[BCG final round] How to estimate if company A's ROE is higher than company B

Question

My friend was asked to determine if the coffee chain A's ROE will be higher than coffee chain B's in BCG's final round. How would you approach this problem?

Here's some general information about these two companis that might help u :)

A: Mass segment, mainly use franchise method to expand, has the largest number of store and is all over the country B - Starbuck: Premium segment, does not use franchise but build and manage their own stores. B's revenue equals 1/3 of A's

This is not like a well writen case, the interviewer just randomly come up with it

Answer 1

If it's not a well written case, the interviewer probably wants to simply test your logic.

In this case, think about the individual components of ROE - (i) Returns and (ii) Equity.

- Returns: if you own your own stores, revenues will be higher (but so will the costs). On the contrary, under a franchise model you will only be paid royalties - but those will go straight to profits (i.e. little costs associated)

- Equity: owning your own stores will require a larger upfront investment and continuous maintenance vs. operating a franchise model. Hence, more equity needs to be invested in the business

In your example, Company B (Starbucks) operates its own stores (which requires more capital) and yet has lower revenues. Moreover, the margins it earns on this revenues are relatively lower than Company A (because of the franchise model point above).

So, keeping things as simple as possible, it's fair to say that its ROE is expected to be lower.