DELLS WORKING CAPITAL

Donna Gracia T. Inso Dr. Elpidio L. Malasig Joryl Mamon

BACKGROUND OF THE CASE

Dell Computer Corporation was founded in 1984 by then 19-year old Michael Dell. The company designed, manufactured, sold and serviced high performance personal computers (PCs) compatible with industry standards. Initially, the company purchased IBM compatible personal computer, upgraded them, and then sold the upgraded PCs directly to businesses by mail order. Subsequently, Dell began to market and sell its own brand personal computer, taking orders over a toll free telephone line, and shipping directly to customers. Selling directly to customers was Dells core strategy. Their modes of advertising were made through computer trade magazines and in a catalog. Dell combined this low-cost sales/distribution model with a production cycle than began after the company received a customers order. This build-toorder model enabled Dell to deliver a customized order within a few days, something its competitors could not do. Dell was also the first in the industry to provide toll-free telephone and on-site technical support in an effort to differentiate itself in customer service.

BACKGROUND OF THE CASE

Dells inventory management practiced the build-to-order model where computers are built only after receiving the customers order. In contrast, industry leaders such as Compaq, Apple, and IBM built to forecast and maintained sizeable finished goods inventory in their stock or at their channel partners. This style yielded low finished goods inventory balances for Dell. The following is a comparison of Dells level of inventory over its competitors:
Nature of Inventory (% to Total Inventory)
WIP & Finished Goods

Dell
10%-20%

Compaq/Apple/IBM
50%-70% (excluding inventory resellers)

Dell however, maintained an inventory of components. The cost of individual components, such as processor chips, comprised about 80% of the cost of a PC. The prices of such fell by an average of 30% a year due to the changing technology. Delivery of parts from the suppliers are often made on a daily basis since many of the suppliers warehoused are closed to Dells plants. The amount of suppliers inventory requisition depends on the companys forecast.

BACKGROUND OF THE CASE

The following shows the highlights of Dells operations from September 1990 August 1993: In 1990, Dell had only 1% of the U.S. PC market share. It was in September 10, 1990 that Dell announced it was breaking from its direct-only business model and would begin to use CompUSA as its channel, in an attempt to capture sales from small businesses and first time consumers. Dell expanded more by adding other mass market retailers. The company also entered the foreign markets, relying on resellers to distribute its product. Annual sales increased by 268% within 2 years compared to industry growth of 5% and moved Dell into the top 5 in worldwide market share. However, it was in August 1993 that Dell reported a $76 million dollars loss for the 2nd Quarter of 1993. The loss was tied to $71 million in charges relating to the sell-off of excess inventory and the cost of scrapping a disappointing notebook computer line. Dell also incurred restructuring charges to consolidate its European operations that had become redundant and inefficient. Its profit margin fell to 2%, which is below the companys target of 5%.

BACKGROUND OF THE CASE

Due to the net loss suffered, Dell shifted its focus from exclusively growth to liquidity, profitability and growth. The following actions were taken by Dell: Adopted a company-wide metrics requiring each business unit to provide detailed profit and loss statements. In July 1994, Dell exited the low margin indirect retail channel. Late in 1995, Dell instituted goals on ROIC (Return on Invested Capital) and CCC (Cash Conversion Cycle). Dell took measures to improve its internal systems for forecasting, reporting, and inventory control. A new vendor certification program was put in place, reducing the number of suppliers, ensuring component quality, and improving delivery performance. Brought in seasoned managers to lead the company during its next stage.

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BACKGROUND OF THE CASE

These changes, combined with Dells re-entry into the notebook market, and its rapid introduction of computer systems based on Intel Corporations new Pentium microprocessor chip, fueled the companys recovery. Dells direct contact with customers helped it anticipate demand for newly developed Pentium-based systems and its low inventory of 386 and 486 technology made it less costly for it to move quickly. Dell beat the competition to the market place with Pentium-based products and was the first in the industry to achieve volume production of systems with the 120 mhz Pentium processor. In July 1995, Dell became the first manufacturer to convert its entire major product line to the Pentium technology. Dell was able to offer faster systems at the same price that rivals were marketing older Pentium technology. Because of its low finished goods inventory, Dell didnt have to dismantle PCs to replace the microprocessor when Intel Corporation discovered its Pentium chip was flawed in 1994. It was able to manufacture systems with the updated Pentium chip, while others were still selling flawed systems from inventory.

BACKGROUND OF THE CASE

With Dells reported revenue of $5.3 billion for its 1996 fiscal year, net income of $272 million or 5.1% of sales, and sales up by 52% over the prior year, Michael Dell expected that double-digit growth would continue. However, management needed a plan for financing the future growth to which industry analyst anticipated the personal computer market to grow 20% annually over the next three years.

PROBLEM IDENTIFICATION
- Given the anticipation of 20% growth rate by the industry analysts for personal computer market, how would Dell finance its sales growth for Year 1997 and beyond?

OBJECTIVES
To be able to come up with funding options for 20% expected sales growth for the Year 1997 and beyond and evaluate the advantages and disadvantages of each option. To be able to continuously improve the internal system of Dell in terms of its forecasting, reporting, and inventory control for the years to come.

To be able to become the world-leader in the computer industry offering the latest computer operating systems and providing at the same time excellent customer service for the next years to come.

AREAS FOR CONSIDERATION

Dell has an effective marketing strategy described as follows: o Dell adopts the direct selling model which is considered to be its core strategy. The direct-selling model makes the company understand their customers better and eliminates the retailer cost. o Being a direct marketer, delivery of computers with updated operating system to the market is made faster. Dell has an efficient inventory control system described as follows: o Dell adopts also the build-to-order model which is considered to be a competitive advantage because the company need not maintain adequate finished goods inventory and will only assemble products as soon as an order is placed. With this, the company can save inventory cost and apply new technology on their product quickly by using the just-in-time approach. o Because of the fast innovations in technology, changing the components of the computer need not be costly on the part of Dell because of the low finished goods inventory maintained on hand.

AREAS FOR CONSIDERATION

Dell has an improving Cash Conversion Cycle evident with the following data:
Quarter Period Days Sales in Inventory (DSI) Days Sales Outstanding (DSO) Days Payable Outstanding (DPO) Cash Conversion Cycle (CCC)

Q1 1993 Q2 1993 Q3 1993 Q4 1993 Q1 1994 Q2 1994 Q3 1994 Q4 1994 Q1 1995 Q2 1995 Q3 1995 Q4 1995 Q1 1996 Q2 1996 Q3 1996 Q4 1996

40 44 47 55 55 41 33 33 32 35 35 32 34 36 37 31

54 51 52 54 58 53 53 50 53 49 50 47 47 50 49 42

46 55 51 53 56 43 45 42 45 44 46 44 42 43 43 33

48 40 48 56 57 51 41 41 40 40 39 35 39 43 43 40

AREAS FOR CONSIDERATION

Dells annual worldwide sales dollar growth always outweigh the industry

Calendar Year 1991

Dell 63%

Industry -2%

1992 1993
1994 1995

126% 43%
21% 52%

7% 15%
37% 31%

ALTERNATIVE COURSES OF ACTION

ALTERNATIVE 1: Finance the 20% expected sales growth by increasing Dells financial leverage. Advantages: Outsourcing funds for future growth is a contingent measure on the part of the company to avoid shortage of funds when needed. Disadvantages: Outsourcing funds through loan borrowings entails interest expense while outsourcing through issuance of capital stock entails diluted earnings/share and dividends/share. Increase in liabilities increases risk of non-payment in case business will not do well. A huge amount of liability in the Balance Sheet is not favorable from an investors point of view.

ALTERNATIVE COURSES OF ACTION

ALTERNATIVE 2: Finance the 20% expected sales growth internally by continuously improving Dells financial performance and position through an increase in profit margin and a decrease further in the Cash Conversion Cycle. Assuming all other ratios remain the same, let us first compute the expected funds needed to finance the said growth rate:

ALTERNATIVE COURSES OF ACTION

If all other ratios remain the same, we can say that Dell need not source out the funds needed to support the 20% sales growth rate.
Advantages:
Internal financing does not entail interest costs. Using Dells internal funds can payout its long term debt and increase its dividend policy without affecting its growth and future expansion potentials. By using its inventory system accurately, the company has more than enough resources to finance its growth internally and without any need for external financing. Same goes with the collection policy of Dell, if DSO remains lower, then the company has sufficient internal funds that can be used as working capital. Capital need not be tied up with Inventory and Accounts Receivable.

Disadvantage:
Failure on the part of the management to maintain the 5% target for profit margin would mean that the expected Net Income will not be achieved, hence additional funding is needed. Same goes if the Cash Conversion Cycle (CCC) is not maintained.

RECOMMENDATION
Given the problem of Dell Computer Corporation, the group recommends Alternative #2 as the solution to the problem. Finance the 20% expected sales growth internally by continuously improving Dells financial performance and position through an increase in profit margin and a decrease further in the Cash Conversion Cycle. This is the best alternative due to the following reasons:
Advantages:
Internal financing does not entail interest costs. Using Dells internal funds can payout its long term debt and increase its dividend policy without affecting its growth and future expansion potentials. By using its inventory system accurately, the company has more than enough resources to finance its growth internally and without any need for external financing. Same goes with the collection policy of Dell, if DSO remains lower, then the company has sufficient internal funds that can be used as working capital. Capital need not be tied up with Inventory and Accounts Receivable.

POTENTIAL PROBLEM ANALYSIS

A growth rate beyond the expected 20% sales growth for the next years to come will not assure that internal funds will still be sufficient to finance the increase if the management failed to maintain or improve its Cash Conversion Cycle (CCC) and Return on Invested Capital (ROIC).