Onlinestar, an online retailer of furniture and garden products (core business), has grown significantly in recent years as a result of an expansion of its product portfolio. The company mainly imports goods from Chinese manufacturers but also operates its own production of cat lavatories (special business) in Eastern Europe. The company sells its goods via Amazon and ebay, and recently via an online shop on its website. Despite this development, the financial ratios have deteriorated in recent years. In particular, gross profit margin decreased significantly. Combined with a significant increase in shipping costs, this led to a negative result for the first time in the recently ended fiscal year and a resulting strained financial situation. Against the background of expected stagnating sales for the current financial year, short-term action is required.
The board of Onlinestar asks you for an analysis of the reasons for the negative result as well as a derived recommendation for action. As a consultant, you should bring in your knowledge in online trading and develop solutions. In addition, the management board would like to receive a sales and gross profit plan from you for the current financial year.
Short Solution (Expand) (Collapse)
In order to gain an overview of the situation, the interviewee should ask questions or get answers on the following items:
- In response to pressure from investors to steadily increase sales, Onlinestar also added products with a low sales value and a low gross profit margin to its product range in addition to products with a high gross profit margin.
- The in-house production of cat lavatories were the sales and profit driver of Onlinestar for many years. Due to increased competition in this segment, Onlinestar had to continuously reduce sales prices to the level of material costs. The new opening of a modern production plant by the competition is expected to reduce prices for cat lavatories further. The strained financial situation of Onlinestar makes extensive investments impossible, other cost-cutting measures have been fully utilized. Therefore, no positive change in the gross profit margin is expected over the next few years.
- Labor expenses in the production of cat lavatories and other operating expenses for the production of cat lavatories amount to EUR 5 million per year in the past financial year. Because of appropriate contracts, costs correlate with sales of cat lavatories with a coefficient of 1. (Consequently: Reduction of turnover by 50% reduces costs by 50%, reduction of turnover by 100% reduces costs by 100%, etc.).
- Possible effects of cross-selling are not to be considered in later calculations.
- So far, Onlinestar has bought all furniture and garden products from many small Chinese manufacturers. In the recent past, delivery delays of ordered goods have occurred more frequently. In order to be able to deliver as quickly as possible, Onlinestar has used fast transport options - such as airplane transportation - for importing the goods. This led to higher transport costs, which are attributed to the cost of materials at Onlinestar.
- A consolidation of suppliers to a maximum of five suppliers would result in a 20% reduction in transport costs. Apart from the reduction of the transport costs by a consolidation of the suppliers, the transport costs are independent of the ordered good value.
- In order to be competitive, Onlinestar delivers free shipping. In the past, however, Onlinestar observed that shipping costs have increased disproportionately high to sales growth.
- Based on a conducted investigation, it was found that products with a gross profit margin of less than 10% do not make a positive contribution to earnings due to high shipping costs.
II. Structure and qualitative analysis
The interviewee should be able to derive the following reasons for the decline in the gross profit margin from the information provided:
- Increased sales of small items (by sales size) with low gross profit margin in core business
- Increased transport costs for goods purchasing due to delivery delays in the core business
- Increased competition in cat lavatories led to significant sales price reductions
Conclusion including an evaluation (If the interviewee does not provide a pro/ contra evaluation, it should be asked for explicitly)
- Adjustment of the product portfolio in the core business
- Items in the core business below EUR 5 do not provide a positive earnings contribution and should be removed from the product portfolio.
- Evaluation: Benefits occur through the increase in the gross profit margin as low margin products are eliminated. A disadvantage could be that articles with a low sales price encourage customers to make additional purchases (reduction of cross-selling).
- Termination of production and sale of cat lavatories
- Cat lavatories are a loss-maker as they do not generate gross profit but account for personnel costs and other operating costs. Consequently, cat lavatories reduce profit. Since costs for employees and other operating expenses can be eliminated, production should be discontinued.
- Evaluation: Benefits result from an increase in profit. Possible disadvantages on the other hand are for example a damage of reputation when ending production and reducing staff.
- Consolidation of suppliers to a maximum of five suppliers
- The number of suppliers should be reduced in order to avoid delays of production and consequently expensive special transports in the future.
- Evaluation: Benefits are lower transportation costs. One possible disadvantage is the higher dependence on products and prices of individual suppliers.
III. Quantitative analyses
Based on the results of the completed fiscal year, the sales and gross profit planning for the next year should be prepared.
- Changes compared to the previous year's sales (EUR 660 million) result from a termination of sales of cat lavatories (EUR 70 million) and the termination of sales of articles
- Consequently, sales planning amounts to EUR 501.5 million (EUR 660 million ./. EUR 70 million ./. EUR 88.5 million).
Gross margin planning
- Gross profit planning is carried out separately for each of the sales price categories.
- Category Selling price <5 EUR: no longer part of the product portfolio, no gross profit contribution
- Category Selling price 6-10 EUR: sales (previous year) EUR 590 million * share of sales [SP 6-10 EUR] (20%) * gross profit margin [SP 6-10 EUR] (15%) = EUR 17.7 million
- Category Selling price 11-30 EUR: sales (previous year) EUR 590 million * share of sales [SP 11-30 EUR] (15%) * gross profit margin [SP 11-30 EUR] (20%) = EUR 17.7 million
- Category Selling price 31-70 EUR: sales (previous year) EUR 590 million * share of sales [SP EUR 31-70] (20%) * Gross profit margin [SP EUR 31-70] (30%) = EUR 35.4 million
- Category Selling price >70 EUR: sales (previous year) EUR 590 million * share of sales [SP> 70 EUR] (30%) * gross profit margin [SP> 70 EUR] (40%) = EUR 70.8 million
- A consolidation of suppliers reduces transport costs by EUR 4 million (EUR 20 million * 20%)
- In total, gross profit planning amounts to EUR 145.6 million
IV. Case result and recommendation to client
- The interviewee should combine the results of the qualitative and quantitative analysis and make an overall assessment of the results
- The interviewee should mention that two levers can improve the gross profit margin:
- Adjustment of the product portfolio, including the termination of in-house production and sale of cat lavatories
- Consolidation of suppliers
- The recommendations to the client are therefore as follows:
- Discontinuation of sale of items with a selling price below 5 EUR
- Cessation of production and sale of cat lavatories
- Consolidation of suppliers to five suppliers
- After implementation of recommendations, sales of EUR 501.5 million and a gross profit margin of 29% (EUR 145.6 million in absolute terms) are expected for the current financial year.