Dell Hbr Case Study

INTRODUCTION dingle Computers was started by Michael dingle in 1984. dingles primary differentiator was its none model. It sold primarily on the B2C grocery and custom built person-to-person computers on demand. Therefore, it had very minuscule memorandum by comparison to its competitors. As a egress of this, dell was equal to ope draw quite expeditiously and pull aheadably in its niche merchandise. By the late 1980s earlyish 1990s, dell sight that its foodstuff parcel was simply 1% of join and that industry amalgamations could potentially force dell out of the market.It was time to gear up a last it could remain come in quo or pursue an hard-hitting ontogenesis st wandergy. The latter option proved to be favour satis accompanimentory and dell work outed into the B2B marketplace through a branch plan that rivet on selling to retailers to improve its market share. The plan worked and dell precept subsequent revenue subjoins of 268% within devil yrs, compa inflamed to industry harvest of 5%. 1 The good times came to an contain in 1993 when dingle affix its initiatory loss later 11 subsequent quarters of make headway. Dell decided to much efficiently like its liquidity, profitability and growth and was exited the substantiating retail channel where strands were exceptionally pocket-sized . The retail channel had served its purpose, however, in emboldening Dell as a dishonor to become well know throughout the market place. Following these measures, and the fact that Dell had exceptionally low relative account, they were sufficient to become the first fpacernity to launch the unexampled Pentium chip computers and retain first m everywhere status with subsequent upgrades.Michael Dell was now in a position to forecast time to come growth for his companionship. STATEMENT OF PROBLEM Michael Dell predicted that the attach tos growth ordain for the next form would again outpace the industry. Dell gather uped to digest on how its functional nifty policy could assist in entrepoting future growth. Further, what other essential and international financing options might assist Dell in reaching their goals? passport Assuming Dells gross revenue go away grow at 50% in 1997, h ow would you recommend that the company fund this growth?How much heavy(p) would need to be shrinkd and/or profit margin ontogenyd if the company were to fund its growth by relying just on knowledge fit sources of peachy? What steps would you recommend the company reappearance? Dells attempt to increase its gross sales by 50% in 1997 pass on require 2 major casings of enthronements Investment in on the job(p) outstanding We estimate this figure to be $345M (please relate to Exhibit 1 for the exposit calculation). Investment in intractable assets Expansion of produceion pass on about possible require the bargain for of the additional equipment.There is no data operational in the case on deprec iation expenses or capital up deal gots make by Dell in 1996 to support the 52% growth of sales. However, if we refer to Dells intact financial statements for 1996, we see that Dell dog-tired $100M on capital expenditures and we bear it give spend approximately the same sum total in 1997. 1 2 Richard Ruback, Dells on the job(p) with child(p), Harvard occupancy Review 9-201-029 (2003) 3. Ibid 1P a ge EDHEC MBA Dell line of merchandise human face From the communicate figures in the Exhibit 1 we reason that Dell lead be able to pay the above investments use the pursuit supporting sources advantage margins and conductment of the operative capital bike Assuming that there is a certain percentage of fixed cost in Dells cost structure, the company will be able to increase its illuminate profit margin from 5. 1% in 1996 to 5. 6% in 1997, generating a force out profit of $448M. Net margin should be sufficient to engender additional running(a) capital of $345 M i f Dell is able to maintain its Cash Conversion Cycle ( cardinal) at 1996 trains of 47 twelvemonths. Maintaining the cardinal at the same train is crucial for this type of financing to be sufficient.An increase in DSO by 5 geezerhood will increase functionals capital delta up to $453M (refer to Exhibit 2) and will force Dell to increase margins, which may abase revenues, or savour for other sources of funding. Debt or theatrical role of the hornswoggle boundary investment mo illuminateary resource The practice session 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 demand to be made in the beginning of the year.Since the company will have no possibility to have profits or free up its running(a) capital, it could either kill some(prenominal) of its short term investments of $591M or get a loan. The decision will depend on whether the s core of render on investment is higher or tear down 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 routine its investment account to finance the capital expenditure. 2. Gradual investment in capital expenditure is possible.This could be get dressede only by using margins generated within the year and decrease in cardinal by managing receivables-old 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), thus making the be net profit open for capital expenditures. How, if at all, would your answers to Question 3 chang e if Dell besides redemptiond $500 million of common fall in 1997 and repaid its long-term debt? If Dell decides to repay its debt of $113M and repurchase credit line of $500M, the following steps could be underi nterpreted.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 funds profit based on $448M in accounting profit (most probable it is higher by the amount of depreciation). These silver amounts will then intromit Dell to repurchase its business line. As Dell expands its customer base and home run penetration in the market it can start working with prepayment for its sites which will help to collect the notes faster. Further, as the size of its orders to suppliers grows, it will be able to exercise its emptor power and negotiate more comfortable payment terms.However the following bodily function should be taken only if Dell shareholders could earn punter return at a similar level of risk in the market. In the current situation it seems that Dell toy abouts better than its competitors thus it would be more appropriate to invest the $500Mof free cash in further expansion. Debt repayment If Dell in creases 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 subject on whether increase in footing will lead to a important 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 using supplement Dell will be able generate better returns for its investors. backchat Explain how Dells working capital policy is a competitive advantage for the company? Strategy strengthened-to-Order Just-In-Time Delivery scattering carry (Retail Stores) Early Adoption of refreshed Technology DELL ? ? X ? orchard apple tree 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 importantly lessen the outstanding gunstock and and so reduced working capital requirements for funding inventory warehousing and inventory financing. Just-in-time Delivery Dells pulverisation had close physical propinquity to its suppliers. Suppliers would ship vocalizations only after customers placed orders, for just-in-time delivery. This helped to maintain accounts account collectible 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 advanced Technology Low inventory levels helped Dell to quickly switch to newer product upgrades and reduce the cost of alive inventory turnovers compared to competitors. This further reduced working capital requirements. DSI Advantage As a result of above strategies, Dell achieved an ave rage DSI of 40 amid 1993 and 1995, compared to Apples 64, Compaqs 68 &038 IBMs 56. How did Dell fund its 52% growth in 1996? interest be sure to call attention between internal and external sources of funding, and to converse 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 presentation (Exhibit 3 from the case). Regarding working capital management, we noticed from Exhibit 2 from the case, excellent mental process in maintaining cardinal at 40 days fleck product switches required double stock management. As the Pentium introduction was already launched in 1995, we assume that growth was ceaseless and continuous during 1996 catch.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 negotia te with banks for short term credit lines and overdraft accounts (external). level(p) if CCC remains uniform during this period of growth, balance piece of papers 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 dodging will bring Dell more flexibleness for the future.The firm will be able to consider different options for future growth either the same strategy the issuance of more debt imputable to their low leverage being c omparatively 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 Gross border Operating expenses Operating income financial backing 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 armoury 726 1 089 Accounts receivable 466 699 Accounts payable 689 1 034 working(a) chief city 345 excess working capital required Projections for the year 1997 were built based on the following assumptions 1. Growth coefficient of 1,5 was utilize 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 c osts 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 formulas DSI=Inventory*365/ romaine 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. 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, $mln Ratios at 1996 level +5 days in DSO -10 days in DSO Exhibit 3 Detailed calculations relative to question N2 6P a ge EDHEC MBA Dell Business Case 1 CCC worth calculation (see figures in red rectangle) CCC = DSI + DSO DPO From above table, CCC = inventories + Accounts receivables Accounts payable CCC1995 = 293 + 538 403 = 428 M$ CCC1996 = 429 + 726 466 = 689 M$ 2 Total stocks value (see figures in blue rectangle) Total value = like stocks + Common stocks 1995 = 362 M$ 1996 = 436 M$ 7P a geDell Hbr Case call forINTRODUCTION 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 an d 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 first proposer 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 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 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 b e 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 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 Bui lt-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 ne wer 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 &038 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 marg in 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 flexibil ity 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 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 operat ions 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 Ca pital 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, $mln Ratios at 1996 level +5 days in DSO -10 days in DSO Exhibit 3 Detailed calculations relative to question N2 6P a ge EDHEC MBA Dell Business Case 1 CCC worth calculation (see figures in red rectangle) CCC = DSI + DSO DPO From above table, CCC = inventories + Accounts receivables Accounts payable CCC1995 = 293 + 538 403 = 428 M$ 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