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MASSACHUSETTS INSTITUTE OF TECHNOLOGY

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JONATHAN L.S. BYRNES LEXINGTON, MA 02421
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FAX: 781-862-0506
JLBYRNES@MIT.EDU

The Case of Dell

Consider the case of Dell, a master of the supply chain. Most


readers know the outline of Dell’s success story. In 1994, Dell was
a struggling second-tier PC maker. Like the others, the company
ordered its components in advance and manufactured to inventory. If
its forecasts were wrong, Dell had major write-downs. Then Dell
began to implement a new business model. It converted its
operations to a build-to-order process, eliminated its inventories
through a just-in-time system, and sold its products directly to
customers. The results were spectacular.

Over a four-year period, Dell’s revenues grew from $2 billion


to $16 billion, a 50% annual growth rate. Earnings per share
increased by 62% per year. Dells stock price increased by over
17,000% in a little over eight years. In 1998, Dell’s return on
invested capital was 217%, and the company had $1.8 billion in
cash.

By putting new supply chain capabilities at the core of its


strategy, Dell developed supply chain mastery that went far beyond
the simple pursuit of efficiency and asset productivity. However,
Dell had to make a series of very difficult strategic tradeoffs to
bring its functional activities into alignment with its new
business model.

Dells Business Model

At the heart of Dell’s supply chain-based strategy is a seem-


ingly-impossible conundrum: the company has adopted a build-to-
order system, yet it must commit to purchase key components 60 days
in advance. How does Dell do this? The answer lies in Dell’s
tightly-aligned business model, which has several key elements.

Account selection. Dell purposely selects customers with


relatively predictable purchasing patterns and low service costs.
The company has a core competence in targeting customers, and keeps
a massive database for this purpose. About 80% of Dell’s business

© 2000, William Copacino and Jonathan Byrnes


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stems from long-term corporate relationship accounts - customers


having predictable needs closely tied to their budget cycles. For
these, Dell develops powerful customer-specific intranet websites
with predetermined, custom specifications and budgets. The
remaining 20% of Dell’s business involves individual consumers. To
obtain stable demand in this segment, Dell uses higher price points
and latest technology products to target second-time buyers who
have regular upgrade purchase patterns, require little technical
support, and pay by credit card.

Demand management. “Sell what you have” is Dell’s phrase for


the crucial function of matching incoming demand to predetermined
supply. This occurs through two related processes: (1) top-level
managers from Sales, Marketing, Manufacturing, and Purchasing meet
weekly to determine where component overages are likely to develop,
and these are revised and adjusted on a daily basis; and (2) the
order-takers can tell from their screens what configurations are
available, and they have incentives to steer point-of-sale demand
toward these.

Dell’s pricing also reflects real-time demand management, and


varies significantly from week to week. This is illustrated by
Chart 1, which displays how Dell’s pricing of a specific PC
configuration changed over the course of a 10-week period, as
compared to three other sellers of another makers similarly-
configured P5000 model. While the competitor’s prices were stable
with periodic adjustments, Dell’s prices varied significantly from
week to week as the company modified its prices to push products
where component inventory was building beyond prescribed levels.
This core philosophy of actively managing demand in real time, or
“selling what you have,” rather than making what you want to sell,
is a critical driver of Dell’s success. Most popular accounts of
Dell miss this key element entirely.

Internet sales. This channel has reached $6 million per day in


sales, and is growing by $1 million per day each quarter. While
revenue growth is attractive, Dell’s business model would have
collapsed if the company’s Internet customers did not fit its
target account profile. Dell continued to be successful, however,
because its Internet customers are repeat buyers attracted to
Dell’s high-end computers, like Dell’s existing customers who use
more traditional channels. As long as the account profile does not
change, channel realignment enhances market share without
endangering the business model.

Product lifecycle management. Because Dell’s customers are


largely high-end repeat buyers who rapidly adopt new technology,
Dell’s marketing can focus sharply on managing product lifecycle
transitions. The company’s direct marketing provides real-time
customer feedback, which leads to the rapid cycles of learning
essential to product development and crisp lifecycle timing. Dell
has become expert at curtailing the end-of-life tail of its 6-9
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month product cycle. In this way as well, Dell manages demand to


match its predetermined supply.

Supplier management. Although Dell’s manufacturing system


features a combination of build-product-to-order and buy-component-
to-plan processes, the company works closely with its suppliers to
build more flexibility into its system. Dell has concentrated its
supplier base, with about 50-100 suppliers accounting for 80% of
Dell’s purchases. Supplier selection is based only 30% on cost,
with the other 70% on quality, service, and flexibility - Dell has
chosen suppliers that are masters of the supply chain as well.
Plus, Dell has instituted a 3-stage process to reduce component
lead times: (1) supplier revolving inventory buffer, (2) supplier
quick response, and (3) Dell product simplification. Through the
Web, both Dell and the suppliers have deep visibility into each
other’s businesses.

Forecasting. Dell’s forecast accuracy is about 70-75%, due to


its careful account selection. Demand management, in turn, closes
the forecast gap. When in doubt, Dell managers over-forecast on
high-end products because it is easier to sell up, and high-end
products have a longer shelf life.

Liquidity management. Direct sales are explicitly targeted at


high-end customers who pay with a credit card. These sales have a
4-day cash conversion cycle, while Dell takes 45 days to pay its
vendors. This generates a huge amount of liquidity that finances
Dell’s rapid growth, and limits its external financing needs. This
cash engine is a key underlying factor that enables Dell to earn
such extraordinarily high returns.

Genesis of Dell’s Mastery

How did Dell master its supply chain, transforming it into


such a cohesive, focused business system? Did the company’s execu-
tives meet in a visioning session and lay out the new system on a
whiteboard? The answer is very telling, and gives insight into why
so few companies have become effective supply chain masters so far.

The seeds of Dell’s success were sown in its failures of an


earlier time. In 1994, Dell created two important products that
were deficient. Sales plummeted and Dell faced imminent insolvency.
The company ran out of cash. The executives met to decide how to
generate the funds to keep the company alive. They had only two
choices: issue very expensive convertible debt, or liquidate their
inventories.

Dell did indeed issue convertible debt, which caused financial


difficulties for some time. In addition, the decision was made to
dramatically reduce inventories. The heads of Manufacturing and
Marketing were charged with devising a way to run the business
without inventories. They protested that it was not possible. Top
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management responded that a way must be found. This was the impetus
for Dell’s masterful new system.

The new Dell business model developed over a period of time.


The build-to-order system was phased in, with finished goods
inventory dropping inexorably from 70 days to 30-40 days, to 20
days, to nearly zero. At the same time, the sales force was trained
to “sell what you have.” As the new supply chain-based strategy
emerged and proved viable, Dell moved aggressively to refine it and
to bring the other functional activities into tight alignment. The
beauty of Dell’s supply chain mastery lies not only in its
insightful strategic objective, but just as importantly in the
laser-like focus and functional alignment of its business model.
Yet Dell was forced to master its supply chain because it had no
choice.

About the authors:

William C. Copacino is Managing Partner of Accenture’s Global


Supply Chain practice. He was the recipient of the 1998 Council of
Logistics Management Distinguished Service Award, and he earned an
MBA from Harvard Business School in 1977.

Jonathan L.S. Byrnes is a Senior Lecturer at MIT and Chairman of


Swift Rivers, a returns management software company. At MIT, he
teaches the graduate course, Case Studies in Logistics and Supply
Chain Management. He earned a DBA from Harvard Business School in
1980, where he was a UPS (1907 Foundation) Fellow.