The Innovation Upstarts
How a group of technology newcomers are moving innovation out of the R&D lab and into the marketing department
Just when all the experts declared the personal-computer industry closed to newcomers, along comes a new generation of brash entrepreneurs to prove them wrong. A few years ago IBM and a handful of other billion-dollar giants seemed to own the industry and dictate all the rules -- but no longer. The fact that the newcomers have so quickly grabbed a piece of the action is surprising enough, but it's how they did it that's the real story. -- J. K.
In a sprawling room in an Austin office tower, nearly 100 salespeople pick up calls from interested buyers around the country. The sales staff is young, mostly under 30. The fluorescent-lit area has the electric atmosphere of a brokerage house on a big day. Everyone is glued to a phone or computer, begging, cajoling, persuading customers amidst a clutter of Coke cans and order forms.
Welcome to innovation in the personal-computer industry, 1989 style. True, it is not the kind of innovation we are used to seeing -- new computer models, faster chips, more complex software. But innovation it is, benefiting enough customers to enable Dell Computer Corp. to grow into a $159-million business in less than four years, with projected 1989 sales of more than $400 million.
Technology was always the ticket in the PC industry. Company founders and financiers always relied on fancier bells and whistles to win market share. But as the market matured and as the technology coalesced around the IBM standard, industry pundits declared that the game was closed to newcomers.
"The winner is . . . IBM," Business Week proclaimed on a 1983 cover, adding ominously on the inside, "The battle for supremacy is over, and few will survive." Sonny Monosson, a Boston-based publisher of computer newsletters and founder of American Technology Appraisal Services, predicted that Asians would soon own this business. "The domination of this industry can't be American in the future." And industry guru Esther Dyson advised entrepreneurs at small computer companies "to go into the restaurant business."
That they didn't take her advice was a good thing. Newcomers continued to flourish, but not necessarily because they had a faster chip or a more powerful box. What these newcomers discovered is that innovation in the way they managed their companies was as powerful a tool as innovation in product design and technology. They found a way to compete successfully by devising sales and marketing strategies that provided added value to their customers.
As a student at the University of Texas in 1984, Michael Dell saw a personal-computer industry that was still full of promise. The 19-year-old premed student started a business selling microcomputer components to local computer enthusiasts. The next year Dell started assembling his own line of PCs. By the end of fiscal 1986 annual sales reached $33 million. "Everything was wrong -- we didn't have the money, the people, the resources," Dell says. "But I had a gut feeling that drove me to start this company."
Direct marketing by phone is at the heart of Dell's success. When he entered the computer market, it was too late to challenge the technological standard that IBM had es-tablished with its PC. So Dell searched for a different niche, one that could be defined by a unique marketing and distribution strategy.
One potential approach -- developing a strong dealers-only network for a PC clone -- had already been worked to perfection by Compaq Computer Corp., while Tandy Corp. enjoyed the benefit of its network of 6,500 Radio Shack stores. IBM, of course, exercised its traditional sway through both dealers and its own vaunted sales staff.
So Dell decided on telemarketing, selling PC compatibles. By sidestepping the dealers and their big markups, Dell has been able to undersell such competitors as IBM and Compaq by as much as 40% while staying in roughly the same price league with the low-balling Korean and Taiwanese clone manufacturers.
But low price is only one piece of Dell's marketing strategy. By selling directly to customers, ranging from individuals to major corporations, Dell gains an instantaneous reading of the latest trends. "Direct sales," one sales manager notes, "gives you fantastic market intelligence."
That intelligence, gleaned from more than 1,000 phone calls a day, coaxed Dell into a new product line. Despite all the hoopla about IBM's new PS/2 line, many customers still wanted upgraded versions of computers based on Intel Corp.'s popular 286 and 386 microprocessors. Rather than meekly following Big Blue's lead, the company developed a series of highly successful PCs based on the older technology.
Equally important in terms of customer satisfaction is the support given by the company's service organization. A team of about 75 technicians deals daily with as many as 1,500 questions from customers. Dell estimates that 90% of the problems encountered by users are solved over the phone. Such responsiveness is particularly appealing to business customers -- now accounting for up to 85% of sales -- who must overcome glitches fast. For repair problems, Dell also offers, for $35 a year, a service contract with Honeywell-Bull, which fixes the machines on site.
The phone calls also enable Dell to identify defective parts quickly. "If we get more than a few complaints," notes Ronald Leonard, a marketing manager, "I go about 130 feet to the people who design the thing. Within five or six hours, engineering has fixed the design, and within two or three days, the factory's got that change incorporated on the line."
Dell's ability to respond quickly gives it a major competitive advantage, particularly over personal-computer makers in Asia. Cut off from their market by thousands of miles and huge cultural gaps, the Japanese have been overwhelmed by the rapid rate of change in the PC industry. Accustomed to large production runs of standardized products with two- to three-year life cycles and the use of mass-distribution channels like retail stores, they have shown only limited ability to adjust to a market that absorbs new models sometimes every six months.
"To them, manufacturing is the lifeblood of the industry. Everything is manufacturing driven," noted Bill Watson, until last September a top Dell marketing executive. "But that's not the way in computers. The ideal -- direct marketing -- is a totally customer-driven system."
The experience of the Japanese in the PC market shows the importance of the customer-driven approach. In the early 1980s, for instance, Japanese manufacturers were slow to adopt the MS-DOS operating standard used by IBM. This compatability problem grew out of the Japanese experience at home, where each company has produced PCs with its own standards, notes Yasuhiro Tsubota, president of Epson America Inc., makers of the largest-selling brand of Japanese-made PCs.
That mistake virtually doomed the first generation of Japanese machines. Even when they finally adopted MS-DOS, the Japanese ignored customer needs, as when they designed computers that couldn't run popular software, such as Lotus 1-2-3, or generate high-quality graphics. Although most of these problems have been fixed, the Japanese -- now burdened by the high yen -- are still struggling to establish themselves in the desktop marketplace.
Small companies such as Dell wield yet another strategic weapon against larger domestic and Asian competitors: their ability to move quickly. In the manufacturing of consumer electronic products, such as televisions and videocassette recorders, standardization and mass production work to the advantage of large companies. But the PC industry's quick-changing marketplace provides a unique opportunity for small companies -- as long as they organize themselves to be fast and flexible.
Asian mass-production lines can provide PC clones at low cost, but they can't do what Dell does: build computers to order and build them fast. Dell's telemarketers take the customers' specs right off the phone. A number is assigned to each customer's request, specifying the kind of machine, the disk drive, memory size, and other components required. Each computer is then assembled and tested individually. Delivery is made within one to three weeks by United Parcel Service, whose trucks pull out of Dell's Austin factory three or four times a day. For an additional fee, the computer will be shipped even faster via Federal Express. For the customer, there's no waiting for a cargo ship to arrive from Asia or for a retail store to receive its back order on memory boards.
Manufacturing to order has cost advantages, too. It keeps down inventory costs by enabling the company to build only what is required. "Each order is automatically entered as a computerized list of all the specs for manufacturing," explains Herschel Hochman, Dell's former vice-president of manufacturing and now vice-president for strategic planning. "At the same time, sales has access to the customers' complete sales histories. We can determine what equipment they already have and their complete repair history. This gives us the opportunity to ensure that customers are ordering equipment appropriate for their needs. You have a sort of inventory control that you never have reacting on the retail level. You can save yourself a bundle on building machines and buying parts nobody wants or needs."
Today Dell's manufacturing operation consists largely of assembly and testing. Given the current realities in the microelectronics industry, components -- including some power supplies and monitors -- are still imported from Asia, which remains an economically viable source of supply for many key items. In order to do this, Dell, like virtually every other U.S. microcomputer company, maintains a strong offshore procurement presence in the Far East. But in the future, Hochman expects Dell to bring more of its component purchasing back home. For instance, the company is now designing its own integrated circuits, which will be manufactured by various U.S. companies.
With the rapid rate of change in the computer industry, such domestic control over production may become even more necessary in the years ahead. Not only does domestic manufacturing, particularly assembly and testing, provide better quality control, it also allows greater customization of products and shorter cycles from product conception and development to delivery.
Another company, Everex Systems Inc., in Fremont, Calif., has built its entire strategy around fast response. Since its founding in 1983, Everex, which manufactures PCs and peripheral equipment, has grown to $266 million in sales. Everex builds and assembles most of its products in Silicon Valley, utilizing a network of local subcontractors and Asian suppliers who do assembly work.
Steve Hui, the Chinese-born founder, organized the company so that it would use Japanese "Just in Time" production methods, but would go beyond them. Hui calls his system "zero response time" -- most orders are translated into a product that is manufactured and shipped within 24 hours.
Everex starts its assembly line every day assuming a certain level of orders for each product, based on recent trends. Like Dell, the company relies on telemarketing. Its 200 salespeople work the phones. Every two hours, their order slips are collected and analyzed. If the orders deviate from what was expected, production managers change the assembly line to make, say, more modems and fewer graphics boards. Mounted on wheels, portions of the assembly line roll away, to be replaced by other manufacturing equipment.
This zero-response-time system, Hui claims, responds to changing conditions that increasingly favor smaller U.S. companies over their giant rivals both here and in Asia. For instance, rapid changes in the life cycles of products and even more rapidly shifting customer demands are undermining the standardized, mass-manufacturing power of the Asian giants. "The Japanese are getting like the Americans were in the '50s," Hui says. "They are getting arrogant. They think with their huge production plants they can win the market. But they are stuck, too slow to market. That's why they are failing in the PC marketplace."
The smaller companies also have cost structures that allow them to make money selling lots of 10s or 20s, says Bruce Dunlevie, vice-president for Everex's computer division. Because of a thinner management structure and generally lower overhead, he argues, smaller companies such as Everex require gross margins of roughly 25%, significantly less than the rate required by an enormous bureaucracy.
"A company like IBM has general sales, marketing, and administrative systems that they have to maintain and that can get in the way," Dunlevie says. "The Japanese and Koreans have shown an even greater lack of versatility. Their manufacturing strategy -- not customer needs -- drives their marketing strategy. Their need for mass manufacturing requires a high degree of product stability. They seek a homogenous market that doesn't change.
"But in this business, it's all pandemonium, constant change, and specialized needs," he continues. "That creates a lot of opportunities for companies like ours."
The telemarketing strategy Dell and Everex use reflects the increasing complexity in the distribution of computers. Whereas earlier entrepreneurs made their mark by building flashier boxes, the new ventures find new ways to sell and distribute established products.
Central to this process has been the fracturing of marketing channels. In 1984 Fortune ran a story called "More Power to the PC Chains." The central points were that the future of computer sales would lie in the hands of a relatively limited number of major chains and that size was critical in establishing a strong distribution channel. Yet instead of the window closing to new outlets, the market opened dramatically to those newcomers who saw the undercurrents of change.
One of the most prominent of these newcomers was AST Research Inc., in Irvine, Calif. Founded by three immigrant engineers, two from Hong Kong and one from Pakistan, AST started as a manufacturer of add-on boards for PCs and did not enter the PC market until October 1986.
By making add-on boards, AST gained valuable manufacturing expertise and exposure to the marketplace. And what was happening in the marketplace was fantastic growth among so-called value-added dealers and resellers, or VADs and VARs. Mostly small companies employing fewer than 20 people, VADs and VARs buy computers from distributors and then customize them for the particular needs of users. Tom Yuen, cofounder and chief operating officer of AST, estimates that the number of VADs and VARS has doubled over the past five years to nearly 20,000. These resellers now account for as much as half of all PC sales, up from around 10% just five years ago.
Driving this shift has been the increasing integration of microcomputers into more and more workplaces. Many VADs and VARs specialize in servicing such markets as doctors, lawyers, and funeral directors.
These new users are not likely to buy computers in the traditional ways -- through mass marketers or by their own data-processing managers -- since they possess highly specialized needs and often have no experienced computer-oriented personnel. On the other hand, VADs and VARs, who often bundle service and specialized software with their hardware, are perfectly suited for meeting these kinds of needs.
"Too many companies have concentrated simply on the mass market, on competing on price," says Roberta Graves, president of Qualitative Marketing, a leading microcomputer marketing company, in San Jose, Calif. "They have not realized that for many of the new users, the key is not price, but service, support, and solutions."
These dynamics have created opportunities for smaller manufacturers. In contrast to large retail chains, which usually favor either name brands or cheap clones, VARs and VADs place more emphasis on the price performance of products -- and the willingness of the manufacturer to customize hardware -- than on price or name brand. In the world of VADs and VARs, the premium is on flexibility, not mass production, mass marketing, or mass strategy.
"There's been a decentralization of the channels because people have become more sophisticated about computers," Yuen says. "People are more interested in having choices. The users have become so diverse that you have a real segmentation."
This decentralization, so evident in the rise of VADS and VARs, plays to the strength of small, highly focused microcomputer companies. "AST keeps its finger on the VAR pulse better than anyone I've ever seen," observes Mary Margaret Gibson, president of Corporate Information Group Inc. "What they are doing are things that are not well suited for large, monolithic organizations. It is difficult for them to be flexible to meet very individual needs. A Hitachi or an AT&T doesn't want to be flexible. They want to be a steamroller going down the road."
New companies such as Dell, Everex, and AST were never supposed to have succeeded. As personal computers grew into a multibillion-dollar industry, the smaller microcomputer companies -- like the carmakers in the early part of this century -- were supposed to fall under the heel of competitors that were larger, better-organized, and better-capitalized.
The entrance of IBM into the PC market seemed to confirm this logic. Within the first two years in the business, IBM established a dominant market share both at home and abroad. Big Blue's standard soon became the indus-try's, and smaller companies that refused to adopt that standard quickly, such as Osborne Computer Corp., failed.
But by refocusing their innovation on management issues, the newcomers have demonstrated that entrepreneurs can still flourish in industries dominated by major corporations. "Everyone has been saying there is no room for the small companies in this business, but that's not true at all," Gibson says. "These companies are succeeding because they are small and focused, because their culture is not IBM or AT&T or the Japanese. Those companies aren't always sure who they are and want to be. But guys like Michael Dell know their focus. They take their ground and stand on it."