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Dell Inc. in 2008: Can It Overtake Hewlett-Packard as the World Leader in Personal Computers?

Feedback on Questions for Week 7, second week of Dell case, week commencing 07.11.11
Questions 1. Is Dells strategy working? What is your assessment of the financial performance that Dells strategy has delivered during fiscal years 2000-2008? Use appropriate financial ratios as a basis for doing your calculations and drawing conclusions about Dells performance.
You will need to get in the habit of crunching the numbers in company financial statements and coming up with an insightful diagnosis of the companys financial performance and financial condition. You should always expect to spend some time assessing the financial statements in the case and then spending a few minutes presenting to the class about the companys performance, rather than just giving off-the-cuff opinions. Those who have done a conscientious job of studying and crunching the numbers in case Exhibit 2 should come up with the following: Dells revenues grew from $25.3 billion in Financial Year (usually abbreviated to FY [sometimes called Fiscal year or even just fiscal]) 2003 to $61.1 billion in FY2008, equal to a compound annual growth rate (CAGR) of 13.4%. Net income rose from $1.67 billion in fiscal 2000 to $2.95 billion in fiscal 2008 - a CAGR of 8.5%. However, Dells 2008 earnings were down from $3.6 billion in FY 2006. Although Dells sales rose annually between 2000-2008, earnings performance was uneven, with both net income and EPS going up in some years and going down in other years. Likewise, Dells net profit margin (shown in Exhibit 2) has varied, hitting highs of 6.6% in 2000, 6.5% in 2006, and 6.4% in 2004 and lows of 4.0% in 2002 and 4.8% in 2008. Due to stock repurchases, the number of outstanding shares of common stock has been trending downward. Despite the earnings volatility, Dell earned a spectacular 78.7% return on total stockholders equity in FY 2008; the ROE rates in earlier years were also very, very good: 59.7% in FY 2007, 89.0% in FY 2006, 46.5% in FY 2005,

41.8% in FY2004, 26.5% in FY 2002, and 31.4% in 2000. Profit margin performance has been uneven; gross profit and operating profit margins in 2008 were better than in 2007 but the net margin was lower. The pattern of profit margin changes is shown below: 2008 Gross profit margin Operating profit margin Net profit margin 2007 2006 2005 2004 2002 2000

19.1% 16.6% 17.7% 18.4% 18.3% 17.7% 20.7% 5.6 4.8 5.3 5.8 7.9 6.5 8.6 6.1 8.5 6.4 5.7 4.0 9.0 6.6

As shown just below, operating expenses as a percentage of sales revenues at Dell trended downward from 11.7% in 2000 to 9.8% in 2005, but then have increased rather sharply to 13.5% in 2008 - part of the rise in expenses stems from accounting requirements to show stock-based compensation as an operating expense. The rising operating expense percentages have been factors in crimping Dells profits. 2000 11.7% 2002 11.9% 2004 9.8% 2005 9.8% 2006 9.9% 2007 11.2% 2008 13.5%

The companys research, development, and engineering spending jumped significantly in 2008 to $693 million, versus spending of $430-$500 million in earlier years. S., G.,& A. expenses as a percent of revenues have been creeping upward at Dell since FY 2004; the big jumps in 2007-2008 were due in large part to the new accounting requirement to report stock-based compensation as an operating expense. 2000 9.4% 2002 8.9% 2004 8.7% 2005 8.9% 2006 9.1% 2007 10.4% 2008 12.3%

From the cash flow and balance sheet data in the bottom portion of case Exhibit 2, you should see that: The companys operations are generating sizable positive cash flows - $3.9 billion in both fiscal 2007 and 2008, but these were down from the amounts in 2006 ($4.75 billion) and 2005 ($5.8 billion). The company is in a strong cash position, with $7.97 billion in cash and marketable securities as of February 1, 2008. However, the amounts held in cash and marketable securities are down from earlier years. The company has very little long-term debt - $362 million in 2008 versus

stockholders equity of $3.7 billion, a very good debt-to-equity ratio of just under 10%. Long-term debt has trended down the past 3 years. Overall, it is fair to say that Dells financial performance has weakened in the last two years of the case studys period. But the companys balance sheet is strong and it has ample financial resources to undertake whatever new strategic moves may be called for. Dell is by no means a financially troubled company. The data in case Exhibit 3 merits some comment: Dell generates a big fraction of its revenues in the Business segment of North America. Dells revenues in the U.S. consumer segment have dropped for two consecutive years, after rising in all the other years shown. Europe is Dells second biggest market. Dell lost money in the U.S. consumer segment in FY2008 - the profit erosion is this segment over the past two years is alarming and surely needs addressing immediately! Dells operating profit margins in the Americas are larger than its margins in other parts of the world. For example: Operating Income as a % of Net Revenues 2008 Americas Europe/Middle East/Africa Asia-Pacific/Japan 6.7% 6.6 5.5 2007 6.9% 4.3 4.5 2006 9.4% 6.8 8.0 2005 9.0% 7.6 8.1

Dells operating profit margins in the Business segment of the Americas region are quite good: 2008 2007 2006 2005 2004 8.2% 8.1% 10.4% 10.0% 10.2%

2. What does a SWOT analysis reveal about the attractiveness of Dells situation in 2008?
The Dell case is an excellent vehicle for conducting a proper SWOT analysis. It should be apparent that much of Dells success stems from the core competencies and strong competitive capabilities that top management has built and conscientiously nurtured doing a proper SWOT analysis tests their ability to identify just what makes Dell such a strong competitor and why it has rapidly climbed into contention for global market leadership. Dells Resource Strengths/Capabilities/Competitive Assets Build-to-order capability - capability to mass produce customized products (a Dell distinctive competence) Proven capabilities as a world-class manufacturing innovator and a low-cost manufacturer/assembler - a one-time Dell distinctive competence that has eroded to a core competence as contract manufacturers have found ways to match (beat?) Dell on low-cost assembly, at least in laptop PCs Just-in-time inventory know-how and exceptional supply chain management capabilities (a Dell distinctive competence) Long-term partnerships with key suppliers Pioneering use of Internet and e-commerce technology - informationsharing and close collaboration with both parts/component suppliers and Dell customers Dell appears to be the low-cost leader among the major players in the IT industry - a very powerful strength and competitive asset Capability to load customer software, install asset tags, create Premier Pages for corporate customers; Dells value-added approach to customer service lowers customer costs and gives them a cost-based reason to buy Dell (a likely core competence!) Intimate knowledge of customer requirements Dells global manufacturing and global sales capabilities More potent direct sales capability than any other rival R&D expertise in selecting the best technologies and parts/components, coming up with low-cost designs, improving users experience with Dells products, improving product quality, and identifying ways to streamline the assembly process A good reputation and brand image Growing breadth of product line (backed by the resources and competitive strengths/capabilities to win sales and market share in several new product categories the company has entered)

Dells Resource Weaknesses/Deficiencies/Competitive Liabilities Dell has recently lost its cost advantage over contract manufacturers in assembling PCs, most especially in laptop PCs; as a consequence, Dells 8 assembly plants may have a become a competitive liability rather than a competitive asset Selling direct to end-users is probably not the best way to access first-time buyers and the home/individual segment; Dell is clearly weak in selling through retail channels No in-house repair service capabilities (as some rivals have)warranty repairs and fulfilling service contracts is outsourced to local service providers Lacks the product line and IT service breadth of Hewlett-Packard The direct sales approach is not the preferred or normal distribution channel in Europe, China, and in several other parts of the world; Dells heavy reliance on direct sales has disadvantages in Japan and China where buyers like to look and touch before buying A somewhat weaker brand name image and reputation as compared to HP (at least for large enterprise customers) Dells Market Opportunities Take sales and market share away from rivals in PCs across all of the worlds major markets Make further inroads in the global markets for servers, data storage products, data routing switches, printers and ink cartridges, and IT services - Dell has a tiny share of the overall global IT market and thus plenty of room to grow its sales and market shares (see case Exhibit 11) External Threats to Dells Future Profitability and Well-Being Contract manufacturers find ways to cut assembly costs of PCs even further, thus putting Dell at a cost disadvantage and allowing other brands (HP, Acer) to supplant Dell as the low-cost leader A long-term slow-down in global sales of PCs, servers, and other IT products - many large enterprises are looking to cut their IT costs. Dells Distinctive Competencies Just-in-time inventory practices and supply chain management (no one in the PC industry does it better - or even comes close to matching what Dell can do) Direct sales capabilities (no rival can yet match Dell) - and the capabilities are global; but strong capability to sell direct does not translate into a competitive advantage in the Home segment (where Dell has recently lost market share, as shown in case Exhibit 5)

Leadership in use of the Internet and e-commerce technologies - but this distinctive competence probably has minimal competitive impact as of 2008 versus the late 1990s and early 2000s when Dell was a pioneer in use of the Internet - today, most large enterprises (and certainly HP) have Internet/e-commerce capabilities on a par with Dells. Class members could thus make a strong argument that any distinctive competence in this area Dell once enjoyed has probably evaporated entirely and that Dells use of the Internet and e-commerce technologies no longer qualifies as a distinctive competence and is a core competence at most. Dells Core Competencies Low-cost build-to-order manufacturing and mass customizationa world-class manufacturing innovator (a former distinctive competence that has been reduced to a core competence by the fast-emerging capabilities of contract manufacturers to match or beat Dells assembly costs; furthermore, Dells resources in plants and assembly may be on the verge of becoming a competitive liability if contract assemblers achieve further cost reductions Value-added customer needs/expectations services and knowledge of customer

Cost efficient and award-winning technical support Dells customer-focused R&D capabilities SWOT Analysis Conclusions: Dells strategy, resource strengths, and capabilities make it a formidable competitor in the global IT market. Dells status as the low-cost leader in a market where IT customers are becoming increasingly interested in reducing their IT costs and where many products are incorporating standardized components and technology (as opposed to proprietary technology) puts it in position to be competitively successful. Two of Dells resource strengths and competitive capabilities seem to have recently lost their competitive power in the marketplace. Contract assemblers have caught up with Dell in assembling PCs at low costs. Since 2005, Dells direct sales approach has not worked to its advantage in winning sales and market share in the Home segment (in years past, Dells direct sale model worked much better in this segment, as can be seen from the data in case Exhibit 5). Theres reason to agree with Michael Dell that There are enormous opportunities for us to grow across multiple dimensions in terms of products, with servers, storage, printing and services, representing a huge realm of expansion for us. Theres geographic expansion and market share expansion back in the core business. The primary focus for us is picking those opportunities, seizing on them, and making sure we have the talent and the leadership growing inside the company to support all that growth.

Overall, Dells situation is very attractive, but the road just ahead will be a tough one. Outcompeting HP is going to be far harder that it was under HPs former CEO, Carly Fiorina. HP, under its new CEO, has recently begun flexing its muscles and has considerable competitive capabilities of its own to do battle with against Dell. Moreover, the global financial crisis and global economic recession that unfolded in Autumn 2008 is going to pose all kinds of challenges to grow revenues and profit - not just to Dell but to HP and other IT companies.

3. What is HPs situation in 2008 and how well does it compare with that of Dell?
We think a good way of matching the two companies is to look at their Relative competitive strengths. Their Relative Cost Position is becoming increasingly important because of falling prices, mounting price competition, and greater use of standardized technologies in PCs. Other factors that you could assign high importance weights to include (1) product customization capabilities, (2) customer service capabilities (since many buyers are looking for value-added services from PC suppliers who can meet their particular needs for technical support and afterthe-sale service), and (3) brand image and reputation (which also reflects buyer perceptions about product quality and reliability). Table 1 Competitive Strength Assessment of Dell versus Hewlett-Packard (Rating scale: 1 = very weak; 10 = very strong) Importance Weight 0.30 0.10 0.10 0.15 0.05 0.10 0.10 0.10 1.00 59 7.85 70 8.65 Dell Rating 9 10 8 6 3 8 8 7 Hewlett-Packard Score Rating 2.70 1.00 0.80 0.90 0.15 0.80 0.80 0.70 8 6 10 10 9 10 9 8 Score 2.40 0.60 1.00 1.50 0.45 1.00 0.90 0.80

Competitive Strength Measures Relative Cost Position Product customization capabilities Brand image/reputation Breadth of product line Range of IT service offerings Distribution strength and access to IT customers and PC users Global market coverage Customer service capabilities/ after-sale technical support Sum of weights Total Rating/Score

The competitive strength ratings in Table 1 shows HP as being the strongest overall, chiefly because of its good cost competitiveness, stronger brand image/reputation, breadth of product line (especially in diversity of IT services), and its global distribution strength. In PCs, the two are probably very evenly matched. Dells competitiveness is strongest in PCs and low-cost servers. Its preference for incorporating standardized technology and avoiding proprietary technology serves it well because of the cost savings that accrue to customers. IT customers are going to be very cost-conscious in the recessionary environment that lies just ahead, so Dells low-cost/low price strategy should serve it well and make its products/services appealing to price-conscious customers.

4. What Generic strategy has HP been following, and what is your judgement about how successful it has been?
We might say that HP has been following a broad differentiation strategy, where they have been using a very strong brand to differentiate themselves in many segments of the wider computing market, but with particular strengths in hardware, software support and printing. We see HPs strategy in PCs as having two main strengths or appeal: Its strategy of outsourcing assembly to contract manufacturers in now paying off. Prior to 2007-2008, Dells assembly costs were typically lower than those of contract manufacturers, which weakened HPs ability to compete with Dell on price and still earn acceptable profits. Most recently, Dells cost advantage has evaporatedand Dells strategy of operating its own assembly plants may prove to be a disadvantage instead of an advantage (why else would Dell suddenly and somewhat shockingly want to sell its entire fleet of assembly plants?) HPs strategy of selling primarily through resellers and retailers now seems to be paying off, particularly in the Home market segment. Such was not the case in the years prior to 2005 when Dells market share in the Home segment was rising. Dell has, in fact, backed off of its 100% sell-direct distribution approach (something that Michael Dell vowed not to do years earlier) and has begun complementing is direct-sales approach with sales through select retail partners. HPs distribution strategy of utilizing resellers and retailers to reach customers looks much better than it once did - and HP has very, very strong global distribution capability using this approach. But it is much too early to declare a strategy winner. The Dell-HP battle for market leadership is going to be a marathon not a sprint. Both companies are formidable competitors, with multiple resource strengths and capabilities. And both will employ strategies that evolve in ways yet unknown. Hence, you should be cautious about making a rush to final judgment. You should recognise that any conclusions you draw are temporary and subject to change as events unfold and the market contest between Dell and HP seesaws back and forth.

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