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DELL COMPUTADORES DO BRASIL LTDA “We don’t try to be all things to all people in all markets. This doesn’t work. We’re maniacally focused on the few things that will make a big difference for us.” ―Michael Dell1 Introduction In November of 1999, Dell Computers announced the launch of a manufacturing facility in Brazil, located in the southern city of El Dorado do Sul (see Exhibit 1 for a map of Brazil). Although the venture was not the company’s first capital investment overseas, it was its first investment in Latin America. The initial market research was extremely favorable to the decision. Brazil was a large and growing market. Dell’s major competitors had already established a presence in the country and had been moderately successful in capturing market share. Multinational corporations that did business with Dell in other countries were placing orders to support their operations in Latin America. Although many indicators pointed to a success in Brazil, existing demand alone would not support the proposed capital investment. It was clear that Dell would have to implement a strategy to compete in the local market. Terry Kahler, vice president and general manager of Latin American operations at Dell, understood that there were many challenges to competing in the local market, especially within the home user segment. The Brazilian personal computer (PC) market was very fragmented due to the large number of firms that operated informally through the gray market. Activities such as tax evasion and software piracy enabled gray market firms to sell their end products at a considerable discount to comparable products sold by legitimate firms. Although the quality and service of the products were inferior to those of leading manufacturers, the price differential was significant enough to woo price-sensitive home consumers.
1
“American Chamber of Commerce: Michael Dell Remarks.” http://www.dell.com/downloads/global/corporate/speeches/msd/2004_11_03_msd_acc.pdf. (Accessed 18 July 2005). This case was prepared by Natalie Casey under the supervision of Peter L. Rodriguez, associate professor of business administration. It was written as a basis for class discussion rather than to illustrate effective or ineffective handling of an administrative situation. Copyright 2005 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an e-mail to
[email protected]. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of the Darden School Foundation. ◊
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Dell Computers Dell revolutionized the personal computing industry by “eliminating the middleman,” or selling directly to consumers through a build-to-order model that bypassed the retail sales channel. On the production side, the build-to-order system operated with the cooperation of suppliers who enabled the flexibility of customization by delivering components to Dell as they were required by customer demand. That practice, known as the “direct model,” eliminated reseller markups and enabled the company to aggressively price its products. The direct model also enabled Dell to efficiently manage its supply chain and carry only six days of inventory, an alarmingly low amount compared with the industry average of 36 days, which, combined with the inventory in the distribution channel, historically exceeded 80 days. Savings from inventory costs led to significant cost/pricing advantages, since component cost reductions of 8% to 12% per quarter were absorbed almost immediately into lower prices, higher margins, or both.2 Selling direct not only enabled Dell to offer lower prices, but also created a business that was oriented around listening to the customer, responding to the customer, and delivering what the customer wanted.3 Dell was able to respond to industry trends more quickly and reduce the time to market for new product development. All those factors contributed to Dell’s overwhelming success in the personal computing industry. (For financial data on Dell, see Exhibits 2 and 3.) International Expansion Dell’s innovative direct-to-consumer business model had been a huge success in the United States. The company was growing rapidly, and only two years after the business was founded, Dell had achieved approximately $60 million in sales.4 Management became concerned about ways to fuel the company’s growth trajectory and chose to expand into international markets. In June of 1987, Dell launched its first international venture in the United Kingdom. By 1990, the company had opened a manufacturing center in Limerick, Ireland, to serve the European, Middle Eastern, and African markets5 (Exhibit 4). Unlike their competitors in the PC industry, Dell’s decision to offshore operations was not driven by the lower cost of labor in developing economies. The success of the direct model was driven by customer satisfaction, notably from customization and short delivery times. In order to compete under the direct model internationally, it was important to be close to the customer. When Dell announced that the company was expanding abroad, the press overwhelmingly predicted a failure. Critics believed that selling direct was an American concept 2
Graham F. Payne, “Dell Computer: Business to Business Over the Web.” Darden Business Publishing, 1999. Michael Dell. “Growing Pains.” Direct from Dell: Strategies that Revolutionized an Industry (New York: HarperCollins Publishers, Inc., 1999): 22. 4 Dell, 26. 5 “Dell at a Glance.” http://www1.us.dell.com/content/topics/global.aspx/corp/background/en/facts?c=us&l =en&s=corp&~section=004 (accessed 18 July 2005). 3
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and that nobody else would buy computers direct from the manufacturer.6 The criticism did not stop Dell’s course of action. By the late 1990s, Dell’s manufacturing presence spanned the United States, Europe, and Asia. Sales grew rapidly in each of the regions, and by 1999, Dell had captured 7% and 5.5% market share in Europe and Asia7, respectively.8 Dell proved the skeptics wrong: International consumers recognized the value proposition of the company and easily adopted the direct sales model. Brazil “Brazil is an important market for Dell. By bringing the true direct model here, we’re giving Brazilian customers a new and simpler way to buy computers directly from a company that designs and builds relevant, leading-edge systems.” ―Michael Dell9 As international expansion initiatives continued, it was clear that there was a glaring gap in the company’s global presence. Dell was present in all of the major world economies with the exception of Latin America. Before deciding to build a facility in Brazil, Dell exported products from its Round Rock facility to Latin American countries. While it was possible to continue serving its Latin American clients from the United States, the export model posed a number of challenges for Dell, including long delivery times, higher delivery costs, and uncertainties arising from changes in customs regulations, tariffs, and frequent strikes in major ports of entry. Import tariffs were also high. In 1998, the import tax rate for personal computers was 32%.10 During the mid-1990s, the white space in the region combined with increasing demand from global clients and difficulties with the export model prompted management to investigate the market potential in Latin America. Brazil was an obvious choice for many reasons. Brazil had the largest population of any country in the region with 180 million inhabitants. The economy outweighed that of all other South American countries, possessing large and well-developed agricultural, mining, manufacturing, and service sectors. In 1998, Brazil reported a GDP of $1.04 trillion. 11 (See Exhibits 5 and 6 for more economic indicators for Brazil.) Brazil also belonged to Mercosur, a customs union that joined Argentina, Brazil, Paraguay, and Uruguay. Therefore, products 6
Dell, 28–29. Includes Asia Pacific and Japan. 8 “Historical PC Share.” http://www.dell.com/downloads/global/corporate/inv_history/idc_share.pdf. (accessed February 2005). 9 “Dell Dedicates First Latin American Manufacturing Plant and Customer Center in Rio Grande do Sul, Brazil.” http://www.dell.com/downloads/global/corporate/speeches/msd/2004_11_03_msd_acc.pdf (accessed 18 July 2005). 10 Antonia J. Botelho and Paulo B. Tigre, “Brazil Meets the Global Challenge: IT Policy in a Post-Liberalization Environment.” (Irvine: University of California Center for Research on Information Technology and Organizations, 1999): 11. 11 CIA World Factbook. http://www.umsl.edu/services/govdocs/wofact98/4.htm (accessed 18 July 2005). 7
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assembled at the Brazilian facility would automatically attain duty-free access to all of the nations in the Mercosur pact.12 In 1998, Brazil represented 70% of Mercosur’s total GDP and it was likely that the majority of the region’s demand would come from local markets. The decision to open the factory in the southern state of Rio Grande do Sul was also an important one. The plant was only a few hours’ flying time from Mercosur’s four major metropolitan centers: Buenos Aires, São Paulo, Rio de Janeiro, and Santiago. Those four cities held the highest concentration of computer users and generated roughly half the region’s wealth. In addition, the El Dorado facility was situated near several universities that provided Dell with access to a highly educated workforce. Finally, the state government offered an attractive incentive package to lure technology manufacturing companies such as Dell.13 Although perhaps unintentional, the timing of Dell’s investment coincided with a changing regulatory landscape, as the government introduced measures to enhance the competitiveness of the Brazilian economy. Government reform in the IT industry during the 1990s removed protectionist policies and began to attract large multinational corporations (MNCs) to the country. Government Reform In 1978, the Brazilian government implemented a market reserve policy based on the creation of a “greenhouse” to nurture locally owned companies, protecting them from direct imports and competition with world industry leaders in a relatively large and fast-growing internal market. The reserve policy excluded foreign firms from import and production activities in the country except through joint ventures with majority-owned Brazilian firms. The policy was designed to protect the infant information technology industry and promote import substitution in an industry characterized by high barriers to entry. By the end of the 1980s, Brazil had a set of diversified information technology companies manufacturing a wide range of hardware and designing software for the local market.14 The market reserve policy achieved mixed results in creating a competitive local computer industry. While a number of local firms were launched to serve the internal market, the industry suffered from higher prices, lower quality, and poor technology standards. Market irregularities also occurred. Smuggling and contraband activities developed as a way to bypass the trade barriers under the market reserve policy. Most of the computers supposedly “manufactured” in Manaus, one of Brazil’s Free Trade Zones, were actually imported computers that were dismantled and re-assembled receiving a local brand. It was common at that time to
12
“Dell Goes for La Vida Loca: New, $108 Million Plant Headed for Brazil,” http://www.conway.com/ssinsider/bbdeal/bd991115.htm (accessed 18 July 2005). http://www.conway.com/ssinsider/bbdeal/bd991115.htm (accessed 15 November 1999). 13 http://www.conway.com/ssinsider/bbdeal/bd991115.htm. 14 Botelho and Tigre.
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simply place a sticker with a local brand on top of the original manufacturer’s name.15 Pressures to change the regime mounted when the U.S. government threatened trade sanctions from the protectionist market reserve policies.16 Restrictions were abolished in the early 1990s as Brazil’s economic policy shifted towards a more liberal regime. 17 Although Brazil did not become an international player in computer production, the market reserve policy led the Brazilian IT sector to invest in technology capabilities that created a favorable environment for investment by MNCs. 18 International firms gradually took over as the local market turned to imports. The surviving locally owned firms were those oriented toward niche markets, client-specific software, and telecommunication equipment, where the client-supplier relationship was strong enough to withstand foreign competition.19 During the wave of liberalization, policies shifted from import restrictions to incentives and tax rebates for local manufacturing and supporting R&D activities. Companies were no longer forbidden to import technology, but they were offered considerable financial incentives to source locally and conduct research within the country. For example, firms were required to invest 5% of their revenues in government-approved R&D programs in order to qualify for fiscal incentives. Exhibit 7 provides an outline of the benefits offered to companies who complied with government guidelines for local content, production, and R&D activities. Exhibit 8 shows the breakdown of the cost structure for the PC market in Brazil. As Dell moved forward with the decision to enter Brazil, all of the pieces seemed to fall into place. Dell had negotiated a deal with the government, providing fiscal incentives for manufacturing. Management understood how to address the challenges of operating in difficult business environments from prior launches in emerging market countries. The Brazilian economy was opening its borders to international trade and the economy was relatively stable. With the launch underway, it came down to doing what Dell does best: beating the competition. The Market Broadly defined, the Brazilian PC market comprised the home, small business, government, and commercial segments. Many of the customers within the commercial segment were multinational corporations that had already established business with Dell in other parts of 15
Renato Bastos, “Computer Hardware and Peripherals.” http://www.corporateinformation.com/data/statusa/brazil/comphardware.html (accessed 18 July 2005). 16 Botelho, Antonio J., Jason Dedrick, Kenneth L. Kraemer, and Paolo B. Tigre, “From Industry Protection to Industry Promotion: IT Policy in Brazil.” (Irvine: University of California Center for Research on Information Technology and Organizations, 1999): 9. 17 Botelho, Dedrick, Kraemer, and Tigre, 11. 18 Botelho, Dedrick, Kraemer, and Tigre, 4. 19 Botelho, Antonio J., and Paolo B. Tigre, “Brazil Meets the Global Challenge: IT Policy in a PostLiberalization Environment.” (Irvine: University of California Center for Research on Information Technology and Organizations, 1999): 7.
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the world. The new facility in Brazil would enable Dell to deepen relationships with global clients by providing comprehensive technology solutions for their business around the world. The demand from multinationals, however, was not enough to justify the capital investment of a manufacturing plant and customer center. To operate profitably, it would be necessary to serve the local markets. Dell began to analyze market opportunities in Brazil during the mid- to late 1990s. In 1997, a total of 1.3 million PCs were sold in Brazil (Exhibit 9). The information technology market was growing quickly, at a rate of approximately 15% per year. 20 Brazil’s telecommunications systems were privatized in 1998, resulting in an expansion and upgrade of the nation’s network and accelerated growth of Internet usage.21 At 4.2 PCs per 100 inhabitants, the rate of technology diffusion in Brazil was relatively high compared with other developing countries (Exhibit 10). The market was far from being saturated, however, and had a long way to go before reaching the levels of developed nations. Despite industry reforms in telecommunications and information technology, the personal computing market remained extremely fragmented. By 1997, Dell’s three major competitors, Compaq, IBM, and HP, had established a presence in Brazil, but were collectively able to capture only 22% of the total PC market. The remainder was served by a large number of smallscale Brazilian firms, many of which operated informally. The informal or gray market companies were usually small businesses that assembled and sold generic, unbranded computer systems. The systems were sold at dramatically lower prices, not only because they lacked the brand equity associated with leading companies, but also because those businesses tended to avoid many of the costs associated with legally doing business in Brazil. Legitimate companies found it very difficult to compete with gray market businesses because of the price differential. Most gray market consumers were home users who could not afford to buy personal computers from legitimate companies. At the time of the decision, roughly half of Brazil’s computers were sold through the gray market. There are five key ways that gray market firms benefited from operating informally. First, they imported parts without duties. Import taxes on computing components continued to be high in Brazil to cultivate the local industry. Under the Mercosur Common External Tax (CET) agreement, imported components could levy a tax of up to 32%. Local suppliers produced some parts that could be used in assembly, but the vast majority of components were sourced from the United States and Asia. Second, informal firms hired workers under the table to bypass the expensive and bureaucratic practices of hiring and firing employees. In addition, those firms avoided social security payments by not registering their workers. Third, gray market firms frequently infringed on software copyrights and did not pay royalties for installed software. Software piracy was very common and difficult to control, and the Brazilian economy lost thousands of jobs and billions in sales each year to counterfeiting and piracy. 22 Fourth, by 20
Botelho and Tigre. “Dell Goes for La Vida Loca.” 22 The Impact of Counterfeiting and Piracy in Brazil. (Sao Paolo: Brazil–U.S. Business Council, June 2005). 21
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operating informally, firms were able to sell their products without paying sales tax. Finally, informal firms were not required to invest in government-mandated local research and development initiatives. Each of those practices led to a significant cost advantage for gray market firms. But there were some major drawbacks to purchasing from these companies. Interactions with informal businesses were largely transactional in nature, and owners did not have a focus on building long-term relationships with customers. Furthermore, they lacked the infrastructure required to provide services such as warranties and after-sales support. In addition, the components used in generic systems did not always meet the quality standards of leading companies. Despite the gray market’s many weaknesses, competing with it was still very difficult because of the cost/price advantages. The Decision Kahler was convinced that the value, cost, and quality equation would continue to differentiate Dell from U.S. competitors operating in Brazil. Dell was able to beat the competition in the United States by passing cost savings on to consumers through the direct model, and he was confident that Brazil would be no different. But the existence of the gray market called for a different competitive approach. If consumers were asking for generic computer systems with second-tier components and no service, surely Dell could offer a barebones model to meet their needs while benefiting from its reputation as a legitimate company known for quality and value. In light of that premise, Dell’s marketing team created a unique proposal to target the home consumer. The strategy, if implemented, would set a precedent for the company. The proposal recommended the creation of a PC manufactured from second-tier components, sub-branded under the Dell name, which was designed to lower cost and compete with the elusive gray market competitors. Kahler wondered about the viability of the sub-branding strategy. The product offering of the new facility would be crucial to building a brand that customers could trust in Latin America. Could Dell possibly reduce cost in a way that would allow them to decrease prices to gray market levels? Would the resulting quality compromise the Dell brand? Was sub-branding the best way to capture local market share? Dell had two options. The company could compete head to head with the gray market by offering a product of comparable quality to serve the home user segment. Alternatively, Dell could stick with its current product line and focus on customers who would value the quality and service that the company offered. Kahler knew that gray market businesses were operationally inefficient. He wondered whether the lower cost of components of the bare-bones product combined with the benefits of the direct model could generate the cost advantage required to offer a price-competitive PC. He also questioned whether the value proposition for the existing product line would be compelling enough to capture local market share.
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Exhibit 1 Map of Brazil
Site location: El Dorado do Sul
Source: CIA World Factbook, 2005
-9Exhibit 2 Dell Income Statements
Source: 1999 Annual Report, www.dell.com
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-10Exhibit 3 Dell Stock Performance
Source: www.dell.com
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-11Exhibit 4 Timeline: International Expansion Year 1990 1996 1998 1999
Location Limerick, Ireland Penang, Malasia Xiamen, China El Dorado do Sul, Brazil
Market Europe, Middle East, Africa Asia Pacific China Latin America
Source: “Dell at a Glance,” http://www1.us.dell.com/content/topics/global.aspx/corp/background/en/facts?c=us&l=en&s=corp&~section=000 (accessed 18 July 2005).
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-12Exhibit 5 Balance of Payments: Brazil
Balance of payments US$ million Itemization
1995
1996
1997
1998
1999
-3466
-5599
-6753
-6575
-1199
Exports
46506
47747
52994
51140
48011
Imports
-49972
-53346
-59747
-57714
-49210
-18541
-20350
-25522
-28299
-25825
Services
-7483
-8681
-10646
-10111
-6977
Credit
4929
5038
6876
7897
7194
-12412
-13719
-17522
-18008
-14171
-11058
-11668
-14876
-18189
-18848
3369
5235
5159
4599
3935
-14427
-16904
-20035
-22787
-22783
Balance on goods (fob)
Services and income (net)
Debit Income Credit Debit Current unilateral transfers
1/
CURRENT ACCOUNT CAPITAL AND FINANCIAL ACCOUNT Capital account
2/
Financial account Direct investment Abroad Equity capital Intercompany loans In the reporting country Equity capital Intercompany loans Portfolio investments Assets Equity securities Debt securities Liabilities
3622
2446
1823
1458
1689
-18384
-23502
-30452
-33416
-25335
29095
33968
25800
29702
17319
352
454
393
320
338
28744
33514
25408
29381
16981
3309
11261
17877
26002
26888
-1096
469
-1116
-2854
-1690
-1096
469
-1116
-2854
-1110
0
0
0
0
-580
4405
10792
18993
28856
28578
4239
9893
16817
25479
29983
166
898
2176
3377
-1405
9217
21619
12616
18125
3802
-1155
-403
1708
-457
259
-244
-270
-361
20
-864
-912
-132
2069
-477
1123
10372
22022
10908
18582
3542
Equity securities
3243
6145
6871
995
2572
Debt securities
7129
15876
4037
17587
971
Financial derivatives
17
-38
-253
-460
-88
280
99
164
257
642
Assets Liabilities
-263
-138
-416
-717
-730
16200
673
-4833
-14285
-13620
Assets
-1819
-10316
-1987
-11392
-4397
Liabilities
18019
10989
-2846
-2893
-9223
2207
-1800
-3255
-4256
194
12919
8666
-7907
-7970
-7822
Other investments
ERRORS AND OMISSIONS OVERALL BALANCE
Source: Banco Centro do Brasil, www.bcb.gov.br (accessed 18 July 2005)
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-13Exhibit 6 Economic Indicators: Brazil
GDP (Millions R$) GDP Per Capita (R$) GDP Growth Rate (R$) GDP (Millions US$) GDP Per Capita (US$) GDP Growth Rate (US$) Exchange Rate (R$/US$) CPI (2000=100) Unemployment (%)
1995 646,192 4,025 n.a. 664,123 4,137 n.a. 0.973 69.749 6.1%
1996 778,887 4,784 21% 749,362 4,603 13% 1.039 80.740 7.0%
1997 870,743 5,275 12% 779,956 4,725 4% 1.116 86.332 7.8%
Source: IMF International Financial Statistics Online
1998 914,188 5,464 5% 756,340 4,520 -3% 1.209 89.091 9.0%
1999 973,846 5,743 7% 544,352 3,210 -28% 1.789 93.420 9.6%
2000 1,101,250 6,410 13% 563,415 3,280 4% 1.955 100.000 n.a.
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Exhibit 7 Incentives in the IT Sector: Overview of Law 8248/91 Incentives: •
Waiver on the industrial goods tax resulting in a reduction of 15% in the final cost of production
•
Revenue shield of 50% of income tax from R&D expenditures, not to exceed 4% of total income tax
•
Government procurement favored the acquisition of IT goods developed and produced in Brazil.
Requirements: •
Firms must invest at least 5% of revenues from IT products on R&D activities, of which 2% must be through joint projects with universities, research institutes, or in government sanctioned programs in IT.
•
Manufacturing firms are to comply with the “Basic Productive Process” which is a production step defined for each class of product. This production phase is considered to be the borderline between imports and local manufacturing. In PCs, for example, most firms assemble the motherboard in Brazil as a minimum standard of value added in order to qualify for fiscal benefits.
•
Firms are required to comply with the quality standards by obtaining ISO 9000 certification.
Source: Antonio J. Botelho and Paulo B. Tigre, “Brazil Meets the Global Challenge: IT Policy in a PostLiberalization Environment” (Irvine: University of California Center for Research on Information Technology and Organizations, 1999) 10.
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Exhibit 8 Breakdown of PC Cost Structure
Local Taxes 10%
R&D Tax 5%
Import Duties 15%
Components and Labor 60% Softw are 10%
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Exhibit 9 PC Market Share in Brazil (1997) Company Compaq (USA) Itautec (Brazil) IBM (USA) UIS (Brazil) Tropcom (Brazil) Byte On (Brazil) Hewlett-Packard (USA) Microtec (Brazil) Fivestar (Brazil) Acer (Taiwan) Others Total
Units 132,609 87,135 73,231 63,238 59,867 43,542 39,453 36,980 36,764 31,638 675,478 1,279,935
Market Share % PC Revenues (Units) (Millions) 10.4% $293.1 6.8% $203.9 5.7% $183.6 4.9% $108.6 4.7% $136.6 3.4% $71.2 3.1% $86.7 2.9% $74.4 2.9% $74.7 2.5% $78.9 52.8% $1,254.9 100.0% $2,566.6
Market Share % (Revenues) 11.4% 7.9% 7.2% 4.2% 5.3% 2.8% 3.4% 2.9% 2.9% 3.1% 48.9% 100.0%
Source: Antonio J. Botelho and Paulo B. Tigre, “Brazil Meets the Global Challenge: IT Policy in a PostLiberalization Environment.” (Irvine: University of California Center for Research on Information Technology and Organizations, 1999) 33.
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-17Exhibit 10 PCs Per Capita and as a Percentage of GNP (1998) Country USA Japan Italy Average developed Brazil China India Mexico Argentina Colombia Average developing Korea Taiwan Average NICS
PCs (millions) 99.2 19.5 8.5 42.4 6.8 4.6 2.4 3.7 1.6 1.3 3.4 4.7 2.6 3.56
PCs/US$ billion of GNP 12,328 3,297 6,757 7,460 8,429 5,380 6,593 12,657 4,862 14,602 8,753 9,109 8,387 8,748
PCs/100 inhabitants 36.9 15.4 14.7 22.3 4.2 0.4 0.2 3.7 4.5 3.5 2.75 10.0 11.8 10.9
Source: Antonio J. Botelho and Paulo B. Tigre, “Brazil Meets the Global Challenge: IT Policy in a PostLiberalization Environment.” (Irvine: University of California Center for Research on Information Technology and Organizations, 1999) 35.
