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Executive Summary

We have analyzed the performance of Dell during the period from 1992 to 1996, particularly between the

year 1995 and 1996 when Dell achieved an extraordinary sales increase of 52%. We have focused our

analysis on Dells working capital management as well as build-to-order inventory model through given

financial and performance data in order to answer two questions below:

1. How was Dells build to order model and working capital implications a competitive advantage?

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

Based on our findings, Dells working capital management has provided significant savings in investment

capital and reduced the risks of discount the obsolete inventory. The inventory model also helped to

mitigate the risk of cannibalization among product lines. Dells focus on managing working capital helped

the firm to fund the growth internally which resulted in 52% increase in revenue from 1995 to 1996. The

detailed analysis below will explain our rationale as well as key assumptions followed by detailed analysis

and calculations.

Question 1: How was Dells build to order inventory model and working capital implications a

competitive advantage?

Dell designed, manufactured, sold and serviced high-performance personal computers (PCs) compatible

with the industry standard. The companys core strategy was selling directly to customers rather selling

through networks of distributors and retailers. In addition, Dell combined this low-cost production and

distribution system with the build to order model a production cycle that began after the company

received a customers order. This build to order model has been a competitive advantage of Dell for a

number of reasons:

1. Much smaller investment in working capital

As mentioned in the case, Dell built computer system after the company received the customers order

while other competitors built and maintained an inventory of finished products. As a result, Dells WIP
and finished goods inventory balance was only around 10% to 20% of the total inventory balance while

industry average of the top competitors ranged around 50% to 70% of their inventory not included the

stock at their reseller.

To illustrate Dells advantage in terms of investing in working capital, we should look at table An of the

case, the Days Supply of Inventory (DSI) of Dell and other major competitors:

Table A Days Supply of Inventory (DSI)a

1993b 1994b 1995b


Dell Computer 55 33 32

Apple Computer 52 85 54

Compaq Computer 72 60 73

IBM 64 57 48

We know that the DSI formula is calculated as:

DSI = (Net Ending Inventory)/(Quarterly COGS/90 Days)

= (Net Ending Inventory)/(Yearly COGS/360 Days)

The yearly COGS of Dell in 1995 in Exhibit 4 was $2,737m and the DSI from Table A was 32 days

Substitute to the DSI formula, we can have the Net ending inventory of Dell in 1995:

Net Ending Inventory = DSI x (Yearly COGS/360 days) = 32 x ($2,737/360) = $243m

If we assume that Dell has the same DSI as Compaq Computer 73 days, we can substitute the assumed

DSI into the DSI formula to find the assumed Net Ending Inventory of Dell

Net Ending Inventory = 73 x ($2,737/360) = $555m

Thus, the capital working policy and build to order model has saved Dell: $555m - $243m = $312m of

working capital in 1995. This $312m of working capital represented 59% of cash and short-term

investment in 1995 and 209% of 1995 net income.

Even if we assume that Dell has the same DSI with IBM the second-best performer in the DSI table, we

can see a total saving in working capital would be:


Net Ending Inventory = 48 x ($2,737/360) = $365m

Working capital saving = $365m - $312m = $53m

A $53m in working capital would represent 10% of cash and short-term investments and 35% of net

income for Dell in 1995.

2. Obsolescence risk and inventory write-off cost reduction

As the cost of individual components comprised as much as 80% of the cost of a PC and computing

technologies changes very fast resulting in the price reduction of the component (fell by an average of

30% a year), Dell could maintain a competitive advantage because the firm can switch to new technology

in a very short amount of time while the other competitors had to market both the new inventory and try

to sell the remained old inventory at the same time.

We will estimate the opportunity cost saving for Dell using the result calculated from part 1 of this paper.

In part 1, we have assumed that with the same COGS, Compaq Computer had to maintain an inventory of

$555m, a $312m higher than Dell. When the new technology arrived, all computer manufacturer had to

sell their existing inventory with 30% discount to clear up the old inventory balance. As a result, Compaq

has to suffer a higher obsoleted loss of:

Additional obsolescence loss = $312m x 30% = $93.6m

If we compared the obsolescence loss as a percentage of COGS

As a % of COGS Dell Compaq


1995 Inventory balance 8.9% 20.3%
1995 Inventory loss (30%) 2.7% 6.1%

Based on the above calculation, the effect of obsolescence cost saving contributed about $93.6m in

additional to Dells 1996 profit.

3. Cannibalization prevention

One additional minor advantage for Dell in using the build to order model and low inventory is to minimize

product lines cannibalization. Dells low inventory resulted in lower obsoleted stocks compared to other
companies such as Compaq. While Compaq had to provide discounts to their old product line, they had

to market new product line at the same time. The discount will attract the customers to buy the old

products line which resulted in the sales cannibalization of the new product line. In addition, the cycle will

lead to the high inventory level of the new product line and Compaq had to discount them again next

year. With Dells inventory management, they could minimize the risks of cannibalization and enhance

their profits as well as their Return on Capital Employed (ROCE)

4. Risk of the build to order model in Dells expansion strategy

Dells build to order model has proved to be a competitive strategy for small-scale computer manufacturer

with 1% of the US PC market share. However, Dells attempt of expanding has shown weakness in their

build to order inventory model.

Dells aggressive inventory model caused the inventory shortage and order backlogs when they expanded

their distribution from direct only to CompUSA and later adding other mass-market retailers. When they

stepped into the territory of other players who were very experienced in building huge inventory, Dell

exposed their weaknesses in inventory planning and forecasting and as a result, the firm reported $73m

loss in August 1993, in which $71m related to the sell-off excess inventory and the cost of scrapping a

disappointing a product line. In the end, the firm exited the low-margin indirect retail channel and come

back to their previous distribution strategy.

In the end, their build to order and inventory management may make Dell vulnerable to sudden high

demand and there was a risk of revenue lost, the rapid technological changes in the computer industry

make Dells business strategy outweighs the disadvantages as the cost of discounted inventory was huge

compared with the risks of revenue lost due to backorders.


Question 2 How did Dell fund its 52% growth in 1996?

1. The funds needed

Year 1995 % of Sales Year 1996 % of Sales


Total Asset 1594 46% 2148 41%
(-) Short-term Investment 484 14% 591 11%
Operating Asset 1110 32% 1557 29%

Based on the assumption that the short-term investments were not relevant to the operation which

means there was no correlation between the increase of sale and increase of short-term investment; the

increase of operating asset of Dell in 1996 should be 32% of Dells total sales in 1996 which was $1,695m

($5,296m*32%). So, the fund needed should be $585m ($1,695m-$1,110m).

2. The source of funds

The internal source of funds could come from two parts. The first one was the operating profit generated

from the year 1995, and the other source was the additional capital generated from increasing in asset

efficiency and profitability.

In this analysis, we have made a projection for 2016 balance sheet position based on the proportional

increase of sales assumption. After that, we have compared the 2016 projection and 2016 actual to find

the area that Dell improved its efficiency.

Account 2016 Projection 2016 Actual 2015 Actual 2015 % of Sales


Short Term Investment 484 591 484 14%
Other Current Assets 1503 1366 986 28%
PP&E and others 189 191 124 4%
Total Assets 2176 2148 1594 46%

Current Liability 1146 939 752 22%


Long Term Debt 33 113 113 3%
Other Liability 117 123 77 2%
Total Liability 1296 1175 942 27%

Owners' Equity 880 973 652 19%


(1) The operational profit

If the profit margin was kept unchanged at 4.3% ($149m/$3,475m) in 1996, Dells would have generated

$228m ($5,296m*4.3%) of net income and the remained funding requirement should have been $357m

($585m-$228m). In reality, Dell has increased its profitability to 5.13% and made a $272m net profit which

helped to reduce the funding requirement to only $313m.

The $313m remained was funded internally by increase in current liability from 2015 to 2016: $187m

($939m - $752m) and the increase in operating asset efficiency by 3% (32%-29%) or $159m (3% x $5,296m)

Thus, total internal fund would be $618m ($272m + $187m + $159m) > required funding of $585m

(2) The increasing asset efficiency

From the table above, we could find that assuming the profitability and the short-term investment

unchanged and other assets and liabilities grew proportionally for the 1996 projection, Dell could have

generated a positive $80m fund to pay for its long-term debt. However, Dell kept the long-term liability

unchanged and used the fund to increase short-term investment by $107m and decreased the proportion

of other liabilities to sales.

On the assets side of the balance sheet, Dell managed to reduce cash, accounts receivable, inventory and

other current assets relative to the projections. The DSO improved by 5 days over the year 1995 as the

account receivable balance as a percent of sales dropped from 15.2% to 13.7%. Also, the inventory level

decreased slightly as DSI improved by 1 day to 31 days in 1996. The asset turnover ratio increased from

2.18 to 2.46 which means the efficiency of the company had increased in 1996.

On the liability side, Dell decreased the DPO by 11 days which made the percentage of current liabilities

of sales decreased from 21.6% to 17.7%. Although Dell decreased the proportion of its funding resource

from the increase of current liability by $207m compared to the projection, it still could make enough

funding for its 52% growth in sales and $107 growth of short-term of investment by increasing its assets

efficiency and profitability.