DellHP Value Chain Presentation

Erik HebertCristian MarcuMarshal Miller

Anna TsaiKai Xia

Joseph Zakzeski

26 September 2007

Dell and HP’s Value Chain

MBA290G 2007

Table of Contents

Executive Summary

Brief History of the PC Industry

Value Chain Introduction

Porter’s 5 Forces Analysis

Value Chain In Detail

Comparable Companies Analysis

Executive Summary• PC industry value chain very different from Mobile Handset industry…why?

• Wintel standard: basic PC largely commoditized with little opportunities for differentiation

• Mature: growth has slowed as new markets have been penetrated and existing markets saturated

• Oligopoly: need for economies of scale and scope drove massive consolidation leaving only the strongest handful of competitors remaining

• Margin compression: maintain/gain market share largely through price competition

• Results on the PC industry value chain?

• Completely fragmented: links separated to take advantage of absolute cost advantages and core competencies, both country and firm-specific

• Economies of scale the rule: with thin industry profit margins, scale is a requirement just to compete

• Wintel stranglehold: Microsoft and Intel able to leverage control over core IP and standards development enabling them to extract enormous economic rents

Personal Computer Industry HistoryComputers Military Research during WWII

1945 1975

Large mainframe computersIBMDEC

1981

Integrated, preassembled PC’sApple Computers MITS

Hobbyists and Educational InstitutionsIncreased popularity

IBM launches first PC

Rivkin., J. W., Porter, M. E., Matching Dell. Harvard Business School, 1999

Where a calculator on the ENIAC is equipped with 18,000 vacuum tubes and weighs 30 tons, computers in the future may have only 1,000 vacuum tubes and weigh only 1 1/2 tons. ---Popular Mechanics, March 1949

Historical Growth of the Value Chain

1981

IBM mainframe and standard

Microsoft software

Intel microprocessor

Components commissioned

Large corporations-Bulk Discounts

Sales Force

Sears and ComputerlandValue-added Resellers

Individuals & small business


IBM opening up its standard is an industry turning point enabled the PC to proliferate very rapidly to a 95% market share in 10 years

The IBM Clone Wars

1982

Low-priced clones enter market-Compaq-Dell-Hewlett-Packard

Use Retailers and Resellers

1986

IBM declines to adopt 386

Compaq adopts 386 and leads clone makers to affirm existing industry standards

IBM market share falls from 37% to 16.9%

1990

Recession

Dell/CompaqPrice war

1983

IBM holds 42% of market


1998-Present


• Hardware components– Highly competitive global markets

• Microprocessors– Supplied by very few companies

• Intel dominated the market (80-90%)• Operating System

– Microsoft also dominated this market• Hardware and software in PC’s sold as integrated bundle by a few

major players

Value Chain Overview

IP

PC Hardware

Microprocessors

Software

Raw MaterialsSand, Quartz, Metals

LandSuitable for Fabs

Capital Equip.AMAT, Novellus, Lam

CapitalFrom Gov’t, Investors

Skilled LaborTechnical, Low Cost

Go To Market

CPUs

Displays

Mother-Boards

Chasis

Hard Drives

Optical Drives

DRAM/ Flash

Memory

Other Comp-onents

Manufacturing & Assembly

• Handful of highly sophisticated, mature competitors

• Combination of competitive variables determines success

Design, Branding, SC Coordination

EnterpriseCustomers

SMB

Consumer/ SOHO

Dis

trib

uti

on

Ing

ram

Mic

ro,

Tec

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ata

Re

tail

Bes

t B

uy,

Co

mp

US

A,

CD

W

Inputs Manufacturing & Assembly

Design, Branding, SC Coordination

Direct Sales

Enterprise Sales Force

Direct Sales

• Online (e.g. Dell Direct)

• Branded Retail (e.g. Apple Store)

– Branding– Go To Market– Procurement– Manufacturing– Outsourcing– R&D– Inventory

Management

Value Chain Feedback and Feedforward

Applying Porter’s Five Forces

• Extremely high!

• Wintel standard removes opportunities for product differentiation

• Excess capacity leads to severe price competition

• Economies of scale are key

• Operational efficiency, supply chain coordination, Q/A and service key determinants of competitive advantage

Intensity of Rivalry• Extremely high with respect to Wintel!

• Wintel dominance enables them to extract enormous rents from PC value chain

• Customers demand compatibility, enabling Wintel standard to remain entrenched

• Other suppliers of commoditized components and services have little power

Bargaining Power of Suppliers

• Moderately high

• Asian competitors, especially China, using learning curve and local market expertise to move up the value chain

• Few opportunities for product differentiation or absolute cost advantage

Threat of New Entrants

• Extremely high in enterprise market, moderately high though increasing in SMB and Consumer/SOHO markets

• Low switching costs

• Role of distribution and inventory management (e.g. Ingram, Tech Data) and retail shelf space (e.g. Best Buy, CompUSA) very important in certain segments

Bargaining Power of Buyers

• Currently low but growing

• PDAs/smartphones increasing functionality

• Proprietary/alternative platforms (e.g. Apple, thin computing)

Threat of Substitutes

Key Themes and their Roles in the PC Industry

Theme Role in the PC Industry

Outsourcing • Labor-intensive links in the value chain (e.g. assembly, packaging)• Outsource activities to locations with absolute cost advantages• Risky to outsource links that transfer IP

Economies of Scale • Critical for high-volume enterprise segment• Enables buyer/supplier power within the value chain in consolidated

procurement and volume purchasing• Complicated by customization and need for flexibility, particularly in

consumer segment

Economies of Scope • Enables product bundling and family branding• Leverages strengths in distribution and retail presence to sell more

products• Halo effect (i.e. iPods driving sales of Macs, Apple software,

accessories)

Ecosystem Development • Growing and controlling the ecosystem can help competitors extract rents (e.g. software and applications developed on the Wintel standard)

• Extremely complex and diverse value chain; no single firm can dominate every link

PC Value Chain

SemiconductorsHardware

ComponentsPC Platform

DesignPC Platform Assembly

Software

Enterprise Consulting and

Integration Services

- microprocessor- graphics processor- memory- HDD controller- power management- WLAN radio- USB controller- display driver

- HDD- optical drive- motherboard- housing- modem- peripherals

- operating system- office productivity- enterprise workflow

Go To Market Strategy

Support and Maintenance

Support

Large Enterprise Customer

Medium Enterprise Customer

Consumer and Small Business

CustomersDistribution Retail

Direct Sales

Companies in the PC Value ChainSemiconductors

Hardware Components

PC Platform Design

PC Platform Assembly

Software





Support





Direct Sales

- Ingram Micro- CDW- Tech Data

- Best Buy- Circuit City- Costco- CompUSA

- Geek Squad (BB)- Firedog (CC)- HP/Lenovo/Acer/ Dell/...

- IBM- HP

- IBM- HP/Lenovo/Acer/ Dell/...

- Intel- AMD- IBM- Texas Instruments- Broadcom- Infineon- Cypress- Samsung- Micron- Nvidia

- Western Digital- Creative Labs- ASUS- Intel (mobo)- Linksys- Logitech- HP- Apple- Viewsonic- LG.Philips LCD- Manufacturers in Taiwan and China

- HP- Dell- IBM- Sun- Lenovo- Apple

- Dell- Manufacturers in Taiwan and China

- Microsoft- Apple- Oracle- IBM- Red Hat- Novell

Lenovo/Acer




Software





Support





Direct Sales

HP




Software





Support





Direct Sales

Dell




Software





Support


Small and Medium

Enterprise Customer

Consumer

Enterprise Direct Sales

SME Direct Sales

Consumer Direct Sales

Support

Apple




Software


Support




Direct Sales

Value Chain Economics

• Illustrative Division of $2,000 Notebook Economics

Microsoft40%

Intel10%

Other Components25%

PC Makers10%

Retail & Distribution15%

• Microsoft is a monopolist so no opportunity to get share of pie from them

• Intel/AMD lately have had to compete more on price though Intel still very powerful

• Retailers and distributors very large and powerful in their own right

• Leaves very little in the value chain for PC makers to work with!!!

Source: Based on Merrill Lynch estimates as of May 2007

Geographic Breakdown

38%

28%

21%

13%

China

Americas

EMEA

Asia-Pac

53%

14%

21%

12%

Americas Business

Americas Consumers

EMEA

Asia-Pac-Japan

49%

21%

6%

17%

7%

Americas

Europe

Japan

Retail

Other

44%

16%

40% Americas

Asia-Pacif ic

EMEA

Dell

HP

Lenovo

Apple

YOY Growth per Geographic Region

0.00

5.00

10.00

15.00

20.00

25.00

30.00

35.00

40.00

45.00

Dell Lenovo Apple HP

Pe

rce

nta

ge

Gro

wth

Americas Asia-Pacific EMEA Europe China Retail Other0.00

5.00

10.00

15.00

20.00

25.00

30.00

35.00

40.00

45.00

Dell Lenovo Apple HP

Rev

enu

es (

Bil

lio

ns)

Americas Asia-Pacific EMEA Europe China Retail Other

• Growth in Asia-Pacific region and China among the highest for all companies– Apple’s “Other” column may

be hiding growth in China

• HP is a mature company with large revenues and slow growth across all segments

• Lenovo is “new” and is showing good growth everywhere but in the Americas

($ in millions, except per share data) (1)

Market Enterprise EV/Revenue EV/EBITDA P/E PEG Rev EBITDA

Company Value Value 2007 2008 2007 2008 2007 2008 2007 2008 Growth(2) Margin(3)

Microsoft 272,640 251,580 4.6x 4.2x 11.5x 9.9x 18.5x 15.7x 1.5x 1.2x 10% 42%

Intel 151,720 143,130 3.8x 3.5x 11.0x 8.9x 22.8x 18.4x 1.3x 1.1x 8% 39%

Apple 128,950 115,180 4.6x 3.7x 23.5x 19.0x 38.0x 31.9x 1.6x 1.4x 23% 20%

US PC Manufacturers

HP 129,520 125,640 1.2x 1.1x 10.3x 9.5x 17.1x 15.1x 1.3x 1.1x 5% 12%

Dell 62,320 62,320 1.0x 1.0x 14.5x 12.5x 20.5x 17.1x 1.7x 1.4x 5% 8%

Gateway 699 743 0.2x 0.2x 11.5x 7.8x NM NM NM NM 2% 2%

Mean 0.8x 0.8x 12.1x 9.9x 18.8x 16.1x 1.5x 1.3x 4% 7%

Median 1.0x 1.0x 11.5x 9.5x 18.8x 16.1x 1.5x 1.3x 5% 8%

Notes:(1) Market information as of 09/24/07. Estimates as of 09/24/07.

(2) Projected 2007 through 2008 Revenue CAGR.

(3) 2008 projected EBITDA margin.

Sources: Capital IQ for stock prices, company filings for financials, Reuters for estimates.

Comparable Companies Analysis – Trading Metrics

• Comparable companies analysis reveals the enormous rents Microsoft and Intel are able to extract from the value chain as shown by huge profit margins (i.e. EBITDA Margin)

• Apple, through tremendous growth prospects and innovation (outside the Wintel standard) enabling it to maintain relatively high margins, is rewarded with a higher valuation

• The PC clone makers struggle with relatively thin profit margins and their valuations are much more modest (compare EV/Revenue multiples)

Comps Analysis for PC Industry

• Effects of value chain on financial ratios• Financial ratios indicate: Margins, Debt, Capital Intensity, Power

Dell HP Lenovo AppleProfitability

Revenue Growth 2.08% 5.41% 9.10% 27.87%Gross Margin 16.78% 24.53% 13.96% 28.98%EBITDA Margin 12.30% 9.72% 1.33% 13.86%Net Income Margin 4.63% 6.76% 1.10% 10.30%

Liquidity RatiosQuick Ratio 1.11 1.35 0.87 2.24Debt/Value Ratio 0.01 0.02 0.07 0.00

Management Return on Assets (ROA) 0.11 0.08 0.03 0.12

PowerAccounts Payable Days 75.59 63.85 57.49 90.21Accounts Receivable Days 26.14 53.01 16.05 23.66

InventoryInventory Turnover Days 4.42 40.89 10.40 7.18

EquityEnterprise Value/Revenue 1.02 1.26 0.39 6.35Enterprise Value/EBITDA 8.31 12.98 29.01 45.76Price/Earnings 24.55 20.91 39.05 64.83Price/Earnings to Growth 11.81 3.86 4.29 2.33E arnings per S hare 1.14 2.40 0.36 2.29

Highlights

• Apple higher margins

• International lower margins

• In general very capital intensive industry

• Dell high ROA and low inventory turnover days

• Apple high A/P days, low A/R days

Documents

DellHP Value Chain Presentation