Essay On Cost Leadership Strategy
Sir Brian Pitman, former CEO of Lloyds TSB used to tell his managers: “There is always a better strategy than the one you have; you just haven’t thought of it yet” (Harvard Business Review, April 2003). As a result, he always encouraged them to come up with 3 or 4 different strategies. But when your name is Michael Dell, and your model is one of the best in the industry for several years, it is hard to think like Pitman. There are several key choices that Dell made in the 1990s, that made it the largest PC manufacturer in the world. One of the most important was to market directly to consumers.
The Direct Model Approach, which Dell pioneered, gave it independency from distributors and retail channels. On one hand, this allowed Dell to drive down its costs and increase its profit margins and on the other, it allowed it to segment its customers into smaller and smaller groups and target those groups that were most profitable. One of these groups, for example, was the corporate clients group who enjoyed doing business directly with Dell. By cutting out the middlemen, Dell could customize their products to the needs of corporate clients quicker and more efficiently.
In terms of Porter’s generic strategy, Dell positioned itself somewhere between product differentiation and cost leadership despite the fact that by doing so, it risked to be stuck in the middle. The truth is that in the 90s it was hard to choose between one of the two generic strategies: on one hand the PC was becoming a commodity therefore limiting the possibility of having differentiated products, and on the other, the prices of PCs were falling, limiting the possibility of pursuing a cost leadership strategy.
However, Dell found the winning formula by differentiating its product by the way it delivered it to the client, enhancing customer relationship and adding value to the customer. Another reason why the Direct Model Approach was the most important step Dell took in gaining its competitive advantage was the inability of competitors to duplicate this model. Paradoxically, the more they tried to do what Dell was doing (i. e. sell directly to customers), the more they increased Dell’s credibility in the market.
The distribution channels on which the competition heavily relied have become both a critical necessity and an impediment with nobody to profit from it but Dell. Dell used the direct sales and build-to-order model to develop an exceptional value chain that led to its renowned competitive advantage. The close relatioship with customers and suppliers was the main focus of the value chain. By maintaing a close relationship with the customers, Dell could gather more information and thus tailor its supply chain and its products so they benefit these clients better.
As part of the primary activities, Dell did a wonderful job in terms of logistics. By maintaining a close relationship with suppliers (literally, as their plants were situated close to Dell’s) and by sharing parts of its information systems with them, Dell was able to keep its inventories low, which resulted in lower costs which eventually transferred to the customer. Dell constructed special Web pages for suppliers, allowing them to view orders for components they produce and thus to plan based on customer demand. The most significant part in Dell’s value chain is – as trivial as it may sound – the Internet.
The Internet allowed Dell to take orders from the customers and tailor its products specifically to one’s needs or wants, thus offering an unlimited variety of PC configurations. Also, the Internet made it possible for Dell to bring its products to market quicker than anybody else. More importantly, but not as visible as the consumer sales, the Internet facilitated the B2B sales, which accounted for most of Dell’s revenue. The Dell Web site offered each corporate customer an individualized interface where purchasing managers could log on and order using an interface customized for their company’s needs.
Last, but not least, the Internet also facilitated Dell with collecting the payments more quickly, allowing it to achieve a low level of inventory and a negative working capital. As Dell’s Direct Model Approach constituted its main strength, it is important to note some of Dell’s weaknesses as well. For example in the consumer market, Dell was able to sell only to knowledgeable customers. For the rest, there was a small chance to purchase a Dell computer since they would have to have a minimum knowledge of what actually goes in it.
Also, in the value chain, outbound logistics were based on shipping contracts with UPS and other third-party shippers which increased the cost of shipping per product. One of the weaknesses of Dell’s supply chain was that cost could not be reduced by accomplishing economies of scale. However, this logistic model allowed Dell to deliver its customized products to specific customers in short amounts of time. Dell’s opportunities in the 1990s were vast as the costumers became more and more educated with regards to computers.
Increase demand in PCs and Laptops were also important opportunities that Dell ended up exploiting. However, in the computer industry threats abounded as technology was changing rapidly, testing the dynamism and flexibility of PC companies throughout the industry. Competition posed a constant threat to Dell who although had a significant competitive advantage, had to work hard in order to maintain it. Applying Porter’s 5 force framework to any company in the PC industry before and after Dell would render different outcomes because Dell changed the structure of the industry and the relative position each competitor had.
For example by consolidating its Direct Approach Model, Dell posed a barrier to new entrants who would have to secure a relationship with suppliers and customers similar to Dell’s. For competitors this would have been even harder as they already relied on distributor channels to sell their products. In terms of buyer/supplier power, Dell was in advantage: its customers were divided in groups that were too small to give them buyer power and the suppliers were too many, too small, and competing with each other on products that were too similar to give them any supplier power.
But while Dell did an extremely good job in the 1990s, it failed to maintain its competitive advantage in the ever-changing tech industry today: “While Hewlett Packard, IBM, and other rivals transformed themselves in recent years by acquiring new companies and capabilities, Dell long stuck with its old playbook of cranking out PCs as efficiently as possible” (BusinessWeek 26th October 2009).
By focusing on the same old strategy, Dell missed the opportunity to maintain its competitive advantage while other competitors have positioned themselves accordingly to the changes in the tech industry today, specifically the shift from PC to the Internet. In other words, there has been a reversal of roles from the 1990s: Dell, the player with the competitive advantage for many years has now become the pursuer, trying to re-position and reinvent itself. While 10 years ago, its competitors were struggling to duplicate Dell’s model, it is now Dell that is completely changing its strategy.
For example, today, Dell sells through retail channels like Wal-Mart and BestBuy to appeal to a wider audience. Also, according to BusinessWeek, Dell is ramping up R&D to make its products stand out with innovative features and designs. In the past, Dell almost never did acquisitions, relying on growth in PC demand to boost its revenues. But with the PC market maturing, Dell is stepping up its deal making to push into tech services, storage, and other promising markets.
In 2005 Dell was valued at $100 billion, or more than HP and Apple combined, but today, it’s worth $30 billion, less than a third of its rivals’ market values (BusinessWeek 26th October 2009). This is nothing but a testament of how merciless the computer industry is today and how important it is to constantly come up with better strategies. Sir Brian Pitman was right after all. If only Michael Dell would have listened.
References
- Edwards, Cliff. “Dell’s Do-Over. ” BusinessWeek 26 Oct. 2009: 37-40. Print. Harvard Business Review Apr. 2003.
