Article Summary

THE POWER OF VIRTUAL INTEGRATION:

AN INTERVIEW WITH DELL COMPUTER'S

MICHAEL DELL I' I J

BY J O A N MAGRETTA ! I I

H OW DO YOU CREATE A $ 1 2 BILLION COMPANY IN JUST I 3 YEARS?Michael Dell began in 1984 with a simple business insight: he could by- pass the dealer channel through which personal computers were then being

sold. Instead, he would sell directly to customers and build products to order.

In one swoop, Dell eliminated the reseller's markup and the costs and risks as-

sociated with carrying large inventories of finished goods. The formula became

known as the direct business model, and it gave Dell Computer Corporation a

substantial cost advantage.

The direct model turned out to have other benefits that even Michael Dell

couldn't have anticipated when he founded his company. "You actually get to

have a relationship with the customer," he explains. "And that creates valuable

information, which, in turn, allows us to leverage our relationships with both

ARTWORK BY NATALIE ASCENCIOS 7 8

THE POWER OF VIRTUAL INTEGRATION:

suppliers and customers. Couple that information with technology, and you have the infrastructure to revolutionize the fundamental business models of major global companies."

In this interview with HBR editor-at-large Joan Magretta, Michael Dell describes how his company is using technology and information to blur the tra- ditional boundaries in the value chain among sup- pliers, manufacturers, and end users. In so doing, Dell Computer is evolving in a direction that Michael Dell calls virtual integration. The individ- ual pieces of the strategy-customer focus, supplier partnerships, mass customization, just-in-time manufacturing-may all be familiar. But Michael Dell's insight into how to combine them is highly innovative: technology is enabling coordination across company boundaries to achieve new levels of efficiency and productivity, as well as extraordi- nary returns to investors. Virtual integration har- nesses the economic benefits of two very different business models. It offers the advantages of a tightly coordinated supply chain that have traditionally come through vertical integration. At the same time, it benefits from the focus and specialization that drive virtual corporations. Virtual integration, as Michael Dell envisions it, has the potential to achieve both coordination and focus. If it delivers on that promise, it may well become a new organi- zational model for the information age.

How has Dell pioneered a new business model within the computer industry?

If you look back to the industry's inception, the founding companies essentially had to create all the components themselves. They had to manufac- ture disk drives and memory chips and application software; all the various pieces of the industry had to he vertically integrated within one firm.

So the companies that were the stars ten years ago, the Digital Equip- ments of this world, had to build massive structures to produce every- thing a computer needed. They had no choice but to become expert in a wide array of components, some of which had nothing to do with creat- ing value for the customer.

As the industry grew, more spe- cialized companies developed to pro- duce specific components. That opened up the op- portunity to create a business that was far more focused and efficient. As a small start-up. Dell couldn't afford to create every piece of the value chain. But more to the point, why should we want to? We concluded we'd he better off leveraging the

investments others have made and focusing on de- livering solutions and systems to customers.

Consider a component like a graphics chip. Five or ten years ago, a whole bunch of companies in the personal computer industry were trying to create their own graphics chips. Now, if you've got a race with 20 players that are all vying to produce the fastest graphics chip in the world, do you want to he the twenty-first horse, or do you want to evaluate the field of 20 and pick the best one?

It's a pretty simple strategy, but at the time it went against the dominant, "engineering-centric" view of the industry. The IBMs and Compaqs and HPs subscribed to a "we-have-to-develop-every- thing" view of the world. If you weren't doing com- ponent assembly, you weren't a real computer company, it was like a rite of passage. You some- how proved your manhood by placing small semi- conductor chips on printed circuit boards.

And Dell Computer came along and said, "Now wait a second. If I understand this correctly, the companies that do nothing hut put chips on moth- erhoards don't actually earn tremendous profit do- ing it. If we want to earn higher returns, shouldn't we be more selective and put our capital into activi- ties where we can add value for our customers, not just into activities that need to get done?" I'm not saying those activities are unimportant. They need to get done very, very well. But they're not sources of value that Dell is going to create.

When the company started, I don't think we knew how far the direct model could take us. It has provided a consistent underlying strategy for Dell despite a lot of change in our industry. Along the way, we have learned a lot, and the model has evolved. Most important, the direct model has al- lowed us to leverage our relationships with both suppliers and customers to such an extent that I be-

Virtual integration means you basically stitch together a business with partners that are treated as if they're inside the company. \

lieve it's fair to think of our companies as being vir- tually integrated. That allows us to focus on where we add value and to build a much larger firm much more quickly. I don't think we could have created a $ 12 billion business in 13 years if we had tried to be vertically integrated.

74 HARVARD BUSINESS REVIEW March-,/^ril 1998

AN INTERVIEW WITH DELL COMPUTER'S MICHAEL DELL

Why can you grow so much faster without all those physical assets?

There are fewer things to manage, fewer things to go wrong. You don't have the drag effect of taking 50,000 people with you. Suppose we have two sup- pliers building monitors for us, and one of them loses its edge. It's a lot easier for us to get more capacity from the remaining supplier than to set up a new manufacturing plant ourselves. If we had to build our own factories for every single component of the system, growing at 5 7 % per year just would not be possible. I would spend 500% of my t i m e i n t e r v i e w i n g prospective vice presidents because the company would have not 15,000 employees but 80,000.

Indirectly, we employ something like that many people today. There are, for example, 10,000 service tech- nicians in the field who service our products, but only a small number of them work for us. They're contracted with other firms. But ask the customer, "Who was that person who just fixed your computer?" The vast majority think that person works for us, which is just great. That's part of virtual integration.

So we cook up a little deal where the supplier agrees to meet 25 % of our volume requirements for displays, and because of the long-term commit- ment we make to them, we'll get our displays year in and year out, even when there's more demand than supply. The supplier effectively becomes our partner. They assign their engineers to our design team, and we start to treat them as if they were part of the company. For example, when we launch a new product, their engineers are stationed right in

you fust outsourcing your after-sales ser- vice? Is what you're describing fundamentally dif- ferent from outsourcing?

Outsourcing, at least in the IT world, is almost always a way to get rid of a problem a company hasn't been able to solve itself. The classic case is the company with 2,000 people in the IT depart- ment. Nobody knows what they do, and nobody knows why they do it. The solution-outsource IT to a service provider, and hopefully they'll fix it. But if you look at what happens five years later, it's not necessarily a pretty picture.

That's not what we're doing at all. We focus on how we can coordinate our activities to create the most value for customers.

With our service providers, we're working to set quality measures and, more important, to build data linkages that let us see in real time how we're doing-when parts are dispatched, for instance, or how long it takes to respond to a request for service. We look at our business and see, for example, that over the next ten years we arc going to be making lots of notebook computers. Dell might need 20 million flat-panel displays, and some years there will be more demand than supply. Other years, there will be more supply than demand. A few com- panies are currently making multibillion-dollar in- vestments in the manufacture of these displays.

-

WC 131111CH our suppliers' engineers are right in our plants. If a customer has a problem, we can fix it in real time.

our plants. If a customer calls in with a problem, we'll stop shipping product while they fix design flaws in real time.

Figuring out how many partners we need has been a process of trial and error. You learn when you operate on the cutting edge of technology that things don't always work as planned. The rule we follow is to have as few partners as possible. And they will last as long as they maintain their leader- ship in technology and quality. This isn't like the automobile business, where you find a tire supplier that you will probably stick with forever. Where the technology is fairly stable-in monitors, for ex- a m p l e - w e expect our partnerships to last a long time. Others will be more volatile. But regardless of how long these relationships last, virtual integra- tion means you're basically stitching together a business with partners that are treated as if they're inside the company. You're sharing information in a real-time fashion.

We tell our suppliers exactly what our daily pro- duction requirements are. So it's not, "Well, every two weeks deliver 5,000 to this warehouse, and we'll put them on the shelf, and then we'll take them off the shelf." It's, "Tomorrow morning we need 8,562, and deliver them to door number seven by 7 A.M."

You would deal with an internal supplier that way, and you can do so because you share informa- tion and plans very freely. Why doesn't the same sharing of information take place across company boundaries? Buyers are often so busy trying to pro- tect themselves that the seller can't really add a lot of value. Government purchasing is the extreme

HARVARD BUSINESS REVIEW March-April 1998 7B

THE POWER OF VIRTUAL INTEGRATION'.

case, with its overly structured procurement sys- tem. Protecting the buyer usually ends up disabling the seller - and hoth lose.

The technology available today really boosts the value of information sharing. We can share design databases and methodologies with supplier- partners in ways that just weren't possible five to ten years ago. This speeds time to market-often dramatically-and creates a lot of value that can be shared between buyer and supplier. So technology enhances the economic incentives to collaborate.

What are the challenges involved in establishing these collaborations?

The key challenge-and the biggest change from business as usual-is changing the focus from how much inventory there is to how fast it's moving. All computer chips carry a four-digit date code. For ex- ample, "97-23" means it was built in the twenty- third week of 1997. You can take the cover off any computer and find out how old its parts are, how long it took to make its way through the system. In our industry, if you can get people to think about how fast inventory is moving, then you create real value. Why? Because if I've got 11 days of inventory and my competitor has 80, and Intel comes out with a new 450-megahertz chip, that means I'm go- ing to get to market 69 days sooner.

I think about it this way: Assets collect risks around them in one form or another. Inventory is one risk, and accounts receivable is another risk. In our case-with 70% of our sales going to large cor- porate customers - accounts receivable isn't hard to manage because companies like Goldman Sachs and Microsoft and Oracle tend to be able to pay their bills. But in the computer industry, inventory

The biggest change from business as usual is changing the focus from how much inventory there is to how fast it's moving.

can actually be a pretty massive risk because if the cost of materials goes down 50% a year and you have two or three months of inventory versus 11 days, you've got a big cost disadvantage. And you're vulnerable to product transitions, when you can get stuck with obsolete inventory.

Inventory velocity is one of a handful of key per- formance measures we watch very closely. It focuses

us on working with our suppliers to keep reducing inventory and increasing speed. With a supplier like Sony, which makes very good, reliable moni- tors, we figure there's no need for us to have any in- ventory at all. We are confident in putting the Dell name on them, and they work fine. We don't even take these monitors out of the box to test them be- cause we've gotten them to under 1,000 defects per million. So 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 ware- house, 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.

So we went to Sony and said, "Hey, we're going to buy two or three million of these monitors this year. Why don't we just pick them up every day as we need them?" At first, it's a little confusing to the suppliers because you're saying, "Now listen care- fully. If you will help us get your product from the end of your line to our customer faster, we won't have any in our warehouse." And the suppliers look at you like you're crazy and not making any sense. They're used to delivering in larger quantities, so at first they think this means you're going to buy less from tbem. And then the lightbulb goes on, and they realize we'll be buying more because we'll be taking it faster.

So now you have Sony producing a level supply of monitors for you. What happens next?

We tell Airborne Express or UPS to come to Austin and pick up 10,000 computers a day and go over to the Sony factory in Mexico and pick up the corresponding number of monitors. Then while we're all sleeping, they match up the computers

and the monitors, and deliver them to the customer.

Of course, this requires sophisti- cated data exchange. Most people are familiar with the way a company like Black & Decker uses informa- tion links with the thousands of re- tailers that sell its product:;. When a customer in Omaha buys a drill from his local hardware store, the system immediately tells Black &. Decker to

send another unit of that particular drill to thai par- ticular store. So their system has to replenish sup- ply, unit by unit, to thousands of outlets. From the supplier's point of view, Dell is dramatically sim- pler. Our orders are typically for thousands of units, and they need to go to only one of three manufac- turing centers: Austin, Ireland, and Malaysia. It's almost ideal from a supplier standpoint because we

76 HARVARD BUSINESS REVIEW March-April 1998

AN INTERVIEW WITH DELL COMPUTER'S MICHAEL DELL

between our largest and our smallest customer. To- day we do. Our customer strategy is one area where our model has evolved. We've become good at de- veloping what we call "scalable" businesses-that is, those in which we can grow revenues faster than expenses. We really look closely at financial mea- sures like gross margins by customer segment-and we focus on segments we can serve profitably as we

have real-time information on what the demand is, and all the supplier has to do is get the product to us.

And because we build to our customers' order, typically, with just five or six days of lead time, sup- pliers don't have to worry about sell-through. We only maintain a few days-in some cases a few hours-of raw materials on hand. We communicate inventory levels and replenishment needs reg- ularly-with some vendors, hourly.

The typical case in our industry is ^ .

the factory building 10,000 units a [t v o u l i a v c H 9 0 - d a v l a g b e t w e e i i dav, dav in and dav out. First the ma- •' JO

the point or demand and the point of supply, you're going to have

me ciiu ur cne cnain noiiers, " wnoa, r* . n > .

hey, we ve got too many of these, a l o t 01 i n e i n d e i i c v 111 t h e p r o c e s s . Everybody stop!" And the order to J T stop flows back through the chain until it reaches every component supplier. It's liter- ally stop and start, because if you have a 90-day lag between the point of demand and the point of sup- ply, you're going to have a lot of inefficiency in the process. And the more inventory and time you h h b l

day, day in and day out. First the ma- chines stack up in the warehouse, and then they stack up in the chan- nel. And all of a sudden, the guy at the end of the chain hollers, "Whoa,

have, the more variability, and the more problems. In our industry, there's a lot of what I call bad hy-

giene. Companies stuff the channel to get rid of old inventory and to meet short-term financial objec- tives. We think our approach is better. We substi- tute information for inventory and ship only when we have real demand from real end customers.

How does the direct model benefit your suppliers? We can go to Sony and say, "We're going to be

pulling monitors from you in a very consistent, predictable way because the distance between the demand and the source of supply is totally shrunk." The longer that distance, the more intermediary channels you add, the less likely it is you will bave good information about demand-so you will end up with more variability, more inventory, higher costs, and more risk.

Another factor that helps keep our demand for computers level is the mix of customers we serve. We don't have any customer that represents more than I % to 2% of our revenues. One week Exxon is buying, the next week Shell is buying, the next week Ford is buying. But all companies don't decide in unison, "Well, this week we're going to buy, next week we're not."

Yon mention yonr customer mix. Does the direct model imply a particular customer strategy?

If you'd asked me that question 12 years ago, I would have said that we didn't differentiate much

HARVARD BUSINESS REVIEW March-April 1998

achieve scale. People are sometimes surprised to learn that 90% of our sales go to institutions - busi- ness or government-and 70% to very large cus- tomers that buy at least $1 million in PCs per year.

When you're trying to target profitable segments, averages obscure a lot, and aggregate financial statements are pretty meaningless. Our approach to segmentation is to take really big numbers and "de- average" them. Until you look inside and under- stand what's going on by business, by customer, by geography, you don't know anything. This is a les- son we learned the hard way. We incorrectly en- tered the retail business in 1989, thinking that our direct husiness wouldn't grow enough, and went into computer superstores and warehouse clubs. But when we really started to understand the seg- ment's profitability, we realized we'd made a mis- take, and so we exited.

For years, we didn't actively pursue the consumer market because we couldn't reach our profit objec- tives. So we let our competitors introduce ma- chines with rock-bottom prices and zero margins. We figured they could be the ones to teach con- sumers about PCs while we focused our efforts on more profitable segments. And then, because we're direct and can see who is buying what, we noticed something interesting. The industry's average sell- ing price to consumers was going down, hut ours was going up. Consumers who were now buying their second or third machines-who wanted the most powerful machines and needed less hand- holding-were coming to us. And without focusing on it in a significant way, we had a billion-dollar consumer business that was profitable. So we de- cided in 1997 that it was time to dedicate a group to s e r v i n g t h a t s e g m e n t . • 1 ii'i'

THE POWER OF VIRTUAL INTEGRATION:

FAST-CYCLE SEGMENTATION Dell's rapid growth in recent years has been aecompaniecl by ever finer cuts at customer segmenta- tion. This is an important element of Dell's virtual integration with customers. The finer the seg- mentation, the better able Dell is to forecast what its customers are going to need and when. Dell then coordinates the flow of that strategic information all the way hack to its suppliers, effectively substituting information for inventory.

In 1994, Dell was a $3.5 billion company Small customers

(Business and consumer) Large customers

In 1996. $7.8 billion Urge

companies

In 1997. $12 billion

So, over time, you cut the market into finer and finer segments?

Yes, 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 some- thing well if it's too hig. Segmentation gives us het- ter attention and focus. [See the exhibit "Fast-Cycle Segmentation."]

Each segment has its own issues. In education, for instance, how do you get tech support to a class- room when the teacher doesn't have a telephone? You need a totally different approach. Segmenting lets you tailor your programs to the customers' needs. If you just lump diverse customers together, you can be sure that some of them will come last on

some manager's list, and he may never get around to solving their problems. That's why we make serving one segment the manager's only job.

Do you get other benefits from segmenting your customers?

Segmentation gets us closer to them. It allows us to understand their needs in a really deep way. This closeness gives us access to information that's ab- solutely critical to our strategy. It helps us forecast what they're going to need and when. And good forecasts are the key to keeping our costs down.

We turn our inventory over 30 times per year. If you look at the complexity and the diversity of our product line, there's no way we could do that unless

78 HARVARD BUSINESS REVIEW March-April 1998

AN INTERVIEW WITH DELL COMPUTER'S MICHAEL DELL

we had credible information about what the cus- tomer is actually buying. It's a key part of why ri- vals have had great difficulty competing with Dell. It's not just that we sell direct, it's also our ability to forecast demand - it's both the design of the product and the way the information from the customer flows all the way through manufacturing to our suppliers. If you don't have that tight linkage-the kind of coordination of information that used to be possible only in vertically integrated companies- then trying to manage to i i days of inventory would be insane. We simply couldn't do it without customers who work with us as partners.

Could you describe how you forecast demand? We see forecasting as a critical sales skill. We

teach our sales-account managers to lead cus- tomers through a discussion of their future PC needs. We'll walk a customer through every depart- ment of his company, asking him to designate which needs are certain and which are contingent. And when they're contingent on some event, the salesperson will know what that event is so he can follow up. We can do this with our large accounts, which make up the bulk of our business. With smaller customers, we have real-time information about what they're buying from our direct tele- phone salespeople. And we can also steer them in real time, on the phone, toward configurations that are available, so this is another way we can fine- tune the balance between supply and demand.

Is that what you mean by virtual integration with your customers?

It's part of it. There are so many information links between us and our customers. For example, we can help large global customers manage their to- tal purchase of PCs by selling them a standard prod- uct. Then when the guy whose com- puter isn't working calls in from Singapore, the IT people don't have to spend the first 30 minutes just fig- uring out what configuration of hardware and software he's using. Selling direct allows us to keep track of the company's total PC purchases, country by country-and that's valu- able information we can feed back to them. We sometimes know more about a customer's opera- tions than they do themselves.

Close customer relationships have allowed us to dramatically extend the value we deliver to our cus- tomers. Today we routinely load the customer's software in our factory. Eastman Chemical, for ex- ample, has their own unique mix of software, some

of it licensed from Microsoft, some of it they've written themselves, some of it having to do with the way their network works. Normally, they would get their PCs, take them out of the box, and then some guy carrying a walkie-talkie and diskettes and CD-ROMs would come to each em- ployee's desk to hook the system up and load all that software. Typically, this takes an hour or two- and costs $200 to $300 -and it's a nuisance.

Our solution was to create a massive network in our factory with high-speed, loo-megabit Ethernet. We'll load Eastman Chemical's software onto a huge Dell server. Then when a machine comes down the assembly line and says, "I'm an Eastman Chemical analyst workstation, configuration num- her 14," all of a sudden a few hundred megabytes of data come rushing through the network and onto the workstation's hard disk, just as part of the pro- gressive build through our factory. If the customer wants, we can put an asset tag with the company's logo on the machine, and we can keep an electronic register of the customer's assets. That's a lot easier than the customer sending some guy around on a thankless mission, placing asset tags on comput- ers when he can find them.

What happens to the money our customer is sav- ing? They get to keep most of it. We could say, "Well, it costs you S300 to do it, so we'll charge you $250." But instead we charge S15 or $20, and we make our product and our service much more valu- able. It also means we're not going to be just your PC vendor anymore. We're going to be your IT de- partment for PCs.

Boeing, for example, has 100,000 Dell PCs, and we have 30 people that live at Boeing, and if you look at the things we're doing for them or for other customers, we don't look like a supplier, we look more like Boeing's PC department. We become inti-

If our customers didn't work with us as partners, managing to 11 days

would be i

mately involved in planning their PC needs and the configuration of their network.

It's not that we make these decisions hy our- selves. They're certainly using their own people to get the best answer for the company. But the people working on PCs together, both from Dell and Boe- ing, understand the needs in a very intimate way. They're right there living it and breathing it, as OP-

H A R V A R D BUSINESS REVIEW March-April 1998

THE POWER OF VIRTUAL INTEGRATION:

posed to the typical vendor Mfho says, "Here are your computers. See you later."

We've always visited clients, but now some of our accounts are large enough to justify a dedicated on-site team. Remember, a lot of companies have far more complex problems to deal with than PC

All our senior executives participate in these meetings with our largest customers. The ratio is about one Dell person to one customer.

purchasing and servicing. They can't wait to get somehody else to take care of that so they can worry ahout more strategic issues.

So some of your coordination with customers is made possible through technology, but there's still a good measure of old-fasbioned, face-to-face hu- man contact?

Yes, that's right. The idea is to use technology to free people up to solve more complicated problems. For example, a customer like MCI can access our internal support tools on-line in the same way our own technical-support teams do, saving time and money on both sides. They simply go to www.deU.com, enter some information about their system, and they have immediate access to the same information that we use at Dell to help cus- tomers. These tools are used by internal help-desk groups at large companies as well as by individuals.

We've developed customized intranet sites called Premier Pages for well over 200 of our largest glohal customers. These exist securely within the cus- tomers' firewalls, and they give them direct access to purchasing and technical information about the specific configurations they buy from us. One of our customers, for example, allows its 50,000 em- ployees to view and select products on-line. They use the Premier Page as an interactive catalog of all the configurations the company authorizes; em- ployees can then price and order the PC they want. They are happy to have some choice, and Dell and the customer are hoth happy to eliminate the paper- work and sales time normally associated with cor- porate purchasing. That frees our salespeople to play a more consultative role.

We also have developed tools to help customers set up their own customized versions of dell.com. There are ahout 7,000 of these to date.

How else do you stay close to your customers? In a direct business like ours, you have, by defini-

tion, a relationship with customers. But heyond the mechanisms we have for sales and support, we have set up a number of forums to ensure the free flow of information with the customer on a constant basis.

Our Platinum Councils, for example, are regional meetings-in Asia-Pacif- ic, Japan, the United States, and Eu- rope-of our largest customers. They meet every six to nine months; in the larger regions, there's one for the in- formation executives - the CIO types-and then there's one for the technical types.

In these meetings, our senior tech- nologists share their views on where

the technology is heading and lay out road maps of product plans over the next two years. There are also breakout sessions and working groups in which our engineering teams focus on specific product areas and talk about how to solve problems that may not necessarily have anything to do with the commercial relationship with Dell. For exam- ple. Is leasing better than buying? or How do you manage the transition to Windows NT? or How do you manage a field force of notebook computers?

People in businesses as dissimilar as Unilever and ICI can learn from each other because, amaz- ingly, they have very similar problems when it comes to PCs. And we send not only our top tech- nologists and engineers but also the real engineers, the people who usually don't get out to talk to cus- tomers because they're too busy developing prod- ucts. All of our senior executives from around the company participate, spending time with the cus- tomer, listening to how we're doing. The ratio is ahout one Dell person to one customer. At our last session, we had about ioo customers.

The councils are another way we're able to play more of an advisory role, trying to help our cus- tomers understand what the flow of new technology really means, how it will translate into specific products. We try to help the customer anticipate what's happening and he ready. And that helps us, as well, with our own demand forecasting. So we're helping each other in important ways. We hire a lot of people from other companies in the industry, and they tell us that these meetings are unique.

Do you speud a significant amount of your time at these meetings?

I spend three days at each of them. They're great events. In the normal course of our business, I have lots of opportunity to talk to customers one on one.

80 HARVARD BUSINESS REVIEW March-April 1998

AN INTERVIEW WITH DELL COMPUTER'S MICHAEL DELL

but there is something much more powerful about this kind of forum. Customers tend to speak more openly when they're with their peers and they know we're there and we're listening.

At every Platinum Council, we review what they told us last time and what we did about it. We keep an ongoing record of the issues. Let me give you a concrete example: A few years ago, the engineers responsible for our desktops were operating on the theory that customers really wanted performance from these products - the faster the better. But what the customers actually said at the Platinum Coun- cils was, "Yeah, performance, that's okay. But what I really want is a stable product that doesn't change. Because if I'm trying to run a bank or an airline, I

don't care if it's 2 % faster or 3 % slower. What really matters is stahility." So our engineers thought one thing, the customers thought another thing. It took the direct feedhack from the Platinum Councils to spotlight this failure to communicate. We re- sponded by building product with intergenerational consistency over many years. The same feedback has helped shape the creation of our brands. For both our desktop and notehook businesses, we cre- ated different brands designed to deliver greater sta- bility to corporate customers, as opposed to the fast technology changes that consumers demand.

As I think back to some of those council meet- ings, things that would seem fairly small at the time have often turned out three or four years later

USING INFORMATION TO SPEED EXECUTION by Kevin Rollins

Most of the managerial challenges at Dell Computer have to do with what we call velocity-sptcding the pace of every element of our business. Life cycles in our business are measured in months, not years, and if you don't move fast, you're out of the game. Managing velocity is ahout managing information-using a con- stant flow of information to drive operating practices, from the performance measures we track to how we work with our suppliers.

Performance Metrics. At Dell, we use the halance sheet and the fundamentals of the P&L on a monthly hasis as tools to manage operations. From the halance sheet, we track three cash-flow measures very closely. We look at weekly updates of how many days of inven- tory we have, broken out by product component. We can then work closely with our suppliers so we end up with the right inventory. When it's not quite right, we can use our direct-sales model to steer customers to- ward comparable products that we do have. So we use inventory information to work hoth the front and hack ends at the same time.

We also track and manage receivables and payables very tightly. This is basic blocking and tackling, but we give it a high priority. The payoff is that we have a negative cash-conversion cycle of five days-that is, we get paid hefore we have to pay our suppliers. Since our competitors usually have to support their resellers hy offering them credit, the direct model gives us an inherent cost advantage. And the more we can shorten our cash-collection cycle, the greater our advantage.

The real-time performance measures in the P&L that we regard as the best indicators of the company's health are our margins, our average selling price, and the overhead associated with selling. We split the P&L

into these core elements hy customer segment, by product, and by country. These metrics can alert us in- stantly to problems, for example, with the mix of products being sold in any particular country.

Working with Suppliers. The greatest challenge in working with suppliers is getting them in sync with the fast pace we have to maintain. The key to making it work is information. The right information flows al- low us to work with our partners in ways that enhance speed, either directly by improving logistics or indi- rectly by improving quality.

Take our service strategy, for example. Customers pay us for service and support, and we contract with third-party maintainers (TPMs) to make the service calls. Customers call us when they have problems, and that initial call will trigger two electronic dis- patches-one to ship the needed parts directly from Dell to the customers' sites and one to dispatch the TPMs to the customers. Our role as information bro- ker facilitates the TPMs' work by making sure the necessary parts will be on-site when they arrive.

But our role doesn't stop there. Because poor quality creates friction in the system, which slows us down, we want to capture information that can be used to fix problems so they won't happen again. So we take back the bad part to diagnose what went wrong, and we feed that information hack to our suppliers so they can re- design the component. Clearly, we couldn't operate that way if we were dealing with hundreds of suppli- ers. So for us, working with a handful of partners is one of the keys to improving q u a l i t y - a n d therefore speed - in our system.

Kevin RoUins is vice cbairman of Dell Computer Corporation.

HARVARD BUSINESS REVIEW March-Apri! 1998

THE POWER OP VIRTUAL INTEGRATION:

THE EVOLUTION OF A FASTER BUSINESS MODEL

The dominant model in the personal computer industry-a value chain with arms-length transactions from one layer to the next:

Dell's direct model eliminates the time and cost of third-party distribution:

Virtual integration works even faster hy blurring the traditional boundaries and roles in the value chain:

to become the basis for billions of dollars of rev- enue-notebooks with longer-life batteries, for ex- ample, or loading customers' softv '̂are for tbem in our plants.

As your customer strategy has evolved, has the Dell brand changed as well?

A big piece of our brand is being tbe most effi- cient and effective way for customers to buy Intel or Microsoft technologies. But beyond tbat, we're evolving into a technology selector, or navigator. We often talk to customers about "relevant tech- nology." Intel and Microsoft tend to launcb into a massive variety of tbings, some of wbicb are specu- lative and aimed at exploring new tecbnologies. We

tbink it's our job to help our customers sort out the technology relevant to today's needs from the bleeding edge.

How does that strategy affect your own R&D func- tion? What role does R&D play in your company?

At Dell, we believe tbe customer is in control, and our job is to take ali tbe technology that's out tbere and apply it in a useful way to meet the cus- tomer's needs. We're not trying to invent new ar- chitecture ourselves, but we'll spend a quarter of a billion dollars tbis year and employ some 1,500 people to improve tbe wbole user experience-that means delivering the latest relevant technology, making it easy to use, and keeping costs down. And

82 HARVARD BUSINESS REVIEW March-April 1998

AN INTERVIEW WITH DELL COMPUTER'S MICHAEL DELL

in addition to selecting appropriate technology, our R&D group focuses on process and quality im- provements in manufacturing.

Before industry standards came into play, the pro- prietary computing environment hred a kind of technical arrogance that, fortunately, won't fly any- more. Once standards were estahlished, the cus- tomer started to define what was going to he suc- cessful, and it didn't matter what you invented or how good it was or how fast it was. Increasingly, what matters is what the customers want and whether it works with all their other stuff.

That means we have to stay on top of our customers' needs, and we have to monitor and understand the inno- vations in the material scienee world - everything from semicon- ductors to polymers to liquid crystal displays. You need to track anything having to do with the flow of elec- trons, and you need to keep asking how these mar- velous developments might he useful to customers. The customer doesn't come to you and say, "Boy, I really like lithium ion batteries. I can't wait to get my hands on some lithium ion." The customer says, "I want a notehook computer that lasts the whole day. I don't want it to run out when I'm on the plane."

I was ahout to leave a meeting at Sony in Tokyo in January of 1993 when someone ran up to me and said, "Oh, Mr. Dell, please wait one minute. I'm from Sony's power technology company. We have a new power-system technology we want to explain to you." And I rememher thinking. Is this guy going to try to sell me a power plant? He starts showing me chart after chart about the performance of lith- ium ion hatteries. This is wonderful, I tell him. And if it's true, we're going to put this in every notehook computer we make.

We then sent a team over to check it out, and a year and a half later we were the first computer company to have a notehook that lasted five-and-a- half, six hours. We tested it with American Air- lines, handing out the notebooks to passengers at the start of fiights from New York to Los Angeles. By the end, the notebooks were still running.

How arc the challenges of leadership in a virtually integrated organization different from those you would encounter running a corporation with more traditional boundaries?

The whole idea behind virtual integration is that it lets you meet customers' needs faster and more efficiently than any other model. With vertical in-

tegration, you can he an efficient producer-as Iong as the world isn't changing very much. But virtual integration lets you be efficient and responsive to ehange at the same time-at least, that's what we're trying to do. We think about Internet commerce as a logical extension of our direct model-and within our first year, we reached a run rate of $2 million a day. It's now about $3 million a day, and during the peak of the Christmas buying season we saw sev- eral $6 million days. I'm only half joking when I say

Things that seemed fairly small at the time have turned out three or four years later to he the basis for hillions of dollars of revenue.

that the only thing better than the Internet would he mental telepathy. Because what we're all about is shrinking the time and tbe resources it takes to meet customers' needs. And we're trying to do that in a world where those needs are changing.

To lead in that kind of environment, you have to he on the lookout for shifts in value, and if the cus- tomer decides, "Hey, I don't care about that any- more, now I care ahout this," we may have to de- velop new capahilities rather quickly. One of the biggest challenges we face today is finding man- agers who can sense and respond to rapid shifts, people who can process new information very quickly and make decisions in real time. It's a prob- lem for the computer industry as a whole-and not just for Dell-that the industry's growth has out- paced its ability to create managers. We tell prospective hires, "If you want an environment that is never going to change, don't come here. This is not the place for you."

Our goal is to be one or two steps ahead of the change, and in fact to bc creating or shaping it, to some extent. That's why we spend so much time with our customers. It's why I personally spend about 40% of my time with customers. Often it's a lead customer that says, "Hey, can you put an asset tag on my PC?" And the first reaction is, "Gee, we've never done that hefore, but why not? Let's give it a try." And then you do it for one customer, then for ten, then for a hundred, and eventually it heeomes a standard offering. Putting asset tags on computers isn't by itself a major value shift, hut what bappens is tbat we get a series of seemingly small innovations that over time add up to a huge

HARVARD BUSINESS REVIEW March-April 1998

THE POWER OF VIRTUAL INTEGRATION

improvement. That's not a bad description of the way we get into husinesses. We don't come at it the other way around, with a consulting study that says, "That's an attractive husiness. Let's go." Nor do we sit around and say, "What do we suppose our customers would like? If we were customers, what would we be thinking?"

So looking for value shifts is prohably the most important dimension of leadership. Then there's the question of managing such a tightly coordin- ated value chain - and there it's all about execution. If you look at Dell's P&L structure, I think you'd be hard-pressed to find companies that deliver the kind of value-added we do with such a small markup. My theory is that if we can continue to keep our markup as low as it is today, we're going to be able to capture most of the opportunities available to us. But that means we cannot get com-

placent ahout our growth and get careless ahout execution.

Sometimes, I'm taken aback when I talk to peo- ple who've been in tbe company for six months or a year and who talk about "the model" as if it were an all-powerful being tbat will take care of everything. It's scary hecause I know that nothing is ever ioo% constant, and the last thing we should do is assume that we're always going to be doing well. But for now, it's working. The direct system really delivers value to the customer all the way from distrihution hack through manufacturing and design. If you tried to divide Dell up into a manufacturer and a channel, you'd destroy the company's unique val- ue. It's something completely new that nobody in our industry has ever done before. ^

Reprint 98208 To order reprints, see the last page of this issue.

This one has it all - plot twists, fast paced action, betrayal, and reconciliation.

And that's just the executive summary."

84 CARTOON BY MARK LITZLER

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