How do you create a $12 billion company in just 13 years? Michael Dell began in 1984 with a simple business insight: he could bypass 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 associated 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 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 traditional boundaries in the value chain among suppliers, manufacturers, and end users. In so doing, Dell Computer is evolving in a direction that Michael Dell calls virtual integration. The individual 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 extraordinary returns to investors. Virtual integration harnesses 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 organizational 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 manufacture disk drives and memory chips and application software; all the various pieces of the industry had to be vertically integrated within one firm.
So the companies that were the stars ten years ago, the Digital Equipments of this world, had to build massive structures to produce everything 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 creating value for the customer.
As the industry grew, more specialized companies developed to produce specific components. That opened up the opportunity 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 be better off leveraging the investments others have made and focusing on delivering 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 be 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-everything” view of the world. If you weren’t doing component assembly, you weren’t a real computer company. It was like a rite of passage. You somehow proved your manhood by placing small semiconductor chips on printed circuit boards.