Kemble, Must Read from New York Times:
July 26, 1998
Is This the Factory of the Future?
By SAUL HANSELL
MEMPHIS, Tenn. -- The conveyor belt deposits a tray holding a half-built computer and a stack of parts in front of Sheila Roby. Wielding an electric screwdriver, Ms. Roby installs the arrayed circuit boards, memory chips and disk drives. Within five minutes, she is ready to snap on the beige cover, emblazoned with a gleaming red Compaq logo.
As that machine glides away, it is replaced by another chassis and another package of parts for Ms. Roby to assemble. But this time, the logo on the cover is blue, and it says IBM.
It has been six months since Ingram Micro Inc., the world's largest wholesale distributor of computers, snaked a conveyor belt three-quarters of a mile long through this converted warehouse. And already, it is producing computers for Compaq Computer, IBM, Hewlett-Packard, Apple Computer and Acer.
As if doing assembly work for archrivals that together control more than one-third of the nation's computer market weren't enough, Ingram has also grabbed a piece of the action traditionally reserved for retailers.
Thick yellow wires dangling from ceiling racks are hooked up to the finished PCs to install both software programs and codes that will enable the users to tap into their employers' networks. Finally, Ingram packs up the computer and ships it directly to the customer with a label that makes the box look as though it came from a local dealer.
Indeed, Ingram wants to do almost everything computer dealers do. It will set up World Wide Web sites for them, answer phones in their name and turn bill collectors loose on their deadbeat customers.
"Our job is to handle more and more of their back room," said Jerre L. Stead, the chairman and chief executive of Ingram, which is based in Santa Ana, Calif.
Here, in this warehouse big enough to house a fleet of jets, is a glimpse of the future of American industry, where manufacturers don't make anything and retailers don't touch the goods they sell. Ruthless competition -- whether from cheap foreign labor, new superstores or the Internet -- is forcing every player in the production process to question old ways of doing things and to look for new ways to make money. And if that means invading somebody else's turf, so be it.
"It's becoming truly unclear who is doing what on what day," said Fadi Chehade, a former Ingram executive who is now the chairman of Rosettanet, a trade group creating standards to aid computer sales. "The consumer doesn't care if all the computers were made on the same production line. The only thing that matters is who will stand behind it."
The blurring of lines among manufacturers, distributors and retailers is occurring in industry after industry, from energy to medicine. But the computer industry is in many ways in the vanguard of these shifts.
Manufacturers now merely design products and advertise their brands, assigning the actual assembly to others. The dominant theory of production is moving beyond "just in time," the inventory-reduction method pioneered by the Japanese in the 1970s, to "on someone else's time," where inventory is foisted on another player in the chain.
Retailers face whole new classes of competitors, from Internet sites that never touch products to the manufacturers who are bypassing retailers to sell to their customers directly.
And the middlemen -- those wholesalers and distributors who were supposed to be squeezed out by the new efficiencies -- are in fact thriving. When they're not building products, they're often taking over from manufacturers and retailers all the logistics of storing and moving goods.
Consider the online music business: Valley Record Distributors in Woodland, Calif., a wholesale music distributor, holds all the inventory and mails all the compact disks to customers on behalf of three of the biggest Internet "stores" -- N2K's Music Boulevard, CDNow and Total E of Columbia House.
Similarly, while travel agents continue to be squeezed, central reservations systems like the Sabre Group thrive as they provide the computerized back office for a new generation of Internet travel services.
What is driving the computer industry to reorganize itself faster than nearly any other is the relentless pace of technological change, which causes today's hot model to become next month's doorstop. The value of a PC falls by 1 percent a week. Getting somebody else to hold an inventory of computers or parts -- or simply making inventory vanish by producing PCs only to order -- can give a huge bounce to any company's bottom line.
"Computer inventory is like fresh fish on the table," said Henry Bertolon, chief executive of NECX, one of the largest on-line computer stores. "It tastes great the first day, but the longer it sits the smellier it gets." Using distributors like Ingram, NECX can undercut local stores and simply has no inventory.
he computer industry was forced into its cost-cutting mania by the rapid growth in the early 1990s of Dell Computer and other manufacturers that sell directly to consumers.
Dell's build-to-order system just about eliminated the need for inventory and enabled it to undercut the big guys' prices by 10 percent to 15 percent. As the computer market shifted from individuals to corporations buying networks of hundreds or thousands of machines, more customers wanted the sort of customization that was Dell's specialty.
Even though Dell lacked an on-the-ground army for sales and technical support, many companies found it cheaper to buy its products and create their own support staffs or hire contractors to do the repair and consulting work.
Other computer makers, meanwhile, were bleeding red ink because they were making mountains of machines that stayed in their warehouses and on their dealers' shelves until long after they were obsolete. And because of a convention known as price protection, the manufacturers had to reimburse the retailers for all the markdowns on aging goods.
Something had to change.
The computer makers decided it was better to be quick than clever, and thus to design simple computers with standard designs rather than trying to innovate.
"We came to the realization that we were just distributors and integrators of Microsoft and Intel technology," said Robert Moffat, general manager of PC manufacturing and distribution for the International Business Machines Corp. That was a hard pill to swallow for all the PC companies, especially for IBM, which pioneered the personal computer market.
In the last two years, the manufacturers have tried to slash inventory by making computers only after customers order them, as Dell does. But this has required reorganizing an entire industry.
The first step was to cut way back on the number of components, like processor chips and hard disk drives, they kept on hand. Instead, suppliers were forced to keep the inventory, typically adjacent to or even in the same building as the computer factory, and sell it to the manufacturers at spot prices throughout the day.
Initially, the suppliers balked at being forced to hold all the inventory, with its ever-deteriorating value, but their complaints were largely ignored.
"If Compaq tried to do this five years ago, there would have been a rebellion," said Charlie Winder, Compaq's vice president for North American operations. "But as the direct model began to grow and challenge the indirect model, our partners began to see there may be an advantage in building a hybrid model," a system that still sells computers through local retailers but that also has some of the efficiencies of a build-to-order company like Dell, he said.
This puts the entire industry on a high wire, with no inventory as a safety net to cover unexpected demand. Computer makers have started signing contracts to deliver machines that not only have yet to be built but for which the components have not yet been procured.
"We're selling on promise, not on inventory," Moffat of IBM said. "Everybody has to trust everybody."
Some manufacturers, realizing that spending on parts dwarfs labor costs, have shut down their factories for days at a time to wait for the price of Intel chips to fall.
nce the manufacturers got a handle on inventory coming into the factory, they faced the more daunting task of finding shortcuts for the meandering paths computers traveled after they left the factories.
"I got on a truck with a computer because I couldn't believe what my guys were telling me," Moffat recalled. "I found there was more time spent waiting than driving."
The most ambitious of their plans was to have wholesalers like Ingram, and even some big dealers that served the corporate market, like the Vanstar Corp. of Pleasanton, Calif., handle some of the actual assembly. Right now, manufacturers are shipping to these companies half-built PCs with the motherboard, floppy disk drive, processor chip and some memory already installed.
Soon, the assembly partners will be building the computers from parts. That way, the processor chips, for example, can be shipped directly from Intel to the distributor, cutting more expensive days off the supply chain. (This arrangement also cuts out several of the quality checks, meaning that a computer's first test is often its last.)
Hot Potato
Why are computer makers reorganizing production to chop inventories? Because the value of an unsold computer drops with each passing day.
It wasn't easy for the computer companies to give up so much control over the manufacturing process, but they realized they had no alternative, according to Jim McDonnell, vice president for commercial sales at Hewlett-Packard.
"We own all of the intellectual property; we farm out all of the direct labor," he said. "We don't need to screw the motherboard into the metal box and attach the ribbon cable."
To be sure, the computer industry's response to Dell has not been an unvarnished success. In theory, the vast ecosystem of manufacturers, wholesalers and dealers is supposed to act symbiotically to build computers the moment a customer orders them, eliminating stockpiles of excess inventory.
In reality, the ecosystem suffers from alternating floods and droughts. None of the computer makers' bold initiatives kept them from choking on excess inventory earlier this year.
"The behavior of Compaq and our channel partners had not changed as much as we needed to," Winder of Compaq said. (In the computer industry, the network of distributors and dealers serving corporate users is collectively known as "the channel.")
Moreover, said Aaron Goldberg, an analyst with the research firm ZD Market Intelligence in La Jolla, Calif., computer distributors and dealers have had a hard time getting their assembly lines working. "These are not manufacturing companies," he said.
The computer makers say that they are working the kinks out of their systems and that the depressed profits of their PC businesses should begin to rebound in the second half of the year. Compaq, for example, says it has 3.5 weeks of inventory throughout the channel, half the level of a year ago and close to its goal of two to three weeks.
For the distributors, the alliance with manufacturers presents mostly opportunity.
While the smaller companies are largely being bought because they cannot cope with the increasingly complex system, a handful of major players -- Ingram, Tech Data, Merisel and Pinacor -- are enjoying much faster growth than other segments of the industry.
Ingram's sales, for example, nearly tripled to $16.6 billion in 1997 from $5.8 billion in 1994, through a combination of acquisitions and market-share growth. Since the company went public in November 1996 at $18 a share, its stock has soared by 149 percent, closing at $44.875 on Friday.
Ingram is vastly expanding its traditional computer wholesale business by building huge, automated warehouses to distribute components like printers and software and setting up factories like the one in Memphis to assemble PCs.
Indeed, it has just struck a deal with the Solectron Corp., a company that manufactures components for nearly all the big computer makers. The companies say that through a joint network of 11 factories worldwide, they will be able to make 10 million PCs a year, doing everything from forging the case to soldering the chips to installing software in each location.
Because PCs are so much alike these days, Ingram is also betting that some people will not care if they do not have a brand name on them. So it is creating separate production lines in its assembly plants to build "white box" PCs. These generic machines, in the past typically built by dealers, have long accounted for a large share of the computer business. Now Ingram will do the building, stamping the dealer's name on the PC cover.
n the new, topsy-turvy computer world, Ingram itself is coming to look more and more like Dell. After all, it is building computers to order and shipping them directly to customers. So why bother with all the complexity of doing business in the names of all those manufacturers and retailers? Wouldn't it be better to start selling the computers directly to the public, as Dell does?
No way, says Stead, Ingram's chief, because his dealers collectively are a vastly more powerful sales army than Dell's.
"We have 120,000 resellers with more than one million feet on the street," he said.
But that infantry of computer dealers is now besieged by almost everyone but Ingram. All the big manufacturers have started selling directly to end users.
Despite limited success in the past with direct sales, Compaq recently revived and expanded an effort to sell computers by telephone and over the Internet. And it is using the big sales force it inherited in its acquisitions of Tandem Computers and the Digital Equipment Corp. to deal directly with big customers.
"Large accounts want a relationship with Compaq," Winder said.
Similarly, IBM has started selling its Netfinity line of servers -- big personal computers that store files for a group of users -- directly to customers.
Unlike previous direct-sales attempts, IBM is not protecting its dealers by charging a high list price rather than the actual street price for its products. And price protection for distributors and retailers has, for the most part, disappeared, too.
"Ten years ago, you had to have a price umbrella so everyone could live in the market," said William McCracken, general manager of PC sales at IBM "Today, everyone has to compete on their own price efficiency."
Perhaps the most efficient players these days are a bunch of companies that try to do for computer sales on the Internet what Amazon.com has done for books.
They do little more than operate Web sites that display repackaged listings from the distributors' catalogues with prices that are barely higher than wholesale costs, and use the distributors to ship the goods to the customer.
Buycomp, founded by Scott A. Blum, the co-founder of Pinnacle Micro, is a vivid example. Located in an industrial park just a few miles from Ingram's headquarters in Santa Ana, Buycomp employs fewer than 50 people to run its site and take calls from customers.
Blum's strategy is to win the business of those customers who use electronic price-comparison shopping services. So he has programmed his service to check out his competitors and to offer the lowest prices on the Web.
Buycomp's shipping and handling charges, which are disclosed only after a customer enters his credit card number, are higher than some others. Even so, just seven months after the service started, Blum says the privately held firm has sales of $10 million a month.
He says he is intent on surpassing the record for the highest first-year revenue of an American business -- a title now held by Compaq, which took in $111 million in 1983.
Coming soon at Buycomp and other online stores is the ability for Internet users to say exactly how they want a new PC configured and to have that order transmitted directly to a distributor like Ingram.
A few manufacturers are actually encouraging these Internet retailers by referring customers from their own Web sites. IBM and Hewlett-Packard, for example, are running their own Internet shopping services that let prospective buyers compare prices for their goods.
For the local dealer who has grown up selling computers to businesses and helping set them up, the competition is getting much tougher.
Thomas Thibault, owner of a small computer dealer in Pleasant Hill, Calif., started losing business in the last two years to direct sellers. "When I started in 1986, I would have made a $500 profit on a $2,500 PC," Thibault said. "Today, you would be lucky with a margin of $80."
Thibault's recipe for success, like that of most of his competitors, is to sell services, including help in setting up a network or installing a complex software package. If he can sell $250 to $500 of service with every $2,500 PC, he will be doing well, Thibault said.
For now, all the supposed streamlining in the way computers are manufactured has done little for him except to make it harder than ever to get the computers he needs.
"There are some very significant gaps," Thibault said. "The biggest worry I have is the instability of the market right now. We're spending 60 percent of our time procuring product and 40 percent out selling."
As for those Internet sites selling computer equipment at pennies above cost, Thibault said his ability to provide advice and service allowed him to compete, for now.
"Most of our customers would pay us 2 or 3 percent more because of our value added," he said. "We know the products better."
But increasingly, companies like Buycomp and NECX are using the new ways of doing business to create storefronts that appear to have all the capabilities of a traditional dealer. Customers will be able to comparison-shop for computers equipped to their liking, and then arrange the financing and service they need to get the systems up and running, all selected from third-party providers.
"We are building a virtually integrated model," said Bertolon of NECX. "You'll be able to access the network to get a quote on an IBM or a Dell or a white box, then plug in the leasing, outsourcing and desktop service you want. The Internet creates an opportunity to further level the playing field."
If all this technology and new thinking have created such a flat playing field, and if PCs bearing the logos of a half-dozen corporate giants are all made on the same production line, customers could be forgiven for wondering what, if anything, differentiates one brand from the next.
The companies' almost reflexive response is that their machines really are better than their rivals', either because of their technical designs, their extra features or the quality controls they have gone through.
Such claims, though, don't cut much ice with Ms. Roby, the assembly-line worker at the Ingram plant here. She says the only difference she sees is where the screws and wires go inside the chassis.
"Once you get used to it," Ms. Roby said, "they're all the same to me."
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