Dell is going gangbusters with its direct sales model. Why don't its competitors follow suit?
Games dealers play
By Daniel Lyons
THE SHELL OIL PRODUCTS CO., a division of Shell Oil Co., used to buy its PCs from Compaq Computer and IBM. But last
year the division switched allegiance and took its $26 million in annual PC purchases to Dell Computer. The decision to
buy PCs from Dell had less to do with the computers than with the way they are sold: Dell deals directly with customers,
while Compaq sells through distributors and resellers.
"The biggest thing was the business model and being able to eliminate the reseller from the procurement logistics,"
says Harold Cohan, the manager of infrastructure at Shell Chemical, another division that made the switch. Negotiations
to purchase PCs took longer because resellers were involved, Cohan says. And the prices were too high.
Dell's direct hit
Dell is growing faster than rivals HP, IBM and Compaq, thanks to its more efficient direct sales model and
lower price points.
Source: Dataquest.
The success of Dell's marketing model is well known and amply reflected in the price of its stock. Dell is gobbling up
market share- 10.1% of desktop PCs worldwide, up from 6.9% at the end of 1997, according to Dataquest. Dell now
outsells Hewlett-Packard and IBM and is gaining on Compaq.
Why don't Compaq, HP and IBM just copy the Dell model and sell direct? If it were that easy, Dell would never have
gotten where it is.
Dealers deliver big sales to IBM, HP and Compaq and almost none to Dell. As a result the big three are dependent on the
good graces of the dealers for 90% of their sales. Dealers can easily retaliate if a supplier gets too aggressive about
selling direct.
IBM, HP and Compaq are vulnerable to dealer blackmail. Dell is not. Giving in to it, the big three have spent the past two
years trying to make their three-step distribution model-manufacturer to distributor to reseller to customer-work as
efficiently as the one-step model that Dell uses. But because they must leave something on the table for the dealers, the
big three must either charge slightly more or accept lower profit margins themselves.
Now, by enlisting distributors to do part of the assembly of their computers, the PC makers may have put themselves
even more at the mercy of their dealers.
Distributors such as Ingram Micro Inc., Tech Data Corp. and MicroAge Inc. have invested tens of millions to build plants
where they assemble PCs to order for Compaq, HP and IBM. But these plants are underutilized. MicroAge is running at
25% of capacity, for example. It would be no big deal for these assemblers to buy parts, slap on a label and provide
computers to dealers at prices below those that IBM, HP and Compaq, with their huge overheads, must charge.
Many distributors are already in the PC-making business, with generic PCs to which local resellers affix their own label.
Resellers in North America last year sold 6.4 million of these so-called white boxes-more PCs than Compaq sold, says
Channel Information Services, a market researcher in Jericho, N.Y.
Ask a reseller for an HP machine and he'll quote you a price. Tell him you're also considering Dell, however, and he'll
immediately pitch you a low-cost white box.
The idea of having distributors build PCs-which seems to be backfiring on its author-originated at IBM. It figured it
could compete with Dell and lower its costs by shipping PCs to distributors in component form. That way distributors
could assemble customized PCs based on what customers were ordering, the way Dell does. Distributors would no
longer get stuck with preconfigured PCs nobody wanted, and IBM wouldn't have to eat obsolete inventory.
Since then HP and Compaq have followed IBM's lead. But the system is far from sleek. Each manufacturer has a different
set of rules and policies for distributors to follow, and some of the rules are counterproductive.
For example, distributors insist the joint manufacturing system could work better if PC makers would let them buy
components on their own for assembling into a name brand product. But PC makers don't want to lose the profit they
make on components. The result? Intel ships microprocessors from a warehouse in Phoenix to an IBM plant in Raleigh,
N.C. Then IBM ships the processors back across the country to a MicroAge assembly plant in Tempe, Ariz., 10 miles from
the Intel warehouse where they started. MicroAge would prefer to drive across town and pick up the chips-but that's
against IBM's rules.
In these custom assemblers, the big three have created a potential Frankenstein's monster of huge size. Ingram Micro
will do $22 billion in sales this year, Tech Data $12 billion, and MicroAge $6 billion. It would be quite easy for any of
them to expand production of white boxes built to dealer order in competition with the big three.
"In the past we've been reluctant to do that [sell branded PCs] because of our relationships with HP, IBM and Compaq.
But that doesn't mean we'll always be reluctant," says Robert O'Malley, chief executive at Pinacor, the $5 billion
distribution division of MicroAge in Tempe, Ariz.
Dell's leap
Dell's sales grew 48% in the first half of 1998, to $5.4 billion.
Source: Dataqwuest.
MicroAge created the Pinacor division earlier this year as a first step toward building a brand identity, O'Malley says.
CompUSA Inc. started selling PCs under its own brand name last year, at prices well below the big-name brands.
The biggest threat to PC makers could come from Ingram Micro. The Santa Ana, Calif.-based company recently opened a
500,000-square-foot assembly plant in Memphis, Tenn. Ingram has struck a deal with Solectron Corp., a Milpitas,
Calif.-based contract manufacturer that will provide manufacturing capabilities in 11 other locations worldwide.
The implied threat is that if the big three push too hard on direct sales they will face white box competition from their
own dealers. Would big corporate accounts buy white boxes? If the prices were right and the quality high, they might.
And certainly retail customers could be turned on to them by adept salespeople.
The dealers have already made IBM and Compaq feel the lash. Both companies started experimenting with limited
direct-selling initiatives this year. IBM's desktop PC revenues declined 24% in the first half of 1998, and Compaq's
revenues were flat. HP, which so far has refused to sell direct, enjoyed a 26% sales gain and gained market share,
according to Data-quest. Compaq and IBM say this had more to do with inventory problems than with payback from
resellers. However, resellers say they're inclined to reward loyalty, and if HP is perceived as being more loyal to resellers,
"that causes them to lead with HP," says Douglas Antone, president of Ingram's assembly division.
Is there then no way the big three PC makers can stop Dell? They will have to find a way. In some cases they are
matching Dell's prices. Nevertheless, in its most recent quarter Dell's sales and earnings grew 54% and 72%, respectively.
Compaq already sells direct to a few big customers like GM. In three years the "vast majority of branded CPUs" will be
sold that way, says Kevin McCarthy, analyst at Donaldson, Lufkin & Jenrette. By then, he says, Dell may get so far ahead
that HP and IBM would have to "reconsider their role in the PC business altogether."
Anthony Ibargüen, president of Tech Data in Clearwater, Fla., insists that joint assembly partnerships will start to pay off
for the big three over the next few quarters. He cites a new "colocation" plan in which Tech Data ships PCs direct from
Compaq and IBM factories and claims it is as efficient as the Dell model.
"This," Ibargüen insists, "is not a one- or two-quarter transition. This is something we need to keep plugging away at."
While Dell develops a hernia carrying all that money to the bank.
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Dell is going gangbusters with its direct sales model. Why don't its competitors follow suit?
Games dealers play
By Daniel Lyons
THE SHELL OIL PRODUCTS CO., a division of Shell Oil Co., used to buy its PCs from Compaq Computer and IBM. But last
year the division switched allegiance and took its $26 million in annual PC purchases to Dell Computer. The decision to
buy PCs from Dell had less to do with the computers than with the way they are sold: Dell deals directly with customers,
while Compaq sells through distributors and resellers.
"The biggest thing was the business model and being able to eliminate the reseller from the procurement logistics,"
says Harold Cohan, the manager of infrastructure at Shell Chemical, another division that made the switch. Negotiations
to purchase PCs took longer because resellers were involved, Cohan says. And the prices were too high.
Dell's direct hit
Dell is growing faster than rivals HP, IBM and Compaq, thanks to its more efficient direct sales model and
lower price points.
Source: Dataquest.
The success of Dell's marketing model is well known and amply reflected in the price of its stock. Dell is gobbling up
market share- 10.1% of desktop PCs worldwide, up from 6.9% at the end of 1997, according to Dataquest. Dell now
outsells Hewlett-Packard and IBM and is gaining on Compaq.
Why don't Compaq, HP and IBM just copy the Dell model and sell direct? If it were that easy, Dell would never have
gotten where it is.
Dealers deliver big sales to IBM, HP and Compaq and almost none to Dell. As a result the big three are dependent on the
good graces of the dealers for 90% of their sales. Dealers can easily retaliate if a supplier gets too aggressive about
selling direct.
IBM, HP and Compaq are vulnerable to dealer blackmail. Dell is not. Giving in to it, the big three have spent the past two
years trying to make their three-step distribution model-manufacturer to distributor to reseller to customer-work as
efficiently as the one-step model that Dell uses. But because they must leave something on the table for the dealers, the
big three must either charge slightly more or accept lower profit margins themselves.
Now, by enlisting distributors to do part of the assembly of their computers, the PC makers may have put themselves
even more at the mercy of their dealers.
Distributors such as Ingram Micro Inc., Tech Data Corp. and MicroAge Inc. have invested tens of millions to build plants
where they assemble PCs to order for Compaq, HP and IBM. But these plants are underutilized. MicroAge is running at
25% of capacity, for example. It would be no big deal for these assemblers to buy parts, slap on a label and provide
computers to dealers at prices below those that IBM, HP and Compaq, with their huge overheads, must charge.
Many distributors are already in the PC-making business, with generic PCs to which local resellers affix their own label.
Resellers in North America last year sold 6.4 million of these so-called white boxes-more PCs than Compaq sold, says
Channel Information Services, a market researcher in Jericho, N.Y.
Ask a reseller for an HP machine and he'll quote you a price. Tell him you're also considering Dell, however, and he'll
immediately pitch you a low-cost white box.
The idea of having distributors build PCs-which seems to be backfiring on its author-originated at IBM. It figured it
could compete with Dell and lower its costs by shipping PCs to distributors in component form. That way distributors
could assemble customized PCs based on what customers were ordering, the way Dell does. Distributors would no
longer get stuck with preconfigured PCs nobody wanted, and IBM wouldn't have to eat obsolete inventory.
Since then HP and Compaq have followed IBM's lead. But the system is far from sleek. Each manufacturer has a different
set of rules and policies for distributors to follow, and some of the rules are counterproductive.
For example, distributors insist the joint manufacturing system could work better if PC makers would let them buy
components on their own for assembling into a name brand product. But PC makers don't want to lose the profit they
make on components. The result? Intel ships microprocessors from a warehouse in Phoenix to an IBM plant in Raleigh,
N.C. Then IBM ships the processors back across the country to a MicroAge assembly plant in Tempe, Ariz., 10 miles from
the Intel warehouse where they started. MicroAge would prefer to drive across town and pick up the chips-but that's
against IBM's rules.
In these custom assemblers, the big three have created a potential Frankenstein's monster of huge size. Ingram Micro
will do $22 billion in sales this year, Tech Data $12 billion, and MicroAge $6 billion. It would be quite easy for any of
them to expand production of white boxes built to dealer order in competition with the big three.
"In the past we've been reluctant to do that [sell branded PCs] because of our relationships with HP, IBM and Compaq.
But that doesn't mean we'll always be reluctant," says Robert O'Malley, chief executive at Pinacor, the $5 billion
distribution division of MicroAge in Tempe, Ariz.
Dell's leap
Dell's sales grew 48% in the first half of 1998, to $5.4 billion.
Source: Dataqwuest.
MicroAge created the Pinacor division earlier this year as a first step toward building a brand identity, O'Malley says.
CompUSA Inc. started selling PCs under its own brand name last year, at prices well below the big-name brands.
The biggest threat to PC makers could come from Ingram Micro. The Santa Ana, Calif.-based company recently opened a
500,000-square-foot assembly plant in Memphis, Tenn. Ingram has struck a deal with Solectron Corp., a Milpitas,
Calif.-based contract manufacturer that will provide manufacturing capabilities in 11 other locations worldwide.
The implied threat is that if the big three push too hard on direct sales they will face white box competition from their
own dealers. Would big corporate accounts buy white boxes? If the prices were right and the quality high, they might.
And certainly retail customers could be turned on to them by adept salespeople.
The dealers have already made IBM and Compaq feel the lash. Both companies started experimenting with limited
direct-selling initiatives this year. IBM's desktop PC revenues declined 24% in the first half of 1998, and Compaq's
revenues were flat. HP, which so far has refused to sell direct, enjoyed a 26% sales gain and gained market share,
according to Data-quest. Compaq and IBM say this had more to do with inventory problems than with payback from
resellers. However, resellers say they're inclined to reward loyalty, and if HP is perceived as being more loyal to resellers,
"that causes them to lead with HP," says Douglas Antone, president of Ingram's assembly division.
Is there then no way the big three PC makers can stop Dell? They will have to find a way. In some cases they are
matching Dell's prices. Nevertheless, in its most recent quarter Dell's sales and earnings grew 54% and 72%, respectively.
Compaq already sells direct to a few big customers like GM. In three years the "vast majority of branded CPUs" will be
sold that way, says Kevin McCarthy, analyst at Donaldson, Lufkin & Jenrette. By then, he says, Dell may get so far ahead
that HP and IBM would have to "reconsider their role in the PC business altogether."
Anthony Ibargüen, president of Tech Data in Clearwater, Fla., insists that joint assembly partnerships will start to pay off
for the big three over the next few quarters. He cites a new "colocation" plan in which Tech Data ships PCs direct from
Compaq and IBM factories and claims it is as efficient as the Dell model.
"This," Ibargüen insists, "is not a one- or two-quarter transition. This is something we need to keep plugging away at."
While Dell develops a hernia carrying all that money to the bank.
| back to top |
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