Our client, Superfix, is a mid-size chain of auto-service garages that has been doing well for the past ten years with 30 stores. However, since management felt that the business was saturating, they expanded with an additional 15 stores in other geographical areas. However, the expansion came with negative effects and falling profits.
You're hired to figure out why the company is losing profit despite its 15-branch growth over the past few years.
This is a candidate-led case which means that the candidate takes the interview from start to finish.
This is a typical case where things aren't as straightforward as they appear to be. Candidate needs to understand clearly where the growth has been coming from and how profits are formed.
Short Solution (Expand) (Collapse)
The following framework/structure provides an overview of the case:
The candidate should ask for more background information on the company.
- Company is an auto service chain that offers off-the-shelf parts and that offers mechanical services.
- Off-the-shelf parts are a low-margin business while the mechanical services are a high-margin business.
- Company added 15 stores in other geographical areas over a period of a few years.
Candidate should start asking for information on revenue, cost and profit margins. Candidate should also ask for more info on the two business segments along with the new 15-store expansion and how those are characterized.
To start off, the following information can be shared if asked by the candidate.
- Same two services are provided in the new 15 stores.
- Prices have stayed the same in the new stores.
- Costs have stayed the same, but proportionally the mechanical service segment carries a higher cost due to the need for skilled labor & special equipment.
Candidate should also note that in the 30-stores area more revenue came from the mechanical-service segment than from auto-parts. In the 15 new stores 75% of total revenue comes from auto-parts which are a small-margin business.
It could be that overall profits have gone down by a change of our product mix towards more low-margin products while fixed costs have stayed the same.
Understanding the WHY behind this:
Candidate should ask for more info on customer behavior and characteristics.
To start off, following information can be shared if asked by the candidate.
- Customers using the mechanical service have a higher income than those buying auto-parts and do the work themselves.
- Most of the high-income customers live in suburban areas where the first 30 stores are located.
- The new 15 stores are located in urban areas where more low-income consumers live.
- It seems that the move of opening 15 stores in urban areas was a wrong one since more revenue is derived from the low-margin products.
- Consumers in urban areas have less to spend and are thus less inclined to pay for expensive mechanical services.
- However fixed costs per store (e.g. rent) at least stay the same; since they are located in more central areas it is likely that fixed costs are even higher compared to suburban areas.
- This shift in revenue breakdown combined with constant fixed costs is causing the overall profitability to fall.
- Client should look into moving the mechanical services out of the urban areas and focus on auto-parts. Doing so will help to reduce workforce in these stores.
- Client should also focus more on areas where they can earn on the high-margin mechanical service business.
- If client is choosing between a focus on low-margin products or high-margin services, which one should client choose and based on what factors?
- Are there any quick short-term solutions the client could implement now to improve profitability?