POSITIVE CASH-FLOW MANUFACTURING: DELL

Dell Computer has been a pioneer in the use of technology to revolutionize the
business of the personal computer industry.
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The Dell model gives tangible meaning
to terms like mass customization, just-in-time delivery, rolling warehouses, inverted
cash float, and virtual retailing. All these terms relate to business practices made
possible by embracing technologies that have changed traditional business practices.
Dell has rewritten the rules of PC manufacturing and distribution. The PC industry
will never be able to return to its former practices, and those who hesitate to adopt
the new, techonomically driven approach will slowly (or rapidly) be overtaken by
the fittest companies.
The key technologies upon which Dell has based its changes are the PC itself
and the Internet.
Since the first two techonomic laws deal with the ubiquity of
computing and the Internet, Dell is the perfect example of playing to the strengths
of techonomic trends. Without the massive penetration of Internet-connected PCs
available to business and home customers, the Dell approach would not be so
dominant. But with the high penetration of networked PCs and the systems that Dell
has developed to optimize mass customization, Dell has masterfully created a fulfillment
system that is difficult for competitors to overcome. The approach has two pillars: give customers exactly what they want, and manage operational cash flow
by using favorable terms on both the seller and the supplier transactions.
Dell is committed to giving customers exactly what they want as quickly as
possible, one customer at a time. Mass customization. Like the Wendy’s hamburger
with 256 possibilities made from eight different ingredients, Dell stacks up a computer
from options on currently available components (microprocessor, memory,
disks, monitors, modems, operating system, etc.) to serve up a smorgasbord of
product possibilities. Good products configured exactly the way you want them,
when you want them, 24/7/365 thanks to the Internet.
Think how hard this would be in a “paper” world. Because computer components
change so rapidly, the order would be outdated before the ink was dry on the form.
The pricing would also require a spreadsheet to calculate as the combinations from
different vendors at different margins were summed to determine a viable margin
at a competitive price. In the traditional paper world, the best approach would be to
make a lot of one configuration (quantity of scale to be competitive) and market the
configuration until they were all sold. This requires warehousing and inventory costs
to support the mass production run. Consider again the implications of Moore’s Law.
The inventory that is aging has at best an 18-month competitive life, and the
manufacturer risks never selling units produced in a traditional manner, particularly
if they are competing against the mass customization model.
Enter the Internet. Now the customer can enter a virtual storefront on the World
Wide Web, select the exact configuration of computer components desired, place
the order, and buy via a credit card. Dell gladly fulfills the order with guaranteed
payment in hand, knowing what the customer wants to buy, knowing that the sale
price is predetermined, and profiting from the fact that there is no additional distribution
channel cost (middleman) other than a modest shipping cost. No inventory
carrying costs. No distribution channel commissions. No finished product returns
due to time-limited shelf life. The Internet transformed the sales approach, cycle,
and channels. But it does even more related to suppliers and cash flow.
Traditional manufacturing systems obtain parts from suppliers, pay for the parts,
inventory the parts until ready for manufacture, assemble the parts into a product,
ship the products to retailers, and then sell products to customers generating revenues
many weeks after the component parts were purchased. This approach is shown in
Figure 6.1, the key elements in a manufacturing cash-flow model for a traditional
manufacturer. Even though favorable terms can be negotiated, the cycle from procuring
components until selling the product via retail channels is long and requires
capital to fund its growth. As production increases, so must financing for production
in the pipeline.
Use of capital to finance inventory was an accepted business practice until
recently, when just-in-time inventory management approaches (JIT) came along.
By
applying JIT on the supply side, with mass customization direct selling on the
distribution side, Dell has developed a twenty-first-century business model that
actually creates an increasing positive cash flow as production increases.
Figure
6.2 shows the key elements for the Dell positive cash-flow manufacturing model.
The
Inverted Cash-Flow Model
is so named because a traditionally negative cash
flow required for work in process and inventory has been inverted into a positive cash flow. Naturally, Dell loves this model; they get the customer’s cash (electronic
payment) for the finished product (assembled computer) long before they must pay
the suppliers of computer components. Electronic data interchange, World Wide
Web, wire transfer of funds, rolling warehouses, just-in-time delivery, plant-to-door
package delivery networks, and the wire transfer of funds are a few of the key
twenty-first-century technology-backed systems that make possible the Dell model
of inverted cash flow.
Compare the two figures and observe the relative location of revenues and
expenses in the models. This is the most important first-order result of the application
of technology to Dell’s operations, but there are noteworthy second-order effects
that contribute to the effectiveness of the model.
When a customer goes on the Web and orders a new PC, the entire configuration
is defined. The first person to see this configuration is the Dell worker assembling
the finished product.
All the communications to component suppliers, distribution centers, purchasing agents, and trucking fleets have been automatically dispatched
based on the customer’s order and the sequencing of production.
Component
suppliers receive specifications for parts in a sequential order to match the production
staging logistics. At a predetermined time, components from numerous suppliers
converge at the Dell plant for assembly. Upon assembly and software loading, a
burn-in period follows. The package delivery partner picks up the PC for its journey
to the customer as the wire transfer of the customer’s credit card is processed. This
whole process often takes less than 48 hours.
Meanwhile, the component supplier provides extended terms to Dell in order to
secure a large and growing business relationship. Payment terms may be anywhere
from 30 to 90 days, and beyond. Since Dell has no warehouse, Dell receives cash
from the customer well in advance of the payment required to the supplier. Up to
three months of positive cash flow is provided for some portions of the transaction.
The financial benefits of this total approach are many, significant, and obvious:
positive cash flow, no warehousing costs, no carrying inventory, no retail distribution
inventory, and no product aging costs. No surprise that Dell has rocketed to the top
of the list of PC suppliers. By contrast, Compaq was merged with HP because its
distribution channel model failed. Even with increasing sales, price pressure from
the streamlined Dell model caused layoffs at HP. IBM, the originator of the PC
platform, sold its PC interest to Lenovo in China. This is an attempt to leverage the
lower-cost Chinese labor and maintain a presence in the market (and to service a
large and growing Chinese market).
While reducing the manufacturing labor cost content of the PC is a traditional
approach that should yield results, it is the mass customization and inverted cashflow
model that is the strength of Dell’s continuing competitive advantage. Dell’s
suppliers have become their bankers and inventory managers. Others will emulate
the techonomic strategies of companies like Dell or become its victims.
Free cash flow is the cash remaining after all expenses (net income plus amortization
and depreciation minus operating expenses, capital expenditures, and dividends)
including investments have been paid. Free cash flow differs from earnings
in that it accounts for capital expenses as it occurs rather than depreciating it over
many years. Free cash flow is meant to capture all real cash outlays of the present
.
Inverted cash flow describes a different concept altogether. It fundamentally
describes and quantifies a process whereby an organization receives payments for
its endeavors before it pays its suppliers. In traditional cash flow, money moves out
of a company to pay for supplies before revenues return to the company to pay for
the end product. Electronic commerce and savvy negotiation has allowed the tables
to be reversed by some key organizations, hence the development of a new
techonomic financial term,
inverted cash flow.
Let us say you want to consider using the inverted cash-flow model as part of
your overall techonomic strategy. How can it be measured and improved? A very
simple techonomic metric can be used to measure cash float for an endeavor. We
will call it
Endeavor Cash Float (ECF), the combination of time and cash flow
contained between the payment for and the costs incurred in the process of
delivering an endeavor.
The key to the ECF techonomic metric is having the systems
in place to measure the components that constitute it. ECF provides a measure for the cash flow produced or consumed from the manufacturing through the sales cycle.
Shorten the sales cycle, and the metric increases. Negotiate better terms with your
suppliers, and the metric increases. Reduce the duration for parts inventory, and the
metric increases. This metric can pinpoint where to make critical improvements to
ECF. Carefully note that the ECF metric does not indicate whether a given product
sale is profitable (it does not consider the cost of labor, cost of marketing, etc.). It
simply quantifies the time value of a product’s material cash flow as the product
moves through the procurement, production, and distribution pipeline from supplier
to customer payment. Increasing the ECF reduces, or can eliminate, the need for
capital to fund cost of goods.
The ECF sums the difference between sales price and cost of each component
times the number of days of float — that is, the number of days between receiving
customer payment and having to pay the supplier. The days of float can be positive
or negative. If customer payment is immediate and all goods are JIT delivered with
30-day terms, then the number of float days is 30, and the ECF is the sales price
minus the cost of goods in dollars times 30 days. If you are a startup manufacturer
with no supplier terms, and your channel is retail with 90-day payments, your float
is –90 days times your sales price minus the cost of goods (ouch!). Here is the
Endeavor Cash Float
techonomic metric.