Dell Inc.: How Its Business Model Sweetens Its Financial Statements


There are many reasons that Dell Inc. has 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 Circuit City, 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 had profound positive effects on Dell’s supply chain and financial activities. Other PC manufacturers 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 There was no “forecasting” of demand because demand was determined in real-time, and Dell never got stuck with outdated computers because it maintained no inventory.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 direct, 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 like Best Buy, Staples, and Walmart. The main reason for the change was that Dell was shifting its emphasis from targeting businesses to targeting businesses, consumers, and international markets. The thinking was that it needed to have its computers side-by-side with its competitors in consumer channels if it hoped to become the preferred computer vendor for consumers along with businesses. It was also problematic to sell exclusively direct in some international markets.

Dell doesn’t disclose the percentage of its sales that originate through its Web site or over the phone (its original direct sales model) versus the percentage of its sales that come through retail outlets. It’s clear though that a significant portion of its sales now occur online and over the phone and an increasing percentage of its sales are generated through retail outlets.

Dell’s Supply Chain and Manufacturing Strategy

Dell’s hybrid sales model has a significant impact on its supply chain and manufacturing strategy. It can produce computers in a highly efficient manner because it does not have to forecast demand and keep excess inventory on hand for a large percentage of its sales. In fact, when Dell receives an order, via the Internet or on the phone, its suppliers are alerted in real-time, and periodically throughout the day deliver parts to Dell’s assembly facilities where the computers are assembled, configured, and shipped. It also sources the world for the best combinations of quality and cost for parts, which results in a complex yet highly efficient supply chain. In fact, in his 2005 book The World Is Flat, Thomas Friedman asked Dell to retrace the supply chain for his laptop computer, to determine where it was made, how many suppliers were involved, and how it reached his front door. The total supply chain for Friedman’s Dell Inspiron 600m notebook computer, including suppliers of suppliers, involved about 400 companies in North America, Europe, and primarily Asia. The computer was codesigned in Austin, Texas, in Taiwan by a team of Dell engineers, and by a team of Taiwanese notebook designers (a globally distributed team can work 24 hours a day). Its final assembly was in a Dell factory in Penang, Malaysia. It was flown from Penang, Malaysia, to Nashville, Tennessee, on a China Airlines 747, the only 747 that lands in Nashville, other than when Air Force One is in town. It was delivered to Friedman’s home via UPS.

To further increase efficiencies and reduce the amount of capital it must maintain, Dell is currently transitioning from this model and is relying increasingly on contract manufacturers.

Financial Advantages of Dell’s Hybrid Sales Approach and Its Supply Chain and Manufacturing Strategy

There are direct financial benefits to Dell’s hybrid sales approach and its approach to supply chain management and manufacturing. One of the biggest advantages is its inventory turnover. Dell turns its inventory over 40.1 times a year, compared to 14.6 times a year for Hewlett-Packard and 11.8 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 1.70 compared to 1.06 for Hewlett-Packard and 0.80 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 postsales 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 man 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 assuming the role of “taskmaster,” as Dell does, 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 isn’t as strong as it once was, when Dell sold primarily online and over the phone. In 2004, its inventory turnover was 107.1, in 2006 it was 88.8, and in 2008 it was 53.8. It’s now 41.0 as reported previously. It’s also unclear whether Dell will be able to maintain the same degree of quality control as it continues to rely on more contract manufacturers to fulfill its manufacturing activities. 

Reference: Entrepreneurship, Successfully Launching New Ventures