Dells Working Capital

Questions Addressed
1) Anuran Chattaraj (B13075) Question: Reasons behind loss reported by dell in 1993? 2) Dhruv Gupta (B13083) Question: Analysis of Dells financing needs? 3) Faraz Mohammed Khan (B13084) Question: How does Dell management of working capital provide competitive advantage? 4) Harshan Agrawal (B13088) Question: Analysis of working capital financing ratios? 5) Subhro Mukherjee (B13118) Question: Future of Dells financing and operation strategies?

Question 1: Reasons behind loss reported by Dell in 1993? Till 1990, Dell had maintained direct only model. It was profitable for the company, but they were able to capture only 1 percent of market share. Michael Dell (owner of the company) believed that fragmented market would consolidate in future and thus if Dell wanted to survive they would have to grow. They shifted from direct-only business model to capture sales from small business and first time consumers by using indirect distribution channel, etc. Dell also expanded to foreign markets through resellers as direct distribution was a constraint. For this new shift they needed to maintain a substantial amount of finished inventory to supply finished goods to indirect distribution channel and resellers. Though they achieved a growth of 268% in two years they reported a loss of $76 million. To provide enough inventories to resellers Dell had to maintain finished inventory on their own part. So they had to write-off $71 million loss for sell of excess inventory which lead to huge loss reported by Dell. Question 2: Analysis of Dells financing needs? Dell used internal capital to finance their working capital requirements. In 1996 they had a total cash of $ 55 million. They had a debt of $ 113 million. Their cost of sales was $ 4229 million with a cash conversion cycle of 46 days. To support their cash needs they might need to increase their debt as this small amount of cash may not be able to support their working capital needs. Working capital management provides competitive advantage to Dell, so in order to maintain this advantage they need high amount of liquidity and so must not rely only on cash but should look for other sources of financing. They have a net working capital of around $ 1000 million. If company keeps growing at a rate of around 50%, their working capital will increase to $ 1500 million, $ 500 million more than previous year. To support this growth by internal capital, either they will have to decrease working capital (which is a source of competitive advantage to the firm, but it may not be possible further to reduce it) or increase profitability (much difficult as already cost is low). So supporting working capital through internal capital is not a viable solution in long term, they would have to look for other short-term debts for financing. Question 3: How does Dell management of working capital provide competitive advantage? Dell manufactures computers after it has received the order from a customer. So they were able to make following changes at the time of production: 1) Dell converted to Pentium technology very easily (first to do so) as they were able to predict demand using their direct contact with customers. 2) In two years Pentium 133 MHz was launched (their ninth upgrade) Dell was able to incorporate change very easily as it could incorporate new chip in the PCs under production.

Other manufactures that had already produced using older chips could not anything about this change. 3) Because of low finished goods inventory, Dell didnt need to dism antle many PCs in order to replace chips rendered faulty by Intel. It was able to sell products with updated chips while others had to either sell PCs with flawed chips or had to dismantle goods and upgrade them which took long time. 4) When Microsoft announced its new Widows 95, Dell was able to incorporate new technology since day of announcement. Being a direct marketer, Dell was able to bring new technologies to market within average of 35 days which was one third the time competitors took for the same. This provided Dell with a huge competitive advantage among its competitors and Dell was growing at a fast pace. Their sales had increased over the years as computer to industry because of this. Year 1991 1992 1993 1994 1995 Dell 63% 126% 43% 21% 52% Industry -2% 7% 15% 35% 31%

So, it is clear that lower working capital provided a huge competitive advantage to Dell. Question 4: Analysis of working capital financing ratios? 1) DSI (Days sales of inventories) increases from 40 in Quarter 1 of 1993 to 55 in Quarter 4 of 55 days. As they had huge amount of inventories which had to be sold off at a loss of $71 million, it gives the cause of increase in DSI during that period. After that when Dell reshifted focus to direct marketing with decreasing number of suppliers to 88 (on basis of delivery performance, etc.), closed down indirect retail channels and improved system of forecasting. Because of this their DSI started decreasing again reaching a low of 31 days in 1996. 2) Their DSO and DPO were more or less constant across the period as they cannot be changed much without changing relationship with customers and suppiers. 3) So overall because of change in DSI their cash conversion cycle (DSI + DSO DPO) increased from 48 in Quarter 1 1993 to 57 Quarter 1 1994 and then because of the measured taken by Dell to reduce DSI reduced to 40 in Quarter 4 1996.

Question 5: Future of Dells financing and operation strategies? Dells future looks promising with a large amount of growth because of low Working Capital and low CCC. But as the company will grow their Working Capital will also increase. Their internal capital will prove to be insufficient to support this increasing Working Capital needs. They should try to keep their Working Capital to minimum as long as possible, but they still will need short term debts from outside to support this competitive advantage. They must apply better Working Capital Management Techniques to support growth and at the same time save their competitive advantage. Conclusions 1) Dell reported loss in 1993 because they were focusing on sales growth and thus ventured into selling through indirect channels and resellers. To support them they had to keep finished goods inventories. 2) After the loss, Dell redirected their strategy towards CCC and cash flows. Because of these measures they were able to reduce DSI and CCC to a large extent and thus established their competitive advantage in industry. 3) Because of this competitive advantage, Dell was able to incorporate technological changes in time one third than industry average. This provided them with large profit growth of 52% as compared to 31% of industry. 4) In future, when companies will go further, their Working Capital will increase, and internal capital will prove to be insufficient to support that and thus Dell should look at other financing options like short-term debt, etc to maintain their competitive advantage.