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Dell’s Working Capital

Essay by   •  February 15, 2017  •  Case Study  •  1,017 Words (5 Pages)  •  1,695 Views

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Dell’s working capital

Background:  Dell Computer Corporation was founded in 1984 by Michael Dell.  The company designed, manufactured, sold and serviced high performance personal computers (PCs) compatible with industry standards.  Dell markets and sells its own brand PC, taking orders via toll free telephone line, and shipping directly to customers.  Selling directly to customers was Dell’s core strategy, primarily through advertising in computer trade magazines and catalog.  The company adopted build-to-order model, where production cycle began after a customer’s order is received.  A customized order is normally delivered within a few days, giving a competitive advantage over its peers.  

  1. How well was Dell doing financially and strategically?  Why?

From 1991 to 1995, Dell appeared to outperform the industry average in terms of global revenue growth as seen in Exhibit 1.  The significant revenue growth was achieved because of the flexibility in working capital and the strategy to expand sales distribution channels to resellers and mass market retailers, i.e. CompUSA and Staples Inc.).  The build-to-order manufacturing system has enabled Dell to move quickly from old to new component technology, such as: Pentinum microprocessor, to anticipate demand, while other players still had to sell piled up old PC systems.  However, sole focus in boosting revenue growth and the lack of inventory management had created excess inventory sell-off (disappointing notebook line) for the second quarter of 1993, which resulted to a $76m loss for that quarter despite a 53% increase in revenue.  Since then, Dell shifted its focus from exclusively growth to liquidity, profitability and growth.  The first step was to exit the low margin indirect retail channel.  In 1995, Dell also started to established goals on ROIC (Return on Invested Capital) and CCC (Cash Conversion Cycle) as well as new vendor qualification programme, in order to improve its internal systems for forecasting, reporting and inventory control.  These changes with Dell’s re-entry into the notebook market and its rapid introduction of computer systems based on new Pentium microprocessor chip, fueled the company’s recovery.  By July 1995, Dell became the first manufacturer to convert its entire major product line to Pentium technology.

In 1996 this strategy shifts proofed successful, as a high growth rate of >50% has been reached (outpacing the industry by 20 percentage points), while still earning a net profit margin of 5,1%.

This has been possible because of several reasons:

  • low capital intensity of growth because of low working capital
  • highly competitive time to market because PCs were only manufactured after a customer has placed an order. In a sector were technological updates occur very fast it is advisable to not hold many finished goods in inventory
  • Good relationships with suppliers (Just in Time production)
  • Ability to quickly act on supplier recalls of components (manufacturing process allows quick time to market without decreasing quality of the products)

The market for PC does not value quick delivery but is highly elastic towards price and technological progress. Dell set up its operation to meet these factors.

  1. How was Dell’s working capital a competitive advantage?

Dell’s working capital is not per se a competitive advantage. It’s manufacturing, sales and supplier processes which have led to low working capital requirements are the real competitive advantage, because of the following factors:

  • Cheap growth
  • High manufacturing flexibility (goods were not finished before the order was placed, only components were held in inventory)
  • Flexible relation with suppliers
  • Direct contact with customers (better demand forecast) – via post sales customer services
  • Ability to offer competitive prices

  1. Assuming Dell sales will grow 50% in 1997, how might the company fund this growth internally?  How much would working capital need to be reduced and/ or profit margin increased?  What steps do you recommend the company take?

By increasing sales by 50%, Sales in 1997 would rise to USD 7.9 bn. and assuming a stable profit margin of 5% net profits would rise to USD401M.

Assuming that the Working capital figures evolve linear, according to their relative value of 1996, the maximum figures of DSI, DSO ad DPO must be take into account, to determine the working capital financing need.

As the Working capital in 1996 has been USD689M. and is projected to be USD997M. In 1997 there is a financing need of USD311M.

This financing need could be covered by reducing the Cash Cycle by around 12 days (see Table 2), for example by reducing the DSO and increasing the DPO. (Inventory are probably already at an optimal level)

If the financing cannot be done internally an alternative would be to increase the net profit margin by 4 percentage points to 9%.

Conclusion:

Increasing profit margin by 80% and at the same time increasing sales by 50% seems very unlikely. It seems more feasibly to further optimize working capital by reducing DSO and increasing DPO. Additionally, the management could decide to use some of the short term investments on the balance sheet to invest it in working capital.
Furthermore, management should first of all carefully analyse if a further 50% sales increase is advisable or if slower growth would not be better for the company and its investors.

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