Dell announced on September 21, 2009 that it will acquire Perot System for $3.9 billion. Dell was the poster child of business model innovation. It had “invented” the direct sales model for PCs. Instead of going via resellers Dell sold its computers directly via telephone or the Internet to its customers. Now, Dell is extending its traditional business into services. Will this work?
I feel very ambivalent about the announced deal. First, Dell pays a premium of a 61% for Perot Systems. That is a huge premium and from my time as an investment banker at Lazard I know it is very difficult to recoup and justify such a premium. But even more problematic is that with the purchase Dell does not solve its problem with its current business model.
The deal makes sense from a corporate strategy perspective. Dell is suffering in its core business a steep fall in prices. For many years Dell was the price leader but now HP tries to undercuts Dell [update: link no longer available]. The first time in the history of PCs, the new Microsoft operating system Windows 7 will need fewer resources than the previous version, Windows Vista. That is bad news for computer makers that usually expect a big boost in sales from a new operating system.
Dell’s former business model innovation
In the past Dell’s value proposition was to sell individually configured PCs and servers at a low price.
Dell’s PCs were the workhorses but never art like Macs. Low-price and custom-made were possible due to Dell’s special value architecture, a classical architectural business model innovation. Dell had besides its direct sales model a manufacturing process that allowed a made-to-order production. Together with its suppliers Dell had optimized its supply chain so a just-in-time production was possible. Therefore it had a small inventory of parts and an almost non-existing inventory for finished products.
So very little capital was tied to inventory and even more important in fast industries like the computer industry where new products come to market every month, it had low write-offs on its (very low) inventory. Another plus of this business model is that Dell has had a negative working capital. Normally, you have to pay your suppliers before you get the cash from your customers. With this very special business model Dell became for a time the largest seller of PCs and servers. Now, it is No. 2 behind Hewlett-Packard.
Pressure on Dell’s business model
Dell’s business model came under pressure from different sides. On the consumer market, Apple made a great come-back with its well designed and easy-to-use computers. On this blog, Mac users have a share of 14.10%. At the same time a new product category enter the market. the net book. Net books are mini notebooks or subnotebooks that are well suited for the mobile worker that looks for a digital companion.
The net book is good for email, writing short text and surfing the Internet. Net books are even cheaper than a regular Dell, so Dell’s value proposition in its traditional business became weak and not appealing anymore to customers. Net books are a typical disruptive innovation since the traditional products overshoot the demand of normal customers. Net books are just sufficient for most tasks a normal user is performing on its computer. In the enterprise market the computer became more and more a commodity where the service component is more important than just the price.
Faced with this situation Dell used parts of its $ 12 billion cash to buy into a potentially higher margin business of Perot. Perot System is an IT service provider with a strong foothold in outsourcing in the health care industry. So from a corporate perspective the deal makes sense even when it is expensive.
Perot does not solve the problem of Dell’s business model
But from a business perspective? Will Dell now solve its problems in the computer hardware business, its core business? Will there be potential synergies to pay for the deal? Why is Dell a better owner of Perot Systems than the previous owners? Will Dell’s customers be better served by the New Dell? Will Perot’s customers be better served with Dell computers?
Well, from a business level perspective the deal is not as easy to explain. Actually, the deal looks like a signal that Dell has no ideas how to solve its issues with its classical business. Dell was once a business innovator but now the others have learned their lesson and are as or more efficient as Dell. Dell is now in the midst of a red ocean and in a red queen race. Dell cuts costs in its core business but it will not escape the fierce competition in the hardware industry unless it finds new way how to differentiate itself from its other competitors.
Dell is just in the midst of a red ocean
Actually, the purchase makes Dell even more similar to the other big computer companies. Dell is just a follower. It follows Hewlett-Packard that purchased EDS last year for $13.2 billion. It follows IBM that moved totally into services and sold its PC business to Lenovo in 2005.
Dell is not a strategic leader but a follower with an overpriced and small acquisition. And now Dell’s management is busy integrating two very different cultures, too busy doing their home work in their core business.
That is definitely not a great strategy and does not solve the problems of Dell.
And the solution
But what can Dell do? In the consumer and SME business it could move into automatic services like online backup, online recovery, and other services that are today still a hassle. And by moving in this direction Dell could also benefit from recurring revenues. In their server business why not offer combinations of cloud computing and servers, so that Dell’s customers never run out of disk space or computing power but still can control which data is in the cloud and which is local? Automatic services and cloud computing are another disruptive technology to hardware producers. These trends usually start in the consumer and SME market and move later into the corporate market.
One can derive several lessons learned from the Dell-Perot case.
- Business model innovation is not a position you can rest on. Your competitors will try to copy you or circumvent your competitive advantage with new business model innovations. The competitive advantage is always limited in time.
- Once the business model innovator is the No. 1 in a saturated market the growth potential is just like the market growth. So there can be no hyper-growth business for ever.
- Corporate strategic moves like acquisitions of a new business do not help to rejuvenate your dated business model. Even when you argue from a shareholder perspective it is easier for the shareholder to diversify his portfolio than for a corporation.
- The solution of a dated business model innovation is not to follow your competitors since that will be a cruel red ocean. You just create more competition when everybody is following the same strategy.
- Instead of diversifying look at the core competencies you have and look if you can apply them to new products and services that your current customers value.
I am interesting in your view of the acquisition. Please share your opinion on this deal with us. Since Dell is such well discussed case in our community it is worthwhile to discuss the change in business model. Thanks in advance!
(Question mark in the picture is by Stewf under cc license)