which diminished the operational financial and market data. advantage that JIT and lean production, together with a States. Overall PC shipment growth was 9.5 in terms of growth, both worldwide and in the Unite For Dell, 2007 was shaping up as a watershed year, something that Dell clearly recognized, as evidenced by growth, 3.5 percent. In fact, the next-lowest growth among the top five manufacturers, Dell saw the low Dell managed to maintain its market share lead competitors-HP, Gateway, Toshiba, and Apple growth rates by a wide margin. Dell’s shipments the United States, but again lagged behind its top pany to show a decline was Gateway, by 1.1 17.3 percent year-over-year, while the only other com See Exhibit 2 for recent financials and market sharest mates for Dell, See Exhibits 3 through 6 for other selected direct-sales model, had provided Dell over the past dozen also found that home-based desktop shipments declined Finally, consistent with Farmer’s analysis, Garte year. percent 20 percent in the fourth quarter of 2006 compared with years. The effect of desktop-PC commoditization on Dell’s operations was as follows: 2005, while laptop shipments grew 20 percent to a time when the customer wanted the optimal mix of configuration flexibility, price performance, and ease “The fourth quarter’s consumer bias favors HP. 46 of ordering. But the enormous, and often unused, pro-Although difficult to predict consumer trends, advances This trend was unlikely to abate in the short term. in mobile-computing technology were likely to continue, cessing power and storage capacity of today’s PCs have made these factors much less important. Increasingly, which-rogether with the increased buying power of the customer-buying preferences are polarizing in ways that middle class in North America, Europe, and Australia (and, one might speculate, eventually in China and are making life more difficult for Dell. Today, if all you want is a low-cost standard PC, India)—would suggest a continuing consumer trend in you can get a perfectly good one in about an hour down that direction. at the local superstore, whose thin margins are much Dell’s Difficult Decisions harder for Dell to undercut. As for laptops driving growth in the market, accord- Dell was not standing still in the face of these and other ing to a December 5, 2006, report by Merrill Lynch recent challenges, including an informal SEC investiga: analyst Richard Farmer, laptops would constitute tion into its accounting practices and the recall of 4.1 mil. 41.6 percent of PC-manufacturing companies’ revenues lion laptop batteries.” Obviously, the return of Michael in 2006, compared with 47 percent for desktops. For Dell as CEO was the most publicized move, but in recent 2007, however, Farmer estimated that the laptop/ months, Dell took a number of other steps. In product desktop breakdown would be 45.6%/43.5%; for 2008, development, for example, Dell introduced AMD chips Farmer expected the percentages to be 50%/40%. In into some of its models, in contrast to its exclusive us 2000, desktops accounted for 64 percent of PC revenue, of Intel chips previously; and according to its most recent with laptops accounting for only 25 percent.40 Form 10-Q, the company was allocating additional The convergence of these factors clearly showed up resources to R&D.50 Dell also introduced new-model in Dell’s recent performance. According to the consulting computers with new designs (e.g., the XPS line), aimed at firm Gartner, Inc., overall PC unit shipments for the the high-end individual consumer. Finally, Dell spent fourth quarter of 2006 rose 7.4 percent compared with substantial sums of money to rehabilitate its decling 2005. Among the top five companies, however, Dell was customer support operations, which were a critical part the only one to show a decline, by 8.7 percent. In com- parison, HP was up by 23.9 percent, Lenovo (the IBM face two fundamental operational issues: unit sold to China in 2005) by 9.3 percent, Acer by 33.1 percent, and Toshiba by 24.5 percent.” In overall market share, HP overtook Dell for the first time, 17.4 percent to 13.9 percent, compared with the 16.4 percent to 15 percent lead Dell had in the fourth quarter of 2006.2 Similarly, while HP and Dell tied for overall market share at 15.9 percent for the entire year, preliminary numbers showed Dell to be the clear laggard of the maximize its competitive advantage? of its direct-sales model.52 Dell continued, however, to 41 1. Did the nature of the changing PC market require De to reevaluate its decision to minimize traditional read in favor of direct sales as its distribution channel? 2. Did the nature of the changing PC market require Dell to reevaluate the extent to which JIT and la to laptop-PC production and to consider whether and how Dell needed to change those process group UNILlal Dald DELL INC. Condensed Consolidated Statement of Financial Position (in millions) (unaudited) Preliminary Preliminary Q3-FY0723 Q2-FY072 Q1-FY07 Prior Quarter Results Q4-FY06 Q3-FY06 Q2-FY06 FY06 Prior Annual Results FY05 FY04 FY03 ssets: $ 7,042 $ 6,841 $ 6,337 $ 7,042 $6,877 1,579 $ 4,747 $4,317 $ 4,232 2,016 2,440 $ 6,801 1,265 4,741 1,453 2,709 2,016 5,060 835 406 4,332 4,299 3,910 4,089 3.563 3,071 Cash & cash equivalents Short-term investments Accounts receivable, net Financing receivables, net! Inventories, net Other Total current assets 4,089 1,363 2,586 1,451 761 693 1,363 985 712 651 636 576 582 570 576 459 327 306 2,522 17,397 2,620 17,706 2,641 17,564 2,579 16,798 2,620 17,706 2,083 16,897 1,371 10,633 1394 8.924 2,510 17,421 2,154 2,696 PP&E, net 2,074 2,005 1,895 1,843 2,005 1,691 1.517 913 Investments 2,690 2,691 2,952 3,578 2,691 4,294 6,770 5,267 272 256 325 221 227 325 199 120 Long-term financing receivable, net! Other non-current assets 605 454 382 242 165 382 134 271 366 Total assets: 23,148 22,871 23,109 22,874 22,611 23,109 23,215 19,311 15,470 10,323 10,069 9,840 9,376 9,196 9,840 8,895 7,316 5.989 6,544 6,251 6,087 5,871 5,172 6,087 5,241 3,580 2,044 16,320 16,867 15,247 15,927 14,368 8,933 15,927 10.896 14,136 506 504 504 503 Liabilities & Stockholders Equity: Accounts payable Accrued and other Total current liabilities Long-term debt Other non-current liabilities Total liabilities: Stockholder’s equity: Total liabilities & stockholders’ equity: 504 504 505 505 504 2,674 2,549 2,302 2,230 2,549 2,089 1.630 13,031 1.158 10,597 18,980 17,102 18,980 16,730 2,652 20,023 3,125 23,148 19,497 3,374 18,053 4,821 6,280 4,873 4,129 4,129 5,509 6,485 23,215 19,311 23,109 15,470 22,871 23,109 22,874 22,611 ancing receivables, net have been separately classified on the balance sheet as of February 3, 2006. Prior periods have been reclassified to conform to the current presentation to investigations into certain accounting and financial reporting matters, Dell has not yet filed its 02 and Q3 financial statements with the SEC. These results are still preliminary se subject to change to reflect any necessary corrections or adjustments identified prior to filing. Additional information about the investigations can be found in Dell’s reports filed with the SEC mirary 3 cash and investments are 5116 billion, and commercial paper outstanding at the end of the quarter totaled 5236 million

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