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What is going on with this Cost Calculation ?
New answer on Jul 05, 2020
1 Answer
1.7 k Views
Anonymous A asked on Jul 04, 2020

Dear Community,

I have a confusion when doing case. I realized the solution assume that the variable cost will be the same for Business model S1,S2 and S3. However, I believe it should be different because (look at the variable cost explanations), because the total variable cost for S3 will be higher for each rental as they only need one shipping/distribution and 3 times of content amortazitation,allowance and others (as they ship 3dvds for 1 shipping). So we cant just use 1.75 for the S2 and S3 for cost/rental. We should use

S2 Var cost : $1(delivery)+(0.75*2 (amortazitation,allowance and others) )= $2.5/Rental

S2 Var cost : $1(delivery)+(0.75*3 (amortazitation,allowance and others) )= $3.25/Rental

Assuming that everyone in S1 will rent only 1 DVD once, everyone in S2 will rent 2 DVD/ship, in S3 will rent 3 DVD/Ship

Components of variable cost: Distribution: Primarily mailing costs----> Based on each shipping time (if we assume shipping 3 DVDs same with shipping 1 DVD) Content amortization: Usable life of movies is 30 rentals.---> Based on Each DVD Allowances: allowance for movies to be lost in mail---> ---> Based on Each DVD Other: DVD cases repair, etc.------> Based on Each DVD

I still dont see why the variable cost for each model will be the same as they ship different numbers of DVD (which will affect the distribution cost, allowance,amortazation,others)

I know we need to stick with the case prompt which says

A unique feature of this case is that the variable costs of Madflix do not depend on sales volume, but on other drivers (e.g. average number of movies returned each month).

But, for each DVD movie return it will apply the same right ? Basically the customer will give the same number of DVD as the already gave them.So,

Customer S1 will return 1 movie/rental, S2 will return 2 movies/rental,, S3 will return 3 MOvies/rental,. Thus the variable cost should be different

How do you explain this problems ? Thank you for your explanaitons,

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Content Creator
replied on Jul 05, 2020
Bain Consultant | Interviewer for 3 years at Bain |Passionate about coaching |I will make you a case interview Rockstar


I think the problem stems from the fact that you are assuming that the customer in model S3 receives/watches all the 3 DVDs at once. My take on the S3 model is simply that the customer can have up to 3 DVDs rented at once but that the consumption pattern can vary. For example, ordering one DVD at a time, 2, or 3.

The amortization costs should be driven by the total rentals per month in each model (table 3) and delivery costs would then depend on the ordering pattern.


Was this answer helpful?
Michelle on Nov 03, 2020

In this case, should we clarify for an adjusted average distribution cost for S2 and S3?

Evgeny on Feb 28, 2021

Good point, but I think we take into consideration the worst case scenario where S2 and S3 customers order 1 movie per once, and in those cases these subscription models will be still profitable. Part of the recommendation can be to encourage S2/S3 customers to order 2+ movies at the time, which would further increase the profitability, but this recommendation can be added at the end, as the main target and focus should be the adjustment and improvement of the S1 model.

Anonymous B on Mar 11, 2021

it doesn't make sense that customers who pay extra to be able to rent 2 or 3 DVDs at a time would NEVER do so (this is the underlying assumption in the calcs).

Axel gave the best answer


Content Creator
Bain Consultant | Interviewer for 3 years at Bain |Passionate about coaching |I will make you a case interview Rockstar
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