Dell Hbr Case Study

INTRODUCTION dell Computers was started by Michael dingle in 1984. dells primary differentiator was its origin model. It exchange primarily on the B2C food market and custom built personal computers on demand. Therefore, it had very diminished schedule by comparison to its competitors. As a consequence of this, dingle was able to operate quite efficiently and accessionably in its niche market. By the late 1980s early 1990s, dell notice that its market shargon was just now 1% of total and that pains amalgamations could potentially force Dell out of the market.It was time to make a finis it could rest posture quo or pursue an aggressive proceeds strategy. The latter option proved to be favourable and Dell expanded into the B2B marketplace through a suppuration plan that focused on selling to retailers to improve its market share. The plan worked and Dell saw subsequent revenue developments of 268% within two course of studys, compared to industry suppuration of 5 %. 1 The good times came to an end in 1993 when Dell posted its first loss after eleven subsequent billet of profit. Dell decided to more efficiently manage its liquidity, profitability and growth and was exited the indirect retail channel where margins were exceptionally low . The retail channel had served its purpose, however, in assisting Dell as a brand to become well known throughout the market place. Following these measures, and the fact that Dell had exceptionally low relative inventory, they were able to become the first keep bon ton to launch the bare-ass Pentium knap computers and maintain first mover status with subsequent upgrades.Michael Dell was now in a position to forecast future growth for his company. STATEMENT OF PROBLEM Michael Dell predicted that the companys growth rate for the next year would again outdo the industry. Dell needed to focus on how its working large(p) policy could assist in financial support future growth. Further, what other indis pensable and international financing options might assist Dell in reaching their goals? RECOMMENDATION Assuming Dells sales leave alone grow at 50% in 1997, h ow would you recommend that the company fund this growth?How much bully would need to be cut down and/or profit margin increase if the company were to fund its growth by relying only on internal sources of expectant? What steps would you recommend the company take? Dells attempt to increase its sales by 50% in 1997 provide require 2 major types of investments Investment in working smashing We estimate this figure to be $345M (please call down to face 1 for the detailed calculation). Investment in fixed assets Expansion of production leave behind most likely require the purchase of the additional equipment.There is no selective information available in the case on depreciation expenses or capital expenditures made by Dell in 1996 to support the 52% growth of sales. However, if we signify to Dells full financial l ines for 1996, we see that Dell spent $100M on capital expenditures and we assume it result spend approximately the very(prenominal) add up in 1997. 1 2 Richard Ruback, Dells workings capital letter, Harvard backup Review 9-201-029 (2003) 3. Ibid 1P a ge EDHEC MBA Dell cable strip From the projected figures in the Exhibit 1 we conclude that Dell will be able to finance the above investments exploitation the quest reinforcement sources wampum margins and management of the working capital cycle Assuming that there is a certain percentage of fixed damages in Dells equal social organisation, the company will be able to increase its concluding profit margin from 5. 1% in 1996 to 5. 6% in 1997, generating a last-place profit of $448M. scratch margin should be sufficient to cover additional working capital of $345 M if Dell is able to maintain its Cash reincarnation wheel ( cardinal) at 1996 takes of 47 long time. Maintaining the CCC at the same level is crucial for t his type of financing to be sufficient.An increase in DSO by 5 geezerhood will increase working capital delta up to $453M (refer to Exhibit 2) and will force Dell to increase margins, which may reduce revenues, or flavour for other sources of funding. Debt or use of the succinct consideration investment funds The use of these resources might be necessary for the financing the purchase of the equipment to expand the production capacity. both scenarios could take place 1. A one-off investment is required to be made in the beginning of the year.Since the company will have no contingency to sire profits or free up its working capital, it could either liquidate some of its short term investments of $591M or get a loan. The decision will depend on whether the rate of return on investment is higher or lower than the interest rate on the loan, taking after assess effects into consideration. If the rate of return is higher, Dell should finance the purchase of fixed assets through the loan, if it is lower , it should use its investment account to finance the capital expenditure. 2. tardy investment in capital expenditure is possible.This could be done only by using margins nonplusd within the year and decrease in CCC by managing dues- age cycle. If the company can manage to decrease its DSO days from 50 to 40 days, it can reduce its working capital delta to $126M (Exhibit 2), consequently making the stay net profit available for capital expenditures. How, if at all, would your answers to Question 3 chang e if Dell also repurchased $500 million of common stock in 1997 and repaid its semipermanent debt? If Dell decides to repay its debt of $113M and repurchase stock of $500M, the following steps could be underinterpreted.Stock repurchase A decrease in DSO by 10 days and increase in DPO by 10 days will release working capital of $44M in addition to cash profit based on $448M in accounting profit (most likely it is higher by the amount of depreciation). These ca sh amounts will then resign Dell to repurchase its stock. As Dell expands its node base and brand penetration in the market it can start working with prepayment for its orders which will help to collect the cash faster. Further, as the size of it of its orders to suppliers grows, it will be able to exercise its buyer power and negotiate more favourable payment terms.However the following action should be taken only if Dell shareholders could earn mend return at a similar level of risk in the market. In the current situation it seems that Dell performs get around than its competitors thus it would be more appropriate to invest the $500Mof free cash in advertize expansion. Debt repayment If Dell increases its margin up to 6. 8% it will be able to make an additional $110M in net profit to repay the debt. Another option is to free up some funds from short term investments. The decision will depend 2P a ge EDHEC MBA Dell Business quality on whether increase in wrong will lead to a significant loss of customers.If this is the case, the company should use its current cash reserves to perform the repayment. We also note, that 0% debt in the capital structure is most likely to be not optimal for the company and by using leverage Dell will be able generate better returns for its investors. DISCUSSION Explain how Dells working capital policy is a competitive advantage for the company? Strategy Built-to-Order Just-In-Time Delivery dispersal carry (Retail Stores) too soon Adoption of New Technology DELL ? ? X ? Apple X X ? X Compaq X X ? X IBM X X ? X Built to Order Unit production only begins after receiving customer orders over phone or via email.This significantly reduced the cracking inventory and hence reduced working capital requirements for funding inventory warehousing and inventory financing. Just-in-time Delivery Dells factory had close tangible proximity to its suppliers. Suppliers would ship parts only after customers placed orders, for just-in- time delivery. This helped to maintain accounts due to a minimum. No Retail Distribution Channels Since orders were only taken via email or phone, Dell was able to cut down on the costs of maintaining distribution channels and reduce accounts receivable from distributors and retailers.This reduced working capital requirements. Early Adoption of New Technology Low inventory levels helped Dell to quickly switch to newer product upgrades and reduce the cost of existing inventory turnovers compared to competitors. This further reduced working capital requirements. DSI Advantage As a result of above strategies, Dell achieved an average DSI of 40 between 1993 and 1995, compared to Apples 64, Compaqs 68 & IBMs 56. How did Dell fund its 52% growth in 1996?Please be sure to distinguish between internal and external sources of funding, and to argue the plenty -off between the use of external funds in order to maintain high growth rates. The 52% growth was a result of the new Pentium chip i ntroduction (Exhibit 3 from the case). Regarding working capital management, we noticed from Exhibit 2 from the case, excellent accomplishment in maintaining CCC at 40 days period product switches required double stock management. As the Pentium introduction was already launched in 1995, we assume that growth was constant and continuous during 1996 period.Compared to 1995, the 1996 financial performance for vulgar margin is lower by 1%, but net profit has increased by 1%. 3P a ge EDHEC MBA Dell Business Case To improve the availability of cash, Dell can implement factoring on receivables (internal) or negotiate with banks for short term creed lines and overdraft accounts (external). blush if CCC remains constant during this period of growth, balance sheets analysis shows that CCC changed from $428M in 1995 to $689M in 1996. As the debt level remained constant during these two periods, this wasted $261M was financed with internal funds.The two main sources of internal funds us ed to finance working capital and CAPEX (not detailed in case information) were The $272M 1996 net profit and the capital increase at $74M (total stock value difference between 1995 and 1996). Even if Dell decided to not reduce its amount of debt, this process will allow the company to reduce the Debt/Equity ratio keeping constant level of debt while significantly increasing equity. This strategy will bring Dell more tractableness for the future.The firm will be able to consider different options for future growth either the same strategy the issuance of more debt due(p) to their low leverage being relatively unleveraged. 4P a ge EDHEC MBA Dell Business Case APPENDIX Exhibit 1 communicate Income statement and balance sheet items for the year 1997 Item Sales Cost of sales Gross Margin Operating expenses Operating income Financing and other income Income taxes 30% Net profit 1996 (actual) 5 296 4 229 1 067 690 377 6 111 272 Growth Coefficient 1,5 1,5 1,4 1997 (projected) 7 944 6 3 44 1 601 966 635 6 192 448 Ratios 37 1 37 DSI 50 1 50DSO 40 1 40 DPO 47 1 47 CCC Balance sheet items 429 644 Inventory 726 1 089 Accounts receivable 466 699 Accounts payable 689 1 034 work Capital 345 Additional working capital required Projections for the year 1997 were built based on the following assumptions 1. Growth coefficient of 1,5 was applied to income sales and cost of sales to reflec t the projected 50% growth in operations 2. Growth coefficient of 1,4 was applied to operating expenses. The assumption was made that part of operating expenses are presented by fixed costs thus they dont grow at the operations growth ration. 0% rate was taken based on the year 1996 increase. 3. Income taxes were calculated using 30% rate being the rate on income tax in 1996 (calculated as Income taxes/(Operating income + Financing income)) 4. Ratios for the year 199 were calculated using the following radiation diagrams DSI=Inventory*365/COS DSO=Accounts Receivable*365/Sales DPO=Accounts Payable*365/COS 5. We assumed that company will maintain the average ratios for the year 1997 6. Using the sneak formula for ratios calculations we derived accounts receivable, accounts payable and inventory for 1999 from the projected sales and COS figures. . We calculated Working Capital for both years using the formula Inventory + Accounts receivable Accounts payable 8. Additional working capital required Working capital 1997 Working Capital 1996 5P a ge EDHEC MBA Dell Business Case Exhibit 2 Variations in working capital requirements 37 50 40 47 37 55 40 52 37 40 40 37 -10 days on DSO + 10 days in DPO 37 40 50 27 Inventory, $mln Accounts receivable, $mln Accounts payable, $mln 644 1 088 699 643 1 197 695 643 871 695 643 871 869 Working Capital 1997, $mln Working Capital 1996, $mln 1 033 689 1 145 689 818 689 645 689 344 456 129 -44 ItemDSI, days DSO, days DPO, days CCC, days Additional working capital required, $mln Ratios at 1996 level +5 days in DSO -10 days in DSO Exhibi t 3 Detailed calculations relative to question N2 6P a ge EDHEC MBA Dell Business Case 1 CCC worth calculation (see figures in red rectangle) CCC = DSI + DSO DPO From above table, CCC = inventories + Accounts receivables Accounts payable CCC1995 = 293 + 538 403 = 428 M$ CCC1996 = 429 + 726 466 = 689 M$ 2 Total stocks value (see figures in blue rectangle) Total value = Preferred stocks + Common stocks 1995 = 362 M$ 1996 = 436 M$ 7P a geDell Hbr Case StudyINTRODUCTION Dell Computers was started by Michael Dell in 1984. Dells primary differentiator was its business model. It sold primarily on the B2C market and custom built personal computers on demand. Therefore, it had very low inventory by comparison to its competitors. As a result of this, Dell was able to operate quite efficiently and profitably in its niche market. By the late 1980s early 1990s, Dell noticed that its market share was only 1% of total and that industry amalgamations could potentially force Dell out of the market.It was time to make a decision it could remain status quo or pursue an aggressive growth strategy. The latter option proved to be favourable and Dell expanded into the B2B marketplace through a growth plan that focused on selling to retailers to improve its market share. The plan worked and Dell saw subsequent revenue increases of 268% within two years, compared to industry growth of 5%. 1 The good times came to an end in 1993 when Dell posted its first loss after eleven subsequent quarters of profit. Dell decided to more efficiently manage its liquidity, profitability and growth and was exited the indirect retail channel where margins were exceptionally low . The retail channel had served its purpose, however, in assisting Dell as a brand to become well known throughout the market place. Following these measures, and the fact that Dell had exceptionally low relative inventory, they were able to become the first company to launch the new Pentium chip computers and maintain fi rst mover status with subsequent upgrades.Michael Dell was now in a position to forecast future growth for his company. STATEMENT OF PROBLEM Michael Dell predicted that the companys growth rate for the next year would again outpace the industry. Dell needed to focus on how its working capital policy could assist in financing future growth. Further, what other internal and external financing options might assist Dell in reaching their goals? RECOMMENDATION Assuming Dells sales will grow at 50% in 1997, h ow would you recommend that the company fund this growth?How much capital would need to be reduced and/or profit margin increased if the company were to fund its growth by relying only on internal sources of capital? What steps would you recommend the company take? Dells attempt to increase its sales by 50% in 1997 will require 2 major types of investments Investment in working capital We estimate this figure to be $345M (please refer to Exhibit 1 for the detailed calculation). Inves tment in fixed assets Expansion of production will most likely require the purchase of the additional equipment.There is no data available in the case on depreciation expenses or capital expenditures made by Dell in 1996 to support the 52% growth of sales. However, if we refer to Dells full financial statements for 1996, we see that Dell spent $100M on capital expenditures and we assume it will spend approximately the same amount in 1997. 1 2 Richard Ruback, Dells Working Capital, Harvard Business Review 9-201-029 (2003) 3. Ibid 1P a ge EDHEC MBA Dell Business Case From the projected figures in the Exhibit 1 we conclude that Dell will be able to finance the above investments using the following funding sourcesProfit margins and management of the working capital cycle Assuming that there is a certain percentage of fixed costs in Dells cost structure, the company will be able to increase its net profit margin from 5. 1% in 1996 to 5. 6% in 1997, generating a net profit of $448M. Net margin should be sufficient to cover additional working capital of $345 M if Dell is able to maintain its Cash Conversion Cycle (CCC) at 1996 levels of 47 days. Maintaining the CCC at the same level is crucial for this type of financing to be sufficient.An increase in DSO by 5 days will increase working capital delta up to $453M (refer to Exhibit 2) and will force Dell to increase margins, which may reduce revenues, or look for other sources of funding. Debt or use of the short term investment funds The use of these resources might be necessary for the financing the purchase of the equipment to expand the production capacity. Two scenarios could take place 1. A one-off investment is required to be made in the beginning of the year.Since the company will have no possibility to generate profits or free up its working capital, it could either liquidate some of its short term investments of $591M or get a loan. The decision will depend on whether the rate of return on investment is high er or lower than the interest rate on the loan, taking after tax effects into consideration. If the rate of return is higher, Dell should finance the purchase of fixed assets through the loan, if it is lower , it should use its investment account to finance the capital expenditure. 2. Gradual investment in capital expenditure is possible.This could be done only by using margins generated within the year and decrease in CCC by managing receivables-days cycle. If the company can manage to decrease its DSO days from 50 to 40 days, it can reduce its working capital delta to $126M (Exhibit 2), thus making the remaining net profit available for capital expenditures. How, if at all, would your answers to Question 3 chang e if Dell also repurchased $500 million of common stock in 1997 and repaid its long-term debt? If Dell decides to repay its debt of $113M and repurchase stock of $500M, the following steps could be undertaken.Stock repurchase A decrease in DSO by 10 days and increase in DP O by 10 days will release working capital of $44M in addition to cash profit based on $448M in accounting profit (most likely it is higher by the amount of depreciation). These cash amounts will then allow Dell to repurchase its stock. As Dell expands its customer base and brand penetration in the market it can start working with prepayment for its orders which will help to collect the cash faster. Further, as the size of its orders to suppliers grows, it will be able to exercise its buyer power and negotiate more favourable payment terms.However the following action should be taken only if Dell shareholders could earn better return at a similar level of risk in the market. In the current situation it seems that Dell performs better than its competitors thus it would be more appropriate to invest the $500Mof free cash in further expansion. Debt repayment If Dell increases its margin up to 6. 8% it will be able to make an additional $110M in net profit to repay the debt. Another opti on is to free up some funds from short term investments. The decision will depend 2P a ge EDHEC MBA Dell Business Case on whether increase in price will lead to a significant loss of customers.If this is the case, the company should use its current cash reserves to perform the repayment. We also note, that 0% debt in the capital structure is most likely to be not optimal for the company and by using leverage Dell will be able generate better returns for its investors. DISCUSSION Explain how Dells working capital policy is a competitive advantage for the company? Strategy Built-to-Order Just-In-Time Delivery Distribution Channels (Retail Stores) Early Adoption of New Technology DELL ? ? X ? Apple X X ? X Compaq X X ? X IBM X X ? X Built to Order Unit production only begins after receiving customer orders over phone or via email.This significantly reduced the outstanding inventory and hence reduced working capital requirements for funding inventory warehousing and inventory financing . Just-in-time Delivery Dells factory had close physical proximity to its suppliers. Suppliers would ship parts only after customers placed orders, for just-in-time delivery. This helped to maintain accounts payable to a minimum. No Retail Distribution Channels Since orders were only taken via email or phone, Dell was able to cut down on the costs of maintaining distribution channels and reduce accounts receivable from distributors and retailers.This reduced working capital requirements. Early Adoption of New Technology Low inventory levels helped Dell to quickly switch to newer product upgrades and reduce the cost of existing inventory turnovers compared to competitors. This further reduced working capital requirements. DSI Advantage As a result of above strategies, Dell achieved an average DSI of 40 between 1993 and 1995, compared to Apples 64, Compaqs 68 & IBMs 56. How did Dell fund its 52% growth in 1996?Please be sure to distinguish between internal and external sources of fund ing, and to discuss the trade -off between the use of external funds in order to maintain high growth rates. The 52% growth was a result of the new Pentium chip introduction (Exhibit 3 from the case). Regarding working capital management, we noticed from Exhibit 2 from the case, excellent performance in maintaining CCC at 40 days while product switches required double stock management. As the Pentium introduction was already launched in 1995, we assume that growth was constant and continuous during 1996 period.Compared to 1995, the 1996 financial performance for gross margin is lower by 1%, but net profit has increased by 1%. 3P a ge EDHEC MBA Dell Business Case To improve the availability of cash, Dell can implement factoring on receivables (internal) or negotiate with banks for short term credit lines and overdraft accounts (external). Even if CCC remains constant during this period of growth, balance sheets analysis shows that CCC changed from $428M in 1995 to $689M in 1996. As the debt level remained constant during these two periods, this extra $261M was financed with internal funds.The two main sources of internal funds used to finance working capital and CAPEX (not detailed in case information) were The $272M 1996 net profit and the capital increase at $74M (total stock value difference between 1995 and 1996). Even if Dell decided to not reduce its amount of debt, this process will allow the company to reduce the Debt/Equity ratio keeping constant level of debt while significantly increasing equity. This strategy will bring Dell more flexibility for the future.The firm will be able to consider different options for future growth either the same strategy the issuance of more debt due to their low leverage being relatively unleveraged. 4P a ge EDHEC MBA Dell Business Case APPENDIX Exhibit 1 Projected Income statement and balance sheet items for the year 1997 Item Sales Cost of sales Gross Margin Operating expenses Operating income Financing and other in come Income taxes 30% Net profit 1996 (actual) 5 296 4 229 1 067 690 377 6 111 272 Growth Coefficient 1,5 1,5 1,4 1997 (projected) 7 944 6 344 1 601 966 635 6 192 448 Ratios 37 1 37 DSI 50 1 50DSO 40 1 40 DPO 47 1 47 CCC Balance sheet items 429 644 Inventory 726 1 089 Accounts receivable 466 699 Accounts payable 689 1 034 Working Capital 345 Additional working capital required Projections for the year 1997 were built based on the following assumptions 1. Growth coefficient of 1,5 was applied to income sales and cost of sales to reflec t the projected 50% growth in operations 2. Growth coefficient of 1,4 was applied to operating expenses. The assumption was made that part of operating expenses are presented by fixed costs thus they dont grow at the operations growth ration. 0% rate was taken based on the year 1996 increase. 3. Income taxes were calculated using 30% rate being the rate on income tax in 1996 (calculated as Income taxes/(Operating income + Financing income)) 4. Ratios for the year 199 were calculated using the following formulas DSI=Inventory*365/COS DSO=Accounts Receivable*365/Sales DPO=Accounts Payable*365/COS 5. We assumed that company will maintain the average ratios for the year 1997 6. Using the reverse formula for ratios calculations we derived accounts receivable, accounts payable and inventory for 1999 from the projected sales and COS figures. . We calculated Working Capital for both years using the formula Inventory + Accounts receivable Accounts payable 8. Additional working capital required Working capital 1997 Working Capital 1996 5P a ge EDHEC MBA Dell Business Case Exhibit 2 Variations in working capital requirements 37 50 40 47 37 55 40 52 37 40 40 37 -10 days on DSO + 10 days in DPO 37 40 50 27 Inventory, $mln Accounts receivable, $mln Accounts payable, $mln 644 1 088 699 643 1 197 695 643 871 695 643 871 869 Working Capital 1997, $mln Working Capital 1996, $mln 1 033 689 1 145 689 818 689 645 689 344 456 129 -44 ItemDSI, day s DSO, days DPO, days CCC, days Additional working capital required, $mln Ratios at 1996 level +5 days in DSO -10 days in DSO Exhibit 3 Detailed calculations relative to question N2 6P a ge EDHEC MBA Dell Business Case 1 CCC worth calculation (see figures in red rectangle) CCC = DSI + DSO DPO From above table, CCC = inventories + Accounts receivables Accounts payable CCC1995 = 293 + 538 403 = 428 M$ CCC1996 = 429 + 726 466 = 689 M$ 2 Total stocks value (see figures in blue rectangle) Total value = Preferred stocks + Common stocks 1995 = 362 M$ 1996 = 436 M$ 7P a ge