Joel wrote yesterday about Local Optimization, or, The Trouble With Dell. It's about how Dell has almost eliminated inventory from their system:

Unfortunately, the dirty little secret about Dell is that all they have really done is push the pain of inventory up to their suppliers and down to their customers. Their suppliers end up building big warehouses right next to the Dell plants where they keep the inventory, which gets reflected in the cost of the goods that Dell consumes.

Although this specific technique is what has made Dell famous, the overall type of business practice isn't unique to them. In school we talk a lot about "sustainable competitive advantage" , we talk about it because in business school everything has to be boiled down to a silly phrase so that you don't think about it too much. Usually, with a SCA, they look at the words Sustainable and Advantage together. The idea being to see how difficult it would be for your competitors to copy what you're doing. However, there's something to the word "sustainable" on its own too.

While the press always praises how well Dell can keep those inventory costs down, all Dell is doing, as Joel points out, is offsetting it to their suppliers. This also gives Dell huge leverage over these suppliers, because now they have warehouses sitting right next to Dell's plants, so they have to sell to Dell, and they have huge sunk costs in building these facilities. So Dell can use their leverage to kill their suppliers' chances at profits, driving margins to almost zero, and the suppliers don't have a choice. In this business its extra bad, because then they have less money to reinvest in technology, making it easier for other companies to catch up.

Outside of computers, Walmart does the same thing. They're so huge that if you produce commodity widgets, you need to sell those widgets through Walmart, or you're not going to have a large enough market. Walmart uses this leverage to kill the margins that producers otherwise would be making. Short-term, this is a great for Walmart, they can extract more rents from the value chain. Long-term, they're just pissing these people off. We'll ignore the similar effects they have on the communities they move into.

Long term, what this means for companies like Dell and Walmart, is that growth is dependent on screwing their suppliers. Once those margins are at zero, growth becomes increasingly difficult. It also means that as soon as there's an alternative, suppliers are happy to move to someone who treats them better. I would hate to sell a product through Walmart, and if I had just created the "Next-Great-Thing, I would avoid them for as long as I could. Long-term, I just can't believe that that's good business sense on their part.