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2

How to best approach Capacity Extension cases?

How to best structure capacity extension cases like:

1) McKinsey: Australian Mining company wants to double its capacity by opening another mine in China. Goal: Generate additional profit

2) BCG: Fast Food Store is considering opening a second branch.

Any best practice structures?

How to best structure capacity extension cases like:

1) McKinsey: Australian Mining company wants to double its capacity by opening another mine in China. Goal: Generate additional profit

2) BCG: Fast Food Store is considering opening a second branch.

Any best practice structures?

(edited)

2 answers

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Best Answer

Hi Anonymous,

at its core, Capacity Expansion, just as basically any other major strategic move, is a strategic investment decision. A very clear approach would be:

1. Core Question: "Should the Mining client invest into opening another mine in China that would double the client's total capacity?"

2. Identify criterion to make this decision: The additional value we can create over the client's investment horizon has to be significantly higher than the related investment cost. Moreover, the client needs to have the required capabilities and the risks need to be manageable.

3. Compile base information: Required investment amount to get the new Chinese mine operational / yearly operating cost of Chinese mine if opened / investment horizon of client / capacity of client vs. market demand / potential implications of output expansion on pricing/ etc.

4. Deep dive into the value bucket by means of a profitability tree: what are the levers of value here? Compare Scenario A (additional mine in China) to Scenario B (no additional mine in China). Probably the value lever lies on the revenue side: how much additional operational profits can be realized? Any repercussions on our existing mine? etc.

5. Calculate annual value (delta between Scenario A and B). If an additional mine in China indeed increases annual operational profits by a certain amount, you then divide the required investment by this additional yearly profit. This gives you the break even point (point in time after which the investment becomes profitable). If this point comes earlier than the investment horizon, then this is a beneficial investment and the client should proceed with the purchase (purely based on financials).

6. Don't forget to compile potential risks and mention them in your summary

The same logic can be applied to the Fast Food branch question.

Cheers, Sidi

Hi Anonymous,

at its core, Capacity Expansion, just as basically any other major strategic move, is a strategic investment decision. A very clear approach would be:

1. Core Question: "Should the Mining client invest into opening another mine in China that would double the client's total capacity?"

2. Identify criterion to make this decision: The additional value we can create over the client's investment horizon has to be significantly higher than the related investment cost. Moreover, the client needs to have the required capabilities and the risks need to be manageable.

3. Compile base information: Required investment amount to get the new Chinese mine operational / yearly operating cost of Chinese mine if opened / investment horizon of client / capacity of client vs. market demand / potential implications of output expansion on pricing/ etc.

4. Deep dive into the value bucket by means of a profitability tree: what are the levers of value here? Compare Scenario A (additional mine in China) to Scenario B (no additional mine in China). Probably the value lever lies on the revenue side: how much additional operational profits can be realized? Any repercussions on our existing mine? etc.

5. Calculate annual value (delta between Scenario A and B). If an additional mine in China indeed increases annual operational profits by a certain amount, you then divide the required investment by this additional yearly profit. This gives you the break even point (point in time after which the investment becomes profitable). If this point comes earlier than the investment horizon, then this is a beneficial investment and the client should proceed with the purchase (purely based on financials).

6. Don't forget to compile potential risks and mention them in your summary

The same logic can be applied to the Fast Food branch question.

Cheers, Sidi

(edited)

Thank you for the insights, very helpful! — Matthias on Jan 07, 2019 (edited)

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Hi,

The approach will really depend on the objective. For example - in the first case it's unclear whether they have already tried to find additional capacity with their current production line. Your 2nd case is unclear since it's unclear what's the objective.

You should ask the following clarifying questions:

1) Clarify the business model. Ask how the company actually makes the money. For several reasons:

  1. Even if you think you understand the business model, you need to make sure that you understand it correctly.
  2. Some cases have pitfalls related to a business model (re profitability cases with several revenue streams
  3. You need to understand the revenue streams to make a proper structure. E.g. if the case is about oil&gas company which revenues are declining, ask if it is Up / mid / down-stream problem. In this case, defining a revenue stream is critical to setting up the right structure. (At the end of the day it may be the decline of snack sales at the gas stations:). In case of telecom company it may be the problem of the core business (wireless) or non-core (landlines, internet)

2) Clarify the objective. Here make sure that your goal is:

  • Measurable
  • Has a time-framed
  • Has / has no limitations

e.g. Should I invest 100k in this business for 1 year if I want to get 15% return?

3) Ask the questions that will help you understand the scope better, build a relevant structure and remove ambiguity.

E.g. in your 1st case ask if they tried to optimize the existing capacity

!!! Finally - do the recap after asking the clarifying questions. Although most of the case books suggest to do it immediately at the beginning of the interview, it makes much more sense to clarify the situation first and then to make sure that you understand everything correctly.

In general, in the capacity cases, the following things are improtant to understand (note - it's not a structure):

1) Demand - look at the current demand and the demand growth projections

2) Capacity - understand the current capacity in the number of units / labor time / machine time

3) Utilization - understand if the capacity is underutilized. If so - go through the value chain and try to find the bottlenecks

4) Costs and benefits - estimate the potential benefits of the capacity increase vs the investments needed

Best!

Hi,

The approach will really depend on the objective. For example - in the first case it's unclear whether they have already tried to find additional capacity with their current production line. Your 2nd case is unclear since it's unclear what's the objective.

You should ask the following clarifying questions:

1) Clarify the business model. Ask how the company actually makes the money. For several reasons:

  1. Even if you think you understand the business model, you need to make sure that you understand it correctly.
  2. Some cases have pitfalls related to a business model (re profitability cases with several revenue streams
  3. You need to understand the revenue streams to make a proper structure. E.g. if the case is about oil&gas company which revenues are declining, ask if it is Up / mid / down-stream problem. In this case, defining a revenue stream is critical to setting up the right structure. (At the end of the day it may be the decline of snack sales at the gas stations:). In case of telecom company it may be the problem of the core business (wireless) or non-core (landlines, internet)

2) Clarify the objective. Here make sure that your goal is:

  • Measurable
  • Has a time-framed
  • Has / has no limitations

e.g. Should I invest 100k in this business for 1 year if I want to get 15% return?

3) Ask the questions that will help you understand the scope better, build a relevant structure and remove ambiguity.

E.g. in your 1st case ask if they tried to optimize the existing capacity

!!! Finally - do the recap after asking the clarifying questions. Although most of the case books suggest to do it immediately at the beginning of the interview, it makes much more sense to clarify the situation first and then to make sure that you understand everything correctly.

In general, in the capacity cases, the following things are improtant to understand (note - it's not a structure):

1) Demand - look at the current demand and the demand growth projections

2) Capacity - understand the current capacity in the number of units / labor time / machine time

3) Utilization - understand if the capacity is underutilized. If so - go through the value chain and try to find the bottlenecks

4) Costs and benefits - estimate the potential benefits of the capacity increase vs the investments needed

Best!

(edited)

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