Developing a Server OEM Strategy during Technology Commoditization
by
Kristie A. Burnham
B.S. Mechanical Engineering
Worcester Polytechnic Institute, 1991
Submitted to the Sloan School of Management and the Department of Civil Engineering
in Partial Fulfillment of the Requirements for the Degrees of
Master of Science in Management
and
Master of Science in Civil and Environmental Engineering
in Conjunction with the Leaders for Manufacturing Program at the
Massachusetts Institute of Technology
May 10, 2002
© 2002 Massachusetts Institute of Technology
All rights reserved
S ig n a tu re of A uth o r .......................................................... I............7 ........................................
Sloan School of Management
Department of ivil and Environmental Engineering
May 10, 2002
Certified by................
Certified by.............................
A ccepted by ...........................................
.. .............................
Charles H. Fine
Chrysler Leaders for Manufacturing Professor
Thesis Supervisor
.....................................................
David Simchi-Levi
Professor of Civil and Environmental Engineering
Thesis Supervisor
.....................................
Margaret Andrews
Executive Director of Master's Program
Sloan School of Management
....................................................
Oral Buyukozturk
Accepted
MASSACHUSETTS INSTITUTE
OF TECHNOLOGY
JUN 2 4 2002
LIBRARIES
Chairman of Committee on Graduate Studies
E epartment of Civil and Environmental Engineering
BARKER
r
Developing a Server OEM Strategy during Technology Commoditization
by
Kristie A. Burnham
Submitted on May 10, 2002 to the Sloan School of Management
and the Department of Civil and Environmental Engineering, in partial fulfillment of the
Requirements for the Degrees of
Master of Science in Management
and
Master of Science in Civil and Environmental Engineering
ABSTRACT
Commoditization of technology is a business dynamic that affects the competitive nature of
the computer industry. The intensity of competition increases the importance of product
strategy and sustainable competitive advantage. Traditionally, outsourcing of some portion
of the manufacturing to contract manufacturers was part of any Original Equipment
Manufacturer's (OEM) manufacturing strategy. This thesis project, at Dell Computer
Corporation, was to explore the opportunity to outsource the design of some of the server
components and to suggest a methodology for implementation of this strategy.
The development of the Enterprise Services Group (ESG) Server OEM Strategy included
evaluation of the business model, core competencies, product portfolio, competitive market
position, and current supply chain design for server products. The literature review explores
published frameworks for making sourcing decisions and also explores the topic of
standardization. The strategy that was developed defines the OEM sourcing model and
considerations for successful implementation, including product and source selection,
competitive landscape and organizational considerations.
Thesis Supervisors:
Charles H. Fine, Chrysler Leaders for Manufacturing Professor
David Simchi-Levi, Professor of Civil and Environmental Engineering
2
ACKNOWLEDGEMENTS
The author gratefully acknowledges the support and resources made available by the
Leaders for Manufacturing program, a partnership between MIT and manufacturing
companies. This project would not have been possible without the support and learning
provided by the LFM program and my classmates.
I would like to acknowledge the support and guidance of my two thesis advisors, Charlie
Fine from the Sloan School of Management and David Simchi-Levi from the Department of
Civil and Environmental Engineering.
I would also like to extend my sincere gratitude to the Dell Computer Corporation for the
sponsorship of my project and for the support of the LFM program. I would especially like to
thank Jens Gruenkemeier for his support and mentorship during the internship. I would also
like to extend my thanks to Ken St. Cyr, Mollie Chang, and Lori Keith for the advice,
information and support they provided. This thesis would not have been possible without
their valuable assistance during my internship at Dell. I would also like to thank Debika
Ingham and Micah Samuels, who were fellow LFM -Dell interns, it was great to be at the
same internship location together.
I also wish to thank my classmates - who have taught me the most during my two years at
MIT. Their wealth of knowledge, experience and humor will always be a part of my
memorable experiences at MIT.
My heartfelt gratitude goes to my family, especially my mother and father, who have
supported me always.
3
TABLE OF CONTENTS
ABSTRACT ..............................................................................................................................
2
ACKNOW LEDG EM ENTS .................................................................................................
3
LIST O F FIGURES ..................................................................................................................
7
1.
8
2.
3.
INTRODUCTION AND OVERVIEW ....................................................................................
1.1.
Project Description...............................................................................................
8
1.2.
Scope and Lim itations.........................................................................................
9
1.3.
Thesis Overview .................................................................................................
9
COMPANY BACKGROUND .............................................................................................
10
2.1.
Chapter Overview .............................................................................................
10
2.2.
Com pany Overview ...........................................................................................
10
2.3.
Com pany History and Position...........................................................................
10
2.4.
Dell's Com petitive Advantage - Direct Model...................................................
11
2.5.
Market conditions...............................................................................................
12
2.6.
Product Overview ................................................................................................
13
2.7.
Organizational structure....................................................................................
14
2.8.
Current supply chain
g ..............................................................................
16
2.9.
Sum m ary ..............................................................................................................
16
PROJECT DEFINITION & BACKG ROUND .........................................................................
17
3.1.
Chapter Overview .............................................................................................
17
3.2.
Changing industry structure - com m oditization.................................................
17
3.3.
Casual Loop diagram of Commoditization / Industry dynamics .............
21
3.4.
Product Description...........................................................................................
23
3.5.
3.6.
Server - Storage Infrastructure Relationship..................................................... 23
Customer Requirements - Performance, Availability, and Scalability ................. 24
3.7.
Com ponent Technology....................................................................................
25
3.8.
Project Definition...............................................................................................
27
3.9.
Enterprise Systems Group (ESG) Strategy .......................................................
27
3.10.
White-box
3.11.
OEM , DMp
3.12.
Project Approach...........................................................................................
30
3.13.
Summ ary ...........................................................................................................
30
t
du t .........................................................................
..................................................................
4
28
29
4.
5.
LITERATURE REVIEW / BENCHMARKING...........................................................................
4.1.
Introduction...........................................................................................................32
4.2.
Strategic Fram eworks........................................................................................
33
4.3.
Make/Buy Decision ..........................................................................................
35
4.4.
Standard vs. Unique Design Com ponents .........................................................
39
4.5.
Clock speed..........................................................................................................42
4.6.
Supplier relationships.........................................................................................
42
4.7.
Importance of Product & Com ponent Design .....................................................
43
4.8.
Autom otive Strategic Sourcing Fram ework .......................................................
44
4.9.
HDD Industry - Effects of Disruptive Technology............................................... 46
4.10.
Benchm arking ...............................................................................................
47
4.11.
Consum er Product Group's OEM strategy ........................................................
47
4.12.
Sum m ary......................................................................................................
50
M ETHODOLOGY FOR THE DESIGN OF THE STRATEGY .....................................................
51
5.1.
Introduction...........................................................................................................51
5.2.
Proposed Models...............................................................................................
51
5.3.
Value Chain ..........................................................................................................
53
5.4.
Potential Benefits...............................................................................................
54
5.5.
Definition of Core Competency .........................................................................
56
5.6.
Custom er Needs...............................................................................................
57
5.7.
Customer needs translated to Product Architecture ..........................................
58
5.8.
Definition of M arket Segm ents...........................................................................
58
5.9.
Supplier Capability .............................................................................................
59
5.10.
6.
7.
32
Engineering / Product Architecture Considerations........................................ 59
DECISION CRITERIA I ANALYSIS......................................................................................61
6.1.
Decision variables.............................................................................................
61
6.2.
Industry Trends.................................................................................................
61
6.3.
Core com petencies...........................................................................................
63
6.4.
M odel Definition / Clarification...........................................................................
64
6.5.
Market segm entation ........................................................................................
66
6.6.
Analysis of Expected Benefits- Economic Value Analysis .................................
67
6.7.
Strategic Benefits...............................................................................................
69
6.8.
Sum mary ..............................................................................................................
74
CONCLUSION .............................................................................................................
5
76
7.1.
Introduction.......................................................................................................
76
7.2.
Im plem entation Status ......................................................................................
76
7.3.
Second Source Selection.................................................................................
77
7.4.
Competitive Landscape ...................................................................................
78
7.5.
Organizational Aspects......................................................................................
79
7.6.
Sum mary .........................................................................................................
80
6
LIST OF FIGURES
Figure 1. High Level O rganizational Chart......................................................................
15
Figure 2. Com m oditization Curve ..................................................................................
18
Figure 3. Causal Loop Diagram of Commoditization Curve Dynamics ...........................
21
Figure 4. Source: IDC Server Tracker CY2000, Disk Storage Systems Market..............28
Figure 5. Foster, Richard N. 'Payoff from technology investment follows S-curve' ......
35
Figure 6. Effect of OEM/ODM barriers on perceptions of OEM ......................................
48
Figure 7. EM-ODM-OEM Continuum Relationship ........................................................
52
Figure 8. High Level Value Chain...................................................................................
54
Figure 9. IDC Server Tracker September 19, 2001 - NT Windows & Linux o/s..............62
Figure 10. Dell Server Segments - % Net Units vs. FY'02 Projected Contribution Margins63
Figure 11. Definitions for EM - ODM - OEM Business models ....................................
65
Figure 12. Matrix of Market Segment vs. Product Characteristic ...................................
66
Figure 13. Economic benefits of the EM-ODM-OEM models..........................................68
Figure 14. Strategic benefits at the high and low-end segments ....................................
71
Figure 15. Potential Benefits High end market segment................................................
73
Figure 16. High-level summary of the Server OEM strategy...........................................75
7
1. INTRODUCTION AND OVERVIEW
The work presented in this thesis was completed as a part of a six and a half-month
internship in the World Wide Procurement organization at Dell Computer Corporation in
Austin, Texas. This internship is a result of the partnership between Dell Computer
Corporation and the Leaders for Manufacturing fellows program at the Massachusetts
Institute of Technology.
Companies in any industry are faced with a choice of deciding what competitive advantage
their business model and products will have that will allow them to have a sustained
competitive advantage. In the computer industry, commoditization of technology is a
prevalent business dynamic. The effect of commoditization on the industry is evidenced by
the lack of differentiation from a hardware perspective. Computer technology
commoditization has contributed the competitive intensity of the industry and has had a
limiting effect on margins. Commoditization has lead to an increased focus on reducing
costs and the evaluation of the value chain for further cost improvement opportunities.
1.1.
Project Description
The objective of the project was to determine what the sourcing strategy should be for the
server product line. The Enterprise System Group (ESG) had traditionally designed some of
the components (motherboard and chassis) and all system level server products in house.
Once the design was complete, a contract manufacturer would be selected to manufacture
the Dell designed components. As a part of the sourcing strategy the goal was to determine
if Dell should continue to design the components and also to consider if they should be
designing the system. At the start of the project, the option to outsource the system design
8
was being challenged as a viable option to consider given the business strategy. The scope
of this project was to explore this opportunity to outsource design and suggest a framework
for the implementation of this concept so that Dell's core competencies were leveraged for
future competitive advantage.
1.2.
Scope and Limitations
The scope of the project was to understand the value chain for server products that Dell is
currently offering in the market. Industry structure and trends will be evaluated to
understand the potential opportunities, risks and the strategic impact of the different
scenarios.
1.3.
Thesis Overview
This document will begin with a brief overview of the Dell Computer Corporation, including
an overview of the company, its history, the business model and current market position.
Chapter 3 will contain a brief discussion of the products that Dell -Enterprise Services
Group (ESG) offers, current supply chain design, and the effects of the current industry
trends with a detailed description of the project. Chapter 4 presents a discussion of relevant
literature on the 'make/buy' decision and standardization of various products. Also, included
will be an example of a make/buy decision in a different group as well as an internal
company example of Dell's success/ failure with the standardization of a product. Chapter 5
will present the methodology for the design of the strategy and the subsequent Chapter 6
will provide the framework for the decision analysis. Chapter 7 gives an overview of the
relevant implementation and organizational issues. The final section, Chapter 8, will discuss
the key findings of the project as well as opportunities for future study.
9
2. COMPANY BACKGROUND
2.1.
Chapter Overview
This section will provide a detailed overview of the company, both from a historical
perspective as well as its current position in the industry. The changing market will be
examined and the industry dynamics that affect Dell's competitive position. Dell's markets
will be examined and aligned with competitors product offering. Dell's competitive
advantage has been attributed to their business model, which will also be discussed in this
chapter. A high level view of organizational structure will be presented as well as an
overview of Dell's current supply chains.
2.2.
Company Overview
Dell is the world's number one computer systems company based on market share. Dell
offers a complete portfolio of products and services, which includes; laptops and desktops
computers, workstations, servers, storage devices, appliances and switches including the
software and services associated with the products. Dell has established this leadership
with a focus on the customer experience by directly selling product to the consumer without
a sales channel. Much of the growth was due to Dell's strategy to initially sell computers online to corporations with less emphasis on the average home user. Dell has grown to be a
$32 billion business that employs approximately 35,000 people, globally.
2.3.
Company History and Position
Michael Dell, CEO, started the company in 1983 during his freshman year at the University
of Texas in Austin. Dell began assembling IBM clones, to customer specifications which
may have included additional memory or specific chipsets that were not offered in the
10
mainstream market systems, etc. By May of 1984, Dell had decided to postpone his
collegiate career to pursue the PC venture full time. In 1988, the company went public
offering stock. By 1992, Dell joined the list of Fortune 500 companies becoming one of the
five largest computer makers in the world. During 1996, computers were being sold via the
company website and four years later sales over the Internet were $50 million per day.
During 2001, Dell captured the lead position in global market share and also aggressively
pursued additional market share by initiating an aggressive price war. During this growth,
Dell's product offering has been expanded from desktop computers to include notebooks,
workstations, servers, storage and switches including the respective software and services
to accompany them. Dell's mission statement is 'to be the most successful computer
company in the world at delivering the best customer experience in markets we serve'.
2.4.
Dell's Competitive Advantage - Direct Model
Dell's advantage in the marketplace is a result of Dell's business model. The direct
business model encompasses the entire value chain from the time the order is placed by the
customer through to the delivery of the hardware to the customer. The following are
attributes of the model as seen through the natural progression of an order:
" The customer places the order directly with Dell, not a reseller, either through the
web, through sales over the phone or face-to-face with a sales representative. If the
order is not entered via the web then the sales representative enters the order.
"
Dell receives the inventory to build the orders as they are received from the
customers on a 2-hour delivery cycle from the suppliers.
*
The order is then pulled, kitted and built to customer requirements. Software is
downloaded into the system and the system is tested. The system is then delivered
to the customer when the order is complete.
11
The advantage of this type of business model is that inventory is lower than that of the value
chain that includes a reseller who must have inventory on the store shelf. This allows Dell to
have a negative cash conversion cycle since supplier terms and customer payment terms
overlap in Dell's favor. Another unique aspect is that Dell can introduce new technology
faster since it does not need to empty the channel of old technology prior to new technology
introduction. In addition, since Dell has a direct one-to one contact with the consumer they
can receive feedback about the product that is unfiltered by a third party reseller. The lack
of the reseller link in the value chain eliminates any non-value added mark-ups on the
product. The model has given Dell an advantage and in the current market has allowed
them to continue to grow and operate profitably.
2.5.
Market conditions
Currently, the players in the computer industry, including Dell, are being affected by the
following conditions:
"
Price war behavior by many of the competitors thus causing intensified competition
and some consolidation.
" A slowing of the world economy.
"
Slower technology adoption.
"
Continued cross-subsidization between products to offset the effects of technology
commoditization by many of the major players in the industry.
The recession-like characteristics of the economy during the calendar year of 2001 has
slowed the explosive growth of the computer industry which was experiencing double digit
growth for several years preceding 2001. This has resulted in slowing demand and excess
capacity. Dell decided that this was an opportune time to launch a price war hoping to
increase its market share and accelerate the consolidation of financially weaker players. A
12
combination of the world economy, Dell's low cost business model and the price war tactics
has caused Dell to gain market share during an unlikely time. This has been a profitable
time for the corporation unlike many of its competitors. Much commentary has appeared in
the press concerning the profitability of the industry and the lasting effects of the price war
on industry margins. Consolidations through mergers, acquisitions and bankruptcy have
also increased during the year.
Another factor that is credited with fueling the computer industry growth during the recent
years was the new millennium and the need for many corporations to upgrade systems to
become compliant. New technology upgrades being driven by business needs also appears
to be slowing during this time and the average corporate market is slowing its demand for
new technology since the current technology is adequate for most purposes.
With the increase in competition and the declining margins due to the price war, another
dynamic that affects Dell is a competitor's ability to compete by cross subsidizing across
products. Examples of this in the computer industry include HP printer cartridges and IBM's
consulting services. These two manufacturers can compete aggressively and possible take
a loss with some products by subsidizing the revenues with profits from product lines where
there is less competition. With both of these examples these companies are less affected
by the price war. In these segments where Dell cannot compete, competitors are able to
charge higher margins in these segments to offset negative profitability in other products.
The following section will explain the markets in which Dell is a participant.
2.6.
Product Overview
Dell offers the following products and services to its customers, the major components of the
product offering are:
13
*
Desktops - 'Optiplex' brand for the corporate customers that need a high reliability in
a networked environment. 'Dimension' brand for the home and small business user
requires the ability to incorporate new technology.
" Workstations- 'Precision' brand name offers customized solutions for more complex
computing environments.
" Notebooks - Like Desktops there is a brand for corporate; 'Latitude' and the
'Inspiron' for the individual or small business user.
*
Servers - 'PowerEdge' brand name is designed to run on standard operating
software and comprised of an Intel processor. Servers were introduced by Dell in
1996 and were designed to provide a reliable, available and serviceable solution to
the customer. Appliances are servers that are targeted at specific web-hosting
applications.
" Storage - 'PowerVault' brand was introduced in 1998 and is leveraging standard
technology to meet customer's storage needs.
*
Switches - 'PowerConnect' brand introduced in 2001.
*
'Premier' services - consists of consulting, deployment and support for Dell's product
portfolio.
As discussed in the company overview, Dell began as a PC maker and has increasingly
been entering new complementary markets where its business model can be leveraged.
2.7.
Organizational structure
With multiple products and customers and suppliers dispersed around the world the
coordination of many activities becomes necessary. Dell has a hybrid matrix organizational
structure. The company has a level of senior vice presidents who report directly into the
14
Office of the Chairman. At this top level are the vice presidents for each international region,
for the Americas, for Product Development, and for the individual support groups, of which
World Wide Procurement is one. Under the Americas group are seven sales segments
headed by vice presidents, VP Americas Manufacturing, and VP Service. The sales
segments are organized by customer type (e.g. military, education, etc.). World Wide
Procurement (organized by commodity or supplier), various other support groups, and the
Product Development Group (organized by product) matrix across each sales segment.
Figure 1 graphically depicts a high level view of the organization.
Office of CEO
Corp
Brand
Investor
Reain
Dell
etrs
Strategy
Reain
etrs
Corporate
Strtg
WW Manufacturing
& Cuatomer
Experience
Fn
I/lTAdmin
HR ILegal
Fiance
aeg
1
1
(Mpo
Se
ICorp
Com
1
W
rcrmn
om
WWPourmn
Global
II
AMERICAS
BSD
PAD
(inSD
OaWare
Americas
inti I
lCanada
&Latin America)
Education
Healthcare &
Government
LCA
I
Americas Manufacturing
I
Nashville Manufacturing
Austin Manufacturing
Americas Services
PRODUCT DEVELOPMENT GROUPS
Client Product Group (CPG)
Enterprise Systems Group (ESG)
INTERNATIONAL REGIONS
EMEA (Europe, Middle East, and Africa)
Asia Pacific (includes Japan)
Figure 1. High Level Organizational Chart
This project work was sponsored by a sub-segment of the World-wide Procurement - OEM
Server group. The supply chain at Dell is the coordination of all the activities, including
manufacturing, between customer order and the delivery to the customer.
15
2.8.
Current supply chain design
Dell has major manufacturing facilities in 6 locations globally;
" Americas: Austin, Texas, Nashville, TN
"
Europe: Limerick, Ireland,
*
Asia: Xiaman, China, Panang, Malaysia
" South America: Eldorado do Sul, Brazil
Dell's goal is to have minimal inventory and to 'Build to Order' once the customer has placed
an order. To support this it is necessary for suppliers to set up hub locations at each of the
Dell manufacturing facilities. With the current business model Dell negotiates and controls
multiple levels of the entire supply chain. Dell, or any OEM, has market power that is
greater than the supplier so they will negotiate the pricing for components that the supplier
consumes in their manufacturing.
2.9.
Summary
Based on various performance indicators and company growth, Dell is a successful
company. In order to maintain this level of performance, Dell is constantly driven to change
and improve as the industry evolves in order to maintain its advantage.
16
3. PROJECT DEFINITION & BACKGROUND
3.1.
Chapter Overview
This chapter will focus on the background for this project and the dynamics in the industry
that make the project pertinent to Dell at this point in time. The technology of the products
will also be discussed as well as the importance of the relationship between Servers and
Storage products. The industry structure as well as the Dell Enterprise Systems Group's
(ESG) position will be examined. This will be the basis for this project's motivation and
definition.
3.2.
Changing industry structure - commoditization
Commoditization, in high technology, results in an increase in the number, availability, and
similarity of products in a given category. Since there is little or no differentiation of
hardware, competitors focus on price and service as differentiation points. Commoditization
is not just about reduced prices and margins for hardware but also typically drives the
standardization of the hardware. This aspect is attractive for Dell since they are a
technology integrator. Dell recently has been referred to as the 'Anti-Technology company'
in the popular press (Red Herring, 2001). The following graphic shows an aspect of a
corporation's financial success as the technology becomes commoditized.
17
a
orage
Proprietary
Commodkization
Fully Commodiftzed
Servers
0
Gross Margin
otebooks
ions
Work
Compe Itors' higher OpInc allows
Desktops
F r Cross-Subs Idation
0
--
-- I---
-------
Dell
OpInc
Advanta e of the Deli Direct model
00/0
_--
Volume
.
.*
---..
Note: Bubble size Indicates ratio between Dell (grey) and largest non-Dell (white) player in the market
Figure 2. Commoditization Curve
Figure 2 depicts a curve that transitions from proprietary hardware through a
commoditization phase, until the product is considered commoditized on the horizontal axis.
The horizontal axis shows the three phases: proprietary, commoditization and fully
commoditized. As this transition happens it is also assumed that volume is increasing as
you move to the right along the horizontal axis. The vertical axis shows the effect of this
transition on the product's gross margin. Conceptual bubbles for the markets that Dell is a
competitor in is displayed along this curve that show the level of commoditization for each
product group. Dell's market position, relative to its nearest competitor is depicted by the
size of the gray bubble relative to the competitor's white bubble. Dell's market position is
more dominant for those products that have moved down the commoditization curve. This
chart considers the hardware and the software as a part of the product that is displayed in
18
the chart. If the chart was for only hardware servers in particular would be considered more
commoditized.
The lower half of this chart shows the Operating Income for a Dell competitor that is a
technology innovator, with the typical characteristics that include: intensive R&D budgets,
high development budgets, proprietary hardware solutions, unpredictable demand and lower
return on investment when all projects are considered. These developers of technology
typically introduce product with proprietary elements. After a product is developed and
introduced to the market, the market is assessed based on market attractiveness by other
potential entrants. Some of the competencies exhibited by the technology innovators are
the ability to differentiate their product through technology. But if the market is seemingly
attractive competitors will enter and some effects might be standardization and increased
competition, both will reduce margins.
Dell's business strategy is not to be a technology innovator but instead to leverage
standardized hardware solutions. This minimizes the need to do research and development
at least not at the scale of a technology innovator. This changes the slope of the operating
income line and enables Dell to have an advantage over the 'technology innovator' as a
product moves down the curve. It should be noted that Dell is at a disadvantage at the top
of the curve. The direct business model allows Dell to differentiate from the competitors
through pricing as well as other customer experience criteria. One of the difficulties that Dell
has encountered along the way with this approach is competitor's ability to cross-subsidize
between products or offset declining margins on commoditized products with higher margins
on proprietary products. This position with regard to commoditization is built on the
following assumptions:
0
Commoditization of products is inevitable due to the increase of open standards.
19
"
Available profits increase as a product moves down the 'commoditization curve'
since the market expands as pricing is reduced since the product is attractive to a
larger market. The increase in volume will create a larger profit pool even though on
a unit basis it may be less.
*
More competitors will enter the market as the product moves down the curve,
increasing the importance of differentiation through non-hardware features.
*
A low cost business model is critical to success once commoditization begins and
the company that ramps up to volume the quickest will capture market share while
maintaining profitability.
This strategy and the ensuing price war has generated concern that computers are
becoming fully commoditized and that it will become a low margin product similar to other
electronic consumer products. The following causal loop diagram was developed to
potentially understand the relationship between the developers of proprietary solutions and
those that commoditized products through standard technology solutions. Also, the diagram
proposes one possible explanation for the reason why computers will not become like other
electronic consumer products at least in the short term.
20
3.3.
Casual Loop diagram of Commoditization / Industry dynamics
Complementary +
Product
Demand(ie. s/w)
Complementary
Product
Reve ue
+Adoption
Price
+
+
Technology
Maturation
+
+
.--Product MarketAttractiveness
Complementary
Technology
Complementary
Product R&D
R
R
+
Industry
Technology
Demand
Adoptio
+
Unit Costs
Market
Attractiveness.
Dell 'Direct' Low
Cost Model
Market Size
New Products
+
R
Technology
Innovator
+
+
S.Market
Power
Product R&D
Revenue
Figure 3. Causal Loop Diagram of Commoditization Curve Dynamics
This loop diagram proposes to show some of the same dynamics discussed above with the
commoditization curve discussion.
'Technology Innovator' loop - shows that the successful innovator invests money in R&D,
thus developing new products that create industry demand, leading to sales and revenue
that is invested in future R&D reinforcing the technology innovation cycle.
'Technology Adoption' loop - shows the relationship between new products and the
subsequent technology maturation as the technology is used and adopted. As the
technology matures and becomes adopted, not only lead users but also the mainstream
market adopt the technology.
21
'Market Attractiveness' loop - As demand for the new technology increases, the
attractiveness of the market to potential entrants also increases. This facilitates the desire
to be able to enter the market with standard technology that is readily available. As new
players enter the market, competition increases and prices drop, expanding the market size
thus increasing sales.
Dell 'Direct' Low Cost Model loop - As sales increase, the market power of the player
controlling market share increases enabling them to reduce unit costs through efficiencies
and power of negotiations. The reduction in unit costs allows Dell to reduce prices, which
has a negative effect on 'Market Attractiveness' from a competitive standpoint.
'Complementary Technology' loop - As the product market attractiveness increases
complementary product demand also increases, this increases complementary product
revenue that can then be invested in complementary product R&D. This increase in
complementary product R&D can also drive product R&D since new hardware solutions will
be needed to facilitate the use of new software or microprocessors, chipsets, etc.
In Figure 3, there is a link between the technologies that are developed and adopted and
those products that become standardized. This relationship seems to benefit both the
integrator and the innovator. The innovator would likely rest if not continually pushed and
would lose the motivation to develop new technologies. The integrator is dependent on the
innovator to develop products that can be standardized for the masses. These dynamics
reinforce the concept that commoditization of new technology will continue and that the
introduction of new complementary product technology will continue to drive hardware
development. It may be that this continuous process of developing new hardware
(components included) creates the capability for more capable software and that the new
software pushes the need for more capable hardware. Dell has also continued to add new
products to its portfolio. Following is a brief description of the products.
22
3.4.
Product Description
The Enterprise Systems Group (ESG) at Dell is responsible for server, storage and switch
products and solutions. Dell has entered all of these markets since 1996, with its entry into
switches as recent as mid-2001. This section will provide a brief glimpse of the technology
and some of the specific industry background and trends.
Servers
Servers are not unlike a personal computer (PC) except for some of the product features
that distinguish them. A server allows multiple users to share resources on a network. The
components that make up a server will be designed to distinguish them from PC
components in three primary areas: performance, scalability and reliability. Also, similar to
PC's customers have accepted products that are built with standard components (Intel
architecture) and this has spurred growth in the low-end server market segment. Server
appliances have also carved a niche in the server market due to the special needs for
servers used by web hosting companies.
Storage
Dell entered the storage market in 1998. This is a natural step since it is necessary to
provide a storage device for a server in a network environment. This market has
experienced significant growth and has, in contrast to PC's, a forecast for continued steep
growth in the near future. It is also important to note that the storage technology is the least
standardized technology of the current markets that Dell is a participant in. Also the link
between servers and storage is also not standardized as well as the respective software
solutions.
3.5.
Server - Storage Infrastructure Relationship
The interdependence of server and storage devices has fluctuated over time. Initially IBM
had a captive market for storage that worked with its servers. During the 1980's this
23
dependence was challenged and broken by the efforts of EMC. By 1993, EMC was selling
more storage for IBM systems than IBM. With the continued shift to open standards and
diminishing margins in the server arena, several server suppliers entered the storage
market. Server OEM suppliers promoted RAID (Redundant Array of Independent Disks)
technology, which created a swing back to the dependence of the storage device to be from
the same supplier as the server. To better understand server and storage products, as well
as to provide background to the strategy, customer driven product feature will be discussed.
3.6.
Customer Requirements - Performance, Availability, and Scalability
The criteria for purchase of a server can be grouped into three main categories for
enterprise products; availability, reliability, and scalability. Each of these may be summed
into an overall dimension, which the industry refers to as 'Total Cost of Ownership' (TCO).
Performance
For a server, performance is the main characteristic that encompasses how the server will
function including speed and power of data transfer. This is a function of the type and
number of processors, amount of memory and chipset that is included in the design.
Additionally, emphasis is placed on the space that the server will need. In the data center
environment servers will be rack mounted and floor space is expensive and therefore a
consideration in the design of the individual servers. This leads to thermal constraints of
cooling the many processors.
Availability
Another facet of total cost of ownership is the metric used to compare the reliability of
servers and equate that to dollars for the owners of server/ storage products. Because of
the nature of application of servers and the negative impact of down time, some servers
24
have redundancy built into the system. Design for serviceability is also a differentiation
criterion between products since this will impact the amount of time a server will stay down
once it is down.
Scalability
Yet another facet of TCO is scalability. As a business owner you would want a system that
can grow with the business since it is difficult to forecast network needs and changes.
Clustering of standard servers will allow the user to realize benefits from having groups of
servers that can often perform tasks that would require larger, more costly proprietary
solutions. This highlights the importance of the server management software and its
importance to be compatible with many hardware providers technology.
3.7.
Component Technology
Within the computer industry, there are multiple strategies that have been deployed but an
important consideration is whether to vertically integrate and perform the tasks required to
develop the component technology internally or outsource the design and manufacture of a
component. A classic example of a large player that has decided to remain vertical in a very
horizontal industry is IBM. Despite the large number of component suppliers, ensuring
adequate competition and continued development of new technology, IBM continues to
design hard drives, chips and various other components. Other large and smaller 'white
box' players have decided to be systems integrators of the component technologies. This is
interesting from the standpoint that they have much lower R&D costs but are also
dependent on component technology that may be developed by competitors
Motherboard
The motherboard is the 'brains' of the server system and as such is a key component. The
motherboard incorporates the processors and the chipsets. Intel is the dominant supplier for
25
processors as well as some chipsets. Dell has a history of only incorporating Intel
processors into their designs but will utilize chipsets from various suppliers. Chipset
selection is closely tied with time to market and cost criterion. The motherboard
components (chips) may be dictated by server management software requirements.
Chassis
If the motherboard is the brains then the chassis is the 'body'. The 'look and feel' of the
chassis is an important attribute to the customer since it is the part of the system that is seen
and physically interacted with. During the server assembly process there are several
chassis attributes that are for the facilitation of the assembly process. Also, features like
tool-less access and other features are to support the installation and service process if
required in the field. This is in support of the TCO concept that the server customer
requires. From our discussion of performance, scalability, availability and component
technology it is evident that TCO is quite different from acquisition cost.
Peripherals
This is defined as components that are part of the server system and are modular
components that may be part of the actual configuration of the system. Typical examples
include network interface cards (NIC), floppy disk drives (FDD), hard disk drive (HDD), etc.
These are commodity-like products and there is commonality between peripherals for
servers, storage, desktop, and laptop computers. The manufacturer of the overall system
verifies that available peripherals will work with the system versus the peripheral supplier
testing to ensure that there component will work with all the system solutions.
Software
Server management software is not standardized. Speculation is that this will happen but
the timing is unknown. This is the key differentiator between the solutions in the Window NT
/ Intel server market at the point this project was completed. Depending on how the
26
particular server management software is designed it may require specific hardware
components as a part of the hardware architecture design.
3.8.
Project Definition
The increase in the commoditization of the computer industry, including servers, implies that
there is a decreasing degree of differentiation at the hardware level and that cost and other
product features become much more important. At the start of the internship Dell had
decided to outsource the design of some of the server components that had been
traditionally designed in house. There were recognized potential benefits to do this for some
products but the most effective application of the model had not been determined. The
project was to focus on developing a strategic framework for the entire server business to
determine which products could and should be OEM'd so that tactical plans could be more
effectively determined for products. The project was a joint effort between engineering and
procurement with input form the marketing and quality organizations. The project was
sponsored by the Enterprise Systems Group, which encompasses the server, storage and
switch products.
3.9.
Enterprise Systems Group (ESG) Strategy
This strategy for the ESG group was established, and as such the strategy that was in
question as a part of this project needed to be synchronous with the ESG business strategy.
Some of the highlights of that strategy are the following:
" Grow revenue by entering into new markets.
*
Focus on cost leadership.
The market entry aspect references Dell's current market offering and the fact that there are
markets that Dell does not compete in at the low end as well as at the high end. Also, this
refers to the opportunity to enter or have a larger presence in global markets.
27
100%-
$19.3B
$11.1B
$7.7B
$10.2B
$17.3B
4-P
8-P
>8P
DAS
cj $6.9B
Total=
$74.7B
80%-
60%-
C,)
Rest of Market
40%-
20%I-
1,2P
SAN
Figure 4. Source: IDC Server Tracker CY2000, Disk Storage Systems Market
Dell has chosen to participate in the SIAS market for servers/storage limiting them to Intel
architecture vs. the Unix architecture. Likewise the software is limited to the Microsoft and
Linux products. Figure 4, above, graphically shows a representation of this market and
Dell's respective share in each market. For calendar year 2000, Dell is less than 5% of this
market. This is one of the catalysts for the OEM strategy for servers. OEM is viewed as a
market entry mechanism as well as a way to supplement current resources so that more
products can be brought to the market. Thus expanding the product portfolio without adding
engineering and other support people.
3.10.
White-box computer industry
In the computer industry there are many large OEM's such as Dell, HP, Compaq, IBM etc.
There are also many other computer sellers that are referred to as 'white-box' makers that
are less recognized brands that offer standardized solutions. Some of these companies not
28
only integrate standard components but, in the case of server products, may design some
motherboards and chassis to be incorporated in their own design. Examples of companies
that fit into this category are Acer, Quanta, Compal, Arima, Inventec and Mitac. Many of the
dominant white-box manufacturers are located or have operations in Taiwan. The major
difference between the OEM and the 'white-box' computer maker is brand. An aspect of this
includes the testing that is done by the OEM to ensure that multiple peripherals are
compatible with the system. A 'white-box' solution would not include this guaranteed
functionality. Surprisingly 'white box' manufacturers have significant market share in some
segments.
3.11.
OEM, ODM and EM relationships
Original Equipment Manufacturer (OEM), Original Development Manufacturer (ODM) and
External Manufacturer all refer to the amount of supplier involvement in the manufacturing
and design process and refer to different sourcing models in most industries, regardless of
product. It is possible to think of these three models as a continuum with variations
positioned in between the pure definitions. An example may be a high touch ODM project
that very similar to an EM structure project. The definitions are as follows:
"
External Manufacturing (EM) - This refers to the outsourcing of the manufacture
of an internally designed component. In the computer industry this is also
commonly called contract manufacturing. The OEM, in this case Dell, would
design motherboard or chassis and then contract out the manufacturing.
" Original Development Manufacturer (ODM) - This outsourcing model involves
the outsourcing of some aspects of the design of the component. A scenario that
would fit into this model most commonly is finding a supplier, maybe a 'white box'
29
company, that has designed a standard component that is similar in functionality
to what is need for the product. The two parties would then work together to
'tweak' the design so that it could be used with minor modifications.
Original Equipment Manufacturer (OEM) - This model involves outsourcing the
manufacturing as well as the design of the component. The product is likely sold
to multiple customers and is a standardized design product. For the computer
industry hard drives would be an example of this.
3.12.
Project Approach
This project involved laying out a framework for deciding which of the outsourcing models
should be used for server products and if the same model was not used for all products the
criterion for making the decision. The beginning of the project was spent learning the
products that were offered and the marketplace for the products. Two avenues were used
for this learning, exploring the web (internal and external) and interviews with people in the
Dell organization. This project crossed functional lines and while the project was chartered
by the Procurement organization, clearly other major stakeholders included Engineering,
Marketing and Quality.
3.13.
Summary
Commoditization, fierce competition and continual exploration of new ways to do things are
the driving forces for the motivation for this strategy. Commoditization can be combated
numerous ways but from this brief introduction, Dell unlike its competitors is not trying to
stop or slow down commoditization. In contrast, Dell is trying to understand how
30
commoditization may affect them and their competition and then use it to their advantage.
This project develops a server OEM strategy by exploring of these issues.
31
4. LITERATURE REVIEW / BENCHMARKING
4.1.
Introduction
The development of this strategy appeared to be a 'make -buy' decision however most
examples that were considered in the literature are the decision to outsource the
manufacturing of internally designed components. This seems to be a popular trend since it
allows a corporation to shed the capital assets associated with manufacturing therefore
improving the short-term financial health. A literature review seemed appropriate since
many lessons could be learned from other make-buy decisions as well as leverage the
thinking that pertained to the methodology of making that decision.
Several sources of relevant information that included strategic sourcing decisions and make
-buy decisions were found in literature. Also, the literature search included looking for
methodologies for making strategic decisions and the process for such decisions.
The literature search included the following components:
*
Historical frameworks for strategic decisions
"
Outsourcing - Make vs. Buy decision frameworks
" Vertical/Horizontal Integration - Modular vs. Integral Product Architecture
" Using standard vs. uniquely designed components
*
The effect of industry/ technology clock-speed on decisions
" The effect of the type of outsourcing relationship
32
4.2.
Strategic Frameworks
Strategy is one of the most vaguely defined concepts of business today. Many thoughts on
how to formulate a strategy exist as well as many definitions. Even more literature exists
that provide a post mortem analysis of less than perfectly formulated strategies. Among the
literature there are several common threads that are correlated with this project, including:
*
Definition of core competency
" Technology Innovation 'S' Curve
" Rivalry
*
Sustainable Advantage
"
Portfolio Analysis
" Value Chain Analysis
Strategy is defined by Fred Gluck as 'an integrated set of action that result in a sustained
competitive advantage' (Gluck, 2000). This may be through a 'positioning' strategy by
focusing on the competition, though product innovation or by leveraging an advantaged
business model. Others have taken a 'core competency' approach meaning they define
those activities that create value to the customer and then seek to do these activities better
and put less importance on the activities that the customer does not value. Yet another,
less competition centric, thought by Roberto Baron is to develop a system for anticipating
product innovation to maximize shareholder return vs. trying to defeat the competition.
Instead of accepting the rules of the market as they are the competitor seeks to shape and
change the market (Baron, 1980).
Core competencies are the set of activities that the firm carries out that cannot be completed
by others because they are not capable or they are those activities completed by the firm
33
because they are of significant value to the customer and therefore a larger proportional
reward can be obtained for completing them. Prahalad and Hamel refer to core
competencies as the internal attributes that have the following characteristics; provides
opportunity in multiple markets, customers think it is important and it is difficult for
competitors to imitate (Prahalad and Hamel, 1990). In parallel if the firm is wasting
resources on an activity that could be accomplished by others, this may be a poor use of the
firm's resources, therefore limiting maximum benefit of its resources.
Technology innovation is also an important strategic factor in some industries and the ability
to anticipate or drive innovation may be of significant strategic and competitive benefit.
Richard Foster asserts that it is the company that can play the 'attacker' in the innovation
war that will receive the 'ultimate competitive advantage' (Foster, 1986). The 'S' curve
illustrated below in Figure 5 shows that initial investment only yields minimal comparable
rewards. However, at some point the performance rewards accelerate and the investment
pays off assuming that the marketplace adopts the technology. Finally, the performance of
the technology will plateau at some point at which time is ripe for a new technology to enter.
It is the anticipation of this point and the development of the new technology that may
benefit the company that is able to anticipate and identify the new technology. The ability
for a company to concentrate on its existing business while at the same time identifying and
developing a 'disruptive technology' is the issue that Clayton Christensen examines
(Christensen, 1997). An analysis of the disk drive industry shows that it is not easy to
accomplish incremental product improvements for existing customers and develop new
technology.
34
AL
Fundamental Limit
of the Technology
Investment in a particular technology
Figure 5. Foster, Richard N. 'Payoff from technology investment follows S-curve'
Rivalry and sustainable advantage are both examined in Michael Porters 'Five Forces'
framework. The model contends that any strategy that is formulated should position the
company with respect to competitors by taking the following five components into
consideration; threat of entry, supplier power, buyer power, rivalry, and the threat of
substitution (Porter, 1980). Porter shows that by understanding the industry forces and then
matching the company's strengths and weakness, a company can formulate a strategy.
Porter also asserts that the forces in this model should also be forecasted so that the
changing industry dynamics may be predicted. For this project, the five forces analysis
shows that rivalry is extremely high in this industry as evidenced by the current price wars.
It is this competitive threat that is the underlying force for most of the businesses activities.
4.3.
Make/Buy Decision
35
A summary of the research will be presented to answer the question of how value chains
are constructed and the subsequent sourcing decisions should be made. This literature
supports the notion that if the manufacture or design contributes to the competitive
advantage when done in house then strategically it should be completed internally. In many
cases the make-buy decision is considered for a small portion of the value chain such as
manufacturing. Much has been written about how to determine if something is strategically
important and if it is lessons that can be learned form others who have made mistakes by
outsourcing something of strategic importance and the implication of not making prudent
decisions when doing this.
The concept of core competency is important to the sourcing or make-buy decision since
literature advocates the concept that the firm should dedicate resources to the processes
that are the core competency of the firm and outsource those activities that are not a core
competency. This is based on the assumption that there is a capable supply base. The
core competency issue will be addressed again in the methodology section with specifics
pertaining to this project.
The value chain is the set of the activities required to create a product from raw material
through delivery to the customer. For a specific industry each company must understand
what differentiates them from the competitor and what it is that the customer values. If one
player in a value chain can control other elements of the chain without actually owning them
they will have an advantage. A way to do this is to own a link in the chain that cannot be
cost effectively duplicated (Percival, 1999). An example of this in the computer industry is
Intel with their development of a brand and technology innovation. The photolithography
equipment and other capital assets make it difficult for others to enter their markets.
36
In fact, it is this analysis of determining what to make or to buy that Fine and Whitney assert
may need to be the core competence of the corporation (Fine and Whitney, 1996). With the
constant evolution of technology and the increasingly complexity of products, it is unlikely
that any corporation will be completely vertically integrated. Therefore, they will need to
outsource some crucial elements of their product. It is the skill of determining what to
outsource that is considered the most valuable skill. The Fine/Whitney article examines the
effect of product development and product architecture on the ability to outsource the
component or product. The matrix presented in the article has dependence on capacity on
the vertical axis and the dependence for knowledge on the horizontal axis. Building on the
type of dependence a second matrix is constructed that also considers the product
architecture. If a component of a product is outsourced, the other proposed factor that
needs to be considered is whether it is decomposable or integral in the product architecture.
The dependence for knowledge could be very dangerous if the outsourced item is integral in
the final product architecture, since you don't understand what you are buying or how to
integrate it (Fine& Whitney, 1996).
An article by Venkatesan tries to simplify the make /buy sourcing decision by saying that a
company should apply the following principles:
" Focus on making those components that are critical to the product and that the
company is good at making.
" Outsource where suppliers have a comparative advantage - greater scale, lower
cost structure, or stronger performance incentives.
" Use outsourcing to generate employee commitment to improve manufacturing
performance.
Venkatesan discusses the fear of 'hollowing' the corporation and the need to have a system
to assess which components are of a strategic importance and which are not. He also
37
raises the issue of fear to outsource since competitors may also outsource from the same
supplier therefore this component will no longer be a point of differentiation. Venkatesan
defines 'architectural knowledge' as the process of evaluating the customer needs and the
translation to product attributes. This will not be easily copied even if components are
sourced from the same supplier. However, if the design is sourced to the supplier by giving
them a performance specification this may accelerate the loss of architectural knowledge.
Because of this potential outsourcing consequence it is vital to systematically determine
what components are core to the product and to maintain knowledge even if the
manufacturing is outsourced. Along with the potential loss of knowledge it is equally
dangerous to over invest resources in commodity like components. An important last point
of the Venkatesan article is that reexamining the categorization of commodity or strategic
components should be review on a periodic basis in order to capture changes in strategic
elements of any industry (Venkatesan, 1992).
Markides and Berg argue that outsourcing should not be undertaken for short-term financial
gains such as lower labor rates or temporary reductions in COGS (Markides & Berg, 1988).
Much has been written about the US manufacturer's inability to be competitive with
manufacturing operations in the US due to non-competitive labor rates. This issue will be
discussed as a part of the methodology section. Many articles highlight the misconception
of the lower labor rate with the offsetting management cost to manufacture outside of the
US. This further highlights the need to carefully consider any outsourcing decision to ensure
that it is being made for the right reasons as well as taking all cost, both tangible and
intangible into account along with strategic advantages that may outweigh short-term cost
improvements.
38
4.4.
Standard vs. Unique Design Components
In a competitive industry, emphasis will be put on effective cost cutting measures. The
computer industry is no exception and with cost of goods sold representing a significant
portion (50-70%) of the total cost, standardization is an important consideration.
Standardization may refer to the reduction of components or the commonality of
components across products. Another type of standardization is the commoditization of
technology, which yields one accepted standard for a product. An example of this in the
computer industry is the LCD flat panel for laptop computers. The standardization of this
product will be discussed in the benchmarking section. Given that it is advantageous from a
cost standpoint to drive commoditization it is necessary to understand the types of
standardization. Utterback examines the standardization process and several historical
examples. Many firms can enter the market prior to there being a dominant design since
customers have yet to commit and the development of the product is still in process. At the
time of a 'dominant' design introduction this signals that there is customer loyalty to one
design and all competitors must begin to adhere to it (Utterback, 1996). The formation of
these standards is not a well-paved path.
Utterback presents factors that have allowed firms to capture the dominant design.
Collateral assets may be market channels, brand, or switching costs that enable a firm to
capture the market. Second, industry regulation, a standard may be determined through
government intervention. Third, strategic maneuvering may enable a firm to capture the
dominant design. An example is the VHS tape becoming dominant over beta even though it
was technologically inferior by establishing alliances. Fourth, market learning is the firm
ability to convince the customer that their solution satisfies all of the customer's
requirements (Utterback, 1996). Sometimes standards don't even appear to make sense
39
but they become dominant such as the QWERTY keyboard. From this we learn that there is
not a defined path to creating a standard and that in history there have been many failures
in this arena.
In the computer industry, as well as others, there are those that resist the standardization of
products since it all but eliminates differentiation at the hardware level and shifts the focus of
the customer to other product attributes. This is difficult for those that have invested in
differentiation. Another aspect of this industry is that the consumer drives the
standardization since they total cost of ownership for a standardized system is less than for
a custom system. In addition to the lower costs for standardized components, it is also likely
that there will be multiple competitive suppliers for the component. Standardization lowers
cost therefore enlarging the market and increasing the ROI for a quality investment in the
standard component. Dell is recognized in literature for utilizing Industry Parts
Standardization whereas HP is recognized for their use of Parts Commonality in their
products and optimization of their supply chain (Jaruzelski et al, 2001). Industry Parts
Standardization is the concept of using components that are offered by many suppliers in
the marketplace. Parts Commonality, in contrast, is the use of a component in multiple
designs, thus reducing the number of parts across multiple products. This article lists the
benefits of Industry Parts Standardization as:
" Lower cost components due to higher production volume
"
Lower cost of obsolescence, since excess can be sold back into the supply base
*
Increased part availability
"
Lower design cost
" Shorter design time
And the benefits of Parts Commonality as:
40
"
Discounts for higher volume purchases
*
Protection from demand forecasting error, since parts can be used on multiple
products
*
Common inventories and assembly procedures facilitating plant consolidations
*
Fewer inventory items reducing operational complexity
*
Fewer parts to manage and fewer parts to qualify
There are many reasons why the total cost of ownership for a standard system is less than
that of a proprietary custom system including, based on a survey conducted by IDC funded
by Dell:
*
Initial setup time and deployment of a new standard system requires less time and
training of IT personnel.
*
Increased compatibility when interfacing with other business partners for ecommerce applications.
*
Decreased prices for hardware, since differentiation is based on price and service
instead of hardware differentiation.
*
Maintenance of the system is simplified. If all standard equipment is deployed the IT
support personnel only need to master one standard system.
IT personnel costs represent the largest component of the maintenance of any IT budget.
So any reduction in the number of people or the amount of time spent to deploy or maintain
the system will represent significant savings. Standard components also make it easier for
the system to be scalable since a particular brand will not have to be utilized when additional
capacity is needed. Another benefit of standard hardware is that there is an increase in
software solutions for the systems. Standard server technology is called 'Standard Intel
41
Architecture Servers (SIAS)'. As this standard server technology has evolved the size of the
market has also grown. Declining prices have made the technology available to a larger
number of customers (Gantz and Turner, 2001).
4.5.
Clock speed
Computer technology and industry clock speed are considered fast and as such any
advantage is temporary. Since any advantage is temporary, the ability to choose
capabilities is the ultimate core competency (Fine, 1998). Fine goes on to note that
resources need to be dedicated to high value added activities vs. the commodity activities.
Since this is not an easy thing to do, many companies in the high technology and fast
clockspeed industries hedge to balance the risk associated with their strategy. An article by
Fine and Whitney examines the issues associated with outsourcing work and present a
framework for determining the different risks associated with outsourcing capacity vs.
knowledge (Fine and Whitney, 1996). This framework argues that it may be the process by
which a firm decides which activities to outsource is more important to the firm than many
other activities. The article includes examples of poor historical sourcing decisions such as
IBM's decision to outsource to Intel and Microsoft.
4.6.
Supplier relationships
There are many reasons for outsourcing some portion of a firm's activities but the most
common is that there is a supplier(s) that can more cost effectively complete the task.
Another firm may be able to more effectively accomplish the task due to superior
technology, process or economy of scale. It is beneficial to outsource a task if your firm
cannot complete it at a world-class level and someone else can. Once the decision has
42
been made to outsource, it is equally important to consider the type of relationship that the
contracting firm will have with the supplier(s). Much has been written in literature about the
choices that IBM made with their PC value chain and their decision to outsource the
operating system and microprocessor to two unknown suppliers; Microsoft and Intel (Fine,
1998).
A corporation can accomplish a task either through vertical integration, or outsourcing.
Outsourcing can be accomplished by either buying it as a commodity in a market or by
forming a partnership with another company. Jeff Dyer's book Collaborative Advantage
examines the advantages and disadvantages of each of these types of relationships (Dyer,
2000). Partnerships, in contrast to markets, generate competitive advantage through
dedicated assets, knowledge sharing routines through proprietary assets, and trust. This
might make one consider the option of vertical integration, but if one did vertically integrate
you would lose the high-powered market incentives, as well as, loss of economies of scale
through the access to other customers. Dyer examines the issue of learning and whether
customer specific knowledge is shared among customers when they share a source. His
finding was that suppliers have controls to prevent this as well as customer approval is often
necessary to make changes. In conclusion, Dyer suggests that it is critical to examine and
understand the economies of the entire value chain and if possible 'expand the pie' that is
available to all including value to the customer and supplier.
4.7.
Importance of Product & Component Design
OEM's in the server industry have used external manufacturers (EM's) to complete many
manufacturing tasks but in the past the EM's were not involved in the design of the
components they will manufacture. Traditionally, OEM's have been very conservative about
43
allowing EM's to be involved in design for fear of them forward integrating and becoming a
competitor. Also, there is a concern about their capabilities in the design arena. This is
changing as EM's are trying to increase their manufacturing volume by becoming involved
earlier. OEMs are considering the outsourcing of design work as pressure increases to get
more products to market in a shorter time. OEMs consider EM's first to complete some of
the more routine design work rather than tying up internal engineering resources. Another
trend in the server industry, driven by standardizing hardware, is to collaborate on design
with a supplier. Instead of using a traditional EM for manufacture an OEM may select a
design that a supplier is using in their server/PC product. The pool of these suppliers is
made up of many Asian 'white box' makers. OEM's have begun to use them as ODM
suppliers, collaborating to tweak one of the suppliers existing designs so that it can be used
in the OEM designed server products.
4.8.
Automotive Strategic Sourcing Framework
A model that takes into account many of the elements in this section is written about in an
article about the process used by General Motors to make strategic sourcing decisions (Fine
et al, 2001). This paper includes a model that was developed for a project in the automotive
industry that asserts that both economic and strategic factors need to be considered when
formulating a strategy that will reallocate rewards from the value chain. The strategic factors
include several qualitative factors that are assessed to determine the impact of the strategic
decision including:
" Customer Importance
" Technology Clockspeed
*
Competitive Advantage
*
Supplier Capability
44
Architecture
.
The quantitative element of the assessment is referred to as the 'Economic Value Added'
and consists of the following components:
"
Costs
" Assets
*
Revenues
*
Competitive Cost Structure
From the integration of the quantitative and qualitative elements of the model, several
recommendations are made with regard to sourcing, investment, architecture and alliance
decisions. In the methodology section, this framework will be applied to this project as a
way to gain insight to the formulation for this strategy.
Applying this model to the project at Dell yielded several observations. The model
comprised of an 'economic value framework' that assesses several financial factors in the
GM example. As a parallel to this Dell is diligent about examining projects to understand the
financial costs and opportunities for improvement. For the OEM and ODM models
engineering has examined where the changes in cost occur between the model and this will
be examined in subsequent sections of this thesis.
The strategic component of the GM sourcing framework applied to the Dell project provides
the following information:
* Customer Importance - the source of server components is transparent to the server
customer. The design of the components is somewhat transparent to the customer
therefore they are primarily concerned with the OEM's warranty and after sale
45
service. What is most important is the Dell brand that is on the box, since this
assures a certain level of quality and warranty for the product.
* Technology Clockspeed - this is very fast with product lifecycles at the low end of
the market in the range of 1 year and at the higher end of Dell's market only a few
years.
" Competitive Position - due to commoditization, Dell is on par with the rest of the
OEM server companies.
" Capable Suppliers - many suppliers are capable of doing this type of work, however
there will be a learning / experience curve for any supplier to learn and be compliant
with the Dell way.
" Architecture - very modular from a physical perspective but as the project
progressed, and continues to progress, there are issues of integrality with software
that is critical to product differentiation.
This strategic framework shows that an outsourcing decision may be appropriate. For the
Dell decision it has not offered insight into which products within servers may be the ideal
outsourcing candidates. This thesis will examine how the strategy was developed for this
product line from a strategic perspective.
4.9.
HDD Industry - Effects of Disruptive Technology
The Innovator's Dilemma by Clayton Christensen examines the hard-drive industry and the
evolution of storage technology. A smaller player drives each successive generation of
technology thus causing the disruptive technology to eclipse the current dominant
technology. A central question that is examined is the reasons why it is difficult to innovate
while concurrently being the dominant player in the market. Also, examined is the concept
46
that the new technology is often not as good as the current widely used technology but that
performance improves as it develops. The market leader often discovers this too late and is
unable to evolve quickly enough. This may be due to the current customer base that is
utilizing the technology and their needs, which often do not require the innovation, and they
choose to adopt it after it becomes widely accepted (Christensen, 1997). When developing
the strategy for the high-end market segment, some of the risks associated with having a
costly R&D program and the associated risks are similar to any market where a disruptive
technology may emerge. This phenomenon may strengthen Dell's position to be a
technology integrator but not an innovator since as an integrator the risk is reduced that a
disruptive technology will affect the Dell's business plans.
4.10.
Benchmarking
Investigation was conducted through interviews within Dell to identify similar efforts that
would have learnings pertinent to this project. During this benchmarking process two unique
decisions were explored for parallel learning. Since Dell is very driven by the financial
numbers each sourcing decision has a business case that quantifies the many alternatives
for make vs. buy for each product. Desktops, as noted in the background section, are more
standardized and have also been considered for OEM outsourcing strategies. Likewise, the
challenges of standardization were consider by a group at Dell that was tasked with Liquid
Crystal Display (LCD) standardization.
4.11.
Consumer Product Group's OEM strategy
The desktop business at Dell is the leader both from a volume perspective and a technology
maturity perspective. The Consumer Product Group (CPG) manufacturers desktop PC's
using a build-to-order manufacturing system. CPG decided to OEM a partially integrated
47
product with the expectation that this would be more cost effective for that product.
Shrinking revenues at the low end of the product portfolio drove this decision. However,
since fixed capital asset were not eliminated in the short term, there was some question as
to the effectiveness of the decision within the organization.
The other concern was that since the OEM model was relatively new, most business
processes were not reconsidered, but rather the existing ones were utilized. This caused
the expectations of the model to become somewhat convoluted and provided enough doubt
such that the next product in the same market segment was not OEM'd. The decision to not
OEM the second generation of the desktop product group created some doubt with regard
to the effectiveness of the OEM model. Another factor that created doubt about the
effectiveness of the model was that even though the first server product to be OEM'd,
continued to be called an OEM project it actually was shifted to an ODM project. This
created a dynamic that is illustrated in Figure 6.
Decision for
In-house design
(7
Resources
svslable?
Start New
Program
Evaluation
Gap - 'Co-design' does not yield
anticipated advantages of
outsourced std design
Decision to OEM
Engineering HW/SW
dependencies prevent true'
OEM solution
ecision to 0DM
Figure 6. Effect of OEM/ODM barriers on perceptions of OEM
48
The first OEM server project had actually transitioned to an ODM model, however it was still
called an OEM product. This contributed to the gap between expectations for the model and
actual results. Another goal of the OEM model is to be able to utilize it as a vehicle to drive
standardization of the remaining components that are not commodities.
4.11.1. Notebook Displays Standardization
Before liquid crystal displays (LCD) became standardized it was impossible to have multiple
suppliers, since each supplier had a unique offering. For a laptop computer the LCD is the
most expensive component in the system. So, unlike the hard drive industry where the
suppliers drove the standardization in the LCD industry the standardization was driven by
the OEM customers. These unique designs were driven by engineering specifications that
were generated by each OEM. The first attempt to remedy this problem was to have a
design that was successfully being made by one supplier 'cloned' by others. While this
provided dual capability in the supply base it diminished the economies of scale since
volume would be split in some way between at least two suppliers. OEM customers each
drove slightly different requirements and were reluctant to adopt each OEMs design since
the benefit of the economies of scale might give a competitor an advantage.
Since the cloning efforts did not provide all benefits of standardization that were desired
there was a strong motivation to continue the efforts. During an industry conference this
was a topic of discussion and some de facto standards began to emerge. Eventually, a third
party became involved as an intermediary for the discussion of between several of the
players. The companies met many times to agree on many mechanical criterions that would
make up the standard. Importantly, none of the companies were able to drop the new
standard LCD into an existing system, so all would have increased design efforts to
49
incorporate the standard. The group was careful not to create specifications around criteria
that would all suppliers to differentiate themselves like weight, size (thickness had a
maximum, but not a minimum) and luminance.
The lessons from this LCD standardization study are applicable to the application of the
OEM model as a methodology to drive standardization of server components. First, cloning
is not enough to drive standardization of components since competitors are unlikely to adopt
a competitor's design since the original owner of the design will be advantaged by the
economies of scale. Second, due to the competitive nature of the industry it is helpful and
may increase the speed of standardization if a third party is involved.
4.12.
Summary
The literature review showed that much has been written about strategic sourcing and the
make/buy decision. Past literature suggests that it is an important decision and several
criterions should be considered in addition to cost. Much has been written about core
competency and determining if a strategy is sustainable. Also, included is a belief that it is
better to outsource capacity but rarely knowledge since it is riskier. Not much work has
focused on trying to drive commoditization and the situation where this may be an
advantage. This thesis will examine a strategy to outsource knowledge and why this may
be a competitive advantage for Dell.
50
5. METHODOLOGY FOR THE DESIGN OF THE STRATEGY
5.1.
Introduction
The Server OEM Strategy project was implemented after a server product had been
selected as the pilot OEM candidate. This provided several beneficial aspects to the
development of the OEM server strategy. The first was that the strategy became not a
question about whether or not the model should be applied but rather about identifying the
logical application of the model. The second benefit was that the current pilot project could
be studied to identify potential improvement and/or obtain insight into the effective
application.
5.2.
Proposed Models
As discussed in the introduction, there are three high-level supply chain models that are
potentially available. Each defines how much the supplier will contribute to the end product.
They can be thought of as a continuum since as you move from an EM relationship to an
ODM model the supplier has more impact on the design, and as you continue towards OEM
the supplier is completely responsible for design. An important note is that they are many
variations with each of the models. At Dell for example, they may have two programs that
are both considered ODM, but one may be 'high touch' ODM vs. a 'low-touch' ODM project
referring to the amount of involvement Dell had in the ODM project. Figure 7 shows a
graphical illustration of the models.
51
OEM
(Original Equipment
Manufacturer)
ODM
EM
(Original Design
Manufacturer)
E
'Virtual' Manufacturing
Virtual Manufacturing
Virtual Manufacturing
+ Design
+ Virtual Design
Collaboration
Figure 7. EM-ODM-OEM Continuum Relationship
Each of the models involves outsourcing and supplier involvement with manufacturing and
design. For definition, if a corporation were completely vertically integrated the following
models would be options:
*
External Manufacturing (EM) model is the classic contract-manufacturing model
where only the manufacturing of a component or system is outsourced. The EM
supplier would be given a complete design with all of the information needed to
define the manufacture of the component. Tool and non-recurring engineering cost
may be required depending on the product, in the case of the computer industry it is
not atypical to have product specific test fixture that would be required by the
supplier for testing of the manufactured product. This may lead to supply inflexibility
in the case of unpredictable demand and dedicated assets that are not fully utilized
as well as capacity constraints. This model may be thought of as ' virtual
manufacturing' since manufacturing is the only aspect of the value chain affected.
Switching between EM suppliers is possible, but is somewhat difficult mid-program
for a specific product due to the short product lifecycle.
*
Original Design Manufacturer (ODM) model includes the EM model but also includes
the design of the outsourced item. This may be through 'white-box' computer
52
makers that may have a component designed for their own product. By working with
a computer system OEM, like Dell, the two parties would agree on 'tweaks' to the
original design so that it would work and meet the specification of the computer
manufacturer. This model includes 'virtual manufacturing' as well as design
collaboration. Depending on the amount of design collaboration and the number and
depth of modifications to the original design will determine if it is a low-medium-high
touch ODM model.
Original Equipment Manufacturer (OEM) model includes the EM model and also the
outsourcing of design since the OEM would select a standard 'off the shelf solution.
This not only assumes that the supplier can design and test a product but also stay
with industry trends to have components ready for the market. This model also
assumes that the component would be used in multiple products. Thus giving the
supplier economies of scale that an OEM computer maker would not have.
5.3.
Value Chain
The three models can be understood by looking at the following simplified version of the
value chain for a computer system. The two main components for a server system that may
be designed are the chassis and the motherboard. The rest of the components that make
up the server such as the hard disk drive (HDD), floppy disk drive (FDD), memory, fans and
processor are all commodity-like and are purchase with no design input. As a part of the
decision as to what to outsource the one factor that weighs heavily is the fulfillment model
and how it may be affected. The OEM/ODM option also may be exercised at the
component or system level of the value chain depicted in Figure 8.
53
Component
mDesign
*SCM
*Mfg.
System
EDesign
MSCM
Fulfillment &
MMfg.(Direct)S
Service
Figure 8. High Level Value Chain
The manufacturing of these components has traditionally been outsourced; the supply chain
was also outsourced but controlled by Dell. Control means that Dell negotiated pricing and
delivery for a supplier's purchased goods. The design of these components had always
been done in house and then given to the supplier to complete the manufacturing. The rest
of the value chain was an internal process. This project entailed looking at the potential
opportunity of outsourcing the design of the components as well as outsourcing the entire
system. With this scenario came the consideration of how this would also impact the
fulfillment and service for the system.
Another important aspect of the outsourcing model is exclusivity, meaning whether or not
the supplier is allowed to sell the product to other customers. This is a paradox since while
someone would like the benefits of being first to market with a concept it also would benefit
that company to drive standardization and time to volume if the product was sold to multiple
customers.
5.4.
Potential Benefits
With definition of what is changed within the value chain for each model it is possible to
define potential benefits and risks for each scenario. Cost is the first benefit that everyone
believes is achieved through any of these models and perhaps is the most misunderstood
perception about these outsourcing models. Other benefits that were considered were
54
speed with time to market, and better utilization of internal resources for projects that will
yield a competitive advantage.
Cost seemed to be the apparent benefit and the thought was that by understanding how the
costs were generated in each of the models then each could be optimized and utilized to the
greatest advantage. Cost for a product was defined to include cost of goods sold,
engineering development costs, time to market as an opportunity cost and the cost
associated with quality or warranty service costs. Through interviews, discussions, and data
from historical programs it was determined that these savings were not significant, except
for high end product development costs.
A second major benefit was the ability to accomplish a development program without having
engineering resources available. Without planning though this leads to making the OEM
decision at the time a program is launched. Though this does not shorten the development
pipeline it does allow more things to make it through the development pipeline at the same
time. The shortfall of this process of making the OEM decision when the product is
beginning the development process is that a product may be OEM'd due to a lack of
resources instead of the reason that it is a good OEM candidate.
The potential intangible benefits that were identified were the time to market advantage that
would be created by being able to develop products more quickly, thus increasing product
breadth. Other potential intangible benefits exist based on the assumption that OEM can be
used as a mechanism to drive the standardization of products. The benefits of this to the
Dell business model are potentially great. The benefits of standardizing server hardware
include:
55
"
Increased supplier competition; multiple suppliers would supply and know how to
make the standard hardware.
" Other computer makers would use the standard hardware increasing the volume
allowing non-recurring expenses to be amortorized across a larger volume.
"
Dell could assess all supplier solutions/offerings and pick that supplier that was going
to be first to market instead of choosing the supplier before development begins.
"
Increased quality levels are typical with a standard product. Suppliers are more
motivated to improve the quality on a standard product that goes to many customers
vs. a custom job that may have predetermined margins.
Much of the realization of these potential benefits is dependent on appropriate business
processes being developed to capture the benefit. If the traditional EM business sourcing
practices are applied to the OEM model the full benefits will not be realized.
5.5.
Definition of Core Competency
As indicated in the literature search, much has been said about identifying those things that
company does that are value-added and give the company a source of differentiation over
the competition. For Dell the items that were identified were system integration, build to
order manufacturing system, system management software, and their brand. Consideration
was given to whether or not component design was or should also be considered a core
competency. Motherboards are integrated with the system and the software and the
chassis design does play into the actual serviceability and manufacturability of the system.
This issue was examined from the customer needs perspective through information
provided by marketing.
56
The core competency assumptions for the strategy defined that for current market segments
the entire system would not be OEM'd, only the components in the system. Another
variation of this would be to OEM a partially built system that would entail a subsystem that
was a combination of some of the components being outsourced.
5.6.
Customer Needs
Interviews with marketing, gave the criteria that customers were most interested in total cost
of ownership and acquisition cost when buying a server. The total cost of ownership
industry metric that incorporates the service and manageability costs as well as start-up
costs to calculate what the owner spends to operate a server. The largest portion of this
cost is the resources that the owner needs to employ, mainly IT people. Acquisition price is
the amount paid to purchase the unit. Since this is a very competitive market feature sets of
competing product are closely matched so that no one gains and keeps advantage over
anyone by offering something different. Depending on the market segment, TCO and
acquisition cost may contribute on a varying scale depending on the specific market
segment.
From a component design perspective the OEM model is transparent to the customer. As
an example, a customer for a new PC is not concerned with who designed the hard drive
but rather concerned with the fact that it is covered by a warranty from the computer
manufacturer. Based on the information obtained about customer needs it was concluded
that component design was not a core competency for the market segments that are
covered by the current product portfolio unless it was something that reduced total cost of
ownership and could not be done through software management technology.
57
5.7.
Customer needs translated to Product Architecture
In Section 2, we discussed the architecture of a server system and examined some of the
customer needs as a function of the hardware that is included in the system. Depending on
the market segment the specific needs of the customer may be defined differently.
Customer needs may be broadly grouped into the following areas for servers; cost,
availability, scalability, reliability, and the end-to-end solution.
During the development of the framework of the project, the vision was to develop matrixes
that showed each of the components for the server that were OEM candidates. Specifically,
the matrix would map the components features against specific customer needs. The next
step was to determine if the feature was not driven by a customer need to eliminate that
feature. If a customer need drove the feature need then determine if it is unique and should
remain so or if it should become part of a standardized design.
5.8.
Definition of Market Segments
Within the server industry there are many ways to segment the market including:
"
Price of the server - most popular is the 11 price bands as defined by IDC. Servers
are separated into market segments according to price.
"
Customer group - relationship vs. transactional type customer, small vs. large
business.
*
Technology - Unix vs. Intel architecture, # of processors.
" Application - meaning what the primary use of the server will be.
*
Server type - rack mounted vs. tower
58
Looking at industry trends and understanding what was changing in the marketplace defined
the timing of the development of the strategy. Another aspect of the strategy was to
segment the market in a way that the strategy could be defined for each segment. The key
aspect of this step of the strategy was to define the segments in such a way that as the
technology evolved the segmentation of the market did not become obsolete thus making
the strategy and its framework obsolete for future decisions.
5.9.
Supplier Capability
Another factor in the execution of any outsourcing strategy is the ability of a supplier to
complete the work that is being considered for outsourcing. The typical supplier selection
process was very tactical and decisions were made for specific programs. The goal was to
be able to pick an OEM source that complemented Dell's engineering resources. Also, Dell
had previously selected an OEM source for a pilot program. This was a tactical decision
and based on the outcome and the development of the strategy a second source would be
added and a determination would be made if the first OEM supplier would be a strategic
partner. More important was to determine which criteria would be used to make this
decision and what the timing of the implementation would be for the second source.
5.10.
Engineering I Product Architecture Considerations
This section of the methodology examined how customer requirements were met through
hardware features. As this was investigated it was learned that many of the hardware
features were actually driven by software dependencies. An example of this was that a
specific chip was needed as a part of the motherboard in order for the software to function
properly. Because of this constraint, any motherboard was Dell unique. This is not
59
desirable since it limits this particular board to be sold only to Dell, thus limiting the potential
volume. Through the development of the strategy these hardware/software dependencies
needed to be better understood.
60
6.
6.1.
DECISION CRITERIA I ANALYSIS
Decision variables
The following factors were considered in the development of the strategy:
*
Industry trends
*
Business Model - Core Competencies
*
Constraints of each Sourcing Model
*
Customer needs
*
Economic value
*
Strategic value
6.2.
Industry Trends
The server industry is experiencing some growth in the in the high-end and low-end market
segments. This growth is in contrast to the high growth that was experienced in the late
1990's. During the time period between 1995 through 1999, the world -wide server market
grew at a compounded annual growth rate of 83%. For the time period between years
2000-2005 the compounded annual growth rate is projected to be 12%.
Breaking down the server market into price components, as defined by International Data
Corp. (IDC), shows that the price segments at the low end and the high end are still
projected to have some growth. The growth for all the segments is shown in Figure 9 - IDC
Server Tracker form September 19, 2001. Dell's product portfolio does not cover all of the
market segments, since they do not offer product that fits into the upper half of the IDC price
bands.
61
Band 1: $0-2.9k
Band 4: $10-24.9k
Band 7: $100-249.9k
Band 2: $3-5.9k
Band 5: $25-49.9k
Band 8: $250-499.9k
Band 3: $6-9.9k
Band 6: $50-99.9k
Band 9: $500-999.9k
36%
22%
14%
12%
-2%
1
2
34
5%
8%
2%
4
-7%
5
7
8
9
10
Total
DC
Server Tacher Septeuiber 19,2001 - NTi V*ndows & Lku 0'S
Figure 9. IDC Server Tracker September 19, 2001 - NT Windows & Linux o/s
Similarly, the Dell product portfolio was mapped to understand the major components that
contribute to margin and what volume portion of the portfolio they represent. In order to
protect the Dell data this will be discussed at a very high level. The ratios that are included
in Figure 9 show the ratio of Contributed Margin (CM) to Net Units. The four Dell market
segments that are illustrated are Ultra-Low End (UL), Low End (L), Mainstream (M) and High
End (H) Two observations should be made from this data; at the low end there is significant
volume but the margins are less. Continual pricing pressures at the low end are continuing
to pressure the margins in this segment. At the high end, even though the margins are
larger, the volumes in this segment are much smaller.
62
1.02
*
%Net Units
0
FY '02P CM %
0.56
3.19
0.22
UL
L
'lH
Figure 10. Dell Server Segments-% Net Units vs. FY'02 Projected Contribution Margins
As discussed in the background section, Dell has captured less than 5% of the market share
therefore; there is significant room for growth for Dell from a market share perspective.
From this data, strategic objectives for the year of 2001 included trying to broaden the
product portfolio at the high and low end market segments as well as trying to grow market
share in non-US markets. With these initiatives a constant vigilance would be kept on cost.
At the low-end OEM provides an opportunity to drive standardization, which would reduce
costs.
6.3.
Core competencies
With regard to core competencies the following were defined with respect to server
products:
63
*
System design - The definition of concept, architecture and performance for each
product.
*
System integration - Design and testing of product to ensure that it is compatible
with market available peripherals and software systems.
*
Fulfillment - is about the coordination and execution of the manufacturing and
supporting supply chains for the product. This includes the assembly of the product
and the software downloads with testing and verification of the system.
*
System Management / Service - each Dell product has a warranty and for corporate
customers may include a service contract for maintenance of the hardware.
*
Brand - a facet of this is that significant testing is done to ensure that the hardware is
tested with all widely available peripherals and software to ensure compatibility.
These competencies define the level of the product architecture that can be OEM'd. Subsystem components are the OEM candidate with these core competencies as constraints.
The areas where there is some flexibility with regard to this is the high end where the
technologies may not be understood in depth by Dell as the 'technology integrator' or the
very low end where cost constraints may preclude Dell from entering the market. In these
instances the system level may be considered for OEM, otherwise the core competencies
are rigid for the current business.
6.4.
Model Definition I Clarification
During the start of the internship, it became apparent that there were multiple ideas
concerning the definition of the models being considered for outsourcing and in particular
what the differences and subsequent advantages and disadvantages. Figure 11 shows a
table that highlights some of the key differences between the sourcing relationships. There
64
are two aspects of these definitions that should be highlighted are the customers right to
reship to other customers and who in the relationship is the financial owner of the required
tooling.
For the EM model, there is an exclusive relationship between the EM and the customer for
the product. This means that the customer is the only one that will purchase the product
therefore the tooling is paid for by the customer and they retain all rights to the design. This
limits the base that the financial burden can be spread over. In contrast, the OEM supplier
would theoretically ship to many customers and therefore there would be significant
economies of scale associated with the increased volumes. In the OEM model the design
and associated Intellectual Property (IP) would belong to the supplier. The shift in this
design aspect is difficult in an industry where many component features have yet to be
standardized.
In-house (EM)
ODM
OEM
(Dell design)
(Co-design)
(Supplier Design)
Customers
Product only ships to Dell
customers
Product can ship to non-Deli
customers
Product does ship to non-Deli
customers
Dell Customizations
No restrictions
Dell specific HW circuits and Dell
chassis features are required
Dell look and feel as long as
it meets Dell's spec.
Development
Dell owns the entire
implementation
Dell Is Involved throughout the
design process
Minimal Dell Involvement
IP Ownership
Dell owns the design IP
Supplier owns the design IP (w
Supplier owns design IP
Tooling
Deli pays for and owns all
the tooling
Supplier pays for and owns all
tooling (w/exception of Dell unique)
Supplier pays for and owns aH
tooling
Manufacturing
Dell chooses, qualifies and
manages the 2 nd tier
Supplier chooses and manages
the 2nd tier supplier, Deli qualifes
them
Supplier chooses and
manages the 2 tnd tier
supplier, Deli qualifies
/audits the selection
process
suppliers
Figure 11. Definitions for EM - ODM - OEM Business models
65
during design and UT
6.5.
Market segmentation
The 'evergreen' market segments for the strategy were characterized by three broad
categories of customer needs; Core Technology, Product Attributes and Brand Attributes.
The market segments were defined as Performance, Mainstream and Value.
" Performance - refers to the group of customers that are the early adopters of
'bleeding edge' technology, they value product features that are beyond off the shelf
products and they seek a trusted brand.
*
Mainstream- is the group of customers who want the current technology, they place
some value in product features that are beyond the 'off-the-shelf products, and they
want an established brand.
" Value - willing to use waning technology, off the shelf product features are
acceptable and they want a brand that is recognized as the value leader.
Each market segment's preferences are shown in Figure 12.
Core Technology
Product Attributes
Brand Attributes
Performance
N+l
+++
+
Mainstream
N
++
++
N-i
+
Value
Figure 12. Matrix of Market Segment vs. Product Characteristic
66
6.6.
Analysis of Expected Benefits- Economic Value Analysis
In order to understand the benefits and the eventual shortfalls of each model, each was
explored from a historical perspective to try to understand where the actual savings were
generated and also understand what misconceptions there might be concerning the models.
Through many interviews of people from Engineering, Procurement, Marketing,
Manufacturing and Quality organizations it was clear that many thought that the only thing
driving the OEM decision was cost. The following generalized assumptions were examined:
" Lower R&D costs
" Quicker time to market
" Equivalent Quality
" Lower Cost of Goods Sold (COGS)
In an effort to understand why these savings could not be generated with the current
sourcing model an investigation was conducted to try to quantify these savings by
benchmarking other projects. R&D costs are the one-time efforts that are completed to
introduce a new product. These costs were made up of engineer's time to design the
system architecture, create the necessary documentation and drawings, tooling, prototypes
and verification testing. Initially, it was thought that sourcing the engineering labor would
generate the largest opportunity for savings. Further investigation showed that the
engineering labor was not the financial lever for R&D costs. It was the prototypes and the
verification testing which represented the largest portion of the engineering costs. These
were not directly affected by the sourcing model since prototypes and testing would still be
required and not reduced in any way. Tooling costs also would not be reduced unless an
OEM model was used and the supplier had multiple customers for the product enabling
economies of scale for the tooling and other fixed production costs.
67
Figure 13 shows a graphical depiction of the changes in cost for the three models as it
applies to the low-end server segments. The left side of the graphic shows the in-house
design model, for which Dell designs the components and outsources the manufacturing to
an EM. The second in-house design model involves using an existing components from
another product instead of design a new one, this is sometimes done with a chassis and it
may be a chassis from a desktop or workstation, not necessarily a server. This leverages
existing tooling but there would still be prototypes and testing costs for the system.
In-house
(2
nDM
models)
"Leveraged Chassis Design"
........
E
Tooling
Savins:
n.r...ECAD
Engliieering
- ECAD EE
Tolin - cmon
AEM
j
Time: Program start to RTS for each model
Figure 13. Economic benefits of the EM-ODM-OEM models
The ODM model will save a small portion of the Engineering costs if the supplier completes
the engineering drawing work. A significant portion of the tooling is not charged to the
customer, except for unique tooling that is customer specific such as the bezel and other
brand identifiers. However, if the supplier is not currently able to reship the product to other
68
customers this will have a negative impact on the economics for the product. The supplier
may be tempted to 'buy' the business but this will not be a repeatable game for the
customer. It is common in this model for a customer to identify a 'white box' component that
they modify slightly to make it suitable for their application. For example, a motherboard
may be selected and then modified so that it can be used with the customer's bios and other
software. Once these modifications are made it may not be feasible to sell it to additional
customer without further modifications. Economies of scale are difficult to achieve in this
case. There is little benefit to this model from a financial perspective but from a strategic
perspective it may be a much greater benefit.
The OEM model is at the right side of the graph and it depicts additional incremental savings
and a savings due to timing of money spent. In this case the components are an off the
shelf item. They are designed without specific customer requirements in mind. Savings
would be gained by not having to be involved in the component-testing phase. This would
enable the customer to develop a system and choose the component that meets the design
criteria from those available on the market. Standardization of features of the components
will make this model possible as the products and components become commoditized. The
low-end market segments are most arguably about cost and the OEM model offers
opportunity to reduce cost. The high-end market segment has similarities to low-end with
regard to cost motivations.
6.7.
Strategic Benefits
Expansion of the product breath on the high end is another opportunity to utilize the OEM
model. The R&D costs to develop a high end product are significantly more than the lowend development programs based on the unit costs. The prototypes that are needed for
69
verification testing are the driver for this increase. Since the Dell business model is to run a
very lean R&D operation, OEM is an opportunity to bring knowledge into the corporation.
Developers of new technology are willing partners in the OEM model since the adoption of
their technology is needed for their success and the Dell fulfillment model is attractive to
these technology providers. Intel currently works with multiple OEMs to design servers that
incorporate their chipsets and processors. This may be a multi-generation project where the
OEM has more value added as they learn the technology and subsequent generations are
developed. The technology partner meets their goal of getting their technology incorporated
so they are not opposed to the OEM doing more value add as future generations of the
product are developed.
It could be argued that at the high end you are also OEM'ing for cost but Dell also gains
knowledge during the process and this actually seems to be the main driver for OEM. Even
if Dell decided to spend significantly more money on R&D, they could develop these
systems with less input from the technology partners but they would still need to work with
them unless they become completely vertically integrated.
The high and low-end benefit is shown in Figure 14. For the high-end Dell is 'pulling'
knowledge into the corporation whereas at the low-end Dell is to some extent pushing
knowledge out through the OEM process as they teach suppliers and try to influence how
they design products for the market. Standardization is likely for low-end server
components and if Dell can push the industry towards its desired feature set the results
could be very beneficial. The segments are positioned on the 'commoditization' curve, with
the high end products being much less commoditized than the low-end products. The Dell
model is applicable when products are transitioning from proprietary solutions to a
commoditized solution. It can be argued that once it is a commodity it is good for no one.
70
The difficulty is that it is not possible to stop on the curve, so once the process begins a
product will eventually become standardized.
A6
Hi
En.
6.
Expand
Product Breadth
3EM
or
Knowledgej
0. Min.
Investme nt
C
"
Dell
OEM
For
Cost / TTM
fsfh
0)
LC w
(U
r
gI a rn"
Anil"
nti'a
"inif J
Volume
Figure 14. Strategic benefits at the high and low-end segments
Since the high and low-end segments of the Dell product portfolios had unique differences
the strategy diverged to examine each individually.
6.7.1.
High End Market Segment
At the top of the curve in Figure 14 there are several industry players that offer proprietary
solutions. Characteristics of these companies are high development expenses, high
margins, unpredictable demand, low return on investment and relatively low volumes when
compared to the low end. Companies that have been successful in this market space have
the following core competencies; technology innovation, and the ability to differentiate
themselves from others through technology solutions. Typical development cycle in this
space is approximately 12-18 months. Dell is unable and unwilling to compete in this space
71
since their business model is built around the designing a system with standard components
and where standard components don't exist, try to be the catalyst towards standardization.
In Figure 14, Dell positions itself in the 'commoditizing' space of the curve. The
characteristic of this area is that it is the transition of proprietary to stand hardware solutions.
The focus of hardware differentiation shifts to differentiation through serviceability and
manageability and the execution of the fulfillment model. Success factors in this space
include transition management capability, and a flexible and scalable fulfillment model.
For Dell to 'pull' technology into the commoditizing space, it first must decide what it wishes
to develop into products by trying to figure out where the market is going. Dell's strategy
gives it an advantage in this area, unlike competitors developing proprietary technology.
Figure 15 depicts the advantage that Dell has in terms of risk by adopting technology that is
developed by others. Absent from this graphic are the potential rewards that may be gained
by each company. It could be argued that if a company develops a technology and
incorporates it in a product that is widely accepted it will reap considerable rewards in
comparison to the margins made by Dell.
72
A
Technology Innovators
have higher development
$ during all phases.
0
W
Risk
e10000
Technology Integral )r
Dell watches and ev fluates
technology in conce pt and
development phase!
Concept
Phase
.
Development
Phase
Productization
Phase
RTS
Figure 15. Potential Benefits High end market segment
6.7.2. Low End Market Segment
In contrast to the high end, the low end is characterized by the following features it is highly
cost driven, has relatively low margins, and high volume. The hardware is highly
standardized and the differentiation is through features included in the 'beyond the box
features'. 'Beyond the Box' features are those soft features that are not hardware driven.
The success factors in this space are to have a low cost development model, low cost value
chain and dominant market share.
The focus shifts in this segment to pushing knowledge into suppliers and to drive the
standardization of components so that economies of scale can be achieved. Investigation
into a historical program, pilot OEM project, showed that unexpected barriers forced the
project to become an ODM project. This lead to misconceptions concerning the model since
it was still named an OEM project. The project could not be an OEM project because of
dependencies created by the software. The dependencies were mapped at a high level, to
73
assess the magnitude of the issue. As a result it became clear that in order to truly OEM a
component or system it would be necessary to change the software so that it did not impose
hardware requirements which were restrictive to the OEM Sourcing option.
The ODM model was viewed as a 'stepping stone' to the eventual OEM sourcing model.
Even though Dell barriers prevented the leap to OEM immediately, this may have been for
the best since it allowed Dell to develop a close working relationship with a supplier which
would in all likelihood evolve to be a OEM supplier. Another question that was answered
was how many suppliers should be allowed in this space and who they should be. The
approach that was taken was to complete the strategy and then based on what was going to
be outsourced determine what skills would be needed as well as which skills the original
OEM supplier did not have so the second supplier could be a complementary asset from a
skills standpoint. Based on the recommendation to use OEM as the model at the low-end,
two major activities needed to take place; enable the OEM model such that the software did
not constrain the hardware that could be used and establish and carry out the process to
select a second supplier.
6.8.
Summary
The OEM strategy in summary was:
*
OEM is the right business model for certain product segments at the high and lowend of the product portfolio. The model saves product and development costs. At
the high end, margins are higher and OEM allows Dell to pull in knowledge. There
are reduced risks and R&D savings associated with the OEM model. At the low end,
OEM allows Dell to expand the product portfolio and provide a vehicle for
standardization.
74
"
For the high-end segment, products with revolutionary technology, OEM is a market
entry mechanism.
"
For the low-end segments, products with standardizing hardware, OEM is the most
cost-effective model, but until it is enabled ODM is an acceptable solution.
*
The strategy will allow functional and tactical alignment and importantly provides the
justification to complete the necessary changes to the server management software.
Figure 16 shows the mirror process for the two segments below as a summary for the
strategy.
Generation 3
High-End
GeneLtion 2
Generation I
OEM
M
In-house
Low-end
Future platforms
Pilot OEM Project
Figure 16. High-level summary of the Server OEM strategy
75
7. CONCLUSION
7.1.
Introduction
This chapter will discuss the organizational implications and the implementation plan for this
strategy. The implementation includes a discussion of the second source selection and also
the effect of the strategy on internal business processes. A summary of the key learnings is
discussed to conclude the thesis.
7.2.
Implementation Status
Strategy is about creating advantage and in this case the actual strategy is important but
also the process of how the strategy was created was important to the implementation. The
length of time that was spent creating the strategy was lengthened due to the process of
involving many parties during the creation of the strategy. Engineering and Procurement
had many potential areas of disagreement that could have stalled the strategy process.
However, both were motivated to seek consensus so that the strategy would be completed
and many of the issues agreed to instead of having the issues unresolved. It would have
been unlikely that the strategy could have been approved and implemented if one of the
organizations had decided to develop the strategy on their own. Undoubtedly, this would
have required less time and the strategy may have been equivalent but with this dual
development there was 'buy-in' as a part of the strategy development process. As a part of
this many organization's input was sought through interviews about OEM and ODM sourcing
models as well as critiquing various components of the strategy itself as it was developed.
76
7.2.1. Strategy Endorsement
In the Dell environment, as well as any typical corporate culture, executive approval is an
important signal to the organization. This strategy was presented to the leadership for the
servers and storage product group. The product engineering and procurement
organizations were also present. The strategy that was presented included the next steps
that would be pursued if it was accepted. The strategy including the plan of action was
endorsed by all of the leadership from the respective organizations. The next steps included
were:
*
Communicate the strategy to all concerned individuals in the organization. Make all
future decisions so that they are congruent with the strategy.
*
Assemble a team to define in greater detail what the barriers are to OEM from a
software perspective. Make the necessary plan to break these barriers.
*
Define the hardware features that should be standardized without compromising the
ability to differentiate the product.
*
Define the business processes that will support the business model since they will
need to be different form the current sourcing models in order to reap all benefits.
*
Define the process for source selection and choose a second source for OEM
projects.
*
Create a timeline that shows when OEM will be enabled and identify the first 'true'
OEM project in alignment with the product roadmaps for the low-end segment.
7.3.
Second Source Selection
Second source selection was completed shortly after the strategy was approved. Not being
constrained to a single source provides leverage in supply base and reduces the risk of
'hold-up'. Another advantage of identifying the second OEM source was that work could be
77
done to develop the relationship and tap their knowledge and resources with the other items
that needed to be completed as a result of the strategy.
The source selection process timing was driven by a development project that was identified
as an OEM candidate project. The organization was faced with deciding to award another
program non-competitively to the existing OEM source or choosing the second source
based on one products business case. To combat this it was decided to pick the second
source in parallel with the product decision. The process was to incorporate an extensive
supplier survey with the Request for Quotation (RFQ) for the product and then to follow-up
on the RFQ and the survey with a joint engineering-procurement visit to the potential
suppliers. The survey was not product specific but rather sought to evaluate the strengths
and weaknesses of each supplier. To be an OEM supplier more product design and testing
tools and skills are desired as well as strong business processes to facilitate supply chain
management. These aspects were the focus on the OEM second source selection.
Interestingly, the existing OEM supplier was awarded the product, but a second source was
named for future projects. Completing both concurrently did create leverage with the
existing OEM supplier.
7.4.
Competitive Landscape
The competitive landscape was considered in each decision in the strategy, including the
second source decision. Several issues exist with being the second OEM customer at the
supplier including protection of intellectual property and having the appropriate leverage to
get enough resources to complete projects in a timely manner. For these reasons this was
also factored into the source selection process.
78
7.5.
Organizational Aspects
The adoption of the OEM strategy by the server business may have organizational
implications in the future. Currently, core teams are launched when a new product is in the
concept phase and they coordinate all activities to get the product to the Ready To Ship
(RTS) date. This team controls and prioritizes engineering resources so that they can
complete the design of the system of the system and coordinate the testing of the
prototypes to verify the design. With the current projects that fit into the ODM model, there
are significant engineering resources involved because they are overseeing all of the
suppliers engineering activities. In the future, when the shift to OEM happens, the
composition of these teams may shift to a program management focus. This would be
difficult for any engineering culture since engineers typically pride themselves on being
designers.
7.5.1.
Business Process Changes
In conjunction with the organizational aspects associated with the OEM model business
processes should also be expected to change. In fact, if the existing processes are used
some of the anticipated benefits of the OEM model will likely be unrealized. An example of
this might be supply chain management where currently Dell negotiates all of the pricing for
components even if they are delivered to a supplier to be assembled into a component. In
the OEM model the suppliers would theoretically have more market power than the OEM
customer since the standard components would have multiple large customers. This is just
one example of how the business processes internal to Dell may be affected in the OEM
environment.
79
7.6.
Summary
The strategy would mean little if it was not implemented. The process of developing this
strategy and the approval process were directly correlated with the ability to implement the
strategy. However, the strategy is still in the beginning phases and significant work still
needs to be completed to ensure full implementation, including a true OEM model with
business processes and an organizational structure to support the OEM model.
In summary, there were many key learnings identified as a result of this internship project at
Dell Computer Corporation. The first is that having the right strategy is dependent on many
factors; the right strategy for one firm in a marketplace may not work for another firm in that
same marketplace. Second, and more importantly, the process of developing the strategy
may be the most important factor to consider when it comes to the consideration of
implementing the strategy. Third, commoditization is an industry dynamic that cannot be
stopped once the process has started, unless someone can develop a technology to replace
the one that is being commoditized. In the case of the computer industry, this is unlikely for
the mass market. Rather than trying to change this phenomenon, Dell is trying to take
advantage of something that it knows will eventually happen. With this dynamic as a given
assumption, Dell is shaping its future success by finding an alternative way to differentiate
them in the server market.
As important as the approval process and the implementation of the strategy, the
organizational issues are also important to consider. The strategy will only maximize its
effectiveness if the supporting business processes and organization are adapted or created
to support the OEM model. The strategy will provide a vehicle to make decisions outside of
the project-by-project business case, which should support the appropriate resources to
80
work the issues of overcoming the software barriers and developing the new business
processes.
81
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