Dell Computer Corp.

The company markets directly to its customers and builds computers

after receiving a customer order.
This build-to-order model enables Dell to have much smaller investment
in working capital than its competitors.
It also enables Dell to enjoy more fully the benefits of reductions in
component prices and to introduce new products more rapidly.
Dell has grown quickly and has been able to finance that growth
internally by its efficient use of working capital and its profitability.

Dr. C. Bulent Aybar

Dells Growth vs Industry

Calendar Year
1991
1992
1993
1994
1995

Dell
63%
126%
43%
21%
52%

Industry
-2%
7%
15%
37%
31%

Days Supply of Inventory

1993

1994

1995

Dell Computer

55

33

32

Apple Computer

52

85

54

Compaq Computer

72

60

73

IBM

64

57

48

One way to quantify Dells competitive advantage is to calculate the increase in

inventory Dell would have needed if it operated at Compaqs DSI level.
Additional Inventory at Compaqs DSI=
= (Dells Daily Purchases)x(Compaqs DSI Dells DSI)
=(($2,737/360)x(73-32)
= $312 million
This $312 million, in perspective, represents 59% of Dells cash & short-term
investments, 48% of its stockholder equity, and 209% of its 1996 net income.

Working Capital and Cash to Cash Cycle

Q193
Q293
Q393
Q493
Q194
Q294
Q394
Q494
Q195
Q295
Q395
Q495
Q196
Q296
Q396
Q496

DSI
40
44
47
55
55
41
33
33
32
35
35
32
34
36
37
31

DSO DPO CCC

54
46
48
51
55
40
52
51
48
54
53
56
58
56
57
53
43
51
53
45
41
50
42
41
53
45
40
49
44
40
50
46
39
47
44
35
47
42
39
50
43
43
49
43
43
42
33
40

DSI (Days Sales of Inventory) = Net Inventory / (Quarterly COGS/90).

DSO (Days Sales Outstanding) = Net Accounts Receivables / (Quarterly Sales/90).
DPO (Days Payables Outstanding) = Accounts Payables / (Quarterly COGS/90).
CCC (Cash Conversion Cycle) = DSI + DSO DPO.

Other Advantages aside from the conservation of capital

Dells low component inventory reduces obsolescence risk
and lowers inventory cost.
Dells inventory was about 8.9% of its COGS while Compaqs
inventory was about 20.3% of its COGS.
If technological change reduced the value of inventory by 30%, Dell
would incur an inventory loss of about 2.7% of COGS and Compaq
would incur a loss of 6.1% of COGS (assuming the same COGS).
The lower inventory losses for Dell imply higher profits. At Dells
1995 COGS of $2.7 billion, the effect of component price reductions
contributes about $93 million to profits ($2.7 billion x(6.1%-2.7%)).

Dr. C. Bulent Aybar

 Dells low inventory levels resulted in fewer obsolete

components in inventory when technology changed.
Others with high levels of inventory, such as Compaq, had to
market both new and older systems.
Older systems were discounted, taking away sales from
newer, higher-margin systems.
Cannibalization was not a significant issue for Dell because
of its low inventory and build-to-order model. Dell was able
to grow sales by offering faster systems at prices of
competitors slower machines.

Dr. C. Bulent Aybar

Risks Involved in Dells Business Model

Dells build-to-order model and resulting low inventory had
some risks.
Component shortages were a disadvantage of Dells aggressive
inventory model! Dell had order backlogs because of part
shortages.

While revenue may have been lost due to cancelled or

delayed orders until supplies were available, the rapid
technological change made the advantages of Dells
approach outweigh the disadvantages.

Dr. C. Bulent Aybar

Funding 1996 Growth

In 1995 total assets were 46% of sales (1,594/3,475). Shortterm investments were 14% of sales.
If we assume the short-term investments were not required
to support operations, Dell would have required 32% of
increased sales in additional operating assets.
Sales in 1996 $5,296m an increase of $1,821m or
52% from 3,475m in 1995.
So if Dell required an increase in operating assets as much as
32% of the increase in sales:
$1.8bn x 0.32 $582m additional investment in operational assets
would be necessary!
Dr. C. Bulent Aybar

Dells Growth and Funding Needs

If 1995 profit margins of 4.3% had held Dell would have
realized
$5,296 x 0.043 =$227 million

in net income; the additional funding requirement would be:

$582-$227=$335m

Note that this funding requirement assumes that liabilities

remain constant!
If we allowed liabilities change proportionally, Dell would
have an excess funding of 139m.

Dr. C. Bulent Aybar

1995 Balance Sheet as a % of Sales

Forecast for 1996 with Actual 1996 Sales

29-Jan-95

% of
Sales

Fixed Liablilities

43

1.24%

66

66

Short Term Investments

484

13.93%

484

484

Accounts Receivables, net

538

15.48%

820

820

Inventories

293

8.43%

447

447

Other

112

3.22%

171

171

1,470

42.30%

1,987

1,987

117

3.37%

178

178

0.20%

11

11

1,594

45.87%

2,176

2,176

355

(139)

Proportional Liabilities

Current Assets:
Cash

Total Current Assets

Property, Plant & Equipment, net
Other
Total Assets
Additional Funding Needed
Current Liabilities:

Dells Sustainable Growth Rate in 1995

NI(t)/S(t) S(t)/A(t-1)

A(t-1)/E(t-1)

% Retained

SGR

Calculations using all assets

1995

4.3%

3.05

2.42

100.0%

31.6%

1996
1997 Projected
1997 Actual

5.1%
5.1%
6.7%

3.32
3.70
3.61

2.44
2.21

100.0%
100.0%
100.0%

41.7%
41.9%
53.2%

2.21

Dells sustainable growth rate was 31.6%, which was below the 52% of
actual growth in 1996.
Typically, when a firm grows beyond its sustainable growth rate, it either
increases leverage or raises additional equity.
Dell was able to grow beyond its sustainable growth rate without increasing
leverage or obtaining additional equity because short-term investments
were assumed not to grow with sales!

Adjusted Balance Sheet

January 28,
1996

January 29,
1995

January 30,
1994

Current Assets:
Cash
Accounts Receivables, net
Inventories
Other
Total Current Assets
Property, Plant & Equipment, net
Other
Total Assets

55
726
429
156
1,366
179
12
1,557

43
538
293
112
986
117
7
1,110

3
411
220
80
714
87
5
806

Current Liabilities:
Accounts Payable
Accrued and Other Liabilities
Total Current Liabilities
Long Term Debt
Other Liabilities
Total Liabilities

466
473
939
113
123
1,175

403
349
752
113
77
942

NA
NA
538
100
31
669

6
430
570
(33)
382

120
242
311
(21)
168

NA
NA
NA
NA
137

1,557

1,110

806

Stockholders Equity:
Preferred Stocka
Common Stocka
Retained Earnings
Other
Total Stockholders Equity

Profit & Loss

Fiscal Year
Sales
Cost of Sales
Gross Margin
Operating Expenses
Operating Income
Financing & Other Income
Income Taxes
Net Profit

1996
$5,296
4,229
1,067
690
377
6
111
272

1995
$3,475
2,737
738
489
249
(36)
64
149

1994
$2,873
2,440
433
472
(39)
0
(3)
(36)

Adjusted Asset Turnover and Leverage Ratios for 1995:

AT(1995)=Sales(t)/TA(t-1)=3,475/806=4.31
Leverage =TA(t-1)/Equity(t-1)=806/137 =5.88

1993
$2,014
1,565
449
310
139
4
41
102

1992
$890
608
282
215
67
7
23
51

What Happens to SGR if we exclude Short Term Investments

NI(t)/S( S(t)/A(t A(t-1)/E(t%
t)
-1)
1) Retained

1995
1996

SGR

4.3%

4.31

5.88

100.0%

108.8%

5.1%

4.77

6.61

100.0%

161.9%

To gauge the impact of these short-term investments on sustainable growth, we recalculate the
sustainable growth rate adjusting for the short-term investments by subtracting them from the
prior-year assets and equity.
Net income should also be adjusted for any after-tax income associated with the short-term
investments but the information is unavailable to make that adjustment.
After a crude adjustment , sustainable growth rate for 1995 turns out to be about 109%,
which is well above its actual growth rate. Thus, Dell could finance substantial growth
without increasing leverage or obtaining more equity.

Dells Actual Funding of Its Growth

Current Assets:
Cash
Short Term Investments
Accounts Receivables, net
Inventories
Other
Total Current Assets
Property, Plant & Equipment, net
Other
Total Assets

29-Jan-96Fixed Liablilities
Variance
55
66
(11)
591
484
107
726
820
(94)
429
447
(18)
156
171
(15)
1,957
1,987
(30)
179
178
1
12
11
1
2,148
2,176
(28)

DSO improved by 5 days

over the prior year as
accounts receivable balance
as a percent of sales dropped
to 13.7% from 15.2%.

355
Current Liabilities:
Accounts Payable
Accrued and Other Liabilities
Total Current Liabilities
Long Term Debt
Other Liabilities
Total Liabilities
Stockholders Equity:
Preferred Stocka
Common Stocka
Retained Earnings
Other
Total Stockholders Equity

466
473
939
113
123
1,175

403
349
752
113
77
942

63
124
187
46
233

6
430
570
(33)
973

120
242
538
(21)
879

(114)
188
32
(12)
94

2,148

2,176

(28)

Inventory levels as a percent

of sales also decreased
slightly as DSI improved by
one day to 31
Overall, assets other than
short-term investments fell
from 32% of sales in 1995 to
29% of sales in 1996.

1996 Projections vs. Realizations

As a result of improved efficiency Dell reduced current
operating assets by $30m.
Dell increased its current liabilities by $187 million. As a
percent of sales, current liabilities fell from 21.6% in 1995 to
17.7%.
Accounts payable was 8.8% percent of sales, a decrease of
nearly 3%. In fact, during Q4 1996, Dell paid its suppliers 11
days faster than a year earlier.
Despite 1% erosion in gross margin, Dells profit margin
improved from 4.3% to 5.1%

Dr. C. Bulent Aybar

 In short, Dell internally funded a 52% growth in sales

largely by increasing its asset utilization efficiency and
profitability.
We could repeat the analysis to see if Dell will be able to
grow at 50%; as we have shown before, provided that Dell
maintains or improves its efficiency and or profitability, it
can grow at high double digit rates.
Since this growth is below its SGR, it is likely to produce
substantial cash surplus,
Dell could consider value creating acquisitions or share
repurchases to return cash to shareholders.
Dr. C. Bulent Aybar

1997 Projections Under Alternative Scenarios

Current Assets:
Cash

Year Ended 01/28/96 Actual Percent of Sales

Fixed
Liabailities

Proportional
Liabilities

Debt Repaid &

Repurchase

55

1%

83

83

83

Short Term Investments

591

11%

591

591

591

Accounts Receivables, net

726

14%

1,089

1,089

1,089

Inventories

429

8%

644

644

644

Other

156

3%

234

234

234

1,957

37%

2,640

2,640

2,640

179

3%

269

269

269

12

0%

18

18

18

2,148

41%

2,927

2,927

2,927

373

(214)

986

466

699

466

Total Current Assets

Property, Plant & Equipment, net
Other
Total Assets
Additional Funding Needed
Current Liabilities:
Accounts Payable

466

9%

473
9%
473
710
Third column assumes $500m Stock
repurchase
and $113mDebt
repayment

Accrued and Other Liabilities

473

A Short Exposition on Analytics of Sustainable Growth

p=profit margin
t=TA/Sales
L=D/E Ratio
d= payout ratio
(1-d)=Retention
Ratio

Source: How Much Growth Can a Firm Afford, R. C. Higgins, Financial Management, Fall 1977

Analytics of growth
Assume that sales grow from t to t+1 by s
This means that assets should grow by t x s which is the
left hand side increment in the assets
The increase in the assets should be matched with increase
in retained earnings and an additional amount of debt that
would not change D/E ratio:
Addition to R/E= p x (S+s) x (1-d)
Addition to debt preserving capital structure=
New Debt =p x (S+s) x (1-d) x L

Dr. C. Bulent Aybar

Reorganize to get SGR..

T x s = p x (S+s) x (1-d) + p x (S+s) x (1-d) x L
T x s = p x (S+s) x (1-d) x (1+L)
T x s = [p xs x (1-d) x (1+L)]+[p x S x (1-d) x (1+L)]
T x s - [p xs x (1-d) x (1+L)]=[p x S x (1-d) x (1+L)]
[T - p xs x (1-d) x (1+L)] x s =[p x (1-d) x (1+L)] x S
Solving for s/S produces:

g * SGR

s
(1 L) p (1 d )
(1 L) p R

S
[T (1 L ) p (1 d )] [T (1 L) p R ]

where R=(1-d)
Dr. C. Bulent Aybar

Recap: Managing Growth

We simplify and approximate SGR as
g=(1-d)x(NI/Sales)x(Sales/TA)x(TA/Equity) or
simply as
g=Retention Ratio x ROE
SGR is the rate of growth that can be achieved by preserving
Net Profit Margin
Asset Turnover
Financial Leverage (=TA/Equity)
Retention Ratio

SGR=RR x ROE or SGR=RR x PM x AT x Leverage

Dr. C. Bulent Aybar