GDP, M&A, EBITDA, P/E, NASDAQ, Econo-thread Part 14

[DanS]

Yes, that's a good point. They might be unloading the delivery time to their suppliers. On a net basis, the economy is no better off. On the customer side, they do offload the delivery time, by charging the credit cards upon shipment (or even earlier).

As to the fact that there's other working capital besides inventory, you also have a very good point.

[HershOstropoler]

Originally posted by DanS

Now another part of this question. In macroeconomic terms, I think the equation is something like money supply x velocity = economic output. If the Dells of the world increase their inventory ratios, then that increases the economy's velocity.

money supply x money velocity = nominal output

The economy has no turnover velocity from the GDP view as it measures only final uses. On the following questions, I've simply lost you... if you include transactions along the supply line, that may have some impact, but I can't relate it to your points...

[TCO]

I was trying to disaggregate all the different issues and hadn't touched the macro point. The other thing is that maybe they can count it as sold as soon as they recieve payment? Which is in advance. Still would mean that they only need to have 3 days worth of parts on hand. Anyhow, I would be pretty suspicious of the accounting on this number. Devil in the details and all.

[TCO]

They have about 9 billion of current assets, nicely matched with current liabilities. Revenue is 39 Billion. I wonder if some of their inventory (or what we would consider inventory) is tied up in "cash equivalents". I guess I could see them being efficient enough to operate the factory with 3 days parts supply. And they build to order a lot, so there aren't many finished goods. Still would not surprise me to find some supplier warehouses next to their JIT plants and some strict penalties for non-delivery, which they must pay for implicitly in price.

[DanS]

if you include transactions along the supply line, that may have some impact, but I can't relate it to your points...

Maybe my points aren't so clear. I guess I make the assumption that decreasing the time to turn over inventory will end up in the turn over of final uses in more or less a 1:1 fashion. M1 velocity is about 8.5 per annum, roughly in line with the little less than 10 inventory turnover per annum for the S&P 500. Perhaps this assumption is daft.

[TCO]

I looked at the 10K for Dell. It is about a day of WIP. A day of finished goods. And 2 days of raw materials.

[DanS]

I guess I could see them being efficient enough to operate the factory with 3 days parts supply. And they build to order a lot, so there aren't many finished goods. Still would not surprise me to find some supplier warehouses next to their JIT plants and some strict penalties for non-delivery, which they must pay for implicitly in price.

Yes, I was curious about that as well. Dell's gross margins are no better than the industry standard, for instance. Also, I was curious about how the increasing scale of Dell's operations would drive the profitability of the chain and who would lock in that profit--Dell or its suppliers.

[TCO]

To the extent that they reduce inventory and don't just dump it on suppliers, they are benefitting the overall economy. Basically making goods cheaper by being more efficient. There are some ineffeciencies from there delivery method and sales method (end up with less bulk transfers), but overall, they sure look pretty cool.

[TCO]

[QUOTE] Originally posted by DanS


Yes, I was curious about that as well. Dell's gross margins are no better than the industry standard, for instance. [QUOTE]

Well, if they are the same. While having less inventory, that sounds pretty good.

Also, I was curious about how the increasing scale of Dell's operations would drive the profitability of the chain and who would lock in that profit--Dell or its suppliers.

You lost me here.

1. "The chain" includes competitors. Could you restate your idea? But assuming that there is competition in among suppliers, I expect Dell to capture the earnings for changes that they make. If certain suppliers change to adapt to JIT better, than they will capture some value. If all competitors ape what Dell does and if the market remains competetive, I expect the value to accrue to consumers.

2. They haven't really radically changed scale over the last few years. I would expect economy of scale changes to be much more interesting earlier in their existence. Economy of scale tends to peter out. I mean they are at the stage where they just add a call center or add a factory. But each facotry or call center will be at scale. There may be some E of S in advertising or the like. But I doubt that this is the significant story in the supply chain. Probably learning and continued innovation/pushing the envelope is the more significant factor here.

[DanS]

Re #1, the chain does include competitors, but I was interested in the fact that while Dell has a pretty large scale, its gross margins were no more favorable than its competitors, who probably don't have Dell's scale. Is this because there are few economies of scale of which Dell can take advantage? Does the price that Dell pays to its suppliers include the implied cost of holding inventory to such a degree that on a net basis, the whole chain is no better off? That's what I mean.

Re #2, Dell's sales have doubled over the last 5 years. I guess that could be due to a larger product line.

[DanS]

There are some ineffeciencies from there delivery method and sales method (end up with less bulk transfers), but overall, they sure look pretty cool.

Yes, that's what I was thinking. In the face of higher sales and a wider product line, they have cut by half the time it takes to turn around their inventory. That's pretty cool and good basic business from a thirtysomething tycoon, if it's real. It seems like this would help them roll over their competitors in pretty short order, but I don't have a good idea about what the relative impact of this would be. If we assume that the inventory ratio is real and not just some supplier agreement sleight of hand, then how can we measure the relative impact?

[DAVOUT]

The Dell business model is based on the reduction of inventory to an absolute minimum, not only for the resulting decrease of the need of working capital, but primarily to suppress the risk of obsolescence of the parts and of the end products. This risk is one of the main dangers of the desk top and portable computers industry. Dell has perfectly solved the problem with no risk at all on the finished products (the one day inventory relates to computers ordered (and generally paid), and a very small risk on parts with a two days inventory.

This impressive performance is made possible by:
- The acceptance by the customers to wait about 10 days before their decision and the availability of the computer, whereas they can go to the computer shop and bring back a computer immediately. These 10 days are the value given by the customer to the Dell quality.
- The Dell quality (production, delivery and after sale maintenance) which remains at a very high level over time and has gained the customer trust.

Therefore it is tempting to say that the Dell business model is perfect. It is but only because Dell has till now perfectly mastered the selling by mail. Selling by mail has two drawbacks : the right of return granted to the customer (which can be devastating if the customers is disappointed with the product); the marketing only through mail and press advertising is not a simple thing.

The Dell performance cannot be compared to classical marketers, particularly with those who are not manufacturers; it can only be compared to manufacturers selling all their production by mail.

Dell has the reputation to provide, at equivalent prices, products incorporating parts more up-to-date than their competitors, thanks to their way to handle inventory. This could explain that their gross margin is not better than their competitors: this advantage is given for free (at least partly) to the end user.

Reasoning about velocity cannot be made with accuracy, and we can wonder if any breakthrough were made whether corrective steps would not be made on the money supply side for fear of inflation. But in any case, it cannot be recommended to all the Dells of the world to shift to the Dell business model; at this point, Dell is a master piece. Would you recommend to all artists to paint like Michelangelo?

I am afraid that your vision of productivity is not complete; both aspects of productivity are always to be considered, and for any contemplated change on one of them the management has to look on the other to check that it will not deteriorate. For instance, the improvement in the capital use resulting from the disappearance of the end products inventory has also a positive effect on the labour productivity (no warehouse employees, no paper work between the plant and the warehouse, no inventory taking, etc). But the same move made with a customer base accustomed to have products available on the shelf, it could badly damaged the productivity of the sales employees. Additionally, improvements in the labour productivity are often a consequence of capital expenditures. The art of management is to properly balance the two sides.

The information age is not supposed to equip the factories with inventory control systems which do not work: lol: Often this system must be finely tune for a long time, but the end result is worth the effort.

[TCO]

Dan, re 1: If they have the same margins and less working capital, their ROIC will be better. All else equal (and we don't know that to be the case) if they have similar margins and lower inventory, it implies that they really do reduce inventory, not just transfer holding costs to the supplier (else they would have to pay a higher costs for parts).

Re 2: I think the Economy of scale between 20 Bil and 40 Bil is not so significant. Like I said, they just add another call center or another factory (which is at scale). The difference between a large factory or small one or large or small call center is more likely what is significant. And that is something one can acheive at 20 Bil or 40 Bil or 5 bil. Economy of scale does not scale linearly with scale.

P.s. I liked Davout's post.

[TCO]

Note that Carly Fiorina would hate me for making this argument re number 2.

[Saras]

--"Economy of scale does not scale linearly with scale."

Sig material.