Dells Working Capital Management Maximizing Sustainable Growth

Dells Early Days

Dell began as a small PC company in the mid-1980s Dell began by buying IBM-compatibles, upgrading them, and selling them directly Then Dell began making its own PCs
Build-to-order After receipt of the order Low finished-goods inventory

Dell Expanded, Then Was Harmed

In 1990, Dell began to sell through CompUSA and then others
Dells market share leaped to the top 5 after a 268% increase in sales 2Q93, Dell reported a loss of $76MM
Excess inventory and bad notebooks

In 1994, Dell left the retail market The shift included a change in focus from growth to growth, liquidity and profitability

1995: Shift to ROC and CFC

Suppliers reduced, inventory better managed Dell upgraded to seasoned managers
Not rare for former entrepreneurial firms

Major shifts occurred

Re-emphasis on direct contact w/ customers Focus on Intel processor-based PCs Began to be able to forecast demand and thus better deal with inventory needs
Flawed Pentium no problem Windows Updates no problem
ROC Return on Capital; CFC Cash Flow Cycle

Exhibit 2: Key WC Ratios

Exhibit 2 Working Capital Financial Ratios for Dell Inv Daysa A/R Daysb Q193 40 54 Q293 44 51 Q393 47 52 Q493 55 54 Q194 55 58 Q294 41 53 Q394 33 53 Q494 33 50 Q195 32 53 Q295 35 49 Q395 35 50 Q495 32 47 Q196 34 47 Q296 36 50 Q396 37 49 Q496 31 42 A/P Daysc 46 55 51 53 56 43 45 42 45 44 46 44 42 43 43 33 CFCd 48 40 48 56 57 51 41 41 40 40 39 35 39 43 43 40

Exhibits 4 and 5: Improvement

After a tough year in 1994
1995 and 1996 showed high growth, increased profitability
And Exhibit 2: Much lower WC requirements

Examine 1995 1996 Balance Sheets

Equity grew by $321MM, but liabilities grew by less What does that say about sustainable growth?

Sustainable Growth
Here are the sustainable growth figures
Panel A: Including All Assets NI(t)/S(t) 4.29% 5.14% S(t)/A(t-1) 3.05 3.32 A(t-1)/E(t-1) 2.42 2.44 Sustainable Growth % Retained 100.00% 31.63% 100.00% 41.72%

1995 1996

But notice the asset called Short-Term Investments.

Consider ignoring that one

Sustainable Growth: Fixed

Sustainable Growth Calculations - W/ and W/out Short-term Investments Panel A: Including All Assets NI(t)/S(t) 4.29% 5.14% S(t)/A(t-1) 3.05 3.32 A(t-1)/E(t-1) 2.42 2.44 Sustainable Growth % Retained 100.00% 31.63% 100.00% 41.72%

1995 1996

Panel B: Excluding Short-term Investments NI(t)/S(t) 4.29% 5.14% S(t)/A(t-1) 4.31 4.77 A(t-1)/E(t-1) 5.88 6.61 Sustainable Growth % Retained 100.00% 108.76% 100.00% 161.90%

1995 1996

What this demonstrates is that once we recognize Dell's non-operational assets, invested for income-earning, we see its stronger sustainable growth.

1997 Forecasts: Source of Funds?

The case author suggests a 1996 forecast based on fixed liabilities versus proportional liabilities (see result) He suggests doing the same for 1997
Also including or excluding share repurchases ($500MM) and payoff of long-term debt See results of the alternatives Consider if added funding is needed

How Working Capital Could Help

Suppose these improvements were made:
Inventory days reduced by 17 A/R days reduced by 15 A/P Days increased b y 20

How much cash would that generate?

What Actually Occurred in 1997

Profits were way up
COGS% was reduced Operating Expense% was reduced

A/R fell about 12% Inventory Days fell about 40% A/P Days rose sharply, more than 60% Shares were repurchased, LTD paid off Put options (warrants) were issued

Dell: The Key Points

Dell addressed its working capital management extremely well Its business strategies of direct sales and of supplier relations were crucial It created a sustainable growth capacity that resolves many problems raised by the earlier cases we studied