In 1994, Dell Computer was a struggling second-tier PC maker. Like other PC makers, Dell ordered its components in advance and carried a large amount of component inventory. If its forecasts were wrong, Dell had major write-downs.
Then Dell began to implement a new business model. Its operations had always featured a build-to-order process with direct sales to customers, but Dell took a series of ingenious steps to eliminate its inventories. The results were spectacular.
Over a four-year period, Dell's revenues grew from $2 billion to $16 billion, at a 50 percent annual growth rate. Earnings per share increased by 62 percent per year. Dell's stock price increased by more than 17,000 percent in just more than eight years. In 1998, Dell's return on invested capital was 217 percent, and the company had $1.8 billion in cash.
Profitability management--coordinating a company's day-to-day activities through careful forethought and great management--was at the core of Dell's transformation in this critical period.
Dell created a tightly aligned business model that enabled it to manage away the need for its component inventories. Not only was capital not needed, but the change generated enormous amounts of cash that Dell used to fuel its growth. How did Dell do it?
At the heart of Dell's profitability management was a seemingly impossible dilemma: The company had adopted a build-to-order system, yet it had to commit to purchase key components 60 days in advance. How did Dell manage this? The answer lay in Dell's tightly aligned business model, which had several key elements.
Dell purposely selected customers with relatively predictable purchasing patterns and low service costs. The company developed a core competence in targeting customers and kept a massive database for this purpose.
A large portion of Dell's business stemmed from long-term corporate relationship accounts--customers having...