Dell’s Working CapitalDell’s Working Capital

B.B.ChakrabartiB.B.Chakrabarti

Professor of FinanceProfessor of Finance

IIM CalcuttaIIM Calcutta

The QuestionsThe Questions

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

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

The QuestionsThe Questions

Assuming Dell sales will grow 50% in Assuming Dell sales will grow 50% in 1997, how might the company fund this 1997, how might the company fund this growth internally? How much would growth internally? How much would working capital need to be reduced and / working capital need to be reduced and / or profit margin increased? What steps do or profit margin increased? What steps do you recommend the company take?you recommend the company take?

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

Dell’s Competitive Dell’s Competitive AdvantageAdvantage

1)1) Conservation of capital due to lower Conservation of capital due to lower inventory holdinginventory holding

CompaqCompaq DellDellDSI in 95DSI in 95 73 73 32 32

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

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

Dell’s Competitive Dell’s Competitive AdvantageAdvantage

2)2) Reduced obsolescence risk and lower Reduced obsolescence risk and lower inventory costinventory cost

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

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

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

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

Dell’s Competitive Dell’s Competitive AdvantageAdvantage

3)3) Quicker adoption of new technologyQuicker adoption of new technology Dell’s low inventory levels resulted Dell’s low inventory levels resulted

in fewer obsolete components as in fewer obsolete components as technology changed.technology changed.

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

Funding 52% Growth in Funding 52% Growth in 19961996

Facts to considerFacts to consider 95- Total assets = 46% of sales95- Total assets = 46% of sales 95- ST investments = 14% of sales95- ST investments = 14% of sales 95- Operating assets = 32% of sales95- Operating assets = 32% of sales 95- Net profit = 4.3% of sales95- Net profit = 4.3% of sales 96- Dell would require 32% of 96- Dell would require 32% of

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

Funding 52% Growth in Funding 52% Growth in 19961996

Facts to considerFacts to consider 96- All assets excepting ST 96- All assets excepting ST

investments will grow at 52% over 95 investments will grow at 52% over 95 figuresfigures

96- Assumed that the liabilities will 96- Assumed that the liabilities will also proportionally increase.also proportionally increase.

96- Need additional $582 million 96- Need additional $582 million assetsassets

Funding 52% Growth in Funding 52% Growth in 19961996

Facts to considerFacts to consider 96- Sources of funds:96- Sources of funds:

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

= $ 227 million= $ 227 million- ST investments = $484 million- ST investments = $484 million

Enough available money for internal Enough available money for internal fundingfunding

How Dell Funded 1996 How Dell Funded 1996 Growth?Growth?

Facts Facts Higher asset efficiencyHigher asset efficiency

- Reduced cash, receivables, - Reduced cash, receivables, inventory and other current assetsinventory and other current assets

- Needed addl. $447 million of - Needed addl. $447 million of operating assetsoperating assets

How Dell Funded 1996 How Dell Funded 1996 Growth?Growth?

Facts Facts Sources of fundsSources of funds

- Increase in current liabilities = $187 - Increase in current liabilities = $187

millionmillion

- Net Profit = $272 million- Net Profit = $272 million

How Dell Performed in How Dell Performed in 1996?1996?

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

aggressive pricing strategies and account aggressive pricing strategies and account mix shift.mix shift.

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

Funding 50% Growth in Funding 50% Growth in 19971997

Facts to considerFacts to consider 96- Operating assets = 30% of sales96- Operating assets = 30% of sales 96- Net profit = 5.1% of sales96- Net profit = 5.1% of sales 97- Dell would require 30% of 97- Dell would require 30% of

increased sales in operating assets increased sales in operating assets i.e. i.e.

$(2336-1557) = $779 million.$(2336-1557) = $779 million.

Funding 50% Growth in Funding 50% Growth in 19971997

Facts to considerFacts to consider 97- Increase in liabilities = $588 97- Increase in liabilities = $588

millionmillion 97- Net profit = 5.1% of $5296*1.597- Net profit = 5.1% of $5296*1.5

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

So, internally growth can be funded.So, internally growth can be funded.

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

Of EquityOf Equity Funds needed = $984 millionFunds needed = $984 million Sources of Funds:Sources of Funds:

- 1% increase in margin = $79 million- 1% increase in margin = $79 million- ST investments = $591 million av.- ST investments = $591 million av.- Also, negative cash conversion cycle can - Also, negative cash conversion cycle can dodo ( 97- Avg. daily sales = 96 sales*1.5/360 ( 97- Avg. daily sales = 96 sales*1.5/360 = $22.1 mn. and Avg. daily COS = = $22.1 mn. and Avg. daily COS =

79.8% of sales as in 96 = $17.6 mn.79.8% of sales as in 96 = $17.6 mn. i.e. 44 days of sales or 65 days of COS.i.e. 44 days of sales or 65 days of COS. 96- CCC = 40 days) 96- CCC = 40 days)

97- Actual Cash Conversion 97- Actual Cash Conversion CycleCycle

QTR.4 1996QTR.4 1996 Qtr.4 1997Qtr.4 1997 Diff.Diff.

DSIDSI 3131 1313 -18 -18DSODSO 4242 3737 -5 -5DPODPO 3333 5454 +21 +21CCCCCC 4040 -4-4 -44 -44

CCC = DSI + DSO -DPOCCC = DSI + DSO -DPO

Savings from WC Savings from WC ImprovementsImprovements

Annual savings from:Annual savings from:

- Reduced inventory = 18*17.6 = $317 - Reduced inventory = 18*17.6 = $317 mn.mn.

- Reduced Receivables = 5*22.1=$110 - Reduced Receivables = 5*22.1=$110 mn.mn.

- Increased Payables =21* 17.6=$ 370 Increased Payables =21* 17.6=$ 370 mn.mn.

Total savings = $797 mn.Total savings = $797 mn.

Actual 1997Actual 1997

Sales grew by 47%.Sales grew by 47%. CCC became – 44.CCC became – 44. Profit margin increased to 6.6% from Profit margin increased to 6.6% from

5.1%.5.1%. Component prices decreased. Component prices decreased.

Advantage over competitors.Advantage over competitors. Dell applied JIT philosophy.Dell applied JIT philosophy.

Actual 1997Actual 1997

Operating assets increased by $199 Operating assets increased by $199 million only.million only.

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

Dell obtained $279 million from put Dell obtained $279 million from put options.options.

About $500 million equity repurchased.About $500 million equity repurchased. ST investments increased by $646 million.ST investments increased by $646 million.

Actual 1997Actual 1997

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