Erik Hebert Cristian Marcu Marshal Miller Anna Tsai Kai Xia Joseph Zakzeski 26 September 2007

1. Dell and HP’s Value Chain MBA290G 2007 Erik Hebert Cristian Marcu Marshal Miller Anna Tsai Kai Xia Joseph Zakzeski 26 September 2007

2. 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

3. 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

4. Personal Computer Industry History Computers Military Research during WWII Hobbyists and Educational Institutions Increased popularity 1945 1975 1981 Large mainframe computers IBM DEC Integrated, preassembled PC’s Apple Computers MITS IBM launches first PC 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 Rivkin., J. W., Porter, M. E., Matching Dell. Harvard Business School, 1999

5. Historical Growth of the Value Chain 1981 IBM mainframe and standard Components commissioned Sears and Computerland Value-added Resellers Intel microprocessor Sales Force Microsoft software Large corporations -Bulk Discounts 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 Rivkin., J. W., Porter, M. E., Matching Dell. Harvard Business School, 1999

6. The IBM Clone Wars IBM declines to adopt 386 Low-priced clones enter market -Compaq -Dell -Hewlett-Packard Compaq adopts 386 and leads clone makers to affirm existing industry standards IBM holds 42% of market Recession 1982 1983 1986 1990 Use Retailers and Resellers IBM market share falls from 37% to 16.9% Dell/Compaq Price war Rivkin., J. W., Porter, M. E., Matching Dell. Harvard Business School, 1999

7. 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 1998-Present Rivkin., J. W., Porter, M. E., Matching Dell. Harvard Business School, 1999

8. Value Chain Overview Manufacturing & Assembly CPUs Displays Mother-Boards Chasis Hard Drives Optical Drives DRAM/ Flash Memory Other Comp-onents Manufacturing & Assembly Design, Branding, SC Coordination Go To Market Inputs Raw Materials Sand, Quartz, Metals Design, Branding, SC Coordination Direct Sales Enterprise Sales Force Enterprise Customers Land Suitable for Fabs • Handful of highly sophisticated, mature competitors • Combination of competitive variables determines success IP PC Hardware Microprocessors Software Capital Equip. AMAT, Novellus, Lam SMB • Branding • Go To Market • Procurement • Manufacturing • Outsourcing • R&D • Inventory Management Distribution Ingram Micro, Tech Data Retail Best Buy, CompUSA, CDW Capital From Gov’t, Investors Consumer/ SOHO Skilled Labor Technical, Low Cost • Direct Sales • Online (e.g. Dell Direct) • Branded Retail (e.g. Apple Store)

9. Value Chain Feedback and Feedforward

10. Applying Porter’s Five Forces Threat of New Entrants • 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 Bargaining Power of Suppliers Bargaining Power of Buyers • 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 • 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 Intensity of Rivalry • 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 Threat of Substitutes • Currently low but growing • PDAs/smartphones increasing functionality • Proprietary/alternative platforms (e.g. Apple, thin computing)

11. Key Themes and their Roles in the PC Industry

12. PC Value Chain

13. Companies in the PC Value Chain

14. Lenovo/Acer

15. HP

16. Dell

17. Apple

18. Value Chain Economics • Illustrative Division of $2,000 Notebook Economics • 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

19. Geographic Breakdown Dell Lenovo Apple HP

20. YOY Growth per Geographic Region 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

21. 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)

22. Comps Analysis for PC Industry • Effects of value chain on financial ratios • Financial ratios indicate: Margins, Debt, Capital Intensity, Power

23. 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