Here’s another story courtesy of Clay Christensen, number one management thinker in the world and keynote speaker at the Drucker Forum in Vienna. It’s about how making good decisions can drive you out of all your markets, with our own take on the numbers.
Once upon a time there was a very small Taiwanese company called Asus – now the third largest computer company in the world. It just made DRAM chips which go into microprocessors. They went to Dell, who made and controlled everything in the production of their computers, and said we can make DRAM chips 20% cheaper than you can and this is our business, we’re really good at it, why don’t we do this for you and you stop making DRAM chips? Dell agreed as they were 20% cheaper so Dell’s margins got better, and they didn’t have to stock all these DRAM chips so they needed less cash. Time passed, and Asus went back to Dell and said we make microprocessors now and we do it really well, we can make them 20% cheaper than you can, so why don’t we do that for you? And Dell looked at the microprocessors said yes Asus can make 20% cheaper, and if we buy from Asus we don’t have to worry about yet more stock so we will do it. And lo, Dell’s margins when up again and Asus got more profitable, and they were both happy.
A pattern emerges, the essence being that Asus kept going back to Dell and kept saying we can do this part of your business 20% cheaper than you can, and we’re really good at it so why can’t we do it? And Dell, every time said yes they can do it 20% cheaper and they are good at it and we can stop all these supply chain issues and all the management of that, we can stop all this capital expenditure, we can get really lean and have really high margins, and they did that until… Asus produce the whole computer and all Dell do is market it.
Asus has squeezed Dell out of the whole business because Dell has chased margin and not net profit. Because they only looked at the margin, which is a ratio (percentage) they lost the plot a little bit about what their core business really was and how they could protect it. And now you see Asus branded computers all over the place – they’re really good – just as good as Dell!
Gross margin is really important. Its really important you also understand what this means – it doesn’t mean cost plus a mark-up; it means the percentage on sales. We’ve had clients go bust thinking gross margin meets cost plus mark-up. But it’s not the whole thing. Large businesses are very good at measuring the wrong things sometimes. Whereas a small business sees the thing it is producing or the service it’s giving as discrete units, which gives it an advantage, as it’s not got a management team whose goals are completely obsessed by the margins. Remember though that all businesses are at the mercy of competitive pressures, or sometimes people being helpful like Asus. We are very much in favour of strategic partnerships, but that doesn’t necessarily mean giving the family silver away piece by piece. If Dell had concentrated on net profit which other companies have done in the face of similar pressures, they would be more robust as a company. And every time, it was a good management decision that eroded their market! Managers were being measured on the wrong things internally, so were looking at the wrong measures and failing to see the units.
The other point is simply this – Dell gamed themselves by following their own self-imposed rules. No one forced them to adopt them. Which ones are you gaming yourself with? Need a hand?