Many people have been very skeptical about Dell’s ability to replicate its famous direct sales model abroad. According to Dell’s CEO, when the US-based computer hardware company first expanded internationally (into the UK in 1987), “of the twenty-two journalists who came to our press announcement, about twenty-one predicted that we would fail. The direct model is an American concept, they claimed; nobody will buy computers direct from the manufacturer … It’s a bad idea, they said. Go home.”[i]
Similar doubts were expressed when Dell entered China. In China, Dell gradually evolved from an indirect sales model to a ‘dual system’ model (i.e., a system that uses both direct sales and distributors). At first, in the early 1990s, Dell exported PCs to China using only distributors. Then, in 1998, Dell set up a manufacturing base in Xiamen, China, and applied a dual system model. In August 2004, Dell pulled out of the low-end PC market in China, thereby reducing the weight of distributors in its dual system model.
In the US, Dell has evolved in the opposite direction, from a direct sales model to a dual system model: Dell USA started to sell PCs at Wal-Mart in 2007.
What future changes should we expect for Dell China?
The direct sales model
A college dropout after his freshman year, Michael Dell capitalized on the opportunity of selling PCs directly to consumers when he noticed a number of anomalies in the computer business. For the components of an IBM PC, manufacturers would pay around US $700; for the assembled PC, retailers would pay US $2,000; and customers would then pay US $3,000 without receiving much technical support. This was the traditional channel model followed by the biggest players in the industry such as IBM and Apple: manufacturers built computers, distributed them to dealers, and dealers sold them to businesses and individual consumers.
Michael Dell thought that end users paid too much. He thought that he could make the process of buying a PC easier and better. In 1983, when Michael was only a freshman, he bought PCs at retail stores, upgraded them by purchasing components, and sold upgraded PCs to people he knew. For him, this was a good opportunity: he could bypass much of the retailer’s markup and pass savings on to end users. In 1984, Michael Dell created Dell Computer Corporation, the first computer manufacturer to sell PCs directly to end users. By the end of 1986, Dell’s annual sales had reached US $60 million.
Much of the success was attributed to the direct sales model. Dell redesigned and integrated its supply chain: it received orders from end users first, then ordered components from its suppliers, assembled PCs and finally shipped PCs directly from Dell’s factories to end users. Compared with the traditional supply chain in the computer industry, the direct model had two major advantages. First, the closeness to end users helped Dell better understand users’ needs, forecast demand more accurately and build long-term relationships with end users. Second, the elimination of distributors helped Dell reduce not only its selling cost, but also its inventory through both accurate forecasting and integration with components suppliers.
The direct sales model seemed to meet two trends in the 1980s very well. First, corporate customers and individuals were becoming very sophisticated and experienced technology users. They often knew exactly what they wanted and did not need intense personal selling. Second, mass customization was also becoming viable as components became standard modules.[ii]
In 1990, Dell experimented with selling computers through retail stores like CompUSA, Best Buy and Sam’s, but pulled out of the retail distribution channel in mid 1994. Dell made a core decision to stick to the direct sales model: ‘never sell indirect’ finally became one of the three golden Dell rules, the other two being ‘disdain inventory’ and ‘always listen to the customer’.[iii]
International expansion and exporting to China: pre-1998
Although Dell always stressed the direct sales model as a ‘golden’ Dell rule, the company applied this golden rule selectively in its international expansion, assessing each host country individually. Dell’s decision as to which model to adopt depended on characteristics along the country’s whole value chain. First, to what extent would end users accept direct sales, especially given Dell’s reputation in the host country? If end users had neither heard of nor seen Dell computers, it would be difficult to convince customers to buy via telephone. Second, to what extent would Dell be able to recruit a skilled sales force for direct sales? Third, were capable suppliers and carriers available to meet just-in-time management? Fourth, was the market size large enough?
International forays began in June 1987 when Dell started its business in the UK. In spite of wide scepticism, Dell’s business in the UK was profitable from the very beginning.[iv] In the next four years, Dell established subsidiaries in 14 countries. In 1995, Dell established the Asia Pacific Customer Center in Penang, Malaysia, which functioned as the hub for sales and marketing in Australia, China, Hong Kong, India, Indonesia, Korea, Malaysia, New Zealand, the Philippines, Singapore, Taiwan and Thailand.
Dell’s history in China can be traced back to 1993, when Dell chose Star Advertising Corporation as its sole agent in mainland China and set up a network of four resellers.[v] The cooperation lasted less than a year. In 1995, however, Dell re-entered mainland China. From this time until late 1998, Dell imported PCs from other countries and then sold Dell PCs through its distributors. The distribution system included four first-tier distributors located in metropolitan areas including Beijing, Shanghai, Guangzhou and Xi’an, as well as secondand third-tier resellers. Dell’s representative office in China decided on the sales plan, designed promotion strategies such as sales rebates and coordinated the relationships among the distributors.
However, Dell’s performance was not very good. By 1996, Dell sold only 20,000 PCs in China, giving it only a 1 per cent market share and putting it in tenth place among PC vendors.[vi] These unimpressive results were largely due to the country’s relatively small market size and the lack of effort from both Dell and its distributors. Dell was waiting for the right time to apply its direct sales model, with no intention of keeping a long-term relationship with the distributors. At the same time, these distributors did not want to invest much in developing the market, anticipating that Dell would soon switch to its famous direct model.
Replicating the direct model in China: 1998–2004
Phil Kelly, President of Dell Asia Pacific, had been pushing Dell headquarters to build a manufacturing base in China and to sell directly. Finally, the tremendous growth of the Chinese PC market convinced the headquarters. In 1998, Dell set up a China Customer Centre (CCC) in Xiamen to manufacture and sell PCs, as well as to provide service and technical support.
Characteristics of the mainland China PC market
The PC market in China grew significantly during the mid and late 1990s: sales rose from RMB 7.6 billion in 1990 to RMB 66.2 billion in 1996.[vii] In 1998, China became the fifth largest PC market in the world, behind only the US, Japan, Germany and Britain. According to the prediction of the Market Information Centre (MIC) in June 1998, the PC market of mainland China would continue to grow and was very likely to become the third largest PC market in the world by 2000.
The Chinese market was distinctive in two important ways.[viii] First, retail buyers accounted for only about 10 per cent of total sales, and a PC would cost nearly two years of an average person’s savings. Thus, buying a PC was something very big for average Chinese families, and the whole family would want to go to a store, touch the machine and test it. Therefore, Dell targeted the corporate market, including MNEs and government institutions. The information officers in these organizations were usually technologically savvy, and they already knew what they needed. Seeing and touching the machine was not necessary. Moreover, these firms did not need much service either.
Second, credit cards in China were issued primarily to corporate bodies and people of high social status. Most Chinese people were not used to credit card sales.
Replicating the direct sales model with minor adaptations
Dell was confident that its direct sales model would work well in China if it focused on the corporate segment.
Dell thus divided its customers into three groups: relationship companies (companies with more than 3,000 employees), mid-sized companies (companies with 500–3,000 employees) and small-sized companies and family customers (companies with less than 500 employees and individual customers). The first two segments were the major targets.
After selecting its target markets in China, Dell modified its direct sales model in two ways to meet China’s distinctive characteristics. First, to contact corporate customers in China, Dell relied more on door-to-door sales and telephone sales rather than Internet sales. Normally, a sales team was comprised of an external salesperson and an internal one, with the former responsible for developing and retaining big accounts and the latter answering customers’ inquiries and handling purchase orders. On average, the salespeople made three to four calls a day and spent one third of the day visiting customers.
Second, Dell recognized that most Chinese people were not used to credit card sales, so it did not insist on pre-payment through the Internet. Instead, Dell signed agreements with several banks to facilitate payments; Dell’s delivery men could also collect cash or transfer money through wireless debit card machines carried by them.
Dell worked hard to reduce its costs in China, as a door-to-door sales channel was very costly, given salespeople’s salaries and commissions “commensurate with those paid in Hong Kong and the US”.[ix] Dell tried to improve efficiency across the whole value chain. For example, in 1999, the time from order to delivery in China was about the same as the 9-day period in the US. In addition, Dell tried to draw on local talent. Although Dell brought in some Dell employees from Southeast Asia, the company soon hired local talent for most positions, even for many managerial ones.
Dell’s direct sales efforts resulted in a much improved market penetration.[x] By 1999, Dell was ranked seventh among the top PC manufacturers in China, with a market share of 2.3 per cent. By 2004, Dell became the top company in sales of servers and commercial computers.
The dual system model: 1998–2004
While replicating its direct sales model in China, Dell continued to sell PCs and provide technical support through a network of authorized distributors, creating the first ‘dual system’ business model for Dell anywhere in the world. Dell named these authorized distributors ‘system integrators’. They received orders from their customers and then ordered PCs from Dell.
These system integrators played an important role. When retail buyers in the form of smallsized businesses and family customers lacked technological knowledge and wanted advice, Dell could not meet their needs, but system integrators could. Moreover, the sales volume through system integrators was too large for Dell to simply dismiss. In 2001, Foo Piau Phang, President of Dell’s operations in China, announced that around 75 per cent of Dell’s sales in China came from direct sales,[xi] although some insiders said that the percentage of direct sales was only around 60 per cent.[xii]
However, Dell was never completely happy with the system integrators. Obviously, they partially competed with Dell’s direct Internet and telephone sales. When system integrators bundled orders from retail buyers, the resulting large orders would win the system integrator better per-unit prices than what retail buyers would pay through Internet purchasing. For example, some notebooks from system integrators could be RMB 1000–2000 cheaper than the listed price on Dell’s website.[xiii] As a result, the system integrators took some sales volume away from the direct channel.
Dell was willing to put up with this, though, because the system integrators helped Dell to maintain and expand its market. What Dell did not tolerate, however, was when system integrators placed large orders with Dell (thereby earning prices below retail) and then sold the PCs to resellers/agents rather than end users. Dell tried to stop these unofficial agents. In 2003, the collision between Dell and these unofficial agents led to a widely reported lawsuit.[xiv] Shanghai Zhiqi Corp. ordered 53 PCs from Dell and prepaid for these at the price of RMB 5,699, but after one week Dell China contacted Shanghai Zhiqi and cancelled the order, arguing that Dell had offered an inaccurate price and needed to triple the price. According to Dell’s spokesman, Dell suspected that Shanghai Zhiqi was selling these PCs not to end users but to smaller distributors. The lawsuit ended with a private settlement between the two parties.
Despite such occasional problems between Dell and its distributors, the dual system worked very well when the retail buyer segment was negligible in the mainland Chinese PC market. Between 2000 and 2002, Dell was delighted to see its market share in the retail market rise from 0.2 per cent to 4.7 per cent, most of which came from system integrators (because Dell itself focused on large and mid-sized companies).
However, the lawsuit case in 2003 signalled to Dell that its dual system model, with the main focus on direct sales, did not fit the market conditions very well anymore. Given the rapid market growth in China, the good reputation of the Dell brand and the impossibility of exercising proper control over independent distributors, the likelihood of opportunistic behaviour by some of these partners was considerable.
Faced with the growth of the retail market: after 2004
The mainland Chinese PC market continued to grow in the new millennium, but most of the growth has come from the retail market. The growth rate of PC demand in urban centres such as Beijing and Shanghai fell to an annual rate of 2–3 per cent in 2004, while the growth rate in midsized cities and small towns soared to around 40 per cent. Compared with retail buyers in big cities, end users in rural areas had less savings to spend, knew less about computers, preferred to receive advice from retailers before they made the important decision to buy a computer, and required convenient technical service after bringing the PC back home.[xv] Commentators noted that businesses were also requiring these services that Dell did not traditionally supply: “demand is emerging elsewhere – in hundreds of smaller cities .. . where even some business customers want to see products before they buy”.[xvi]
In China, Dell’s performance started to fall after 2004. From being second in 2003, it fell to fourth in 2004 with a market share of 7.2 per cent, even though PC shipments rose by 29 per cent. In 2006, Dell still lagged behind three local vendors: Lenovo, Founder and Tongfang. Lenovo, the market leader, had a market share of 25.1 per cent with around 4,800 retail outlets in China. In addition,
Acer was catching up in China, totally relying on distributors and outsourcing all production to factories in China.[xvii] Compared with these rivals, Dell was still doing very well in the corporate segment, but was falling further and further behind in the retail segment.
In 2003, Dell rejected a plan from its executives in China to sell computers online, but then accepted the plan one year later when statistics showed that more than 90 million people in the coastal cities in China had access to the Internet, either at home or work.[xviii] At the same time, Dell exited the low-end PC market, because that market required distributors with physical access to local consumers. In 2005 and 2006, the presidents of Dell China and Dell Asia-Pacific, together with four top executives in Asia, left Dell to join Lenovo. A major reason for the exodus was that Chinese executives wanted to focus much more on distributors and resellers, while Dell headquarters disagreed.
In China, Dell has started to focus on low-end consumers again by designing a new computer in 2007, priced at US $335 to meet the needs of novice users in this emerging market.[xix] However, the lingering problem for the firm is that, according to one consultant, “ ‘Dell needs to establish more of a presence on the street’ either through kiosks or retailers.”[xx]
Dell’s retail move
In 2006 and 2007, Dell lost its position as the largest PC maker in the world to Hewlett-Packard.[xxi] Additionally, Dell lost its top ranking for highest notebook and LCD shipments to Acer and Samsung respectively. Its reputation was also jeopardized with recalls of over four million laptops and allegations of fraud in financial reporting. Michael Dell, who had resigned as CEO in 2004, resumed this role in 2007 to help turn around the struggling company. In an email sent to Dell’s worldwide staff in April 2007, Michael Dell indicated that Dell would pursue new models of manufacturing and distributing computers. “The Direct Model has been a revolution, but is not a religion … We will continue to improve our business model, and go beyond it, to give our customers what they need.”[xxii] Dell’s restructuring plan was to centre around the consumer.[xxiii]
The year 2007 was a time of change for Dell as the company stepped away from its core strategy of direct ‘modeling’ and moved towards the more traditional retail approach. Dell recognized that its built-to-order strategy had been key to its success in the past, but acknowledged the fact that the PC industry was changing and that Dell would need to change with it.[xxiv] PCs were now being used as more of a ‘hub for multimedia’, creating a greater need for consumers to physically evaluate a product before making a purchase.[xxv] In addition, the growing demand for PCs in emerging markets shifted attention to these new consumers. With its experience in China, Dell recognized that consumers in emerging markets did not benefit from the direct model as much as they did in developed markets. Although the direct model was still expected to be the primary method for selling in mature markets, the need to open up other distribution channels in emerging markets was evident.[xxvi]
Dell initiated a change to its model in the US in June 2007. Moving away from its traditional reliance on the direct sales model, it started selling computers through Wal-Mart.[xxvii] Internationally, Dell opened retail locations in Russia and Hungary and partnered with retail chains in various countries including the UK, Japan, and China. By 2008, Dell products were located in roughly 10,000 retail locations. This was still significantly lower than Hewlett-Packard, whose products were found in over 110,000 locations.[xxviii]
Rethinking retail in China
Effectively capturing the market in China required Dell to compete in a similar retail fashion to its main competitors Lenovo and Hewlett-Packard. Selecting the right retailer was imperative for Dell as it wanted to pursue a selective strategy. Michael Dell stated “[Dell didn’t] want to just show up everywhere”.[xxix] In 2007, Dell partnered with Gome, the largest electronics retailer to provide the face-to-face contact that the Chinese consumers’ desired. Gome is found extensively throughout China, with over 1,000 stores in 168 cities.[xxx] Inventory in each store varies depending on the location, with some retail locations requiring no inventory.
The move to partner with a large retailer like Gome has been met with some criticism from industry executives as the majority of electronics is bought from small retailers located in IT malls. With close to 100 retailers, consumers are able to get access to numerous products at one location. It is estimated that around 80 per cent of all PC purchases are made in these IT malls, however Dell’s Consumer VP Michael Tatelmen foresees a consolidation in the industry.[xxxi]
To establish more commercial clients, Dell has developed its service capabilities to compete better with rivals in the market. Hardware has become a struggling sector in terms of its capacity to make profits, so services such as storage and cloud computing have taken on a stronger focus. In 2009, Dell acquired Perot Systems, an IT service provider, for US $3.9 billion to further develop its service competencies.[xxxii] Steve Felice, President and Chief Commercial Officer, describes Dell’s service and customer focus as a “[return] to a value-products oriented company. At the same time, [Dell is] transforming into a solutions company.”[xxxiii]
In 2010, Dell started to see its efforts pay off with record growth in China that has been unmatched by any other country. In the first quarter, Dell experienced 81 per cent growth over the previous year’s results.[xxxiv] An increase in Dell’s commercial clients in 2011 can be attributed to turmoil at Hewlett-Packard after that company announced its intention to sell off its PC segment, causing customers to switch to more stable competitors even though Hewlett-Packard inevitably cancelled the initiative months later.
To continue its growth, Dell is now putting efforts into capturing the rural market in China. Although this segment has generally not been seen as containing many PC consumers, the vast number of potential customers is attracting attention from many PC manufacturers. Accessing this segment requires Dell to display its technology and educate villagers on the benefits of using a Dell PC. By tapping into new customer segments, increasing service capabilities and improving distribution tactics, Dell hopes to cling to its position as the second largest PC manufacturer in China.[xxxv]
QUESTIONS
- What are Dell’s FSAs? What are the macro-level requirements for the direct sales model to be successful? What are the major advantages of the direct model, compared with the traditional channel strategy in the computer business?
- How did Dell treat its distributors in China during its re-entry into China in 1995? Was there a vicious cycle of bounded reliability involved? Who should be blamed for Dell’s initial failure?
- According to Arnold’s seven guidelines, discussed in Chapter 11, what mistakes did Dell make?
- Given Dell’s FSAs and China’s location advantages in the late 1990s, why was the direct model successful? What has changed since?
- With the changing market situations after 2004, what new location-bound FSAs should Dell develop to cater to retail buyers in China? Or, alternatively, what complementary capabilities should Dell expect from its distributors?
- Did demand and supply uncertainties affect Dell’s channel strategies in China? How?
- Arnold recommends simultaneously internalizing some distribution activities and outsourcing other activities to external distributors. This is the ‘dual system’ model already followed by Dell in China. Please use Figure 11.2 to analyse possible channel strategies Dell could use in the future.
- Can you provide an update on Dell’s distribution strategy in China, using materials available on the Web?
Notes
[i] Michael Dell and Catherine Fredman, Direct from Dell (New York: HarperCollins, 1999), 28.
[ii] Anil K. Gupta and Vijay Govindarajan, Global Strategy and Organization (New York: John Wiley & Sons, 2004), 155.
[iii] Dell and Fredman, Direct from Dell, 43.
[iv] Ibid., 28.
[v] ‘Business briefs’, Wall Street Journal (7 October 1993), B.4.
[vi] Wayne Arnold, ‘Dell feels the heat in computer dispute with Chinese buyer’, Wall Street Journal (Eastern Edition) (18 April 1997), B.16.B.
[vii] B. Buchel and S. Raub, ‘Legend Group and the Chinese Computer Industry’, Asian Case Research Journal 3 (May 1999), 51.
[viii] Neel Chowdhury, ‘Dell cracks China’, Fortune 139 (21 June 1999), 120–4.
[ix] Ibid.
[x] Ibid.
[xi] Mingshun Li, ‘What is hidden under the direct model’, 21 Century Economic Report (5 June 2003).
[xii] ‘Misery of Dell – the story from an insider’, IT Times Week (23 March 2004).
[xiii] Li, ‘Hidden under the direct model’.
[xiv] Ibid.
[xv] Mure Dickie and Scott Morrison, ‘In China the agent enters the equation’, Financial Times (26 August 2005), 13.
[xvi] Louise Lee, Peter Burrows and Bruce Einhorn, ‘Dell may have to reboot in China’, Business Week (7 November 2005), 46.
[xvii] Bruce Einhorn and Olga Kharif, ‘A racer called Acer’, Business Week (29 January 2007), 48.
[xviii] Evan Ramstad and Gary McWilliams, ‘Computer savvy: for Dell, success in China tells tale of maturing market’, Wall Street Journal (Eastern Edition) (5 July 2005), A.1.
[xix] Gordon Fairclough and Jane Spencer, ‘Dell’s PC for China marks developing-market rush’, Wall Street Journal (Eastern Edition) (22 March 2007), B.3.
[xx] Lee, Burrows and Einhorn, ‘Dell reboot in China’, 46.
[xxi] Michael Kanellos, ‘Global PC shipments grow, but revenue remains flat’, CNET News.com (17 January 2007), accessed 12 June 2007.
[xxii] Christopher Lawton, ‘Dell could go beyond its direct-sales model in bid to bolster growth’, Wall Street Journal (Eastern Edition) (28 April 2007), A.6.
[xxiii] Cliff Edwards, ‘Dell’s extreme makeover’, BusinessWeek (15 October 2009).
[xxiv] William Hoffman, ‘Redirecting Dell’, Traffic World (21 April 2008).
[xxv] Kevin Allison and Robin Kwong, ‘China chapter of Dell’s retail adventure opens NEWS ANALYSIS Computer maker’s latest move is part of the overhaul of its longheld direct sales model’, Financial Times (25 September 2007), 26.
[xxvi] William Hoffman, ‘Redirecting Dell’, Traffic World (21 April 2008).
[xxvii] Kevin Allison and Chris Nuttall, ‘Dell to sell its computers at Wal-Mart’, Financial Times (25 May 2007), 24.
[xxviii] Christopher Lawton, ‘Dell treads carefully into selling PCs in stores’, Wall Street Journal Eastern Edition (3 January 2008), B.1.
[xxix] Ibid.
[xxx] Mark McSherry, ‘Dell to sell computers through China’s Gome’, Wall Street Journal (23 September 2007).
[xxxi] Bruce Einhorn, ‘Dell goes retail in China with Gome’, BusinessWeek (24 September 2007)
[xxxii] ‘Dell to acquire Perot Systems for $3.9 billion, creating comprehensive, customer-focused IT-solutions company’, Dell Inc. press release. http://content.dell.com/us/en/corp/d/ secure/2009-09-21-Perot-Systems (21 September 2009).
[xxxiii] Gaurav Raghuvanshi, ‘Dell Counts on Local Leaders’, Wall Street Journal (Online) (4 April 2012).
[xxxiv] Loretta Chao, ‘Dell intends to extend services unit in China’, Wall Street Journal Eastern Edition (25 March, 2010), B.8.
[xxxv] Gaurav Raghuvanshi, ‘Dell Counts on Local Leaders’, Wall Street Journal (Online) (4 April 2012).