Dell’s Working Capital

The Questions

• How was Dell’s working capital policy a competitive advantage?

• How did Dell fund its 52% growth in 1996?

The Questions

• 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?

• How would your answer to the above question change if Dell also repurchased $500 million of common stock in 1997 and repaid the long-term debt?

Dell’s Competitive Advantage

1) Conservation of capital due to lower inventory holding

Compaq DellDSI in 95 73 32

Cost of sales of Dell in 95 = $2737 mn. (Ex.4)

Additional inventory at Compaq’s DSI = $2737 * (73-32) / 360 = $312 million

Dell’s Competitive Advantage

2) Reduced obsolescence risk and lower inventory cost

• Component cost can reduce by 30% a year as new technology is introduced.

• Inventory as % of COS – Dell (8.9%) and Compaq (20.3%)

• Inventory loss due to 30% reduction in price – Dell (2.7%) and Compaq (6.1% of COS)

• Comparative increase in profit in Dell in 96 = $2.7 billion *(6.1%-2.7%) = $93 million

Dell’s Competitive Advantage

3) Quicker adoption of new technology• Dell’s low inventory levels resulted in fewer

obsolete components as technology changed.

• While Compaq had to market both new and older systems due to high levels of inventory, Dell could offer new and faster systems quickly due to low inventory and build-to-order models.

Funding 52% Growth in 1996

Facts to consider• 95- Total assets = 46% of sales• 95- ST investments = 14% of sales• 95- Operating assets = 32% of sales• 95- Net profit = 4.3% of sales• 96- Dell would require 32% of increased sales

in operating assets i.e. $(5296-3475)*32% = $582 million.

Funding 52% Growth in 1996

Facts to consider• 96- All assets excepting ST investments will

grow at 52% over 95 figures• 96- Assumed that the liabilities will also

proportionally increase.• 96- Need additional $582 million assets

Funding 52% Growth in 1996

Facts to consider• 96- Sources of funds:

- Increase in liabilities = $494 million- Operational profit = $5296*4.3%

= $ 227 million- ST investments = $484 million

• Enough available money for internal funding

How Dell Funded 1996 Growth?

Facts • Higher asset efficiency

- Reduced cash, receivables, inventory and other current assets- Needed addl. $447 million of operating assets

How Dell Funded 1996 Growth?

Facts • Sources of funds

- Increase in current liabilities = $187 million

- Net Profit = $272 million

How Dell Performed in 1996?

• Dell introduced Pentium technology.• Unit sales grew by 48%.• Average unit revenue grew by 3%.• Gross margin declined by 1% due to

aggressive pricing strategies and account mix shift.

• Net margin improved from 4.3% to 5.1%• Common stock was issued to employees.

Funding 50% Growth in 1997

Facts to consider• 96- Operating assets = 30% of sales• 96- Net profit = 5.1% of sales• 97- Dell would require 30% of increased sales

in operating assets i.e. $(2336-1557) = $779 million.

Funding 50% Growth in 1997

Facts to consider• 97- Increase in liabilities = $588 million• 97- Net profit = 5.1% of $5296*1.5

= $405 million• ST investments = $591 million av.

• So, internally growth can be funded.

97 with Repayment of LT Debt and Repurchase of $500 mn. Of Equity

• Funds needed = $984 million• Sources of Funds:

- 1% increase in margin = $79 million- ST investments = $591 million av.- Also, negative cash conversion cycle can do ( 97- Avg. daily sales = 96 sales*1.5/360 = $22.1 mn. and Avg. daily COS = 79.8% of sales as in 96 = $17.6 mn. i.e. 44 days of sales or 65 days of COS. 96- CCC = 40 days)

97- Actual Cash Conversion Cycle

QTR.4 1996 Qtr.4 1997 Diff.

DSI 31 13 -18DSO 42 37 -5DPO 33 54 +21CCC 40 -4 -44

CCC = DSI + DSO -DPO

Savings from WC Improvements

Annual savings from:- Reduced inventory = 18*17.6 = $317 mn.- Reduced Receivables = 5*22.1=$110 mn.- Increased Payables =21* 17.6=$ 370 mn.

Total savings = $797 mn.

Actual 1997

• Sales grew by 47%.• CCC became – 44.• Profit margin increased to 6.6% from 5.1%.• Component prices decreased. Advantage over

competitors.• Dell applied JIT philosophy.

Actual 1997

• Operating assets increased by $199 million only.

• Total liabilities increased by $733 million even after repayment of LT debt.

• Dell obtained $279 million from put options.• About $500 million equity repurchased.• ST investments increased by $646 million.

Actual 1997

Dell funded 1997 growth internally, repaid long-term debt and repurchased about $500 million in equity through a combination of working capital and margin improvements.