Case Scenario: DELL INC.: HOW ITS BUSINESS MODEL SWEETENS ITS FINANCIAL STATEMENTS
Introduction: There are many reasons that Dell Inc. has, for the most part, been successful over the years. Two of the most compelling reasons are its direct sales model and its ultra-efficient global supply chain. While a start-up can't quickly emulate what Dell has done, there are lessons to be learned from Dell's experiences that any start-up can benefit from. Historically at least, Dell's approach to business made it the preferred computer brand for many businesses and consumers. Additionally, the business approach has sweetened Dell's financial statements and its ability to make money. Dell's hybrid sales approach (combining Direct sales and retail sales) Dell was founded in 1988 touting a direct sales model.
Rather than selling through stores like Sears and Best Buy, Dell sold direct, first over the phone and then via the Internet. Its business model not only allowed businesses and consumers to "customize" their computers, but also had profound positive effects on Dell's supply chain and financial activities. For a period of time after Dell launched its business model, other PC manufacturers, like Hewlett-Packard, had to forecast demand, build computers, ship them to retailers, hope they'd sell, and then wait 30 days or more for payment. Dell sidestepped all of this via its direct sales model. It received orders, built computers, and then shipped them to the buyers via UPS or FedEx. There was no "forecasting" of demand because demand was determined in real time, and Dell never got stuck with outdated computers because it maintained no inventory. Its customers also essentially financed its operations by paying in advance. Dell maintained this business model from 1988 until 2007, when it shifted its sales strategy. Rather than selling exclusively directly, it decided to transition to a hybrid model, where it would continue to emphasize direct sales, but also sell a portion of its product line through retailers such as Best Buy, Staples, and Wal mart. The main reason for the change was that Dell was shifting its emphasis from targeting businesses to times a year, compared to 13.9 times a year for HewlettPackard and 14.6 times a year for the S&P 500 average. Inventory turnover is determined by the following formula (the higher the number the better):
Inventory Turnover = Cost of Goods Sold/Average Inventories
A high inventory turnover means that a company is converting its inventory into cash quickly. Turning its inventory over quickly allows Dell to generate cash that's used to fund its growth, and to not get caught with out-of-date inventory. An often-told joke in the PC industry is that unsold inventory is like unsold vegetables-it spoils quickly. So maintaining a favorable inventory turnover ratio is critical. Another ratio that's important is the asset turnover ratio. Asset turnover reflects the amount of sales generated for every dollar's worth of assets. It's calculated using the following formula (the higher the number the better):
Asset Turnover = Sales/Assets
Dell's asset turnover ratio is 1.26, compared to 1.06 for Hewlett-Packard and 0.34 for the S&P 500 average. Asset turnover denotes the amount of sales generated for every dollar's worth of assets. It's a measure of efficiency in regard to a firm's ability to use its assets to generate sales. Along with crunching numbers, savvy managers assess the impact of their financial strategies on their overall goals and levels of customer satisfaction. Ultimately, it doesn't matter that a company has attractive-looking financial statements if its customers are starting to go elsewhere. Dell's hybrid sales approach and its supply chain and manufacturing strategy shine in this area too. Because it turns its inventory over quickly, it offers its customers the latest technologies rather than saddling them with products that likely will soon be outdated. It can also pass along the advantages of falling component costs quicker than its competitors can. the Downside of pushing cost savings too Far Although the majority of the decisions that Dell has made have both sweetened its financial statements and pleased its customers, Dell is learning the hard way that cost savings can be pushed too far. In the early 1990s, partly in response to the challenges imposed by its rapid growth, Dell started outsourcing the majority of its call center activities to low-wage countries in Asia and Central America.
This strategy led to a chorus of growing complaints about long wait times for customer service calls and poor post-sales support. In response, Dell has spent over $100 million to revive its customer service, including an effort to increase the percentage of full-time Dell employees who staff customer service support lines and reduce its use of part-time and contract workers. The jury is still out on whether Dell has done enough to stem the tide of customer dissatisfaction. Another downside is that Dell pushes its suppliers hard. While most suppliers respond positively, it's hard to gauge the long-term impact in supplier relations by Dell's appearing to assume the role of "taskmaster" in its relationships with its suppliers. It's also unclear how long Dell's hybrid sales approach will maintain an advantage. Although its inventory turnover number is still strong, it's not as outstanding as it was when Dell sold primarily online and over the phone. In 2004, Dell's inventory turnover was 107.1, but it is 31.4 today. Dell also has a formable competitor in Apple. Apple's inventory turnover is 63.0. It may be unfair to compare Dell directly to Apple, given that Apple is a more diversified company, but the comparison highlights the fact that Dell is no longer a trendsetter in inventory management efficiency. Another challenge that all computer manufacturers face is a global decline in personal computer sales. In slightly different words, global declines in computer sales is the reality of the day, even for premier firms like Dell, Hewlett-Packard, and Apple.
Discussion Questions
1. Investigate the financial ratio of inventory turnover. Find current information about Dell (www.hoovers. com is a good starting place) and report whether its inventory turnover is still as impressive as the number mentioned in the case. How does Dell's current inventory turnover ratio compare to that of some of its competitors such as Apple and Hewlett-Packard? Do the same for Dell's asset turnover ratio.
2. Locate Dell's most recent 10-K report and either locate or compute what you believe are the three most important financial ratios for Dell. Are the ratios impressive or do they provide you reason for concern?
3. If you were the CEo of Dell Inc., what expectations would you reflect when preparing a pro forma income statement for your company?
4. What lessons can a young entrepreneurial firm learn from Dell's experiences?