Case: Dell Inc.: Improving the Flexibility of the Desktop PC Supply Chain
It was June 2005, seemingly a good time for Dell Inc. Since the dot-com bubble burst in 2001,
the price of the company’s stock had roughly doubled. Both the company’s revenue and net
income were reaching new heights. In spite of the confidence and optimism, however, Dell’s
desktop PC manufacturing division found that its manufacturing costs had continued to surge.
Tom Wilson, one of the division’s directors, revealed: “The recent increase in Level 5
manufacturing is alarming to us at Dell. From Dell’s perspective, this adds cost to our overall
manufacturing process. We are not able to take as much advantage as we should of the lower
cost structure of our contract manufacturers. Instead, we have to rely more heavily on the 3rdparty integrators (3PIs). Not only do we get lower-quality products because we currently don’t
require 3PIs to perform integration unit testing, we also have difficulty forecasting for the 3PIs
how much manufacturing capacity they should have available to support Dell’s demand.”
History of the PC Industry
In the 1960s, the first so-called personal computers (PCs)—non-mainframe computers—such as
the LINC and the PDP-8 became available. They were expensive (around $50,000) and bulky
(many were about the size of a refrigerator). However, they were called “personal computers”
because they were small and cheap enough for individual laboratories and research projects.
These computers also had their own operating systems so users could interact with them directly.
The first microcomputers hit the market in the mid-1970s. Usually, computer enthusiasts
purchased them in order to learn how to program, and used them to run simple office or
productivity applications or play games. The emergence of the single-chip microprocessor led to
substantially lower computer prices, and, for the first time, a broad spectrum of buyers from the
general public. The first widely and successfully sold desktop computer was the Apple II
introduced in 1977 by Apple Computer.
In the 1980s, computers became increasingly cheaper and gained great popularity among home
and business users. This trend was partly driven by the launch of the IBM PC and its associated
software, which enabled the use of a spreadsheet, a word processor, presentation graphics, and a
simple database application on a single relatively low-cost machine. In 1982, Time magazine
named the personal computer its Man of the Year. Laptop computers truly the size of a notebook.
also became available in the 1980s. The first commercially available portable computer was the
Osborne 1 in 1981, which used the CP/M operating system. Although it was large and heavy by
today’s standards, with a tiny CRT monitor, it had a near-revolutionary impact on business, as
professionals were able to take their computer and data with them for the first time. However, it
was not possible to run the Osborne on batteries; it had to be plugged in.
Personal computers became more powerful and capable of handling more complex tasks in the
1990s. By this time, they were becoming more like multi-user computers or mainframes. During
this decade, desktop computers were widely advertised for their ability to support graphics and
multimedia, and this power led to increased usage of desktop computers by movie studios,
universities, and governments.
By the end of the 1980s, laptop computers, truly the size of a notebook, were becoming popular
among business people. By 2005, high-end PCs focused more on greater reliability and more
powerful multitasking capability.
Dell’s Company Background and its Direct Model
Dell was founded by Michael Dell in his University of Texas–Austin dorm room in 1984 based
on a simple business model: eliminating the retailers from the sales channel and selling directly
to customers. By using this model to deliver customized systems to customers with lower-thanmarket-average prices, Dell soon started to enjoy business success, joining the ranks of the topfive computer system makers worldwide in 1993, and became Number 1 in 2001. With three
major manufacturing facilities in the United State (Austin, Texas; Nashville, Tennessee;
Winston-Salem, North Carolina) and facilities in Brazil, China, Malaysia, and Ireland, Dell’s
revenue for the last four quarters totaled $56 billion. Dell employs 65,200 people worldwide. 1
Dell Company Web site, Company Facts.
In addition to personal computers, Dell’s current product offerings include a variety of consumer
electronics: workstations, servers, storage, monitors, printers, handhelds, LCD TVs, projectors,
and so forth. Some of these products are manufactured by Dell factory associates; other products
are manufactured by other companies but sold under the Dell brand.
Throughout the company’s history, Dell’s fundamental business model has not changed: selling
directly to customers has become Dell’s key strategy and strength. The direct business model
includes no retailers and starts and ends with the customer: a customer orders online or via phone
a computer system according to his preferred configuration, Dell manufacturers this computer
system, and Dell ships directly to the customer. Dell has been able to keep manufacturing costs
lower than competitors’ costs because it not only saves money by shipping directly to customers,
but it also only builds to order, so raw material inventory is low. The direct model also reduces
the time from customer order to receipt of the system. Moreover, the direct model provides a
single point of accountability so Dell can more easily design its customer service model in order
to provide the necessary resources to satisfy its customers.
By 2005, most PC makers utilized contract manufacturers to produce high-tech electronic
products. The phenomenon of contract manufacturing began in the 1980s. To take advantage of
labor cost differences, many original equipment manufacturers (OEMs) initiated business
engagements with contract manufacturers (CMs). When the contract manufacturing business
model was first implemented, CMs were responsible for producing materials or unassembled
components in less expensive regions and shipping them to the OEMs’ factories in the United
State or Europe for product assembly. By the late 1990s, however, more and more contract
manufacturers began to perform some level of manufacturing/assembly for their customers. This
helped fuel the growth of contract manufacturing. According to Alameda, California–based
Technology Forecasters Inc., in 1998, the contract manufacturing industry was worth $90 billion.
By 2001, this figure almost doubled to $178 billion. 2 OEMs chose to let contract manufacturers
own and manage part of the manufacturing process for the following reasons: 3
Drew Wilson, “Contract Manufacturing Revs Up for 2000,” The Electronics Industry
Yearbook/2000, p. 88.
Charles H. Fine and Dan Whitney, “Is the Make-Buy Decision Process a Core Competence?”
MIT CTPID Working Paper, 1996.
1. Capability: The OEM cannot make the item or easily acquire this capability and must seek a
2. Manufacturing competitiveness: The supplier has a lower cost, faster availability, and so forth.
3. Technology: The supplier’s version of the item is better.
By 2005, almost all the desktop PCs sold in the United States were initially produced by contract
manufacturers in China. In a typical contract manufacturing transaction, the OEM approaches the
contract manufacturer with a product design. The two negotiate and agree on the price, property
of materials, subtier suppliers, and sometimes even the manufacturing process. The contract
manufacturer then acts as the OEM’s factory. Most contract manufacturers for both desktop and
laptop PC products have factories in China or other parts of Asia. Depending on the degree of
manufacturing competency and cost, some contract manufacturers do everything from
manufacturing all the way to shipping fully assembled products on behalf of the OEM.
Therefore, by 2005, most American PC makers had become “fabless,” and Dell was one of the
few American companies that still retained manufacturing facilities in the United States.
In Dell’s case, because customers can customize some components of their PCs when placing an
order, manufacturing a fully finished product and shipping it by ocean from the contract
manufacturer’s facility in China to the customers in the United States would be time-prohibitive,
and manufacturing a finished product and air-freighting it would be too cost-prohibitive if it is a
heavy or bulky desktop product. Therefore, for Dell’s desktop products, contract manufacturers
in China produce and ship (by ocean) half-assembled products to Dell’s factories in the United
States. Once the supply arrives and the components preferred by a customer are known, Dell
factory associates perform further product fulfillment: building in the customized components
(including the processor, memory, hard drive, speaker, etc.), installing the necessary software
application, performing final unit testing, and then delivering the fully assembled and functional
product to the customer in a timely fashion.
Critical Components of a Desktop PC
Two major components of a desktop PC are the motherboard and the chassis. (See Figure 6-1 for
an illustration of these components.) A motherboard is the “nervous system” of a computer: it
contains the circuitry for the central processing unit (CPU), keyboard, and monitor and often has
slots for accepting additional circuitry. A chassis is the enclosure or framework case that
contains and protects all of the vital internal components from dust or moisture. Motherboards
are typically screwed manually to the bottom of the chassis case, with the input/output (I/O)
ports exposed on the side of the chassis. The chassis also contains the power supply unit.
Figure 6-1 Critical components of a desktop PC and major component manufacturers.
A motherboard contains three critical components: chipset, printed circuit board (PCB), and local
area network (LAN) chip. A PCB is the base of a motherboard; it consists of etched conductors
attached to a sheet of insulator. Various components are soldered to the circuit board. A chipset
is a group of integrated circuits that contains the northbridge and southbridge. The northbridge
communicates with the CPU and memory; the southbridge communicates with the slower
devices, such as the Peripheral Component Interconnect (PCI) bus, real-time clock, power
management, and so forth. A LAN chip enables a computer to communicate with the Internet via
Ethernet or Wi-Fi technology.
Level 5 Versus Level 6 Manufacturing
In desktop PC manufacturing, the degree of assembly can be broken down into 10 levels. The
higher the level, the more fully integrated it is. Figures 6-2 and 6-3 depict the 10 levels of
desktop PC assembly. This scale also can apply to the manufacturing of servers and storage.
Figure 6-2 Levels 1–5 of desktop PC assembly.
Figure 6-3 Levels 6–10 of desktop PC assembly.
Source: Foxconn Company presentation.
Level 5 (L5) includes the assembly of desktop PC chassis, floppy disk drive, and fan. Depending
on the chassis configuration, it also can include the power supply in some cases. In Level 6 (L6),
along with these components, the motherboard is also installed into the chassis. In other words,
when a supplier performs Level 6 manufacturing, the supplier installs the motherboard in the
chassis—an activity not performed in Level 5 manufacturing.
When a contract manufacturer in China produces an L6 desktop PC chassis, the chassis is not a
functional unit yet and still requires customized parts such as the processor, memory, hard drive,
speaker, and so forth. The contract manufacturer ships the L6 chassis from China to Dell’s
factories in the United States and Ireland, and then Dell factory associates install these
customized parts to make the unit “Level 10.” A Level 10 product is a fully assembled and
functional product that can be shipped to the customer. Figure 6-4 shows the similarities and
differences between the L5 and L6 value chains.
Figure 6-4 L6 versus L5 value comparison.
Some of Dell’s products, such as handhelds and printers, are manufactured to Level 10 by the
contract manufacturers. This means that Dell does not have dedicated manufacturing resources
or capability to manufacture these products. Rather, the contract manufacturers produce these
products, include the user manuals in the packaging, and ship the products to Dell’s merge
centers. These products are then “merged” with PCs manufactured by Dell factory associates into
the same shipment, so the customer can receive a single shipment with all of the items in the
order. Dell uses this shipping strategy to create a more satisfying customer experience.
Root Causes of Increasing L5 Manufacturing
L5 manufacturing has higher overall manufacturing and logistics cost than L6. Dell’s rising
manufacturing cost, caused by an increase in the utilization of L5 manufacturing, can be seen in
Figure 6-5. Furthermore, as can be seen in Figure 6-6, the level of L5 manufacturing (relative to
L6) started to increase quite significantly in March 2005. The L5 percent in June (27 percent)
was more than six times the L5 percent in March (4 percent).
Figure 6-5 Motherboard air-freighting and 3PI integration costs (Q3FY05–Q4FY06).
Note: Data from Dell’s Worldwide Procurement (WWP) organization. AMF includes 3PI
integration cost. EMF (European Manufacturing Facility) and APJ (Asia Pacific Japan) don’t as
intergration is done in Dell factory. In Dell’s financial year Q1FY05 is February–April 2004;
Q4FY06 is November 2005–January 2006.
Figure 6-6 Percentage of L5 versus L6 production from July 2004 to June 2005.
Most of the root causes of the rise of L5 manufacturing have to do with Dell’s inability to
provide motherboards in a timely fashion to contract manufacturers. These causes can be
summarized as follows:
1. Chipset supplier decommit or supply issues. When a chipset supplier is unable to deliver
the previously agreed quantity of chipsets, it creates a disruption in the desktop PC
supply chain. According to the data gathered in the first half of 2005, this accounted for
more than 60 percent of the L5 manufacturing, as motherboards were not available for L6
2. Quality/engineering issues. These issues lead to dysfunctional or problematic
motherboards that need to be repaired or replaced by a new supply, which can
subsequently create an additional unexpected demand of motherboards that were not part
of the forecast agreed to by Dell’s chipset supplier.
3. Dell forecast accuracy. When the actual demand surpasses the forecast, Dell needs to
source extra chipsets or risk the possibility of not meeting customer demand. Since the
lead time for manufacturing, assembling, testing, and delivering a chipset is on average
13 weeks, such a long lead time makes it difficult for the chipset supplier to provide the
additional chipsets in order to meet Dell’s demand schedule.
4. New product introduction (NPI). Since the actual demand of a newly released PC
product can be especially volatile, the forecast uncertainty can create a need to air-freight
extra motherboards normally not required when the product is in a mature stage with a
stable level of demand and a constant level of L6 manufacturing. The volatile demand
can lead to an increase of L5 manufacturing (motherboard-chassis assembly in the United
State in order to reduce the time to market for a newly launched product). However, as
Figure 6-7 indicates, the amount Dell spends on expediting motherboards under this
particular circumstance is rather small—only 3.8 percent.
Figure 6-7 Dell AMF expedite expenses by root cause (January to June 2005)
Source: Data from Dell’s Worldwide Procurement (WWP) organization.
Figure 6-7 shows the breakdown of motherboard air-freight costs by root cause from Dell
AMF (America Manufacturing Facility).
Dell BPI Team’s Methodology: Focusing on Complexity Management
In order to solve the problem of continuously rising manufacturing cost induced by an increasing
level of L5, a task force was assembled at Dell. The cross-functional business process
improvement (BPI) team consisted of employees from a variety of organizations at Dell:
manufacturing/operations, worldwide procurement, regional procurement, production master
schedulers, production control, quality, process engineering, supplier quality engineering, cost
accounting, inventory control, and logistics. The team, consisting of members from the different
organizations affected by the chipset supply shortage, jointly identified six manufacturing
options for managing the assembly work in the United State:
1. Keep as current. Motherboard-chassis integration performed by a 3rd party integrator (3PI)
managed by the contract manufacturers.
2. Dell America Operations (DAO) cellular integration. Enable the Dell factory work cells to perform
L5 to L10 manufacturing work.
3. Offline integration at the supplier logistics center (SLC). Keep the current L6 to L10
manufacturing process unchanged; handle motherboard-chassis integration work at an SLC.
4. Offline integration at a Dell-leased building. Keep the current L6 to L10 manufacturing process
unchanged; handle motherboard-chassis integration work at a separate building leased by Dell.
5. 3PI managed directly by Dell.
6. L6 from equipment manufacturers’ Mexico plants. Many CMs have manufacturing facilities in
which they produce for their other customers. Dell can potentially negotiate with the CMs to
dedicate a portion of the CM’s manufacturing capacity to support Dell’s business.
The BPI team determined that it would survey of the various departments impacted at Dell to
quantify the complexity and cost of managing each of the six manufacturing options. The
categories of the survey were established by the team based on the attributes or business
processes that would be impacted by the change of manufacturing method.
The survey was sent to the content expert within each affected department. These experts were
involved in the day-to-day business processes and planning and would be the best source of
information regarding the impact on their departments of each manufacturing option. Table 6-1
illustrates the result of the survey.
Table 6-1 Complexity and Cost Analysis of the Six Potential Manufacturing Options
Option 3A Option 3B Option 4 Option 5
Option 3A Option 3B Option 4 Option 5
Cost per box $10.07
Notes: The “cost per box” data has been modified to respect Dell’s data confidentiality.
Option 1: CM-managed 3PI (original baseline). Option 2: Integration at DAO work cells.
Option 3A: Integration at SLC/hub.
Option 3B: Integration at Dell-leased building.
Option 4: Dell-managed 3PI.
Option 5: Integrated chassis from CM factories in
On the basis of manufacturing complexity, the original option (1) of having the contract
manufacturers manage the 3PI had a medium complexity score. Option 3A receiv ...
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