Problem Definition
Your client, Bookl, is a publishing company with stable sales in terms of both volume and price.
Its distribution warehouse is reaching maximum capacity. This has lowered its service quality.
The head of Bookl’s distribution department wants to extend the warehouse. The extension will cost $15 m and will NOT increase the company’s revenues.
The CEO wants your company to determine whether the investment is necessary.
Comments
Since this is an interviewer-led case, the interviewer should guide the candidate through the interview. The questions should be read out to the interviewee.
The case is split into two parts:
The first part is more qualitative. The open-ended questions should prompt the interviewee to think about the problem and its solution.
The second part is more quantitative in nature. In order to solve the questions, the interviewee should perform calculations.
Short Solution (Expand)
Detailed Solution
The following structure provides an overview of the case:
I. Background
1. Why could the warehouse be reaching its maximum capacity?
The interviewee should ask what drives warehouse capacity. Each book has a specific storage location (SSL) in the warehouse. Capacity utilization can be expressed as:
There are three possible reasons for an increase in capacity:
- Number of SSL is increasing (more different titles)
- Number of volumes per title is increasing
- Decrease in total capacity (warehouse is being used for other purposes)
The interviewee should find potential ways to increase the capacity.
- There has been NO increase in the number of new titles stored.
- The company provides storage and order fulfillment services for third parties (other publishers).
This business accounts for up to 50% of the warehouse’s flows. - The warehouse charges for this service. It might be possible to terminate all or part of these services.
Main conclusion
Bookl can decrease the number of SSLs and free up extra warehouse space for its own use by terminating its services to other publishers.
2. How would you determine which publishers Bookl should stop serving?
The interviewee can come up with multiple criteria. The objective is maximising the positive impact on the warehouse. This mostly depends on the following drivers:
- Amount of space freed up
- Suppressed costs
- Revenue loss
- Economic impact
II. Cost
3. If Bookl stops serving a particular publisher, how would you determine the impact of this action on the warehouse’s P&L statement?
The impact would be the change in revenue minus the change in costs. The interviewee should identify possible cost changes.
Total costs can be divided in fixed and variable costs:
Fixed costs (independent from the number of publishers):
- Warehouse
- Sets of shelves
- Admin staff
- IT staff
- Other infrastructure
Variable costs (decreasing if number of publishers decreases):
- Staff who handle books
- Packaging
4. What are the main drivers of the company’s variable costs?
Variable costs include staff who handle books and packaging. This involves filling SSL spots, fetching books and packing the books for distribution.
Drivers of these variable costs are:
- # of movements performed:
How often operators have to fetch one or more books of a same type. Personnel expenses vary depending on the number of order lines - # of boxes/packages:
Costs increase with the number of boxes/packages, which corresponds to the number of books. (Assumption: the size and type of book does not change)
III. Options
5. Third-party publishers pay your company 10% of a book’s price. How would you determine which publishers to remove?
We want to remove a publisher from the warehouse in order to maximize profit. Thus, since revenue depends on price, there are two possibilities:
- Terminating publishers with a low average price and replacement
- Terminating publishers that sell many titles in small amounts
6. If we terminate this publisher, how will it affect our profit?
- Current warehouse margin: $4m, which is 20% of the sales
- Number of volumes indicates level of necessary packaging
- Number of order lines indicates level of necessary personnel
Current revenue
Current costs
Current total costs = revenue - margin = $20 m - $4 m = $16m
Fixed cost = $16 m * 50% = $8m
Personnel cost = $16 m * 35% = $5.6m
Packaging cost = $16 m * 15% = $2.4m
Expected Revenue (w/o publisher)
Lost revenue = Current revenue * volume reduction = $20 m * 15% = $3m
Expected revenue = $20 m - $3 m = $17m
Expected Costs (w/o publisher)
Fixed = $8 m (no change)
New personnel cost = old person.cost * (1- % order line reduction) = $5.6 m * 75% = $4.2m
New packaging cost = old pack.costs * (1 - % volume reduction) = $2.4 m * 85% = $2.04m
Expected total costs w/o publisher = $8 m + $4.2 m + $2.04 m = $14.24m
Expected margin
New margin = expected revenue - total cost w/o publisher = $17 m - $14.24m = $2.76m
Change in margin = new margin - old margin = $2.76m - $4m = -$1.24m
Main conclusion
If this publisher is removed profit will decrease by $1.24m.
IV. Conclusion
7. Since removing this publisher reduces our profit by $1.24m every year, is it better to remove this publisher or to build the extension?
Assuming other factors remain the same and ignoring the time value of money, in 12 years, the planned extension will cost as much as removing this publisher.
After about 12 years, the extension is the better option, because the lost profit for the removed publisher keeps adding up.
However, it is risky and unrealistic to plan for periods of over 10 years because the industry is unstable and changes quickly.
The client should NOT build the extension.
Difficult Questions
How else could we solve the capacity problem?
Possible solutions (some mentioned at the beginning of the case):
- Destroy old unsold stocks
- Avoid overstocking
- Minimize the initial stocksize
- New copies of old titles can only be obtained on request
- Minimize replenishment times
More questions to be added by you, interviewer!
If the interviewee solves the case very quickly, you can come up with more challenging questions to ask them.
