Dell vs. Gap
Merchant-King vs. Cash-King
by Al Levit (alanl@ix.netcom.com)

Glendale, CA (Nov. 12, 1998) -- I received an email last month from Cash-King reader Joel Shaw after I wrote my two columns on Merchant-Kings. Joel asked a very good question, namely:

"I wonder if you would explain why you consider Gap (NYSE: GPS) a Cash-King and Dell (Nasdaq: DELL) a Merchant-King (other than just gross and net margin comparisons please)?"

I promised Joel that I'd answer his question during the next week that I was writing columns, and today is the day.

First of all, Joel's point about the difference between the profit margins for the two companies must not be overlooked. Gross margin for Gap was 44.1% for the most recent quarter, which was closing in on the Cash-King minimum of 50%. On the other hand, Dell's gross margin was about half this level (22.9%), nowhere near the Cash-King standard.

As far as net margins are concerned, both companies are barely above the Cash-King minimums of 7%, although once again Gap leaves a little more room to spare. (The Gap's net margin was 8.6% for the quarter ending in July 1998; Dell's net margin was only 7.8% for the July 1998 quarter).

Clearly, I would not use margins as a strong point to justify either company as a Cash-King. In addition, I'm not too bothered by the near miss on Gap gross margins, since its other Cash-King criteria are so strong. I find it considerably more difficult to "explain away" Dell's gross margins, since they are so far away from our standard.

Moreover, I see striking differences in the way that the two companies do business. The Gap is a model of a Cash-King retailer. The company is a no-question-about-it consumer brand. It is strictly in business to sell clothes to consumers. It is not tied to any specific type of clothes, other than a generic casual style.

The Gap creates value by being the store when consumers know they will get the clothes they want without worrying about saving the very last dollar. When I go there I know that some one will be able to help me find what I need, in the size that I need, without being pushy about it. As a result, Gap has kept its margins at acceptable levels and it has been able to expand its business rapidly at the same time. Margins in casual clothing are not as high as in pharmaceuticals or software, but in Gap's world they have played the Cash-King game.

For Dell, the story is different. First of all, most of Dell's business is not done with consumers, it is done with corporations and with the government. That is not consistent with the Cash-King model, although it certainly wouldn't prevent Dell from being a Cash-King company all by itself. When you look at the business model, however, it becomes clear that Dell is a Merchant-King.

Dell makes its money by delivering commodities faster and cheaper than the next guy. Some of the commodities that Dell makes are better than the next guy's, and some are not. This, of course, stands to reason since both Dell and the next guy make a whole line of commodities at various prices and the higher-priced ones are better than the lower-priced ones. The point is that Dell is in a commodity business.

It is very tough for a commodity business to be a high-margin business. Dell's business isn't. When your business doesn't have high margins, then there better be other ways to make money. Fortunately for Dell, there are, and they are often summed up in the word execution.

Here are some examples of Dell's execution:

  • Dell's commodities work better when they are delivered,
  • When Dell's commodities don't work they are fixed or replaced faster,
  • Dell keeps less inventory on hand to build its commodities,
  • Dell needs less of a sales force because a large portion of its order come directly from the Internet.

For me, then, the bottom line difference between these companies is their approach towards business. Gap is first and foremost a customer service company. It is there to get its customers the clothes that the customer needs, and to give the customer all the help the customer may need to select it. Price is important, but second to making sure that the customer has the clothes that he or she needs.

Dell is coming from a different angle. Dell assumes that the customer already knows what is needed. Dell wants to deliver that merchandise for the least possible price. Therefore, Dell must operate with maximum execution.

Two companies operating under two different business models, both of which have been extremely successful. There's no reason why you can't invest in both.

By the way, Dell reported earnings after the market's close today. Revenue rose 51% to $4.8 billion and earnings per share gained 65%, to $0.28 per share. The company continues to lower its expenses -- or sell more leanly. Over 20% of sales took place on the Internet this quarter. Feel free to post any questions or comments on the Cash-King message folder.


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11/12/98 Close

Stock  Change    Bid
AXP   -  3/16  92.38
CHV   +3 1/8   83.00
CSCO  -  7/8   65.19
KO    -  3/4   70.56
GPS   -2 9/16  66.13
EK    -  1/2   77.25
XON   +2 11/16 72.81
GM    -  13/16 67.00
INTC  -1       102.69
MSFT  -2 5/16  108.75
PFE   -1 5/8   104.31
SGP   -1 3/8   102.75
TROW  -  3/8   29.88

                 Day     Month   Year    History
        C-K      -0.94%   2.28%  13.68%  13.68%
        S&P:     -0.25%   1.77%  11.15%  11.15%
        NASDAQ:  -0.60%   4.50%  11.09%  11.09%

Cash-King Stocks

    Rec'd    #  Security     In At       Now    Change
    2/3/98   24 Microsoft     78.27    108.75    38.94%
    5/1/98   37 Gap Inc.      51.09     66.13    29.43%
    2/3/98   22 Pfizer        82.30    104.31    26.75%
   2/13/98   22 Intel         84.67    102.69    21.27%
   6/23/98   34 Cisco Syst    58.41     65.19    11.60%
   8/21/98   22 Schering-P    95.99    102.75     7.05%
   2/27/98   27 Coca-Cola     69.11     70.56     2.11%
   5/26/98   18 AmExpress    104.07     92.38   -11.23%
    2/6/98   56 T. Rowe Pr    33.67     29.88   -11.28%

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   20 Eastman Ko    63.15     77.25    22.33%
   3/12/98   20 Exxon         64.34     72.81    13.18%
   3/12/98   15 Chevron       83.34     83.00    -0.41%
   3/12/98   17 General Mo    72.41     67.00    -7.47%

Cash-King Stocks

    Rec'd    #  Security     In At     Value    Change
    2/3/98   24 Microsoft   1878.45   2610.00   $731.55
    5/1/98   37 Gap Inc.    1890.33   2446.63   $556.30
    2/3/98   22 Pfizer      1810.58   2294.88   $484.30
   2/13/98   22 Intel       1862.83   2259.13   $396.30
   6/23/98   34 Cisco Syst  1985.95   2216.38   $230.43
   8/21/98   22 Schering-P   2111.7   2260.50   $148.80
   2/27/98   27 Coca-Cola   1865.89   1905.19    $39.30
   5/26/98   18 AmExpress   1873.20   1662.75  -$210.45
    2/6/98   56 T. Rowe Pr  1885.70   1673.00  -$212.70

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   20 Eastman Ko  1262.95   1545.00   $282.05
   3/12/98   20 Exxon       1286.70   1456.25   $169.55
   3/12/98   15 Chevron     1250.14   1245.00    -$5.14
   3/12/98   17 General Mo  1230.89   1139.00   -$91.89

                              CASH    $120.62
                             TOTAL  $24834.31
*Please note: On 8/4/98 $2,000 cash was added to the
portfolio. $2,000 will be added every six months.

*The year for the S&P and Nasdaq is as of 02/03/98