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FOOL ON THE HILL
An Investment Opinion
Iron Rules and Evolution
By Dale Wettlaufer (TMF Ralegh)
August 26, 1999
Dell Computer (Nasdaq: DELL) is driving once again, and its competitors should pay attention. At the DellDirect conference held this week in Texas, company founder and Chairman Michael Dell laid down three iron rules of commerce, according to Goldman Sachs' eminent analyst Rick Schutte in a research note today:
Michael Dell listed three rules he views as a guide for "Internet revolutionaries" to remain successful in the future:
1. Trend towards Velocity -- "the ultimate source of competitive advantage" -- the Internet allows for the compression of both time and distance and provides companies with the ability to significantly reduce inventories and drive efficiency (a la Dell's direct model).
2. Efficiency and Execution are as important as the actual Services and Products offered by the company. He highlighted that 80% of issues/problems that occur with Dell users are effectively resolved over the phone with a qualified technician as compared to the significantly lower 27% industry average. This high rate of issue resolution reduces cost for both Dell and the customer.
3. Customer Experience -- the experience a customer has online must be superior to the one they have off-line. He pointed out that studies show e-customers are more loyal to a particular site than customers are to a particular product or store.
The first one is the financial sine qua non of the direct PC model. You reduce capital costs per dollar of revenue and you take profit layers out of an industry and you create value for customers and shareholders. As I said in my preface to Dell's Q2 conference call, we've talked about that ad infinitum in this space.
The second one is the less-discussed aspect of Dell's model but is equally interesting and germane to a company like competitor Gateway (NYSE: GTW). Being a big Gateway supporter, I would frame the point by saying that Gateway has made incredible strides in executing the direct model. It's also well known that Gateway customers are very loyal. What Dell is doing here, though, is seeing a model where every PC can be a managed PC with many helpdesk support functions moving out of the field and out of a company and into Dell. Once again, Dell is reducing cost and profit layers between the original equipment manufacturer (OEM) and the customer, giving back most of that to the customer in terms of lowering PC lifecycle acquisition and operating costs, and keeping some of that for Dell and its shareholders.
What's interesting here, financially, is that it can probably do so without investing tons of additional capital in the business to do so. This once again fulfills my thesis that Dell takes a number of different business models -- 1.) Precision manufacturer, 2.) Service, 3.) Distributor, and 4.) Retailer -- and combines them within one organization, generating four levels of profits out of an invested capital base no bigger than any one of these business models might need on its own. That, in my mind, explains the phenomenally high return on capital the company generates.
Tired: Compaq acquires DEC for service profit layer. Wired: E-Support-Direct
So now it's sucking into its model another profit layer -- in service. With the company's Resolution Assistant software installed in a server (and I would think in desktops not that far down the line), the number of problems that can be solved remotely by a Dell technical support person increases. That decreases the number of field calls that have to be made and can increase the effectiveness of in-house PC support personnel for businesses.
According to the company's white paper, Resolution Assistant allows support personnel in an organization to:
- Test the health of the disk subsystem, processor, memory, and peripherals through online diagnostics
- Intelligently self-diagnose problems
- Electronically request service
- Receive automated solutions
Which then allows Dell support personnel to:
- Remotely collect, organize and act upon relevant information about a particular system
- Quickly diagnose problems on a remote machine
- Deliver solutions to customers in a distributed environment
While homo sapiens neanderthalensis and homo sapiens sapiens existed at the same time a couple hundred thousand years ago, and while the neanderthal being had a larger brain than that of our species, the doubly wise man had an enlarged frontal lobe, much better logical reasoning capacity, and was therefore much better equipped to master, or least deal with effectively, its environment. (Bionomics, Michael Rothschild, 1990). While the direct PC model is a later-stage being in the evolutionary chain of the PC industry, we can see how it is much better suited to its environment than its industry co-inhabitants.
The direct PC model is ideally suited to the evolution of the needs of PC industry customers. In the first and second quarter every year, the media freaks out about falling PC prices. But they never seem to take into account the total cost of ownership of a PC -- which includes the cost of servicing them. As far as I've seen, those costs haven't declined that much, which makes this area of the industry a perfect strategic objective for Dell and the direct PC model. Dell is fulfilling iron laws number one, two, and three (referenced above) and is coming up with ways to keep driving those ahead. Its competitors must attempt to fulfill them to even survive and must master them if they want to continue to create value.
How an investor wants to build these into their model of valuing Dell, Gateway, Compaq, IBM, H-P, and others is entirely up to them. I'll say this, though: I don't really get how some of the multimillion sell-side guys can look at Compaq, build in the cost-saves from the continued restructurings, and slap a market multiple on it to get a price target. That's about the last thing that's going to get you to figuring out the intrinsic value of a company. If you're not thinking about how well and how willing a company is equipped to deal with the evolution of manufacturing, distribution, and service models and the implications those have on the cost of ownership for the customer, you'll get a better answer on things. The financial metrics -- return on capital, capital build on so forth -- are pretty straightforward. You have to be blind not to see the financial results for the direct PC companies. This isn't a P/E-to-growth rate sort of problem and it's not a P/E-to-market or P/E-to-peers sort of proposition. It's a strategy question and the financial results will flow from there.
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