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microprocessor, the 386 chip. In introducing its PS/2 line of computers in 1987, IBM tried to make the

PC more proprietary. Compaq both adopted the 386 chip and led a group of nine clone makers in

affirming the existing industry standards. Though IBM subsequently accepted the 386, its market

share fell from 37.0% in 1985 to 16.9% in 1989.9

Like IBM, makers of IBM clones relied on resellers and retail stores to reach customers. While

IBM initially steered resellers away from the largest corporate accounts, start-ups such as Compaq

without internal sales forces encouraged resellers to cater to large customers. In time, even IBM

relied heavily on resellers to service large accounts.

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Throughout the 1980s and 1990s, PC performance improved and prices fell at a rapid clip.

Intel’s 386DX microprocessor, introduced in 1985, was priced at $299 and could perform 2.5 million

instructions per second (MIPS)—a price of $120 per MIPS. Intel’s Pentium II microprocessor,

launched in 1998, was priced at $699 and could carry out 675 MIPS—$1 per MIPS.10 In addition, the

range of software available for the personal computer expanded dramatically.

Microsoft released its new operating system Windows 3.0 in 1990, and over the next four

years, the user-friendly Windows became ubiquitous on PCs configured to the IBM standard. Indeed,

the standard soon became known as “Wintel,” reflecting the combination of the Windows operating

system and Intel’s x86 microprocessor architecture. By 1991, between 85% and 90% of computers

sold conformed to Microsoft / Intel standards, with the remainder using the proprietary Apple

operating system and a Motorola microprocessor.

The initial surge in sales of personal computers crested in 1990, just as a recession gripped the

United States. In newspapers around the world, Dell Computer ran advertisements showing that its

prices were much, much lower than Compaq’s list prices. Compaq usually discounted its PCs well

below the list price, but the advertising campaign was highly effective. In response, Compaq slashed

its prices by as much as 32%, introduced 41 new products in 1992, and added new distribution

channels.11 A vigorous price war followed.

Demand growth recovered in the mid-1990s, buoyed by strong economic growth and the

emergence of new, popular services involving computer networks. Proliferation of electronic mail

and growth of the World Wide Web gave customers, especially individual consumers, new reasons to

purchase a personal computer. PC prices continued to decline. Compaq offered a powerful personal

computer for less than $1,000 in 1997, and other companies rushed to offer similarly inexpensive PCs.

By December 1998, the prices of the least expensive PCs had plunged to $499. In the United States,

45.5% of households owned a computer in 1998, and the figure was expected to rise to 49.5% by

2000.12 Household ownership levels were lower but also growing in Europe and Asia. See Exhibits 1

and 2 for market size and share data over time.

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Hardware components such as housings, keyboards, memory chips, motherboards, disk

drives, monitors, modems, and connectors could be purchased in highly competitive global markets

served by numerous companies. In contrast, microprocessors were supplied by only a handful of

companies. Intel dominated this market, providing 80-90% of the microprocessors for Wintel PCs.13

By 1998, roughly 96% of new PCs followed the Wintel standard.14 Virtually all of the rest employed

the Apple standard with PowerPC microprocessors. Other semiconductor makers such as AMD and

Cyrix offered low-priced microprocessors which competed with Intel’s and used a similar

architecture, but historically, these companies had made few inroads into Intel’s near-monopoly. In

the sub-$1,000 market, AMD and Cyrix appeared finally to have made some headway in unseating

Intel. Roughly half of the sub-$1,000 PCs sold during 1998 were equipped with an AMD processor.15

Intel ordinarily made its microprocessors available to all major purchasers at a standard

price, thereby maintaining a level playing field among the leading PC makers. When Intel released a

new generation of microprocessors, demand typically exceeded supply. Intel then rationed its new

product, allotting microprocessors to PC makers in proportions that were based roughly on past

purchases. The price of a microprocessor of a given generation declined rapidly as a generation aged,

as did the price of PCs made with them. PC margins were typically highest during the early days of a

microprocessor generation.

Products in 1998. PC makers followed well-established standards to piece together modular

components of hardware and software. The resulting machines differed widely in their processing

speeds, memory capacities, portability, software configurations, modem speeds, and screen sizes, for

instance.

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The hardware and software that comprised a PC were often sold as an integrated bundle. PC

makers such as IBM, Compaq, and Dell would deliver computers with a Microsoft operating system

already installed and, in turn, would pay a fee to Microsoft. Increasingly, PCs were delivered with

pieces of application software also already installed.

Customers. PC buyers were usually divided into four categories: large and midsize

businesses / government; small businesses and offices; individual consumers; and educational

institutions. Exhibit 3 shows the portion of PC units and sales revenue accounted for by each set of

customers.

The core piece of software on a PC was the operating system. Virtually all PCs with x86

microprocessors employed an operating system made by Microsoft, usually some version of

Windows. A number of vendors offered “application software” such as word processors,

spreadsheets, database management systems, financial organizers, Web browsers, and electronic

messaging software. In this market, also, Microsoft held a preeminent position, accounting for nearly

80% of the market for so-called “office productivity applications” (e.g., word processors,

spreadsheets) and 10% of the overall $56 billion market for application software.16

As processing costs declined, the lines between PCs and other devices blurred. At the lower

end of the processing and memory spectrum, handheld electronic organizers had begun to compete

with the personal computer for applications such as electronic mail and portable computing. At the

higher end, PCs had become increasing hard to distinguish from workstations. Historically,

workstations had been several times faster and more expensive than PCs and had employed specially

designed microprocessors and distinct operating systems. In recent years, however, PCs based on the

fastest x86 microprocessors and Windows NT had begun to compete with the low end of the

workstation market. PC makers had also extended their product lines to include servers, powerful

computers that sat at the hubs of computer networks.

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Large and midsize businesses and government institutions usually had significant MIS

departments that purchased, maintained, and supported PCs in a centralized fashion. Staff members

were highly knowledgeable about PCs. They were charged with providing a reliable network of

high-performance computers while also controlling information system costs. The capital cost of a PC

was only a portion of the total cost associated with the machine. Once a PC was purchased, MIS staff

had to tag it for identification purposes, configure software, install the machine at the user location,

train the users, and help users when they encountered problems. By one estimate, corporations spent

between $8,000 and $12,000 annually to support each desktop PC.17 Most large organizations had a

motley collection of PCs of various brands and vintages, making maintenance, support, and reliability

of machines problematic.

Individual consumers purchased PCs for home or home-office use. In choosing among

brands, individuals relied heavily on the evaluations of independent organizations such as Consumer

Reports. Individual buyers were a diverse lot, but tended to be more sensitive to price and more

interested in a computer’s brand name than were business buyers.18 Some consumers also paid

attention to the brand of the microprocessor. Since 1990, Intel had spent an estimated $3 billion on

brand advertising for its microprocessors. Among individual consumers in the U.S., 30% of

purchasers were first-time buyers in 1998. This figure was expected to decline to 16% by 2000.19

Small businesses and offices typically lacked MIS staffs. Reliability, performance, support,

service, price, brand, and channel recommendations (see below) all played roles in the choice of a PC

by such organizations. By 1998, virtually all businesses had extensive experience with personal

computers.

In the eyes of some industry observers, buyers were divided into two true camps: Apple and

Wintel. Many long-time owners of Apple computers were highly, almost emotionally, attached to the

Apple standard, and they cursed the ascendancy of Wintel. Wintel customers, in contrast, tended to

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be less attached to a particular brand of computer. Apple was more successful in selling its PCs to

individuals and educational institutions than to businesses, though it thrived among desktop

publishers.

Channels. Personal computers flowed from manufacturers to customers via four channels:

retail stores, distributors (working with small resellers), integrated resellers, and direct distribution.20

Exhibit 4 shows the portion of PCs passing through each channel in various regions of the world.

A handful of large distributors such as Ingram Micro (with 1998 sales of $22.0 billion) and

Tech Data ($7.1 billion) supplied a full range of computer hardware and software to nearly 100,000

resellers.21 These resellers, typically small owner-managed firms, worked with business customers to

design, buy, configure, install, and support computer networks. According to one survey, 93% of end

users accepted reseller recommendations for computer purchases.22 Beyond charging for their value-

added services, distributors and resellers typically marked up hardware by a total of 5-7%, though

this mark-up had fallen in recent years.23

Retailers such as Circuit City and CompUSA in the United States and Time Computers in

Europe took delivery of PCs directly from manufacturers. Machines then passed through distribution

centers owned by the retailers on their way to stores. In stores, retail displays and sales people

played a significant role in helping customers select among models and manufacturers. Retail shelf

space was limited, and even large superstores typically carried only 3-5 brands of PCs. Computer

retailers operated on very thin margins. CompUSA, for example, earned overall gross margins of

14.1% and gross margins of roughly 7-9% on computers. It registered a net margin of 0.6% in 1998.

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A few resellers were large enough to deal directly with manufacturers rather than buy

through distributors. Integrated resellers such as MicroAge and Vanstar operated distribution

centers, fielded extensive sales and service organizations, and in some cases, managed the PC

networks of clients on an on-going basis. Vanstar, for instance, split its operations into three distinct

segments. The largest, involved in the procurement and installation of corporate PC networks,

earned a gross margin of 9.7% in 1998. A second segment devoted to network design and consulting

reported a gross margin of 44.4%, while a third involved in on-going network support and

maintenance earned a gross margin of 53.1%. Overall, Vanstar’s net margin in 1998 was a thin 1.3%.

Manufacturers usually agreed to buy back channel inventory that did not sell. In addition,

they provided price protection to resellers and distributors: if the price of a computer fell while it was

in the distribution channel, the manufacturer would reimburse the reseller or distributor accordingly.

By one estimate, inventory buy-backs and price protection cost PC manufacturers 2.5 cents on every

dollar of revenue. Manufacturers spent another 2.5 cents advertising to resellers and distributors,

funding the market development activities of channel players, and managing product returns. PCs

typically took four to five weeks to pass from the PC maker through distributors and resellers to

customers.24

Manufacturing. Computer makers used basic assembly-line techniques to assemble PCs

from standard parts. By the early 1990s, a manufacturer could buy and install the capital equipment

required for an efficient PC assembly line, capable of assembling 250,000 PCs per year, with an

investment of roughly a million dollars.25 Contract manufacturers, many in Asia, also stood ready to

make PCs on behalf of other firms. Exhibit 5 shows the structure of the costs typically incurred to

assemble a PC that would retail for roughly $1,000.

A fourth and final channel led directly from the manufacturer to the customer. A handful of

PC manufacturers took orders directly from customers, either over the telephone and Internet or by

means of internal sales forces. They then delivered PCs via third-party shippers such as UPS.

The prices of components used to make PCs had typically declined 25-30% per year. In 1998,

prices declined even faster, at a rate of roughly 1% per week. The financial crisis in Asia (where

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Dell Computer Corporation

many component makers were located), increased competition faced by Intel, and gluts in the

markets for several components all contributed to the faster decline in prices.26

“It was too late to challenge the technical standard and the dealer network had been done

already. Compaq was already very strong in retail. A new marketing and distribution

strategy was something new, however.”28

While a freshman at the University of Texas at Austin, 18-year-old Michael Dell started a

part-time business in his dorm room: he formatted hard disks for personal computers and added

extra memory, disk drives, and modems to IBM clones, selling them for as much as 40% less than

comparable IBM machines. Reluctant to reveal this distraction from his studies, Dell hid PCs in his

roommate’s bathtub when his parents came to visit.29

Marketing and sales. PC manufacturers took a variety of approaches to marketing and sales.

Companies such as Apple, Hewlett-Packard, and IBM spent as much as 2-3% of sales on advertising

in order to develop recognizable brands. Others produced unbranded “white box” PCs and did not

advertise to end users at all. Sales forces varied from the 25,000-strong sales organization of IBM to

the virtually nonexistent sales forces of white-box PC makers. White-box manufacturers served 23%

of the market in North America, 50% in Europe and Asia, and as much as 90% in China.27

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Dell used indicators of a company’s potential PC purchases, such as the number of employees

and the number of PCs per employee, to divide customers into two groups: Relationship buyers and

Transaction buyers.33 Relationship buyers were large companies and institutions that could be

counted on to place repeated orders for multiple PCs. Dell assigned a team of outside sales reps and

inside sales reps to each Relationship account. Over a thousand outside sales reps spent their time in

the field, understanding customer needs, courting customer personnel, helping customers configure

their information systems, and promoting Dell’s products and services. Inside sales reps, located in

call centers, received telephone calls from assigned customers. Because Relationship customers

typically specified particular PC configurations that their employees were allowed to order, the inside

reps serving such customers simply took orders and provided product and delivery information.

Both inside and outside sales reps had access to on-line information about a customer’s entire

Sales and marketing. While most competitors supplied machines based on orders from

distributors, resellers, and retailers, Dell took orders directly from customers. Businesses and

government institutions accounted for 77% of Dell’s sales, home and small office users 18%, and

educational institutions 5%. Very large customers, who purchased more than $1 million in PCs each

year, provided 70% of the firm’s revenue.31 No single customer represented more than 2% of Dell’s

sales.32

When revenue reached $80,000 per month in 1984, Dell dropped out of college and founded

Dell Computer Corporation. Already, companies such as Exxon and Mobil were clamoring for 50 to

100 of Dell’s machines at a time.30 In 1985, Dell shifted from upgrading the machines of other

manufacturers to assembling Dell-branded PCs. Revenue rose each subsequent year. (See Exhibit 6

for financial results.)

The basic elements of Dell’s Direct Model came together early in the company’s history and

remained in place in 1998. The company dealt directly with end customers. It served primarily

corporate customers and offered them high-performance PCs at relatively low prices. PCs were

customized to buyer specifications, and assembly commenced only after Dell received an order.

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purchase history and worked closely with Dell personnel responsible for after-sale service and

technical support. Dell tended to realize its highest gross margins among Relationship buyers.34

Transaction buyers included small-to-medium businesses and home computer users. The

company reached these customers via advertisements in trade journals and business publications,

catalogs, and direct marketing. Customers who wanted to buy a PC or obtain information could

reach an inside sales rep by calling 1-800-BUY-DELL (a different number than that used by

Relationship buyers). Inside sales reps for Transaction buyers provided product information and

actively encouraged customers to purchase more advanced PCs. Traditionally, Dell avoided the

inexperienced Transaction buyer. Morton Topfer, Vice Chairman of Dell, explained: “Consumers at

retail don’t know what they are looking for, other than price. We, on the other hand, like to sell to the

educated consumer.”35

In late 1990, Dell departed from its Direct Model and entered the retail channel. The move,

Michael Dell said, would “[provide] us with the opportunity to generate significant new business and

increase Dell’s market penetration,” especially among “PC customers—particularly at the entry

level—who want to physically ‘touch and feel’ a unit before they buy.”36 Accordingly, Dell produced

two lines of standard PCs and reached distribution agreements with computer superstores such as

CompUSA and warehouse clubs such as Sam’s Club. Sales through the retail channel were brisk, but

Dell soon found that it was losing money on retail sales. Exhibit 7 compares the margins which Dell

earned in the direct and retail channels. Retail losses contributed to Dell’s poor financial results in

1993, as did a major recall of notebook computers. In 1994, Dell withdrew from retail stores.

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As Dell had grown, it had subdivided its customer base into finer and finer categories. In

1994, buyers were classified as large customers or small customers. By 1996, the large customer

classification had been split into large companies, midsize companies, and government and

educational institutions. By 1998, large companies had been split into global enterprise accounts and

other large companies; government and educational accounts into federal, state and local, and

educational; and small customers into small companies and consumers.37 In addition, sales efforts

were divided by region and, within region, by country. Michael Dell explained that such divisions

were accomplished “for a lot of reasons. One is to identify unique opportunities and economics. The

other is purely a managerial issue: you can’t possibly manage something well if it’s too big.”38

For thousands of Relationship customers, Dell had designed custom Premier PagesSM. On

these secure Web pages, an employee of a customer might find pager numbers for their Dell account

team or a list of computer configurations that had been approved by the customer’s purchasing

manager, for instance. By December of 1998, transactions totaling $10 million per day involved

www.dell.com.39

Dell launched its Web site www.dell.com in July of 1996, and increasingly, customers were

using the site to contact Dell. Transaction buyers could obtain product information, configure a

computer system, check pricing, place an order, and track an order’s progress. They could also gain

access to the complete catalog of service and support information used by Dell’s service

representatives.

Occasionally, Dell sold to resellers. In December 1997, for instance, it sent a flyer to a limited

number of resellers offering older systems to resellers at prices 15-20% below the prices quoted at

www.dell.com. However, Dell did not allow returns or provide price protection.40 Roughly 5% of

Dell’s systems were purchased by resellers.41

Production, logistics, and procurement. Dell manufactured machines that were—within the

guidelines of a broad menu—tailored to customer needs. The company made customized PCs based

on actual orders and held no finished goods inventory of standardized machines. Dell operated

manufacturing facilities in Austin, Texas; Limerick, Ireland; Penang, Malaysia; and Xiamen, China. A

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fifth site was slated for Alvorada, Brazil. Daily meetings matched production schedules with sales

flows. Keith Maxwell, Dell’s vice president for worldwide operations, commented:42

[The current production system] requires that the whole organization be

integrated. You’ve eliminated buffers. When you have no buffers and you have no

inventory, the whole organization has to work together. There is no way to let things

pile up, because you have no piles.

Once received, an order was sent electronically to the appropriate manufacturing facility.

There, a computer generated a parts list for the order and assigned the order a bar code for tracking

purposes. Dell’s older facilities were organized in assembly-line fashion: as the chassis of the

machine traveled down the line, the hardware specified by the parts list was added. Its newest

facility in Austin employed five-person manufacturing cells: parts for a PC were compiled in a bin,

the bin sent to a cell, and the computer assembled there. The company found that the cells delivered

machines with fewer defects more efficiently.43

After assembly, the machine moved to a software loading zone. There, special machines and

a very-high-speed computer network installed software specified by the customer: an operating

system, commercial application software, and diagnostic software. For some corporate customers,

Dell also loaded proprietary software. The fully equipped machine proceeded to a “burn-in” area,

where it was tested for several hours. Finally, it was boxed along with accessories and shipped to the

customer. Dell maintained shipping contracts with a number of third-party shippers such as UPS and

Airborne Express.

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Dell worked closely with suppliers to arrange just-in-time delivery of parts. Dell had

whittled its days of inventory down from 32 in 1995 to 7 in 1998.47 Since 1992, it had reduced the

number of suppliers for its Austin facility from 204 to 47.48 With remaining suppliers, Dell maintained

close electronic links, communicating replenishment needs to some vendors on an hourly basis. The

electronic links allowed Dell to direct some suppliers’ shipments straight to its customers. Computer

monitors supplied by Sony, for instance, never passed through Dell’s facilities. Rather, Dell

communicated the order for a monitor to Sony and to its shipper. The shipper picked up the

computer at Dell’s site, picked up the monitor at Sony’s, brought the boxes together, and delivered

them simultaneously to the customer. A web site customized to Sony gave both Sony and Dell

continuous access to ordering and manufacturing information.49 Michael Dell explained:50

The production process, from order entry to shipping, took about a day and a half.44 In the

midst of the Asian economic crisis in October of 1997, for instance, Dell received an emergency order

from the Nasdaq stock exchange for eight servers. The exchange’s existing servers were being

strained by unprecedented trading volumes. Dell shipped the customized, tested servers within 36

hours.45 At the same time, the production process could handle large orders. Also in late 1997, for

example, Dell built 2,000 desktop computers and 4,000 servers for Wal-Mart, loaded the machines

with proprietary software, and shipped them to 2,000 Wal-Mart stores.46

Dell encouraged suppliers to locate warehouses and production facilities close to its assembly

operations. Co-location was particularly easy to arrange near Dell’s major facilities in Austin, where

local and state government officials had worked since the 1950s and 1960s to attract high-technology

companies. Now known as “Silicon Hills,” the Austin region included 72 semiconductor

manufacturers and related suppliers, 160 computer and electronics manufacturing firms, more than

600 small and midsized software companies, and 825 technology consulting and services firms.51

…what’s the point in having a monitor put on a truck to Austin, Texas, and

then taken off the truck and sent on a little tour around the warehouse, only to be put

back on another truck? That’s just a big waste of time and money, unless we get our

jollies from touching monitors, which we don’t.

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In addition to selling hardware, Dell offered to install off-the-shelf software and a customer’s

proprietary software. On a custom basis, it installed and tested computers and networks at customer

sites. A new venture, Dell Financial Services, offered leasing, technology planning, and asset

management services.

Products and services. Dell provided two lines of desktop computers, one designed to be

reliable, stable, and highly compatible with corporate networks, the other intended to incorporate the

latest technology. Desktop computers ranged from $1,250 machines for individual consumers to

$4,000 PC for corporate networks. The company also offered two lines of notebook computers, with a

similar distinction between the lines. A line of network servers and, since 1998, a line of workstations

filled out the company’s product range.52 Dell’s workstations and servers used Windows NT and x86

microprocessors.

After a sale, Dell supported its products in several ways. Online, Dell offered 50,000 pages of

customer support information. A customer with a problem could also reach a technical support staff

of 1,300 representatives via a hotline that was manned 24 hours a day. Upon receiving a call, support

personnel would retrieve a file containing details of the customer’s computer, starting with the

original order and recording all subsequent service calls. Using the diagnostic software installed in

the factory, the customer and the support specialist could resolve the problem over the telephone in

approximately 90% of cases. For problems requiring an on-site visit, Dell contracted out service to

companies such as Xerox, Wang Global, and Unisys rather than employ service personnel itself. Most

problems requiring an on-site visit were resolved with 24 to 48 hours.53 Dell was working with

service providers to create measures of service quality and to improve the flow of data between them

and Dell.54 Dell also conveyed information concerning defective parts from the service providers back

to its suppliers.55

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In 1998, senior management paid special attention to several performance metrics. The

company monitored days of inventory by product component. It managed receivables and payables

such that, on average, it received payment for its produc...