Financial Analysis of DELL

University Degree Business and Administrative studies

DELL Case study

I) Analysing the performance of Dell financial terms and strategic implications of financial analysis.

Introduction

The computation of analytical ratios from financial statements and interpretation of these ratios to determine their trends as a basis for management decisions. Financial ratios provide a quick and relatively simple means of assessing the financial health of an organization/business. From Dell’s case study, financial performance was analysed and was compared with their competitors for the better understanding of their position in the market. From this study we gain insight of a company future by comparing their historical data.

Dell computer was solidly entrenched as the market leader in PC sales in the United States with nearly 28 percent market share in 2002(from Case study) comfortably ahead of its competitors. However its worldwide market share was compared to its competitors for the year 2002 was explained in the graph.

Fig.1 Market share in 2002

When it comes to worldwide leadership dell is closely fallowed by its competitor HP in desktop sales and a strong battle for leadership of the market became almost unavoidable. A recent data shows that dell was able maintain its position as market leader in the 2003&04 fiscal year also (stocks.us.reuters.com, 2008).Fig.2 explains the market share achieved by Dell and its competitors during those fiscal years.

Fig.2 Worldwide market share from 2002-2004

The key analysis were done on the study include profitability, liquidity and return on investment.

Financial analysis and discussion

Profitability:

Business generally exist with the primary purpose of creating wealth for their owners. Dell’s key strategies were implemented with great precision and discipline that they could make good profits even if they have low margins when compared to the competitors like HP and IBM.

Dell’s average gross margin was 17-18 percent when compared to their competitor’s 24-26 percent. Dell was able to sustain in the market with this low margins because of their low operating expenses in turn good net profit percentage. Dell shown a significant 356 percent increase in their sales from 1997 to 2003 at a growth rate of 34 percent. Fig 1 explains the increase in the sales year wise of Dell computers and its growth.

Fig.1 Net revenue generated by DELL (from case study)

It is when Dell’s internet site took off in selling PC’s to individuals their sales volume increased and they concentrated most on their strategy ‘Direct Selling’ and ‘Build to Order’. Dell’s strong e-commerce presence made them successful in their sales during fore coming years.

Dell shown a constant increase in sales all through the years
Dell recorded a negative sales growth of -2% during the year 2002 which was challenging for them.
The tragic September 11th attack on WTC affected the US stock market and slow down in the PC industry.
Acquisition of HP and Compaq in 2002 gave a competitive advantage over Dell in acquiring more customers and increasing market share.
Despite of the worst scenario in market, Dell continued to maintain its profitability through out.

Gross Profit Margin :

Gross profit margin indicates the profit made by the company without taking its administration and selling cost into account. Gross profit is a percentage used to determine how much money is remaining with company to pay the overhead expenses.

Dell’s gross profit margin was explained in the graph ( Fig.2) to understand how it was doing during the years and when compared to customers. Dell was able to maintain its gross profit margin steadily because their strong process management. Their Just-in-Time practise enabled them to compensate for the low gross profit margins when compared to their competitors.

Fig.2 Gross Profit Margin of Dell (from case study)

Fiscal 2003 year was Dell’s strongest year as they recorded highest ever sales , operating income and lowest operating expenses. This is a result of 13.5% sales increase and 8% shipment increase in PC’s and servers. Dell also increased their shipments to its focused countries by 25 percent in this year. Recent report shows that Dell has improved its Gross profit margin average to 18.4 percent (Forbs.com, 2008). Dell kept increasing their sales volume year by year while keeping the gross profits steady. They also had a good control of their operating expenses as they are not increasing drastically. The difference between Dell and its competitors are mainly its operating expenses and operating income. Figure 3&4 explains the operating expenses as percent of net revenue and operating income per employee of Dell and its major competitors.

Fig.3 Operating expenses of net revenue in 2003 (from case study)

Fig.4 Operating Income per employee in $ (from case study)

Net Profit :

Net profit margin measures the amount of profits available to shareholders after interest and taxes have been deducted on the income statement.

Fig.5 Net Profit Margin of Dell

Dell maintained an average Net income of 6.56 % which is healthy. Dell’s net margin decreased to 6 % from about 8 percent, this may be due to their expansion and diversification strategy. Dell is trying to reach many countries where there is heavy potential for the PC market. Dell utilizing its profits to strengthen their customer service and technical support areas to gain more customer satisfaction and there by retention of the customers and new customer development.

Return on Capital Employed(ROCE):

One of the most important ratio to be calculated in order to analyse company’s performance. It shows how much profit did shareholder gained of his investment. Dell’s ROCE was illustrated in the graph Fig.6

Fig.6 ROCE of Dell (from case study)

Dell’s recent data shows that its maintaining a healthy ROI average of 35 percent when compared to the industry average 25 percent (stocks.us.reuters.com,2008)

Fig.7 ROI of Dell during fiscal year 2000-2003(from case study)

Liquidity Ratio :

Current and quick/acid ratios are calculated to analyse the liquidity of Dell. Fig.8 explains ...

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Return on Capital Employed(ROCE):

Fig.6 ROCE of Dell (from case study)

Dell’s recent data shows that its maintaining a healthy ROI average of 35 percent when compared to the industry average 25 percent (stocks.us.reuters.com,2008)

Fig.7 ROI of Dell during fiscal year 2000-2003(from case study)

Liquidity Ratio :

Current and quick/acid ratios are calculated to analyse the liquidity of Dell. Fig.8 explains ratios in different years. These ratios measure the extend of which assets can be turned into cash quickly (Dyson.J,2007).

Fig.8 Liquidity ratios of Dell for the fiscal year 1998-2003

Current ratio of Dell during all the fiscal year has been normal. Since Dell runs at very low inventory their quick ratio is also healthy. There is not been any substantial drop in the ratios. Dell has been effectively maintaining healthy ratios for years. Dell has an average current ratio of 1.3:1 for period 1998-2003. Dell has always been company who’s trying to improve always as its currents data shows that its has a 1.11 of a current ratio and 1.08 of quick ratio in the fiscal year 2006 (Dell.com, annual report 2006) showing its significant improvement in deploying the money and assets.

Conclusion and Recommendations:

Overall Dell seems to be running its operations smoothly when compared to their competitors.

Dells earning are stable and sustainable over the years
Its been identified that there is a decreasing trend in the gross profit for Dell as a result of increase in cost of sales
In 2002 it is observed that increased cost of sales was accompanied by decrease in sales revenue. This might be due to the severe competition from their rivals and market down.
Dells operating profit margin and net profit margin were declined over a period of time (net profit fell from 8% to 4 %(1999-02)).This decrease might be due to increase in the operating expenses from year to year
Dell increased its revenue and earnings per share at double-digit rates in the fiscal year 2003.
Dell eliminated some 5700 employees worldwide to align its cost structure with slowdown of industry PC sales when compared with its major competitor who cut their work forces by 17900.

Dell has sold its PC’s in more than 170 countries and 97% of their sales came from 60 countries. So Dell can improve its sales and market share by expanding its business to heavy potential countries.

Direct selling model and their shorter value chain model makes more profit than any other company in their sector.

Dell should come up with some strategy to face heavy market demand and their inventory in the coming years, because when the demand goes high they can not rely on their shorter inventory method hence it may effect or delay their product delivery time. This may lead customer dissatisfaction.

Dell is behind HP and IBM in the area of Printers and high range servers in the market share. It is desktop PC’s that keeping Dell on the top, but with the continuous decrease in the PC price Dell may have to concentrate on the other areas to improve upon and maintain its leadership.

II) Mapping and analysing key drivers and processes critical to the strategy and performance of Dell

“An organization’s strategy map and Balanced Scorecard should tell the story of its strategy, a story that differentiates the organization from competitors.”

– Robert Kaplan and David Norton

Good performance of an organization depends on how they implement their strategies according to the market needs. So mangers need to have a clear idea about their key sources and drivers of performance and value in their organization (Bernard Marr& Andy Neely, 2004).These resources could be either physical such as machines, land or financial. Robert Kaplan and Norton (2000, 2003) suggested strategic mapping techniques in order to identify the key drivers and resources of the organization. The strategy maps provides series of ‘levers’ for managing performance of an organization and have control on the changing trends of the business (Mark Wilcox, Mike Bourne,2003). It has been observed by Bernard and Andy (2004) that it is difficult to identify how individual resources contribute to success without taking into account the interdependencies with other assets. So simply mapping performance and outcome seems to break down with the arguments noticed by Bernard and Andy (2004).

Kaplan and Norton (2000) introduced strategy maps as a tool to illustrate how intangible assets are converted into tangible outcomes. The authors continued to explain how strategy maps help employees in relating their jobs to the organization goals. Importantly, balance score card helps to translate vision and strategy to lay down a concrete direction of action to the employees in the entire organization.

Value creating

Balance score card initially proposed to improve the measurement of intangible assets but it can be a powerful tool for describing and implementing organization strategy. Strategy map is considered to be as a visual representation of the cause and effect relationships among the components of an organization’s strategy.

Strategy map is based on several principles:

Key principal of balance score card (Kaplan and Norton, 1996) has been its four essential perspectives.

Financial Perspective
Customer Perspective
Internal Perspective and
Learning and growth Perspective

Objectives of four perspectives link together in a chain of cause and effect relationships. If there is an improvement in intangible assets that means company is improving its performance which in turn benefits the customer and share holder.Fig.1 shows the template for strategy maps with different perspectives illustrated by Kaplan and Norton (2000).

Fig.1 Strategy Map

The questions that can be asked in each perspective are mentioned in the below given picture. Each perspective was seen with some importance and each question leads to the next step of achieving vision.

Fig.2 Balance score card Frame work (adopted from winningmeasures.com)

Fig.2 explains how different perspectives link together to achieve a combined vision.

Drivers and processes critical to Dell’s Performance and Strategy

Table 1 explains key drivers of different perspectives in strategy map of Dell. As mentioned earlier, the entire perspectives link together to achieve the core objective/goal of Dell. ‘Dell’s vision is to create a company culture where environmental excellence is second nature’ (Dell.com) was carefully aligned to the balance score card in order to achieve it. Achieving the financial perspective goals will eventually lead to the vision of the company. In order to achieve the financial goals Dell must analyse and list out their key processes and excel in them.

Table.1 Dell’s key drivers and processes critical to strategies and performance

(* Adapted from Dell website)

Discussion

Under Michael Dell’s strong leadership and years of learning process, Dell has reached to the market leader position. He says ‘The most important thing is to satisfy customer and second most is to make profit. If we don’t do the first one well, the second one doesn’t happen.’ He also mentioned that Dell has been so successful in implementing the strategies as a result of many, many cycles of learning.

Some of the key points from the table

Dell’s hard to copy direct selling and build-to-order models lead them to strong customer satisfaction (low cost & high performance) in turn strong profitability (measured in financial perspective).
Their strong E-Commerce, assembly line approach and strong supply chain helped them to serve customer better than their competitor giving them a competitive edge.
Their strong Just-in-Time practice helped them minimizing their inventory and enabled them to attain more profits and taking off the risk of obsolete inventory in case of technology change. Because of their low inventory they have a competitive edge of hitting the market first if the technology/market changes.
Dell is creating value by working in partnership with its suppliers and customers and making them feel that they are part of their business.
‘Balance score card helps organizations to execute strategies without fail’ says David Norton in an interview about his book ‘Intangible assets and value creation’ (New economy analyst report, 2001). It provides focus to the organization about their future and that’s what makes the difference, says the author.
Each perspective in the balance score card is analysed and measured independently so that it leads them to the goal they want to achieve. Short term goals are fixed to achieve the long term benefits. The financial perspective is analysed in terms of profits generated, market share gained and improved customer number.

III) Potential operational and corporate risks faced by Dell

Risk is the possibility that any specific threat will exploit a specific vulnerability to cause harm to an asset. Most of the good effective strategies that are implemented by companies like Dell carry some of amount risk. According Richard Lynch (2006) risk means that the strategy does not expose the company to unnecessary hazard. Risks need to be carefully assessed when they are implementing the strategies.

Risks faced by an organization can be internal driven or external driven forces. Internal forces include liquidity, R&D, information system etc. External drivers may be seen in Strategic risk, financial risk, operation risk and hazard risk.

Fig.3 explains the external and internal drivers of the total risk of company.

Fig.1 Forces that create risk (adopted from IRM publications)

From the Fig.1 risks can be further categorised as Strategic risk, Financial risk , Operation risks and hazard risks (IRM, 2002).

Dell has been operating in different countries with their build to order and direct selling strategies for more than 20 years. The system in their operations has been well defined and executed so that it is not exposed to any potential risk. But still company like Dell may find them in difficult situation if one of their strategies go wrong in coming years with the changing world.

Some of the potential risks Dells facing are listed below

Corporate risks and suggestions

There is always been a risk of price in the competitive world. As dell considered to be one of the best low cost PC providers it potentially under risk of getting less profit than the other companies.
Since there is a heavy competition in PC market and maintain leadership in the market Dell is forced to keep its price down and cut their other expenses and profits.
Since one of the industry leader HP merged with Compaq, Dell’s business risk increased and left them fighting hard for the leadership of the market share. Dell is closely fallowed by HP-Compaq in their market shares and sales.
Dell’s competitors are into more diversified market and have competitive edge of providing their own technology to the customer like the sector printers, high end servers, cash registering services etc.
Dell is at comparatively less risk than its competitors if the technology change happens because of their Just-in time practise. In the case of technology change, Dell hit the new market much before than the competitors.
Since the major market for Dell is in US, it is very much likely that an upset in US market can cause poor performance of Dell overall.
By adopting direct sales model Dell accepted the risk of not touching common man who want to buy PC’s from stores or want to have a feel of the product.
Dell can adopt a new strategy to set their own stores at all geographical locations to gain more market share. This will not hinder with their strategy direct selling and cutting the middle man.
Since Dell is having operations in many countries, Dell is exposing itself to the currency fluctuation risk because of investments. It is recommended that Dell should insure its investments in case of major financial hedging.
It is observed from the case study that Dell has relatively earned low revenues from geographical areas other than United States. A compound of average of 10 percent from Asia and 20 percent from Europe of their entire sales in the year 2003 and 2002. A graphical (Fig.3) representation shows explains how Dell’s sales were doing in the year 2003 as an example.

Fig.3 Sales percentage of total sales from different geographical locations

In order to achieve more market share and profit Dell has to work collectively to improve its performance in the high potential market area like Asia and Europe.

Some of the Operational risks and suggestions

For several years Dell’s major strength has been its low just-in-time practice and build to order strategy. These are not possible without the coordination and mutual benefit from the suppliers. Dell’s strategy is to work in partnership with suppliers helped them in implementing their key strategies.
Dell may face major threat when their supply chain fails to achieve its goal. Dell has to depend a lot on their suppliers to supply the raw material at cheaper cost. To reduce this risk Dell can come up with agreements/contract with their suppliers for longer period even if the raw material cost increases in future. So Dell can still benefit from their suppliers of getting the raw materials cheap.
Dell’s build to order model designed to serve customer better and achieve customer satisfaction. But because of high demand and low inventory, there might be a risk of severe stress among the employees and processes causing burnout (Employee survey, Vault.com)
Another issue might be related to recruitment. Dell has a world wide employee population of 34000 in the year 2002. In order to manage their cost of production/sales Dell must utilize its resources effectively. Increase in the employee size may increase the cost to the company and reduce its profits. Current data shows that Dell almost doubled its employees in 2006 from 2002. In 2006 Dell has a work force of 65000 worldwide (money.cnn.com).
With increasing demand it is clear that they need more workforces but at the same time to keep their costs under control Dell must revise their employment structure. They might consider taking contract employees (Temporary) to minimize the cost incurred by giving benefits to the permanent employees.
With the increasing number of customers every year Dell’s web site traffic may increase and may lead to non response from the site. And Dell must also be aware of hackers of the site which will cause potential damage to them. ’A common man perception is that internet shopping is not safe’ So Dell should provide awareness to its customers about how safe is their website and user friendly nature.

IV) Critical features and capabilities of the financial management system of Dell to support the management.

Organizations now focusing on delivering the highest value to individual customers through better personalized communication system, faster delivery and tailor made products and services. Dell’s financial system was linked with the strong information support. To achieve higher share holder value Dell’s financial system was carefully coordinated with the help of data management system, Supply chain management, Ecommerce, customer relationship management and ERP systems etc.

Customer relationship management integrates sales, customer service, marketing, field support and other area which touch customer. Customers include internal and external which organization involved in relationship. This will help organization keep their most profitable customers intact and continue relationship. Dell’s customer service has been their competitive strength for years in maintaining the existing customers and new customers as well. Dell integrated their front and back office operations with the advanced IT systems and developed strong database of customers.

Data warehousing is an IT management tool that helps Dell in pooling the customer data and help management to take vital decisions. Careful analysis of customer database reveals interesting insights of customer behaviour in buying. This will help Dell in moving their resources accordingly.

Dell’s ERP system fine-tunes the supply chain management and there by work cost effectively. ERP integrates all the processes that involve logistics, production, supply chain etc. This played a major role in Dell’s performance. As Dell maintains low inventory, Dell should be very careful with their supply chain and production. This is not only profitable for Dell but also profitable for their customers also.

Strong IT infrastructure of Dell helped in achieving profits through the years. Their network system enabled them to communicate, knowledge transfer, customer sharing, information processing etc between different operations units in different locations. From this Dell can understand the buying pattern of the customers.

Strong Ecommerce also played a major role in being profitable for Dell. Ecommerce allows customers to select their customized product online and pay it online. Dell keeps a clear record of customer sales and their credit history. This will help in taking key decisions when announcing product rebates, discounts etc.

Overall dell’s performance appears to be good in terms of profitability and market share. But as discussed above continuous improvement in their processes will make them even stronger and compete with their competitors strongly. For Dell everything fell in the right place, ‘the leader and the strategy’.

Reference:

Bernard Marr and Andy Neely, The dynamics of value creation: mapping your intellectual performance drivers, Journal of Intellectual Capital, Vol-5 No.2, 2004, pp. 312-325

Dyson John, Accounting for non accounting students,2007,Seventh edition,p224,Pearson education ltd.

Employee survey, http:// www.vault.com/ companies / company_main.jsp? co_page=13&product_ id=337& type=workplace , Accessed on 1st April 2008

Fortune global 500 report , Money.cnn.com, accessed on 1st April 2008.

Institute of Risk Management (IRM) (2002) , A Risk Management Standard, Published by AIRMIC,ALARM,pp1-17,visit http://www.theirm.org/publications/ PUstandard.html.

Kaplan,R.S. and Norton, D.P. (1996) ,Using a balance scorecard as a strategic management system, vard business review,September/October,vol.39,No.1, pp.53-79

Kaplan,R.S. and Norton, D.P. (2000) ,Having trouble with your strategy? then map it’, Harvard business review, September/October, pp.167-76

Kaplan,R.S. and Norton, D.P. (2003) ,Strategy Maps-Converting intangible assets into tangible outcomes, Harvard business school press, Boston,MA

Mark Wilcox, Mike Bourne, 2003, Predicting Performance, Journal of Management decisions Vol.41 issue.8, pp 806-816

Marshall D.H, McManus W, Viele D.F,2003 Accounting: What the numbers mean, 6th edition, Boston:Irwin McGraw-Hill.

Richard Lynch, (2006), Corporate Strategy fourth edition, Aldergate consultancy, pp 496.

The New Economy Analyst Report – July 18, 2001, ‘ New Economy Best Practice service,

http:// www.juergendaum.com/news/07_18_2001.htm, Apr 1st 2008.

Bibliography

http://finapps.forbes.com/finapps/jsp/finance/compinfo/Ratios.jsp?tkr=DELL on 24th March 2008.
.http://www.dell.com/content/topics/global.aspx/about_dell/investors/reports/annual?c=us&cs=04&l=en&s=bsd&redirect=1 .
Hp annual report, .
http://www.macworld.com/article/43741/2005/03/marketshare.html, 26th March 2008,
http://stocks.us.reuters.com/stocks/ratios.asp?rpc=66&symbol=DELL.O, march26th 2008
http://www.winningmeasures.com/aboutUs/balancedScorecard.html, march 28th 2008

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Financial Analysis of DELL

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