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.
Short Solution (Expand) (Collapse)
Suggested case structure:
I. Revenue analysis
First we should have a look at the revenue:
- The company’s revenue comes from two types of chewing gum:
- 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.
- Costs can be broken down into:
- Indirect costs
- 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.
- 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.
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).