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Dell bucks the notebook-outsourcing trend

The PC industry buys its notebooks fully assembled, but Dell likes to put the pieces together in-house, even though it costs more.

In a year that has seen a lot of changes at Dell, tradition is holding in one key area of the company's manufacturing strategy: building notebook computers.

Dell, of course, rose to prominence by emphasizing a direct sales model and building computers based on actual customer orders, rather than on the expectation of orders.

Sounds simple, but Dell rode that formula to become the leading maker of PCs in an era when desktop computers were far more popular than notebooks. Today, however, notebook PCs are all the rage, and most cost-conscious PC companies purchase their notebooks fully assembled from contract manufacturers in Taiwan and China.

Not Dell. Dell assembles a significant portion of its notebooks in its own facilities, just like it has done for years with desktop PCs.

The question now is whether the tried-and-true "Dell way" will work in the notebook era. Is Dell trying to impose a desktop manufacturing model on a notebook industry that operates very differently? Or is Dell once again ahead of the curve and already anticipating a time when notebooks become as easy to build as desktops?

Making the right bet on laptop manufacturing is unquestionably a key to the company's future, because notebooks are where the PC industry is headed. Notebook shipments are now expected to grow by 24 percent in 2006, while desktop shipments will increase by only 4 percent this year, according to data from research firm IDC.

As the market shifts toward mobility, the Round Rock, Texas, company is dealing with significant issues. Dell has lost its top spot in the PC market, endured the largest recall in the history of the consumer electronics industry, and overhauled its service and support groups in recognition of customer frustration.

Building the perfect beast While they may perform the same tasks, desktops and notebooks are different animals when it comes to the manufacturing process. Putting together a desktop is a fairly trivial exercise: The plastic molds that form the chassis come in standard sizes, the motherboards are standardized, and the components can be purchased off the shelf at a store like Fry's Electronics and assembled even by a technical novice.

Dell arguably does this more efficiently than anyone in the PC industry. Its manufacturing facility in Round Rock is a model of efficiency, with raw components coming in one end of a massive building, and packaged desktops coming out the other end. The company operates several plants like this around the world, allowing it to quickly get its desktops in the hands of customers in those regions.

Notebooks, however, aren't like this. A single desktop motherboard, for example, can be used in up to eight different desktop models in a given product family, said Roger Bhalla, the director of supply chain strategy in Hewlett-Packard's notebook division. But eight different laptop models require eight different motherboards, because they vary in size or in the components they use, he said.

The distribution model isn't the same for notebooks and desktops, either. Notebooks are shipped by air, while desktops travel over sea. So even though notebook assembly is concentrated in one region of the world, companies can quickly get notebooks to customers.

Also, notebook assembly is trickier, because all the components must nestle together in a compact package. Something as simple as putting too much torque on a notebook screw can cause major problems, said Richard Shim, an analyst at IDC. For that reason, there are virtually no "white book" makers, or small system builders that assemble unbranded laptops for regional markets, as there are for desktop PCs.

Hewlett-Packard and many other notebook makers leave just about all of the laptop manufacturing process up to partners like Quanta, Compal, Wistron or Asustek. HP designs its own systems and supervises the production, but a partner builds its notebooks from start to finish for about 97 percent of all units, Bhalla said.

That's not the case at Dell. The company does all the final assembly of its laptops at its own facilities in Malaysia and Ireland, said Glenn Neland, senior vice president for procurement at the PC maker. It takes partially assembled systems from its manufacturing partners--the "carcass," as Neland puts it--and sends them to its own facilities to add the finishing touches, such as the installation of the processor, hard drive, memory and other system components.

This approach allows Dell to keep its customized, build-to-order strategy in place for the notebook market, Neland said. The company is unique in its reluctance to use indirect channels, such as retail stores, to reach customers.

If Dell was to leave the final assembly in the hands of its manufacturing partners, it would have to predict what types of configurations its customers are likely to order, and therefore carry more inventory than it would prefer, he said.

So in order to deliver a notebook to a buyer, Dell has to ship the partially assembled notebooks to its assembly facilities, coordinate the delivery of the key components from suppliers' warehouses, assemble the notebook and then ship it off to its destination. In a twist for a historically low-cost manufacturer like Dell, this actually increases its manufacturing costs to a certain degree, Neland said.

The company believes that it recoups that increased cost through its ability to offer buyers a specialized product, Neland said. Dell depends on business customers for the lion's share of its revenue, and those can be very exacting on the specific configuration of components they require, he said.

Will it work?
Dell has been able to make this approach work for many years because of its size and aggressive cost management, said Samir Bhavnani, an analyst at Current Analysis. But its rivals are catching up. HP has made significant improvements in reducing the cost of operating its PC business, and rivals like Lenovo and Acer are making similar strides, he said.

But as long as Dell wants to continue to worship at the altar of the direct model, it's likely to keep running its notebook factories like it always has, analysts said. Jeff Clarke, senior vice president of Dell's Product Group, said at a recent dinner that while "" has prompted a lot of soul-searching and reconsideration of long-held beliefs this year, moving away from the direct model is a "nonstarter."

Some analysts believe Dell is smart to stay the course. IDC predicts that notebook shipments will overtake desktop shipments in 2008 in developed economies like the U.S. and Western Europe. As the market grows, Dell might have an edge over competitors who are tied to their manufacturing partners, IDC's Shim said.

"As the market shifts more and more toward mobility, the bar is essentially going to rise," where unique products and service matter more than cost, he said.

If he's right, Dell might wind up ahead of its rivals with a unique manufacturing strategy that could be hard to duplicate.