Quantification of Dells Competitive Advantage

Dell has managed to do well in a tough industry because it has positioned itself in such a way that it enjoys sustainable competitive advantage over its competitors. Just how big is this competitive advantage? This is a question we will try to answer here. It is just one possible way of arriving at an estimate of the competitive advantage. Many other equally valid ways of quantifying competitive advantage exist. As long as a method is backed by sound logic, it is acceptable. To quantify Dells competitive advantage, following issues need to be considered: -Competitive advantage can be quantitatively measures by the difference between relative costs & relative willingness-to-pay. (It is relativebecause competitive advantage is measured relative to the competitors.) -Both Dell & its competitors have product mixes that vary substantially. Hence, comparison based on income statements & balance sheets (which give aggregate data of substantially different product mixes) will be misleading for calculating competitive advantage. For more reliable estimate, we may confine our attention to a single typical/ representative product of Dell and try to build its competitive advantage from all the information given in the case (& not just income statements & balance sheets). -Since Dells major revenue comes from corporate clients, its typical product may be taken as the advanced Dell PC manufactured for its corporate clients. (Exhibit 10 b) -Since Dell has adopted Direct Model, it deals directly with the end consumer. The nearest competitor of Dells typical product is Compaq along with its chain of resellers. Hence the appropriate competitors are: Dell on one side and Compaq + its resellers on the other side. So, we will estimate Dells competitive advantage by computing competitive advantage for Dell in its typical product relative to Compaq & its resellers.

COST ADVANTAGE Price of typical Dell PC = $ 2313 (average of quarterly figures for 1996 given in Exhibit 10 b) Dells gross margin = 21.5% (from Exhibit 6) Rate of decline of prices of inputs = 0.6% (which is roughly equal to 25-30% p.a. given on page 5) Dell days of inventory = = = 15 days (from Exhibit 6)

Competitor days of inventory = 65 (from page 11) Channel markup = 7% (from page 5)

Assume, annual cost of capital for dell = 20% Dells COGS (cost of goods sold) for one typical Dell PC = 2313 (1-21.5%) = $ 1816 Competitors COGS = = $ 1896

Many students had difficulty in understanding the derivation of COGS for Compaq. Following explanation may help: Suppose the prices of PC components are falling at the rate of r % per week and Dell purchases the components n weeks after Compaqs purchase of the same components. If Dell purchased components for $1 today, price of the components one week ago = & price of the components n weeks ago Since Compaq purchased the components n weeks ago, COGSCompaq= For the case, r = 0.6% per week = 0.006 n =[ (65-15)/7] weeks Now, Dells cost advantage is due to 4 sources: 1. Inputs purchased later (saving due to fall in prices of inputs) = 1896- 1816 = $ 80 2. Lower inventory carrying costs (saving due to fewer days of carrying inventory) = * 20% = $ 50 3. No channel-related costs (saving due to direct selling: Dell need not spend on advertising to resellers which costs its competitor 2.5% of revenue: mentioned on page 5) = 2313*2.5% = $ 58 4. No channel markup (saving due to direct selling: Compaqs resellers markup by 7%: mentioned on page 5) = 1816*7% = $127 Hence, total cost advantage = $80 + $50 + $58 + $127 = $315 = 13.6% (of price $ 2313)

WILLINGNESS TO PAY Based on the facts given in the case, the willingness to pay for Dell or Compaq appears to be comparable. (This is essentially qualitative assessment.)

Hence, Dells competitive advantage = Dells cost advantage = $ 315 for a PC priced at $ 2313 = 13.6%