Problem Definition
An online travel agency earns a 10% commission on all of its bookings. Currently, their profits before taxes are $1 m, while the industry average is around $2.5 m. The client wants to know why they're making less than the industry average?
Comments
This is a candidate-led case which means that the candidate has to take the interview from start to finish.
Short Solution (Expand)
Detailed Solution
The following framework/structure provides an overview of the case:
I. Background
Candidate should want to look into revenues first, since lower profits could mean that the company isn't turning as much revenue as its industry peers.
- Agency books flight tickets for its customers and earns a commission.
- Total revenue per year on average for the agency is $10 m.
- The agency has a similar size and revenue size as its peers.
- Average industry margins are around 43%.
- Costs have stayed the same and are set at $9 per transaction regardless of the traveller type.
II. Analysis
Next, the candidate should want to understand the revenue breakdown and business segments as well as their profit contribution. With the information given, candidate should calculate profit contribution for each segment.
- The agency has two business segments: business travellers & leisure travellers.
- Business travellers account for 40% of total revenue & leisure travellers account for 60%.
- The agency processes around a million bookings a year.
- 300,000 bookings go to the business traveller & 700,000 go to the leisure traveller.
The candidate should calculate profit per transaction for both segments to see how profits are structured and where the problem lies.
Business segment:
- 40% of total revenues of $10 m with a transaction cost of $9
- 40%*$10 M=$4 m.
- Revenue per transaction: $4 m/300,000 bookings=$13.33.
- Profit per transaction: $13.33-$9=$4.33.
- Total profits: $4.33*300,000 bookings=$1.3 m.
Leisure segment:
- 60% of total revenues of $10 m with a transaction cost of $9
- 60%*$10 M=$6 m.
- Revenue per transaction: $6 m/700,000 bookings=$8.57
- Profit per transaction: $8.57-$9=$-0.43.
- Total profits: $-0.43*700,000 bookings=$-0.3 m.
III. Solution
It seems that the agency is earning less in absolute profit from the leisure segment which makes up for the majority of its revenue, whereas the business segment has a higher absolute profit per transaction.
- The agency should benchmark its competitors and mimick them in terms of cost structures & revenue-structures.
- The agency should focus more on the business traveller, since they make more money on those bookings.
- The agency can also see if they can renegotiate transaction costs for the business traveller, since those travellers travel a lot and could thus earn a discount for the agency.
- The agency can also choose to offer the leisure traveller more products to increase the revenue and profit per transaction.
Difficult Questions
- What are some quick-win & short-term solutions the client can implement to increase profit margins?
- Do you think airlines would offer lower transaction costs to business travellers? How can the agency make that pitch strong?
