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Dell’s Working Capital B. B. Chakrabarti Professor of Finance IIM Calcutta The Questions ? How was Dell’s working capital policy a competitive advantage? ? How did Dell fund its 52% growth in 1996? The Questions ? Assuming Dell sales will grow 50% in 1997, how might the company fund this growth internally? How much would working capital need to be reduced and / or profit margin increased? What steps do you recommend the company take? How would your answer to the above question change if Dell also repurchased $500 million of common stock in 1997 and repaid the long-term debt? ? Dell’s Competitive Advantage 1) Conservation of capital due to lower inventory holding Compaq Dell DSI in 95 73 32 Cost of sales of Dell in 95 = $2737 mn. (Ex. 4) Additional inventory at Compaq’s DSI = $2737 * (73-32) / 360 = $312 million Dell’s Competitive Advantage 2) Reduced obsolescence risk and lower inventory cost ? Component cost can reduce by 30% a year as new technology is introduced. ? Inventory as % of COS – Dell (8. We will write a custom essay sample on Sr.Pablo or any similar topic specifically for you Do Not WasteYour Time HIRE WRITER Only 13.90 / page 9%) and Compaq (20. 3%) ? Inventory loss due to 30% reduction in price – Dell (2. 7%) and Compaq (6. 1% of COS) ? Comparative increase in profit in Dell in 96 = $2. billion *(6. 1%-2. 7%) = $93 million Dell’s Competitive Advantage 3) Quicker adoption of new technology ? Dell’s low inventory levels resulted in fewer obsolete components as technology changed. ? While Compaq had to market both new and older systems due to high levels of inventory, Dell could offer new and faster systems quickly due to low inventory and build-to-order models. Funding 52% Growth in 1996 Facts to consider ? 95- Total assets = 46% of sales ? 95- ST investments = 14% of sales ? 95- Operating assets = 32% of sales ? 95- Net profit = 4. 3% of sales ? 6- Dell would require 32% of increased sales in operating assets i. e. $(5296-3475)*32% = $582 million. Funding 52% Growth in 1996 Facts to consider ? 96- All assets excepting ST investments will grow at 52% over 95 figures ? 96- Assumed tha t the liabilities will also proportionally increase. ? 96- Need additional $582 million assets Funding 52% Growth in 1996 Facts to consider ? 96- Sources of funds: Increase in liabilities = $494 million Operational profit = $5296*4. 3% = $ 227 million ST investments = $484 million ? Enough available money for internal funding How Dell Funded 1996 Growth? Facts ? Higher asset efficiency Reduced cash, receivables, inventory and other current assets Needed addl. $447 million of operating assets How Dell Funded 1996 Growth? Facts ? Sources of funds Increase in current liabilities = $187 million Net Profit = $272 million How Dell Performed in 1996? ? Dell introduced Pentium technology. ? Unit sales grew by 48%. ? Average unit revenue grew by 3%. ? Gross margin declined by 1% due to aggressive pricing strategies and account mix shift. ? Net margin improved from 4. 3% to 5. 1% ? Common stock was issued to Funding 50% Growth in 1997 Facts to consider ? 96- Operating assets = 30% of sales ? 96- Net profit = 5. 1% of sales ? 97- Dell would require 30% of increased sales in operating assets i. e. $(2336-1557) = $779 million. Funding 50% Growth in 1997 Facts to consider ? 97- Increase in liabilities = $588 million ? 97- Net profit = 5. 1% of $5296*1. 5 = $405 million ? ST investments = $591 million av. ? So, internally growth can be funded. 97 with Repayment of LT Debt and Repurchase of $500 mn. Of Equity ? Funds needed = $984 million ? Sources of Funds: 1% increase in margin = $79 million ST investments = $591 million av. Also, negative cash conversion cycle can do ( 97- Avg. daily sales = 96 sales*1. 5/360 = $22. 1 mn. and Avg. daily COS = 79. 8% of sales as in 96 = $17. 6 mn. i. e. 44 days of sales or 65 days of COS. 96- CCC = 40 days) 97- Actual Cash Conversion Cycle QTR. 4 1996 Qtr. 4 1997 DSI DSO DPO CCC 31 42 33 40 13 37 54 -4 Diff. -18 -5 +21 -44 CCC = DSI + DSO -DPO Savings from WC Improvements Annual sa vings from: Reduced inventory = 18*17. 6 = $317 mn. Reduced Receivables = 5*22. 1=$110 mn. Increased Payables =21* 17. 6=$ 370 mn. Total savings = $797 mn. Actual 1997 ? Sales grew by 47%. CCC became – 44. ? Profit margin increased to 6. 6% from 5. 1%. ? Component prices decreased. Advantage over competitors. ? Dell applied JIT philosophy. Actual 1997 ? Operating assets increased by $199 million only. ? Total liabilities increased by $733 million even after repayment of LT debt. ? Dell obtained $279 million from put options. ? About $500 million equity repurchased. ? ST investments increased by $646 Actual 1997 Dell funded 1997 growth internally, repaid long-term debt and repurchased about $500 million in equity through a combination of working capital and margin improvements.