Dell Case Study

1. How and why did the personal computer industry come to have such low average profitability?

We can make use of the Porter’s Five Forces to analyze the profitability of the personal computer industry.

The availability of perfect substitutes can lower the profitability of PC industry as it reduces the profits the companies can earn as consumers can easily find cheaper alternatives instead of buying PC. Electronic devices such as smartphones, personal digital assistants and tablets are substitutes of PC as they are able to perform some functions of a PC such as reading emails but they are not perfect substitutes. Businesses, educational institutions and government organizations still require PCs to perform many other specific functions such as design and advanced excel functions. Hence, the threat from substitutes is weak to moderate.

A high threat from new entrants can result in low profitability as new players fight for market share and intensify the competition. In this case, the threat from new entrants in the PC industry is weak to moderate. The knowledge and technology needed to produce PCs are relatively low. The components can be easily purchased and assembled from existing component manufacturers. However, existing PC firms may have established supplier relationships, distribution methods, resources, research and development (R&D) and infrastructure. Therefore new entrants will require some time and expertise in the field to compete at the same level.

PC buyers consist of large and midsize businesses and governments, small businesses and offices, individual consumers and educational institutions. The number of buyers is huge and they have the power to negotiate for lower prices, better quality and services. These buyers are price sensitive. Despite Apple’s efforts to differentiate their products and gain a larger market share, the majority of consumers still make purchase decisions, for PCs with similar technical specifications, based on price. The increasing penetration of Internet and email decreases the cost of switching between brands as the software is constant. The Internet also enables consumers to make comparisons across brands and choose the most value for money product dragging prices and profits for the industry down.

The components of a PC are divided into hardware and software. The hardware components such as housings, memory chips, keyboards, motherboards, monitors, disk drives, modems and connecters are highly standardized and can be purchased from a variety of suppliers. Hence, the hardware suppliers do not have much bargaining power in the PC industry. However, microprocessors are supplied by only a few suppliers, which in turn have significant power. For example, Intel dominated the market with 80-90% market share. In addition, software suppliers for essential applications have huge bargaining power, as they tend to be part of oligopolies. Such apps include word processors, spreadsheet managers, financial organisers, database management systems, web browsers and secure electronic messaging software. For example, Microsoft with its Windows operating system (OS) dominates the market with 80% market share. Hence, the bargaining power of suppliers as a whole is strong; these suppliers can push maintain or increase the price of their products and increase cost to PC firms. For example, after paying Microsoft for the OS, Intel for the processors, and Samsung for the LCD screens, the profit margin left is narrow.

Fierce rivalry amongst PC firms drive profits down. During the early days of PCs in 1981, IBM launched her first PC and within a few years, multiple clones and similar products appeared in the market. This happened because of the open architecture of PCs when IBM set a standard with the combination of Intel’s microprocessors and Microsoft’s Windows operating system, Wintel. The PC industry is fast cycle and technology is diffused rapidly to competitors. Technology is rarely protected by patents. Hence, more and more start-ups entered the industry and adopted the standard; IBM lost her pricing power because she no longer set standards.

Intense competition led to price wars and the subsequent erosion of profits. Companies such as Dell knew they had to find their competitive advantage. They started distributing and marketing the PCs themselves. Without the need for retailers, their products were relatively cheaper than their competitors. This method proved successful and soon other PC manufacturers followed suit, stealing some profits from Dell. As most PCs firms have a huge organizational size, they are less nimble and flexible. They are less able to adapt to the latest change in consumer demands and expectations to reap greater profits.

From the Porter’s Five Forces analysis, we discover that low average profitability of PC industry is due to the strong bargaining power of buyers and suppliers and the intense competition among the existing firms. The buyers are price sensitive and are able to nudge prices down. Suppliers would like to reap more profits by increasing the prices of components, which in turn increases the cost of production. Hence, these resulted in the lower profits of manufacturing PCs and hence lowered the profitability of the PC industry. As competition stiffened, a price war broke out and further eroded profitability. To illustrate the low average profitability of the PC industry, we can look at exhibits 5, 10a and 10b, where the cost of PC is about $800-$900, but the sales price of PC has been decreasing over the years from about $3000-$$1500 and will continue to drop, this demonstrates the decline of a PC’s profit margin over time and subsequently, the average profitability of the PC industry.