Your client is a chewing gum manufacturer.
The CEO of the manufacturing company wants you to find out why his company is experiencing a declining profit margin. He then wants you to suggest ways to improve his company’s profit margin.
Since this is a candidate-led case, the candidate should drive the case from start to finish. The key to solving this case is realizing that the sales mix has changed and that different products have different product margins.
- The two products have different profit margins.
- Sales of the product with a smaller profit margin (flavored chewing gum) have increased while sales of the product with a higher profit margin (flavorless chewing gum) have remained constant.
- This caused the company’s overall profit margin to decline.
Paragraphs highlighted in green indicate diagrams or tables that can be shared in the “Information to share” section.
Paragraphs highlighted in blue can be verbally communicated to the interviewee.
Paragraphs highlighted in orange indicate hints for you how to guide the interviewee through the case.
Suggested case structure:
I. Revenue analysis
First we should have a look at the revenue:
that can be shared if inquired:
- The company’s revenue comes from two types of chewing gum:
Share Diagram 2 with an overview of the sales by volume and price if inquired.
- Sales have increased in terms of volume.
- Since prices have been constant, overall revenue should be increasing.
- Since profit margins are declining, the logical conclusion is that costs must have increased.
II. Cost analysis
Now, we can analyze the cost side of the business.
that can be shared if inquired:
- Costs can be broken down into:
- Raw material prices have not changed.
- Indirect costs per unit have remained constant.
- Flavored chewing gum sales have increased but flavorless chewing gum sales have remained constant.
Share Diagram 3 with a cost breakdown by percentage and Table 1 with the cost breakdown by cents if inquired.
- Indirect costs have not increased. However, if the price of raw material and the amount of raw material used in both products has not changed over time, why are costs increasing?
- The interviewee should realize that although both products have the same price, flavored chewing gum requires an additional raw material - flavor. Since flavored chewing gum costs more to produce than flavorless chewing gum, the profit margin of both products must be different.
Ask the interviewee to calculate the profit margin of the products!
Profit margin for flavored chewing gum:
Profit margin for flavorless chewing gum:
- Both products are sold at the same price. However, flavored chewing gum costs more to produce because it requires an additional raw material. Thus, it has a lower profit margin compared to flavorless chewing gum.
- As both products have the same price point and the flavored chewing gum needs the same raw material as the flavorless gum plus the flavor, this results in higher costs per unit and furthermore in a lower margin per unit.
- Therefore the only way of explaining the lower profitability is that more of the flavored gum is being now sold than flavorless gum.
The profit margin has declined because sales of flavored chewing gum, the product with a lower profit margin, have increased while sales of flavorless chewing gum have remained constant.
To improve the profit margin, the interviewee can suggest both short-term and long-term solutions.
- Negotiate lower prices with current suppliers
- Look for other suppliers
- Buy in bulk to reduce per-unit costs
- Vertical integration
- Release new products (e.g.: low-calorie gum or sugar-free gum) with better profit margins
- Increase product prices. However, our client risks losing sales if customers are very price elastic. (Before increasing product prices, we should conduct price elasticity.)
How would you analyze whether vertical integration can reduce costs?
If our client merged with a competitor, our client could benefit from synergies and economies of scale. How would you analyze this idea?
More questions to be added by you, interviewer!
At the end of the case, you will have the opportunity to suggest challenging questions about this case (to be asked for instance if the next interviewees solve the case very fast).