Mon. Dec. 10, 2007
by Robert L. Williams, Director - Investor Relations
Last Thursday, we announced that in the next several weeks, Dell XPS and Inspiron PCs would be carried in over 900 U.S. Best Buy locations and at bestbuy.com. With this agreement, Dell PCs will be available in over 10,000 locations worldwide, which in turn helps us drive towards one of our key strategic priorities: focusing on consumer. We've received several questions from the press and investors seeking additional insights into retail initiative and its impact on our business model. Since we've announced partnerships with Staples, Wal-Mart, Sam's Club, Gome, Carrefour, Bic Camera, Carphone Warehouse, and others over the past several months (with the intention of forging 1 to 2 partnerships in the top 20 countries over time), we thought this would be a good opportunity to discuss what the impact retail partnerships will have on our P&L and cash conversion cycle (CCC).
Let's tackle the impact of retail on our CCC first. To review, CCC is a metric used by investors to understand how long it takes a company to create cash flows. This metric takes into account the number of days a company keeps inventories (DSI), the amount of time it takes a company to collect money from customers (DSO), and the amount of time a company waits to pay its suppliers (DPO). In short, CCC = DSI + DSO - DPO. The shorter a company's CCC, the less time capital is tied up in the business, and hence, creates better cash flows. The beauty of the Dell model is that we typically don't take possession of parts inventory until a customer has ordered and paid for a system. Meanwhile, customers typically pay for systems immediately (with a credit card in the case of consumers), and we we'll usually ship a PC to a customer within a matter of days. Meanwhile, our suppliers don't receive payment for roughly 2 months after we take possession of parts (last quarter it was 81 days), so Dell's CCC was -35 days in Q3'08. Dell's strong cash position is then reinvested back into the business in the form of capital expenditures or acquisitions, as well as returned to shareholders in the form share repurchases.
So back to the impact of retail partnerships on our CCC. The most consistent question we've received is whether we'll see our days DSI and DSO go up when dealing with a large retailer. The best way to answer this question is to think of a retail partner similar to a commercial customer. Retail, like commercial customers, will order 100s, if not 1000s of PCs at once. And these PCs will likely consist of just several specific configurations. We'll build these PCs to the customer's specification from one of our 11 global manufacturing facilities, leverage our world-class supply chain, and ship directly to the customer much as we would a commercial customer -- so there's little impact on DSI. As for the impact on DSO, we expect retail's accounts receivables will look much the same as our commercial customers. And remember; roughly 85% of Dell's business today is driven by commercial customers, so the impact on overall DSO should be minimal.
From a P&L perspective, the retail model impacts our business differently than our direct-to-consumer model does. Though it's early in the initiative, we expect retail-driven gross margins will be lower than direct since we'll have to share part of the margin with our partners. On the other hand, the sales and marketing costs associated with the retail model should be lower since our retail partners will shoulder much of these costs. Further, another benefit of our retail model could be that these additional revenues will help offset some of the fixed costs associated with our direct business.
But it's important to remember that our US consumer business posted -1.4% operating profit in Q3'08. While the retail partnerships are a step in the right direction, there's still a lot to do to return this business to profitability. It could take time to ramp and fine tune the initiative, but eventually, we expect retail will be accretive to our bottom line.