Swiss Coffins – The Death Business

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Example of an excellent exhibit analysis:

An excellent candidate understands straight ahead of the meaning of "average life expectancy" in market sizing problems: 

• Little´s law: the number of elements in the system (i.e., total population) divided into lead time (i.e., the average number of years each person lives)
• Intuitively, every year, 1/70th of the population will turn 71 and therefore (on average) will die

A very solid quantitative candidate realizes quickly that no complicated calculations are needed since you have the number 70 both in the denominator (1/70 people die yearly) and in the numerator (70% of people prefer coffins to cremation).

Example of a good exhibit analysis:

An average/good candidate performs the operations step by step:

Example of an excellent exhibit analysis:

This is a HARD problem with lots of information, in which being very diligent and following clear steps is key:

1. Prepare a table with the info that we have: 

• Price = $5,000
• COGS= $4,800, of which:
  • $480 (10% of $4,800) is material cost
  • $4,320 (90% of $4,800) is labor
  • *TIP*: it´s easier to calculate the 10% of 4,800 first (since it´s only removing one zero), and then to the subtraction of 4,800-480 to obtain the other 90%

4. We know from previous calculations that our client sells 9,000 coffins per year (10% of a 90,000 total market). 

See Figure 2 for the table and explanations

Now, let´s calculate profitability figures if the client were to adopt the new industrialized method:

1. Let´s start with the costs, that change in the new model:

• Material costs are the same: $480
• Labor costs will be reduced to 1/3 of what they currently are: $4,320 / 3 = $1,440
• Hence, total new COGS is $1,920

2. Gross profit is the same = 4%. 

3. Since we know that Gross profit = (Price - COGS) / Price, we solve for the new price (profit = 1 - COGS/price ; price = cost / (1-margin) = $1,920 / (1-4%) = $2,000

4. Contribution margin is $80, calculated as price - COGS

5. Since our market share is now 20% instead of 10%, total sales are 18,000 coffins/year

6. The total contribution (i.e., what you obtain "clean" from each ALL SALES deducting COGS) is $1,440,000, obtained as 8,000 coffins * $80/coffin

7. Total profit is -$60,000, obtained subtracting $1,500,000 of Fixed Costs from the total contribution - And we haven´t subtracted the CAPEX investment yet

Example of an extraordinary exhibit analysis:

An extraordinary candidate realizes that, for this operation to be worth it, the price drop needs to be less than 50% (since we would increase sales x2 because we double our market share). Since we will keep the gross margin equal (which means that the decrease in costs would translate directly into a decrease in price), we are told that the most significant cost (labor cost is 90% of all COGS) is reduced to 1/3 to what it is now, we can already see that it´s not going to be worth it. 

Very few candidates see this from the beginning, but it´s not difficult, once you have done enough of these problems! If you have the overall picture in your mind, it´s a couple of multiplications that can save you LOTS of trouble and mathematics. 

See Figure 3 for the complete table

As we can see, the new method would yield fewer profits than the original one ($300,000 vs. -$60,000 yearly profit), despite the increase in market share. It´s not worth it to adopt the new technology since the price drop would be so significant that it wouldn´t compensate for the extra sales. 

• It´s not worth adopting the new technology, since we would lose money vs. our current profit
• We should maintain our business as it is, which generates $300,000 per year
• As the next steps, and given that the client wants to maximize profitability, we should look into additional revenue sources, such as other uses that could be given to the current manufacturing facilities

Value in perpetuity = Yearly cashflow / discount rate

Value in perpetuity = $300,000 / 0,1 = $3,000,000

An excellent candidate would realize that he/she needs to use the "rule of 72" here. Using the “rule of 72,” a 6% growth rate will double the investment every 72/6 = 12 years. Since the property was held for 48 years, it would have doubled 4 times (48/12=4). 

Hence, the current value will be $100,000 * (2 ^ 4) = $1,600,000

Since the business in perpetuity is worth almost double than the current value of the assets ($3,000,000 vs. $1,600,000), it´s better to continue operating it. 

Without the "rule of 72" it´s almost impossible to calculate the value since we would need to resolve the calculation of $100,000 * (1.06 ^ 48)