Dell’s Working Capital Business Case
A different way to calculate the DSI: Average Inventory / (Annual Cost of Goods Sold / 365) DSI of 1994: (220. 000. 000+293. 000. 000/2) / (2440. 000. 000/365) = 38 DSI of 1995: (293. 000. 000+429. 000. 000/2) / (2737. 000. 000/365) = 48 Question 5: KennisInzichtToepassen xx 10 punten Please motivate why Dell probably used the following formula for calculating their DSI? Question 6: KennisInzichtToepassen xxx 20punten In the case is mentioned “As new technology replaced old, the prices of components fell by an average of 30% per year” (page 2).
What would be the inventory loss for Dell for 1995, if they would operated at the DSI level from Compaq? (please show the full calculation and formula’s used) Question 7: KennisInzichtToepassen xx 20punten Please motivate how Dell’s working capital policy was a competitive advantage. Dell used its working capital policy as a competitive advantage by reducing the amount of WIP and finished goods inventory in its system. As a result of maintaining a minimum amount of inventory, Dell reduced its need for inventory financing, warehousing and inventory control.
Dell kept its accounts payable (A/P) account to a minimum volume by waiting until the customers order was received before placing the “release” order with their suppliers.
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Dell’s suppliers were all located very close to Dells manufacturing plants, and made daily deliveries to Dell based on just-in-time delivery. By not receiving the parts until the last minute, Dell kept both its inventory and its accounts payable to a minimum. On the sales side, Dell took orders directly from consumers who normally pay with a credit card online, or over the phone.
Because Dell waited until they received the order from the customer to start building the computer, Dell kept the CCC (cash conversion cycle to a minimum). If Dell were to operate at Compaq’s DSI level, we estimate that Dell would have to increase its 1995 inventory from $293m to $668m, which is an increase of $375 million. This would mean that Dell would have needed to invest in $668 million in inventory. I believe that the main reason that Dell was able to maintain such a low level of inventory compared to their competition has a direct result of their competitive strategy to maintain a minimum level of inventory.
From Dells perspective, there is a competitive advantage to maintaining a low level of inventory in case of a technology change. Because they have less WIP and FG inventory, Dell is better positioned to take advantage of quickly changing technology (processors, for example). If technology were to reduce 30% of the inventory value, Dell would be better off with a lower quantity of inventory which has to be written down. If the inventory were based on Compaq’s DSI number ($668m in inventory), then the write off would need to be $112 more. (30% of $668-$293).
On the other hand, there are some disadvantages to having a low level of inventory on hand, as was shown by Dell in 1996 when they indicated that sales could have been higher if they would have had additional inventory in stock. Sometimes you might have to forfeit sales if you keep your inventory level too low, and can not deliver quick enough to your customers. Dell’s competitve advantage 1)Conversation of capital due to lower inventory holding Compactdell DSI in 957332 Cost of sales of dell in 95 = 2736 m Additional inventory at compaq’s DSI = 2737 * 73-32 / 360 = 312 milion 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. 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. 7 billion *(6. 1%-2. 7%) = $93 million 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. Sources used: