(FORTUNE Magazine) – It's a wet morning in old Shanghai, and Dell salesman Peter Chan is selling hard. As the Yangtze River flows by the Bund district a few floors below, Chan is getting into a flow of his own. His subject: computers and the unique benefits of Dell's direct-selling model. His customer: Xiao Jian Yi, deputy general manager of China Pacific Insurance, a fast-growing state-owned insurance company. The audience: three of Xiao's subordinates.

China Pacific, a potentially big account, is in the process of computerizing its entire billing system. It already has about 400 desktops and about 70 servers, mainly from IBM and Hewlett-Packard. But Xiao needs more hardware. Much more.

Though Xiao's sleep-heavy eyes suggest he's heard it all before, Chan excitedly says that "direct selling" means China Pacific can order PCs directly through the Internet, the telephone, or salesmen like himself. At the mention of the Internet, still a rare marketing tool in China, the fustily dressed bureaucrat visibly perks up.

Chan goes on to explain that direct selling not only eliminates middlemen--saving Xiao and China Pacific a chunk of change--but also means that Dell can build China Pacific's computers to the firm's exact requirements, from the hardware on the outside to the software on the inside. A murmur of approval ripples through Xiao's subordinates. By the time Chan finishes with a description of Dell's convenient after-sales service, the rain has stopped and Xiao is smiling. "All salesmen from computer companies are aggressive," he says. Then Xiao whispers to FORTUNE: "But the Dell guys are even more aggressive."

That aggressiveness is beginning to pay off. Not only did Dell reel in the China Pacific account, but it is well on its way to becoming a major player in China. Last August, 34-year-old billionaire Michael Dell opened the fourth Dell PC factory in the world in Xiamen, a windswept city halfway between Hong Kong and Shanghai on China's southeastern coast. The point of Dell's push into China seems so obvious as to be a cliche: China is becoming too big a PC market for Dell, or anyone, to ignore. "If we're not in what will soon be the second-biggest PC market in the world," asks John Legere, president of Dell Asia-Pacific, "then how can Dell possibly be a global player?"

China is already the fifth-largest PC market, behind the U.S., Japan, Germany, and Britain. But if PC shipments in China continue to grow at an average annual rate of 30%--as they have over the past three years--China's PC market will surpass Japan's in only five years. Not even the Asian crisis has slowed down this growth. While crisis-wracked Asian markets like South Korea saw a 46% decline in PC shipments in 1997-98, for example, PC shipments to China surged 48%.

Though the competition is intense, Dell is confident it has a strategy that will pay off. First, it has decided not to target retail buyers, who account for only about 10% of Dell's China sales. That way Dell avoids going head to head against entrenched local market leaders like Legend. "It takes nearly two years of a person's savings to buy a PC in China," notes Mary Ma, the chief financial officer of Legend. "And when two years of savings is at stake, the whole family wants to come out to a store to touch and try the machine." Dell just isn't set up to make that kind of sale yet.

Instead, the company thinks it can make big inroads by selling directly to corporations. Established American PC makers in China--Hewlett-Packard, IBM, and Compaq--depend largely on resellers. Because of the cost savings derived from cutting out the middleman, Dell believes it can sell computers at lower prices than its competitors can--and thus steal market share. Already the gambit seems to be working: At the end of last year Dell's market share tripled to 1.2%, while Compaq's fell from 3.5% to 2.7%.

The outlook wasn't always so rosy. When Dell set up its first Asian factory in Malaysia in 1996, there were serious doubts as to whether its direct-selling model would work. Skeptics fretted that Asia's low Internet penetration and the value Asians put on personal relationships with distributors would punish the Dell model. But in practice Dell has managed to pump up sales during one of Asia's worst economic crises. That has silenced most of the critics.

In fact, the direct-selling model has almost certainly been a boon, not a barrier, to Dell's plans. "With low-priced, entry-level PCs shaving traditional profit margins, the direct-order model is gaining popularity across Asia," says Archana Gidwani, an analyst with the Gartner Group in Singapore. She figures that starting in 1998, direct sellers like Dell saw shipments in Asia jump 15%, while Hewlett-Packard, IBM, Compaq, and other PC makers that go through resellers saw shipments decline 3%. And she expects 40% of Asia's PC shipments to be ordered directly this year, up from roughly 30% last year. "Dell," she concludes, "is changing the way computers are being sold in Asia."

Though Dell started shipping computers in China only last August, it has already risen to become the country's eighth-largest PC maker; quarter-on-quarter sales are growing 50% on average, admittedly from a very low base. Dell will not say if its operations there are profitable yet.

More impressive is the fact that Dell is starting to rattle Chinese PC makers like Legend and Founder by nibbling into their most valuable client base: state-owned enterprises. These bureaucratic behemoths may seem an odd fit with Dell's fast-as-lightning direct model, but somehow it works. Two-thirds of Dell's corporate customers in China are state-owned enterprises, up from next to none ten months ago. The rest of Dell's customers are multinationals like Ericsson, Nortel, Motorola, and Ford. Dell hopes to keep signing up more Chinese companies--not easy, given the price-slashing tactics of the small shops that sell cheap PCs with bootlegged software. But if it does, then Dell will do something few U.S. companies in China ever manage to do: turn a profit without investing a fortune in manufacturing and without sharing the booty with a Chinese partner or middleman.

Why is Dell's direct model winning in China? First, look at the way Dell is selling to the Chinese. Shredding the myth that to sell in China requires padding the egos (and wallets) of capricious bureaucrats--usually during long and boring banquets--Dell is winning over the chief information officers of state-owned companies the American way: with speed, convenience, and service. "We don't have to change the formula," insists Dell salesman Peter Chan. "It will work in the U.S, China, India, or even in space."

At the heart of that "formula" is the simple tenet that the customer knows best. When Dell's Chan pauses for breath after his sales pitch at China Pacific, for example, the newly awakened Xiao peppers him with questions. How quickly will the computers arrive? Can Excel be loaded onto the hard drive? What kind of service does Dell offer? And, ahem, how much?

What is powerfully clear is that Xiao knows computers. He knows what he needs from Dell. He knows how much he wants to pay. Critically, Xiao knows enough that he does not need to see or touch the machine, or even raise a few glasses of Tsingtao beer with a honey-tongued distributor, before he orders it. All Xiao needs is a phone or, better yet, an Internet connection, to buy what he needs.

Such tech savviness and straightforwardness is increasingly common in China, and that is a terrific advantage for Dell, whose biggest perceived shortcoming was that it lacked the kind of service network that Hewlett-Packard or IBM has. These service networks can provide companies like China Pacific with technical advice and long-term system consultancy. But as Xiao makes clear, Chinese managers are growing more and more tech savvy on their own. They simply don't need that kind of babysitting--and they don't want to pay for it. "We may still need some consulting services, but in our front offices we know how to choose our equipment," says Xiao. "Dell provides exactly what we need, and with Dell we can choose exactly what we want."

In response, IBM, Hewlett-Packard, and other PC makers are changing tactics. Says Dennis Mark, Hewlett-Packard's computer-marketing director in Asia: "We're doing less with smaller local companies and focusing our resources more on big nationwide technology projects." For now, that gives Dell a clean shot at the low end of the PC market. But down the line Dell too may want to go after bigger, more complex sales. At that point competitors like Hewlett-Packard and IBM will have a considerable head start.

In the meantime, Dell will have its hands full in the direct-sales market. Chinese Internet use is spreading like a brushfire. Between 1997 and 1998, according to technical consultants at International Data Corp., the number of Internet users in China jumped 71%, to more than two million. But so far Dell sells only 5% of its PCs in China through the Net, compared with 25% worldwide. Dell's telephone sales also represent just a small percentage of its total, even though the company advertises aggressively on billboards. Part of the problem is that the Chinese are uncomfortable with credit card sales.

For now, however, Dell's going to have to invest more time and money in door-to-door sales calls to Chinese companies than it might like. For example, Dell's two dozen or so young, gung ho salesmen in Shanghai usually make three to four sales calls a day and spend roughly one-third of their time on the road. Not an easy life, but they are well rewarded for it. Dell will not tell how much they make, but says its sales staff in China is paid salaries and commissions commensurate with those paid in Hong Kong and the U.S. That's expensive, and until China catches up to the West in terms of Internet penetration and credit card use, those costs will take a tidy chunk out of Dell's earnings.

To offset its higher-than-expected marketing costs, Dell is cutting out fat and boosting operational efficiency at its Xiamen plant. In fact, Dell's modest manufacturing operations are a paragon of financial restraint in a country like China, where land and equipment costs can spiral out of control.

In Xiamen the operation is lean and smart. The entire assembly process employs only about 200 workers and is housed in a modest, airy room about the size of a high school gym. Workers scrutinize sales sheets detailing the hardware and software specs of each computer, which is then built according to the buyer's taste (luckily for Microsoft, the Chinese version of Word for Windows is the leading software request).

After the "fully loaded" computer rolls off the line, it goes to Xiamen's sleek and spacious airport to be flown to wherever the customer is located. In China the time it takes for a Dell PC to reach a customer, from order to delivery, is nine days, about the same as in the U.S. "We're leading the entire Dell world in terms of keeping to our promised delivery date," boasts David Chan, president of Dell China.

Behind that boast, of course, is China's increasingly impressive infrastructure of roads, airports, and ports. Belying those horror stories of endless paperwork slowing the traffic of goods or bad phones or potholed roads, most of urban China is relatively well linked. Bureaucratic bottlenecks do arise from time to time, but Dell's just-in-time model is probably easier to execute in China than it would be in, say, the Philippines or India.

Getting the PC to the customer quickly also saves Dell a ton of cash. Because its just-in-time model forces Dell to keep its inventory levels low--about six days' worth of supply, compared with 40 for Chinese PC leader Legend--Dell saves time and money that would otherwise be wasted on warehousing. Shorter inventory cycles also give Dell a greater degree of control over price and profitability than its Chinese competitors have. "The sub-$1,000 PC has been driven by Chinese distributors who have to move obsolete products that have been lying around their warehouses," argues Dell's Legere. "We'll never be driven by those factors, because our inventory cycles in China are so short."

Also greasing the efficiency of Dell in China is money, or to be more precise, stock options. David Chan says the options scheme is meant to "instill a sense of ownership," but most Chinese workers are likelier to see a direct link between their output and the stock price--which is, after all, not a bad way to look at it. Around August every employee in Xiamen got roughly 200 shares of Dell, back when its stock was trading near $60. Three months later Dell's shares had shot up to $110, giving each employee a paper gain of about $10,000. That equals roughly one year's salary for the average Xiamen worker. "Then it dawned on me that they had no idea of the value of the paper in their hands," says Chan. After the worth of the options was explained at a workers' meeting, Chan noticed an uptick in productivity: "They were good before. Now they're better."

So what can go wrong? To some extent, Dell has had to deal with the traditional bugbears of factory life in China: idleness and corruption. The concept of a job for life, though no longer a guarantee in today's China, still attracts workers who expect to spend hours drinking tea or reading the papers on the factory floor--and keep their jobs. Dell China executives acknowledge that at first a little "reeducation" was necessary in Xiamen so that workers understood that their jobs depended on their performance.

Corruption has been a trickier issue. Though Dell vehemently denies that it has ever paid a bribe to get a license or a sales order, David Chan admits he had to "terminate" two Chinese employees suspected of corruption. It's no coincidence, either, that Dell's top salesmen in China are not mainland Chinese but predominantly Overseas Chinese from Hong Kong or Singapore, where the sales culture is defined more by doggedness than by personal favors. Peter Chan, for example, is from Hong Kong.

The company must also grapple with the problem of software piracy. Microsoft estimates that over 95% of the software in use in Chinese corporations is stolen. In fact, setting up a factory in China was Dell's defense against pirates. Concerned that pirates would load bad software onto its machines, ruining its reputation, Dell now controls the process from beginning to end. That quality control is a relief to Dell, its customers, and Microsoft, which collects its Dell-related revenue reliably. But quality costs: No matter how frugal Dell's operations, it cannot compete on price with the small job shops that sell knockoff PCs equipped with bootleg software. Dell computers sell for about the same as in the U.S.--$1,200 to $1,500 each, depending on what is loaded.

Dell's biggest problem, though, is a product of its success: Because the Dell direct model is so simple, it can be copied. And that's just what Legend is doing. "Yes, we're using Dell's direct-selling model when we target Chinese government companies or multinationals in China," admits Mary Ma. For a start, Legend is aping Dell's cash-management model, reducing the time it takes to get payment from its distributors by half, to 30 days. It is also rapidly moving toward Dell's just-in-time delivery model, trying to sell directly to its corporate customers and shaving excess inventory. It is even offering stock options to employees. All these copycat moves will make Legend a more formidable company and should therefore have Dell worrying.

Another cause for concern is China's often nationalistic politics, which can quickly turn against U.S. corporations. Consider, for example, the rash of anti-American demonstrations that swept across China after NATO's accidental bombing of the Chinese embassy in Belgrade in mid-May. Not only were U.S. embassies pelted with eggs and stones, but so were Nike and McDonald's outlets. Given the billions at stake in the telecom and PC markets in China, high-profile U.S. companies like Motorola or Dell could be vulnerable to the ups and downs in Sino-American relations, though retail outlets, not tech factories, seem to be bearing the brunt of patriotic dudgeon so far. "It's not a given for U.S. companies, especially information technology companies, to come into China and grab the entire market," warns Dong Tao of Credit Suisse First Boston Securities in Hong Kong. "The Chinese government has made no secret of the fact that it wants to promote national industries like IT."

Where will Dell be in China five years from now? It will probably never be the No. 1 PC maker in China, or even No. 2, slots that are likely to be occupied by local manufacturers, which will always be able to sell more cheaply to China's masses. Ironically, that seems to suit Dell just fine. Grabbing market share, in the U.S., China, or anywhere else, has never been its highest priority. Profits are. Says John Legere of the estimated $25 billion in revenue that computer sales will generate in China by 2002: "Even if we get 1% of $25 billion, that's a lot. You don't need to be the market leader in China to be profitable."

One thing's for sure: The Dell model is working in China. And as long as China's PC market continues to grow, Dell is ready to grow with it--provided it sticks to that model and continues to execute it better than anyone else.