Virtual Integration 1
Note: The following article is from the Harvard Business Review, MAR-APR 98, pages 73-84, author Joan Magretta
The Power of Virtual Integration:
An Interview with Dell Computer's Michael Dell
How do you create a $12 Billion company in just 13 years? Michael Dell began in 1984 with a simple business insight: he could bypass the dealer channel through which personal computers were then being sold. Instead, he would sell directly to customers and build products to order. In one swoop, Dell eliminated the reseller's markup and the costs and risks associated with carrying large inventories of finished goods the formula became known as the direct business model, and it gave Dell computer Corporation a substantial cost advantage.
The direct model turned out to have other benefits that even Michael Dell couldn't have anticipated when he founded his company. "You actually get to have a relationship with the customer," he explains. "And that creates valuable information, which in turn, allows us to leverage our relationships with both suppliers and customers. Couple that information with technology, and you have the infrastructure to revolutionize the fundamental business models of major global companies. "
In this interview with HBR editor-at-large Joan Magretta, Michael Dell describes how his company is using technology and information to blur the traditional boundaries in the value chain among suppliers, manufacturers, and end users. In so doing, Dell Computer is evolving in a direction that Michael Dell calls virtual integration. The individual pieces of the strategy -- customer focus, supplier partnerships, mass customization, just-in-time manufacturing -- may all be familiar. but Michael Dell's insight into how to combine them is highly innovative: technology is enabling coordination across company boundaries to achieve new levels of efficiency and productivity, as well as extraordinary returns to investors. Virtual integration harnesses the economic benefits of two very different business models. It offers the advantages of a tightly coordinated supply chain that have traditionally come through vertical integration. At the same time, it benefits from the focus and specialization that drive virtual corporations. Virtual integration, as Michael Dell envisions it, has the potential to achieve both coordination and focus. If it delivers on that promise, it may well become a new organizational model for the information age.
How has Dell pioneered a new business model within the computer industry?
If you look back to the industry's inception, the founding companies essentially had to create all the components themselves. They had to manufacture disk drives and memory chips and application software; all the various pieces of the industry had to be vertically integrated within one firm.
So the companies that were the stars ten years ago, the Digital Equipments of this world, had to build massive structures to produce everything a computer needed. They had no choice but to become expert in a wide array of components, some of which had nothing to do with creating value for the customer.
As the industry grew, more specialized companies developed to produce specific components. That opened up the opportunity to create a business that was far more focused and efficient. As a small start-up, Dell couldn't afford to create every piece of the value chain. But more to the point, why should we want to? We concluded we'd be better of leveraging the investments others have made and focusing on delivering solutions and systems to customers.
Consider a component like a graphics chip. Five or teen years ago, a whole bunch of companies in the personal computer industry were trying to create their own graphics chips. Now, if you've got a race with 20 players that are all vying to produce the fastest graphics chip in the world, do you want to be the twenty-first horse, or do you want to evaluate the field of 20 and pick the best one?
It's a pretty simple strategy, but at the time it went against the dominant, "engineering-centric' view of the industry. The IBMs and Compaqs and HPs subscribed to a "we-have-to-develop-everything" view of the world. If you weren't doing component assembly, you weren't a real computer company. It was like a rite of passage. You somehow proved your manhood by placing small semiconductor chips on printed circuit boards.
And Dell computer came along and said, "Now wait a second. If I understand this correctly, the companies that do nothing but put chips on motherboards don't actually earn tremendous profit doing it. If we want to earn higher returns, shouldn't we be more selective e and put our capital into activities where we can add value for our customers, not just into activities that need to get done?" I'm not saying those activities are unimportant. they need to get done very, very well. But they're not sources of value that Dell is going to create.
When the company started, I don't think we knew how far the direct model could take us. It has provided a consistent underlying strategy for Dell despite a lot of change in our industry. Along the way, we have learned a lot, and the model has evolved. Most important, the direct model has allowed us to leverage our relationships with both suppliers and customers to such an extent that I believe it's fair to think of our companies as being virtually integrated. That allows us to focus on where we add value and to build a much large firm much more quickly. I don't think we could have created a $12 billion business in 13 years if we had tried to be vertically integrated.
Why can you grow so much faster without all those physical assets?
There are fewer things to manage, fewer things to go wrong. You don't have the drag effect of taking 50,000 people with you. Suppose we have to suppliers building monitors for us, and one of them loses its edge. It's a lot easier for us to get more capacity from the remaining supplier than to set up a new manufacturing plant ourselves. If we had to build our own factories for every single component of the system, growing at 57% per year just would not be possible. I would spend 500% of my time interviewing prospective vice presidents because the company would have not 15,000 employees but 80,000.
Indirectly, we employ something like that many people today. There are, for example, 10,000 service technicians in the field who service our products, but only a small number of them work for us. They're contracted with other firms. But ask the customer, "Who was that person who just fixed your computer?" The vast majority think that person works for us, which is just great. That's part of virtual integration.
Aren't you just outsourcing your after-sales service? Is what your're describing fundamentally different from outsourcing?
Outsourcing, at least in the IT world, is almost always a way to get rid of a problem a company hasn't been able to solve itself. The classic case is the company with 2,000 people in the IT department. Nobody knows what the do, and nobody knows why they do it. The solution -- outsource IT to a service provider, and hopefully they'll fix it. But if you look at what happens five years later, it's not necessarily a pretty picture.
That's not what we're doing at all. We focus on how we can coordinate our activities to create the most value for customers.
With our service providers, we're working to set quality measures and more important, to build data linkages that let us see in real time how we're doing -- when parts are dispatched, for instance, or how long it takes to respond to a request for service. We look at our business and see, for example, that over the next ten years we are going to me making lots of notebook computers. Dell might need 20 million flat-panel displays, and some years there will be more demand than supply. Other years there will be more supply than demand. A few companies are currently making multibillion-dollar investments in the manufacture of these displays.
So we cook up a little deal where the supplier agrees to meet 25% of our volume requirements for displays, and because of the long-term commitment we make to them, we'll get our displays year in and year out, even when there's more demand than supply. The supplier effectively becomes our partner. They assign their engineers to our design team, and we start to treat them as if they were part of the company. For example, when we launch a new product, their engineers are stationed right in our plants. If a customer calls in with a problem, we'll stop shipping product while they fix design flaws in real time.
Figuring out how many partners we need has been a process of trial and error. You learn when you operate on the cutting edge of technology that things don't always work as planned. The rule we follow is to have as few partners as possible. And they will last as long as they maintain their leadership in technology and quality. This isn't like the automobile business, where you find a tire supplier that you will probably stick with forever. Where the technology is fairly stable -- in monitors for example -- we expect our partnerships to last a long time. Others will be more volatile. But regardless of how long these relationships last, virtual integration means you're basically stitching together a business with partners that are treated as if they're inside the company. You're sharing information in a real-time fashion.
We tell our suppliers exactly what our daily production requirements are. So it's not, "Well, very two weeks deliver 5,000 to this warehouse, and we'll put them on the shelf, and then we'll take them off the shelf." It's, "Tomorrow morning, we need 8,562, and deliver them to door number seven by 7 A.M."
You would deal with an internal supplier that way, and you can do so because you share information and plans very freely. Why doesn't the same sharing of information take place across company boundaries? buyers are often so busy trying to protect themselves that the seller can't really add a lot of value. Government purchasing is the extreme case, with its overly structured procurement system. Protecting the buyer usually ends us disabling the seller -- and both lose.
The technology available today really boosts the value of information sharing. We can share design databases and methodologies with supplier-partners in ways that just weren't possible five to ten years ago. The speeds time to market -- often dramatically and creates a lot of value that can be shared between buyer and supplier. So technology enhances the economic incentives to collaborate. |
