How a capacitor popped Dell's reputation

November 24, 2010 10:44 AM EST

From 2003 to 2005 Dell shipped 11.8 million PCs with a known defect but chose not to fully disclose the situation to all of its customers. The inside details of its management decisions, unsealed after settlement of a lawsuit, and the consequences of its customer service blunders, appeared side-by-side in two New York Times stories recently.

Dell finally settled the lawsuit in September and its enterprise business has recovered. But the consumer side is struggling, in part because of what one analyst called "lingering" negative perceptions of its customer service.

There's a lesson in this, and if you think your business is immune from the slippery slope that took Dell down I've got news for you: It's not. I've been there. I've seen it happen. History repeats itself in this industry - over and over again. And unless you have the right corporate culture and policies in place you could easily be next. Here are the failure points to avoid.

Failed capacitor. Source: Wikipedia. See Capacitor plague. For a different view see the image of a failed Dell capacitor in How cheap technology is costing us dear.

Failure to stand down

At first Dell underestimated the scope of the problem, which it tracked back to inferior capacitors that could lead to a catastrophic failure of PC motherboards. Dell grossly underestimated failure rates. Early on it expected rates as high as 12%, which is bad enough. But even as it revised estimated failure rates drastically upward, Dell continued to ship PCs with the defective capacitors as it struggled to identify the components and remove them from its supply chain.

Dell kept production moving and revenues coming in in the short term, but it also dramatically increased its liability and damaged the company's reputation for quality.

Failure to be proactive

Rather than be proactive, Dell's strategy was to "fix on fail." Even as some frustrated customers reported failure after failure and rumors began to circulate, for the vast majority of customers Dell did not choose to proactively replace or repair machines known to have the defective component.

As the scope of the crisis became clear, with at least one volume customer reporting failure rates exceeding 20 percent, and with its its own estimates projecting potential failure rates of of 45 to 97 percent, management made a series of decisions that appear to have been carefully calibrated to minimize Dell's financial exposure and avoid a full recall.

The PC maker began proactively replacing PCs with the defect, but only for its large customers that made volume purchases, and then only after the customer experienced a failure rate exceeding 5%. It also triaged customers into three categories: Those who might move their accounts over the issue, those who might cut back on purchases over the problems - and everyone else.

For consumers, small volume purchasers and those larger buyers not deemed to be a sales risk, Dell apparently instructed its support teams not to proactively notify and replace but to continue to "fix on fail." This wasted the time of IT professionals who had to call in failures one at a time as batches of PCs purchased from Dell continued to break after placed into service.

Failure to come clean

Dell didn't level with its customers. Some of the most damaging internal documents described in the New York Times article were those instructing Dell employees to keep customers in the dark. Employees were told "Don't bring these to the customer's attention," and "Emphasize uncertainty." In so doing, Dell breached the customer's trust.

In an apparent attempt to assuage employees' consciences about this decision, a management memo explained why Dell wasn't being more proactive: "Our approach to this issue delivers the best customer experience because it minimizes disruption."

But it didn't minimize disruption forĀ  customers, some of whom were on the phone repeatedly as shipments of computers failed one by one. In at least one case a customer reported a failure rate of 20%.

Dell's experience is far from unique. More than 25 years ago, when I worked for a top-tier PC clone maker's technical support department, I received similar instructions with regard to a defective batch of chips that affected all shipments for an entire line of computers. We were not to disclose that it was a known problem - even after we finally had a fix for it. To management, hiding the truth from customers was all about business. But everyone in that technical support group knew what we were doing.

We were lying to our customers.

I left a few months later.

The fallout

Dell settled the lawsuit over the capacitor failure issue with Advanced Internet Technologies this fall, and eventually replaced 22 percent of the motherboards in 21 million OptiPlex computers at a cost of $300 million - about $65 per serviced PC. Those are just the costs we know about.

Dell may have saved money in the short run by keeping the assembly lines running and not being more proactive in fixing known problems. But I doubt the profitability of machines shipped during that period look very good when adjusted for these costs. Clearly, Dell's profitability took a big hit in the long run.

But more importantly, Dell degraded its most valuable asset: Goodwill. It's hard to place a cost on a loss of brand equity.

Who's next?

Problems like this don't drop like a bomb. They creep up slowly and insidiously. Tactics that may be appropriate early on may need to change quickly in response to market and customer feedback. As the problem scales up, however, human nature will take a business down the slippery slope - unless you're prepared. Do you have a plan?

If you don't have a culture that stresses quality and long term value over short term profits, that stresses a real-time, open and honest exchange with customers, that offers a well defined strategy on how to escalateĀ  problems - and a clearly communicated policy up and down the chain of command to enforce it - you just might find yourself in the same place.

History repeats itself in this business. Don't let the next company in the news be yours.