A major juice producer sells packaged fruit juice to retail outlets. Normally, the juice is packed and sold in 16-ounce carton containers, but recently the producer added a new machine that packages the juice in 32-ounce plastic containers. So he was selling both the 16-ounce & the 32-ounce products. This allowed the business to grow 18% per year, but as sales continued to rise, profits kept falling.
The producer hired us to figure out why profits are falling despite higher revenues.
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Candidate is not required to give a quantitative solution, but he/she needs to understand and be able to explain in overall what's going on and what factors are causing the profit problem.
Candidate should lead the case whereas interviewer shares the data & information upon request.
Profits are falling since client is selling more units of his new low-margin product without accounting for the higher costs it incurs. Need for ABC-costing and proper price-allocation.
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Paragraphs highlighted in blue can be verbally communicated to the interviewee.
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Suggested case structure:
The hints below can be shared with candidate if she struggles, but only after an initial brainstorm and approach explanation by the candidate.
Candidate should use the profit framework and focus on revenue & costs. Since revenues have gone up, it's most likely that costs are the problem here, so candidate should define the hypothesis around costs.
- The candidate should ask for data on pricing of both products, before and after investing in a new machine.
- Candidate should also ask for sales breakdown between the two products.
- Candidate should ask for the unit costs for both products.
- Candidate should ask how cost per unit is calculated by client.
Upon request, the interviewer can provide the following information:
- Price per unit was $2.00 for the 16-ounce product.
- After investing in the new machine, prices have been increased by $0.50 for each product.
- This means that the 16-ounce has a price tag of $2.50 and the 32-ounce $4.00 respectively.
- 60% of total sales comes from the 32-ounce and 40% comes from the 16-ounce.
- The plastic 32-ounce container costs more to produce since it required the new machine and more specialized labor.
- As for remaining overhead, the producer just sums them up and divides them across all units produced for both products.
Candidate should be able to explain the overall situation based on the information above. The following insights can be drawn from that information:
- Firstly, sales per ounce are lower for the 32-ounce product than it is for the 16-ounce product.
- Secondly, it costs more to produce the 32-ounce product, but we're not making more money on it in terms of sales.
- Thirdly, overheads are divided across all products when there should be specific cost-allocation measures that client should use.
- So we're selling more 32-ounce units that have a higher cost, but the pricing per ounce is lower than the cheaper 16-ounce product.
This means that for every 32-ounce we sell, we lose profit since that product is a low-margin product.
This is a clear case of not allocating the proper costs to the proper product and pricing it accordingly. The client should conduct a thorough cost analysis and allocate costs to the right product and adjust pricing.
Applying ABC-costing is a good approach here.
- How do you think the client should price its 32-ounce products?
- Explain your next steps to help this client move forward.