Dell's Working Capital

FM-1 ASSIGNMENT

ON

DELL’S WORKING CAPITAL

BY

MITRAPUTRA GANGULI

BM SECTION B

B17090

CASE BACKGROUND

Dell Computer Corporation, founded in 1984 in its early days dealt in selling IBM compatible personal computers by upgrading them. The business was done by directly selling the computers to the businesses through mail order. Soon Dell began to market its own brand of computers by taking orders over toll free telephone and transporting them directly to the customers. In fact this low cost sales/distribution model of beginning the production cycle only after receiving the order from the customer became Dell’s core strategy along with them being the first company in the personal computers industry to provide toll-free telephone customer service.

During the 1980s and 1990s most of the prominent companies in the personal computers industry forecasted the demands for a specific time period and kept sizeable finished goods inventory in their stock, in contrast Dell’s total work in progress and finished goods inventory was just 10% to 20% of the total inventory. Most of Dell’s inventory consisted of the components, such as processor chips, of which the 80% of a computer is built. The advantage of this process is that when the current technology became obsolete, which happened fairly regularly, the price of the finished products reduced even up to 30% but just keeping components gave Dell the flexibility to manufacture as per the customer’s requirements. Also other companies spent a lot of money on maintenance of inventory in stock and retail channels.

Between 1990 and 1996 Dell had come a long way from just 1% market share in the US PC market to being one of the market leaders. Dell realized their standalone direct sales will not allow them to expand, hence they started selling their computers through indirect channels such as CompUSA. Additionally Dell also targeted the foreign markets. Soon sales increased by a total of 268% between 1990 and 1993, in comparison the industry growth was just 5% per annum. Even though they had captured a significant part of the market they were unable to generate a profits, evident from them making a loss of 76 Million USD in the second quarter of 1993. Hence they slowly shifted their focus from market capture to liquidity, profitability and growth. They attained this by dropping the indirect channels that were giving them low profit margins as well as improving their forecasting reporting and inventory controls. Dell was the first company in the personal computers space to convert its entire major product line into the latest Pentium Technology. Dell was also able to quickly upgrade its systems when they became old and obsolete while the others were still selling these obsolete units. Similarly Dell also equipped its systems with Windows 95 operating system the very day Microsoft launched it.

Although Dell had shown excellent financial results and growth in the recent times the management wanted to strategize its plan for future growth while expecting double-digit growth in the coming years.

PROBLEM STATEMENT

• Requirement of funds to support the growth

Dell has shown an impressive growth in net revenue by 52% in 1996 over 1995 which happens to be much better than the growth reported by the personal computers industry which stands at 31%. This impressive figure can be mainly attributed to the technological advancement flexibility of the company such as converting the entire product line to Pentium and equipping all the systems with Windows 95 operating system on the day of the launch itself and now Dell is expecting similar growth in the fiscal year of 1996-97. Growth is usually funded in two possible ways, internally and externally. Internally funded growth means the company funding its growth through the retained earnings from the last fiscal year while externally funded growth uses external sources of monetary supply such as taking loans or issuing new shares to the market. Till 1996 Dell had mostly funded its growth internally but now with the company going bigger and bigger they needed to come up with an optimum strategy for funding.

• Problems related to the present Build to Order Strategy

The present system of beginning the production cycle only after receiving the order from the customer is the primary the reason behind Dells success. It has various advantages such as low finished goods inventory reducing the carrying and maintenance cost, much better flexibility in terms of modifying the equipment to suit the current requirement of the customers. One of the major problems on the other hand was running out of stock when the market demand suddenly soars. For example when in 1996 the demand went much more than the forecasted numbers they suffered opportunity loss. Another major problem with this was the bargaining power it gave to the suppliers, as Dell required constant and steady flow of components to ensure low inventory the suppliers of those components enjoyed bargaining power over Dell. Also because of the new vendor management system brought into business in 1993, the number of suppliers had greatly reduced. Even though the quality and performance of the components improved, but this in turn increased the risk for the company in terms of the supplier control over the services it offers to Dell.

• Declining Debt to Equity ratio

If we look at the long term debt to equity ratio we will find that it has constantly decreased over the past 3 years. The Debt to equity ratio in 1994 was 0.21, in 1995 the same was 0.17 while in 1996 the ratio has come down to 0.11, it shows that the funding of Dell Computer Corporation has been heavily dependent on the funds received through equity and not taken any major long term loans in the recent years.

Debt is always a cheaper source of funding when compared to equity hence we can correctly conclude that Dell has been opting for the more expensive source of funding and it would be beneficial if they raise some fund through long term loans. Although Dell had been funding its recent growth internally they might be willing to consider the option of funding the growth through external option, primarily long term loans.

• Working Capital Management

Dell has always maintained a low inventory business model which helped them stay assets light and hence the company had a low Days Sales of Inventory (DSI). DSI means the average number of days supported by the inventory kept in stock at a specific time. Dell had considerably reduced this number from 55 in 1993 to 32 in 1995 and presently keeping it at 31. This number is much lower when compared to its major industry competitors with Apple keeping its DSI at 54 and Compaq keeping the same at 73. But the only problem with this is that in case the sales demand suddenly increases Dell will not be able to meet the demand requirements for as many days as the others. If we look at its Days of Sales Outstanding (DSO) number it is averaged around 50 for the year of 1996 which hasn’t improved much over the past few years, while the Days Payable Outstanding has consistently reduced from around average of 50 in 1993 to 40 in 1996 and 33 in the most recent quarter. This shows loss of credibility of the company in front of its suppliers and increase in the power of the suppliers over Dell. The Cash Conversion Cycle has not improved either hence it reduces the liquidity of the company by depriving it of readily available cash.