Wednesday, November 23, 2011

(empo-tuulwey) @stevedenning on Clayton Christensen, Ratios, and Absolutes

When I was taking my MBA classes at Cal State Fullerton, we spent a lot of time analyzing companies and looking at various ratios.

According to a Forbes article by Steve Denning (H/T Bill Gross via a Google+ share), Clayton Christensen believes that our concentration on these ratios is stifling innovation in the United States.

Christensen cites the story of an American company, Dell, who pursued higher profitability ratios and ended up creating a competitor:

Christensen retells the story of how Dell [DELL] progressively lopped off low-value segments of its PC operation to the Taiwan-based firm ASUSTek [LSE: ASKD]—the motherboard, the assembly of the computer, the management of the supply chain and finally the design of the computer. In each case Dell accepted the proposal because in each case its profitability improved: its costs declined and its revenues stayed the same. At the end of the process, however, Dell was little more than a brand, while ASUSTeK can—and does—now offer a cheaper, better computer to Best Buy at lower cost.

Dell isn't the only company who has outsourced huge chunks of operations to Asia. Morris Chang, whose company TSMC is one of the beneficiaries of American outsourcing, thinks that we're crazy:

You Americans measure profitability by a ratio. There’s a problem with that. No banks accept deposits denominated in ratios. The way we measure profitability is in ‘tons of money’. You use the return on assets ratio if cash is scarce. But if there is actually a lot of cash, then that is causing you to economize on something that is abundant.

Read the rest of the Forbes article here.

In the spirit of what Christensen has said, it's interesting to read the press release which accompanied Dell's latest quarterly statement. Here are some excerpts:

Dell's continued strategic focus on higher-value opportunities, combined with an increased mix of enterprise solutions and services sales, resulted in increased profitability on revenue of $15.4 billion in its third quarter, flat compared with revenue a year ago....

Revenue for Dell's enterprise solutions and services business -- including sales of servers, storage, networking, and services -- increased 8 percent over the same quarter last year to $4.7 billion, an all-time high. As the revenue mix steadily shifts more to the higher-value enterprise portfolio, Dell is delivering on its commitment to improve profitability, with operating income up 12 percent for the quarter and at 7.6 percent of revenue for the fiscal year to date.

So Dell is moving into "higher-value" businesses - something that many people, including myself, would praise. I've been in the software industry for over two decades - sometimes in software-only situations, and sometimes in situations in which fairly unique software is bundled with mostly-commodity hardware. With this mix of hardware and software, software is obviously better from a margin standpoint.

So what has this targeted strategy done for Dell?

Revenue in the quarter was $15.4 billion, flat compared with the same quarter last year.

Remember what Morris Chang said. From Chang's perspective, are this year's dollars better than last year's dollars? And when you look at Dell division by division, you can see some cracks in the story.

Consumer revenue was $2.8 billion, a 6 percent decline. Operating income was $76 million or 2.7 percent of revenue. The migration to higher-value products has proven to be effective, with overall company revenue for the high-end XPS consumer laptop growing 207 percent. XPS revenue now accounts for nearly 20 percent of Dell's total consumer laptop business.

An outstanding success story - and it's probably the reason why I'm not typing this post on a Dell (or Hewlett-Packard) computer. In fact, I happen to be using an Asus netbook.

Of course, we all know that schlock companies like Asus are no competition for a strong American company like Dell.

And of course, thirty years ago we all knew that schlock companies like Dell and Compaq (at the moment, part of Hewlett-Packard) were no competition for a strong American computer manufacturer like IBM.
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