Case

Madflix.com

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Problem Definition

Our client is madflix.com, a website similar to Netflix. The biggest difference is however that Madflix targets mainly men and provides a majority of “mad movies”, such as action, horror or science-fiction movies.

Clients sign up online, order online, receive the movie and mail it back. They are not satisfied with the profit margin, as it has declined over the last two years.

The CEO has hired us to recommend a solution.


Comments

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).

The interviewee should understand the revenue and cost structure, identify the increase in cost and recommend a solution.


Short Solution

Madflix has to increase the profitability of subscription model 1 as it has negative earnings from it.


Detailed Solution

Paragraphs highlighted in green indicate diagrams or tables that can be shared in the “Case exhibits” section.

Paragraphs highlighted in blue can be verbally communicated to the interviewee.

The following topics can be discussed:

Case Structure

I. Revenues

Information that can be shared with the interviewee on his/her inquiry:

  • Subscription models:
    • S1: 1 movie at a time / $9.99/month
    • S2: 2 movies at a time / $14.99/month
    • S3: 3 movies at a time / $19.99/month
  • Key revenue drivers:
    • Price
    • Subscription mix
    • # of customers
  • Subscription model 1 introduced 2 years ago.
  • Growing number of customers and revenues
  • Unchanged prices

Share Diagram 1 if the interviewee requires information about the revenues.

II. Costs

Information that can be shared if inquired:

  • Key cost drivers:
    • Fixed costs (administrative)
    • Variable costs
  • Components of variable cost:
    • Distribution: Primarily mailing costs
    • Content amortization: Usable life of movies is 30 rentals.
    • Allowances: allowance for movies to be lost in mail
    • Other: DVD cases repair, etc.
  • Insignificant fixed costs
  • DVD amortization is variable
  • Distribution cost on a per unit basis

Share Diagram 2 if the interviewee requires information about the costs.

Main conclusion:

  • Revenues are growing for all subscription models.
  • Variable costs depend on number of movies rented per month (not subscription volume). Distribution costs and amortization make up the biggest share of the variable costs.
  • 2 key gross profit drivers are:
    • Subscription mix
    • Average rentals per month

III. Competition

Information that can be shared if inquired:

  • Possible key issues:
    • New competitors
    • More rivalry
    • Studios sell fewer movies
  • No other competitor in Madflix’s niche.
  • Margins for competitors are not decreasing.
  • Studios are expected to sell the same amount of movies.

IV. Market

Information that can be shared if inquired:

  • There were no changes in demand from target audience.
  • There were no changes in customer preferences.

Tasks

After discussing these topics ask the candidate to solve two tasks.

Share Table 1-3 if the interviewee requires information about the market and customers.

Analyse the gross profit margin for subscription type 3 (in 2012)

Revenue per month and customer

Average rentals per month

= 8 (Table 3)

Revenue per month and rental

For each rental of a customer Madflix receives revenues of $2.50.

Costs per rental

= $1.75 (Diagram 2)

Gross profit margin

Calculate the required price for subscription type 1 & 2 in order for Madflix to have a 30% profit margin.

Average rentals per month

= 6 (Table 3)

Costs per rental

= $1.75 (Diagram 2)

Required price related to required gross profit margin

Current gross profit margin

Subscription 2

Average rentals per month

= 7.5 (Table 3)

Required price

Current gross profit margin

Main Conclusion

The main conclusions here should be:

  • S3 is more profitable than the other models.
  • S2 is still profitable, but S1 is a loss.
  • Madflix is subsidizing its own growth (sells at a loss).

V. Conclusion

The final recommendation should include:

  • Madflix increased its revenues by adding customers in S1 and S2. It has subsidized S1 with S2 and S3 as S1 is generating negative margins.
  • Madflix needs to restructure S1 to make it profitable.
  • Possible ways to increase profitability:
    • Adjusting the price
    • Rationalize costs (focus on distribution cost and amortization)
    • Enter other market niches (women, children, etc.)
    • Targeted advertising to increase customer base
  • Possible risks:
    • Adjusting prices could lead to switching of customers (from S3 to S2 and from S2 to new restructured S1)
    • Madflix needs to identify premium offering of S2 and S3
    • Madflix needs to be cautious not to lose customers while restructuring S3
  • Next tasks:
    • Analyse the price elasticity of the customers to find suitable price for each subscription
    • Renegotiate contracts

Difficult Questions

What possibilities would you suggest in order to reduce the costs (cost rationalization)?

Possible answers:

  • Renegotiate volume discounts to decrease distribution costs.
  • Encourage S2 & S3 customers to order more than one movie together.
  • Promote (with discounts, etc.) rentals of older movies that have lower amortization costs.
  • Renegotiations with film studios in order to reduce DVD costs.

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).

Related consulting question(s)
Best answer so far:
McKinsey / Accenture / Collected all Big 3 offers / Harvard Business School

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1 Comment(s)
Case exhibits

Case Structure


Revenue overview


Variable cost components


Detailed overview of revenues


Number of customers


Average rentals per customer