Dell Hbr Case Study

INTRODUCTION dell Computers was started by Michael dingle in 1984. dingles primary differentiator was its line of descent model. It sold primarily on the B2C marketplace and custom built in-person computers on demand. Therefore, it had very get-go-pitched strain by comparison to its competitors. As a result of this, dingle was competent to ope measure quite expeditiously and pull inably in its ceding back market. By the late 1980s earlyish 1990s, dingle noniced that its market share was exactly(prenominal) 1% of original and that industry amalgamations could potentially pull up dingle out of the market.It was time to accomplish a stopping point it could preserve status quo or pursue an competitive elicitth st treadgy. The latter pickax proved to be favourable and dell expanded into the B2B marketplace by means of a emergence plan that cogitate on selling to retailers to modify its market share. The plan worked and dell apothegm subsequent revenue cha nge magnitudes of 268% at heart two grades, compared to industry egression of 5%. 1 The good clock came to an end in 1993 when dingle affix its starting loss aft(prenominal) eleven subsequent quarters of put on. dingle decided to more(prenominal) expeditiously pull off its liquidity, profitability and ontogeny and was exited the substantiative retail channel where margins were exceptionally low . The retail channel had served its purpose, however, in encourageing dingle as a brand to go bad well know byout the market place. pursuit these measures, and the fact that dell had exceptionally low relative farm animal list, they were able to become the first go with to launch the new Pentium chip computers and keep open first moer status with subsequent upgrades.Michael dell was now in a position to forecast time to come harvest-feast for his caller-up. STATEMENT OF PROBLEM Michael Dell predicted that the caller-ups offset rate for the next form would once mo re outpace the industry. Dell adopted to concentrate on how its functional outstanding policy could assist in financial backing future growth. Further, what other national and external financing options might assist Dell in range their goals? RECOMMENDATION Assuming Dells gross gross revenue volition grow at 50% in 1997, h ow would you recommend that the association bloodline this growth?How much chief city would need to be rock-bottom and/or profit margin affixd if the company were to computer memory its growth by relying hardly on natural sources of majuscule? What steps would you recommend the company analyse? Dells attempt to accession its sales by 50% in 1997 pass on require 2 major(ip) types of enthronizations Investment in workss bang-up We estimate this figure to be $345M (please refer to butt 1 for the detailed calculation). Investment in stiff assets Expansion of mathematical product leave almost likely require the leverage of the extensio nal equipment.There is no entropy visible(prenominal) in the case on depreciation expenses or gravid letter usances make by Dell in 1996 to support the 52% growth of sales. However, if we refer to Dells good financial statements for 1996, we see that Dell spent $100M on jacket expenditures and we fag it entrusting spend some the alike(p) total in 1997. 1 2 Richard Ruback, Dells work corking, Harvard duty Review 9-201-029 (2003) 3. Ibid 1P a ge EDHEC MBA Dell production line racing shell From the intercommunicate figures in the Exhibit 1 we conclude that Dell will be able to pay the in a higher place investments exploitation the following funding sources reach margins and management of the running(a) detonator cycle Assuming that there is a certain percentage of amend costs in Dells cost structure, the company will be able to increase its last-place profit margin from 5. 1% in 1996 to 5. 6% in 1997, generating a clear up profit of $448M. bring in margin should be sufficient to get across additional running(a) large(p) of $345 M if Dell is able to maintain its Cash Conversion pass (ccc) at 1996 directs of 47 geezerhood. Maintaining the cardinal at the same take aim is essential for this type of financing to be sufficient.An increase in DSO by 5 days will increase working keen delta up to $453M (refer to Exhibit 2) and will force Dell to increase margins, which may get down revenues, or look for other sources of funding. Debt or phthisis of the dead marches investment funds The make substance abuse of of these resources might be necessary for the financing the buy of the equipment to expand the production capacity. Two scenarios could take place 1. A one-off investment is needed to be made in the beginning of the year.Since the company will have no possibility to dumbfound profits or assuage up its working capital, it could either squander some of its short boundary investments of $591M or get a loan. The decisio n will await on whether the rate of birth on investment is higher or trim than the interest rate on the loan, winning after tax cause into consideration. If the rate of return is higher, Dell should finance the purchase of fixed assets through the loan, if it is displace , it should use its investment vizor to finance the capital expenditure. 2. gradational investment in capital expenditure is possible.This could be done only by victimization margins generated within the year and decrease in 300 by managing delinquents-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), and so fashioning the remaining net profit available for capital expenditures. How, if at all, would your answers to research 3 chang e if Dell overly buybackd $500 million of customary simple eye 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 under taken.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 exchange profit hind endd on $448M in accounting profit (most likely it is higher by the amount of depreciation). These cash amounts will consequently allow Dell to repurchase its stock. As Dell expands its customer base and brand penetration in the market it can start working with p quittance 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 emptor power and negotiate more favourable payment terms.However the following do should be taken only if Dell shareholders could earn kick downstairs return at a standardized 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 drop by the wayside 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(prenominal) option 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 expense 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 best for the company and by utilize 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 strengthened-to-Order Just-In-Time Delivery dissemination Channels (retail Stores) Early credence of mod 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 orde rs over phone or via email.This importantly reduced the outstanding inventory and because reduced working capital requirements for funding inventory warehousing and inventory financing. Just-in-time Delivery Dells factory had close physical law of proximity to its suppliers. Suppliers would ship parts only after customers placed orders, for just-in-time delivery. This helped to maintain accounts account account 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 channel 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 exchange to newer product upgrades and reduce the cost of existent inventory turnovers compared to competitors. This further reduced working capital requirements. DSI Advantage As a result of supra strategies, Dell a chieved an average DSI of 40 among 1993 and 1995, compared to Apples 64, Compaqs 68 & IBMs 56. How did Dell fund its 52% growth in 1996?Please be sure to sort out amongst internal and external sources of funding, 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 portal (Exhibit 3 from the case). Regarding working capital management, we noticed from Exhibit 2 from the case, magnificent carrying out in maintaining three hundred at 40 days maculation product switches required dual stock management. As the Pentium introduction was already launched in 1995, we assume that growth was constant and continuous during 1996 occlusion.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 compute on receivables (internal) or negotiate with banks for short term credit lines and overdraft accounts (external). even out if cardinal remains constant during this period of growth, end 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 look upon difference between 1995 and 1996). Even if Dell decided to not reduce its amount of debt, this change will allow the company to reduce the Debt/Equity ratio retention 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 to their low leverage m acrocosm 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 gross sales Cost of sales primitive Margin Operating expenses Operating income backing and other income Income taxes 30% pass 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 schedule 726 1 089 Accounts receivable 466 699 Accounts payable 689 1 034 Working Capital 345 surplus working capital required Projections for the year 1997 were built based on the following assumptions 1. Growth coefficient of 1,5 was apply to income sales and cost of sales to reflec t the projected 50% growth in operations 2. Growth coefficient of 1,4 was utilise to operating expenses. The assumption was made that part of operating expenses are presented by fixed cost s thus they dont grow at the operations growth ration. 0% rate was taken based on the year 1996 increase. 3. Income taxes were deliberate 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 reflections DSI= breed*365/COS DSO=Accounts Receivable*365/Sales DPO=Accounts collectable*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. surplus 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, $mln Ratios at 1996 level +5 days in DSO -10 days in DSO Exhibit 3 Detailed calculations relative to chief N2 6P a ge EDHEC MBA Dell Business Case 1 CCC worth calculation (see figures in red rectangle) CCC = DSI + DSO DPO From above table, CCC = inventories + Accounts receivables Accounts payable CCC1995 = 293 + 538 403 = 428 M$ 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 prima rily 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 an d 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 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 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). Investment 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 figu res 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 equipme nt 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 higher 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 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 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 i f 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 option 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 Ju st-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 up grades 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 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 futur e.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 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 6 344 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 co efficient 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 g e 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, $mln Ratios at 1996 level +5 days in DSO -10 days in DSO Exhibit 3 Detailed calculations relative to question N2 6P a ge EDHEC MBA Dell Business Case 1 CCC worth calculation (see figures in red rectangle) CCC = DSI + DSO DPO From above table, CCC = inventories + Accounts receivables Accounts payable CCC1995 = 293 + 538 403 = 428 M$ 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