Problem Definition
Our client is a European venture capital firm. They are potentially interested in investing into a new restaurant franchise player from Austria, called “VegDigi”. VegDigi has just 3 corporate restaurants in Vienna and no franchisees, yet, but their business model is considered innovative for a restaurant industry, and is based on 3 pillars:
- Proprietary IT system – VegDigi’s team has developed their own IT system (which manages all restaurant processes – from cashier desk and employee schedules to inventory management and delivery).
- Innovative vegan menu – VegDigi offers fresh, whole-foods vegan menu, which differentiates itself from the rest of the fast food offering in taste and quality. VegDigi puts a lot of focus on its foods being healthy.
- Transparent business practices and processes – VegDigi prouds itself to be a transparent business, meaning they publish all their data and talk about their success and failures openly online.
Our client has engaged us to help them to determine whether or not to make an investment into the VegDigi.
Comments
This is a typical McKinsey case and consists of 3 types of questions + a short summary:
- Structuring – a candidate is expected to put together an issue tree / hypothesis tree
- Exhibit – a candidate is expected to look at the exhibit and to draw some insights from it / formulate hypotheses
- Math – a candidate is expected to calculate something and to formulate a hypothesis based on the calculation
All McKinsey cases are interviewer-led cases, so the interviewer should guide the candidate through the interview.
Structuring:
- There are several factors which will affect how VegDigi will do economically in the next years: a) Consumers b) Prices c) Franchisees d) Competitors e) Costs f) Out-of-the-box opportunities. Hypothesis: VegDigi's focus on trendy consumer preferences (vegan) as well as on franchisee acquisition (digital management) will definitely play a positive role in VegDigi growth.
Exhibit:
- VegDigi's restaurant has a worse cost/revenue ratio per dish than this of the competitor, however absolute gross profit is almost the same. Also, VegDigi has a best-selling dish (pizza), which sells much better than competitor's best-selling dish (burger). Hypothesis: there is an opportunity to further increase gross profit, beyond competitor's numbers.
Math:
- Fixing cost/revenue ratio this through reduction of prep items doesn't help. Hypothesis: the price increase should however be feasible and realistic (because of more qualitative and healthier offering of VegDigi vs competitor);
Summary:
- VegDigi seems like an interesting target for investment, however, this requires further analysis.
Detailed Solution
Paragraphs highlighted in green indicate diagrams or tables that shall be shared in the “Case exhibits” section.
Paragraphs highlighted in blue shall be verbally communicated to the interviewee.
Paragraphs highlighted in orange indicate hints for you on how to guide the interviewee through the case.
Question 1 – Structuring: What do you think are key factors which would influence how VegDigi will perform economically in the next 5 years?
Example of an excellent structure:
Consumers
- Preferences – is vegan trend here to stay? Hypothesis: very probably, because of environmental and health concerns connected to animal farming as well as due to animal rights activism
- Geography – is VegDigi able to focus on the right geography, where the vegan trend is the strongest? Hypothesis: yes, it is probably going to be Europe)
- Marketing – will VegDigi be able to deploy efficient marketing to appeal to the key customer groups? Hypothesis: yes, if focused on middle class, educated, environment- and health-conscious
Price
- Price Sustainability – will VegDigi be able to charge a good price (maybe even price premium?), due to its business model and focus on veganism? Hypothesis: yes, VegDigi's values are easy to communicate and to understand, therefore price premium is possible
Franchisees
- Acquisition of franchisees – will VegDigi manage to acquire franchisees? Hypothesis: interesting value proposition for franchisees, because 1) vegan is very popular 2) potential ease of management through IT 3) VegDigi’s core business value is transparency
- Retention and work with franchisees – more difficult to say how this will go. Hypothesis: depends on the future contractual and business relationships, for example in terms of kitchen: 1) will VegDigi be selling something to franchisees as franchisor (e.g. ingredients) or 2) will just mediate between franchisees and a supplier – first option might create mistrust and conflict of interest in a long-term
Competitors
- Vegan – development of other vegan offerings can have double effect: a) negative: create more fierce competition but also b) positive: create an atmosphere in which vegan food is more acceptable. Hypothesis: market is not saturated yet, so positive effect shall outweight the negative
- Franchisors – VegDigi is competing with other franchisors for franchisees, the question is whether VegDigi’s offering for franchisees will have a competitive advantage? Hypothesis: yes, due to its IT system
Costs
- Fixed
- IT costs – since VegDigi is IT-focused company, it will need to acquire IT talent in the future, so price development in this area will affect VegDigi. Hypothesis: costs for IT will definitely rise, it will be difficult for VegDigi to attract IT talent, because it's a restaurant company (not as cool as working for other type of start-up)
- Rent – Development in real estate market will affect VegDigi, since they have corporate brick & mortar locations. Hypothesis: due to current economic situation (post-corona), the prices for real estate will go down
- Variable
- Cost of ingredients – Hypothesis: it is the most important variable costs component, since it will affect both VegDigi corporate locations and its franchisees
Out-of-the-box opportunities
- Comprehensive vegan brand – vegan market is growing rapidly day after day. Hypothesis: if VegDigi is able to branch out into other consumer products (vegan clothing, vegan cosmetics), it might be able to build a comprehensive vegan brand
Main hypothesis: Out of all the factors 1) strong appeal to trendy consumer preferences (vegan) and 2) strong value proposition for franchisee acquisition (digital management) are the biggest factors which play in favour of DigiVeg for its future development (Candidate can also formulate any other main hypothesis, as long as there is a hypothesis)
Question 2 – Exhibit: Here is some data we got from the client about our target and the target’s competitor. Can you take a look at the table and tell me which insights you can draw from it?
Exhibit 1 shall be shared with the candidate.
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If the candidate asks: prep items (mise en place) are processed final ingredients (for example, roasted onions or cut tomatoes), which are required to assemble the final dish.
Example of an excellent exhibit analysis:
- Outlier: Cost-structure of VegDigi is worse than this of the competitor (cost/revenue ratios are higher for all positions), it seems like the cost structure is also correlated with the number of prep items within each player (i.e. more prep items -> higher cost / revenue %) Hypothesis: VegDigi has potential to improve cost /revenue ratios, maybe by a) reducing number of prep items; or b) by increasing prices? Price premium vs competitor could be a reasonable thing to do, since VegDigi has more focus on quality and health (bowls & soups vs hotdog & French fries).
- Outlier: Vegan Pizza is definitely a best-seller, it is the highest selling dish not only at VegDigi – but also if compared to the competitor’s bestseller (burger). Vegan pizza sells 50% more per day vs burger (300 / 200 – 1 = 50%). Hypothesis: definitely keep and develop further the dish, regardless of its high cost/revenue ratio.
Optional: candidate suggests to calculate the gross profit – interviewer agrees (table below is not shareable with the candidate!)
- Outlier: Absolute gross profits are almost the same (EUR 3,300 per day) for both VegDigi and the competitor. Hypothesis: VegDigi is definitely an interesting investment target, because it’s already now matching gross profit of the competitor, but could further improve it.
Question 3 – Math:
We just saw we have a problem with our cost/revenue ratio as compared to a competitor. We want to analyze how reducing the number of the prep items (i.e. simplifying the dish) would affect the gross profit for Pizza of VegDigi. We know that if we take out 1 prep item from the dish, we would decrease cost/revenue ratio by 5 percentage points, but the sales/day would also decrease by 10% (customers would find the dish less interesting and would order less of it).
If we take out 3 prep items from Pizza, how this will affect absolute gross profit of VegDigi?
- New cost/revenue ratio = 45% – ( 3 * 5%) = 30%
- New gross profit % = 1-30% = 70%
- New sales/day = 300 * (1-30%) = 210
- New revenue = 210 * 9 = ~ 1.900 EUR
- New absolute gross profit for Pizza = ~ 1.300 EUR (vs old one of 1.500 EUR)
Hypothesis: Reducing number of prep items for dishes for VegDigi doesn't make sense, because it's clearly driving sales and gross profit down –> if we would want to increase the gross profit for the VegDigi, it's worth to think about increasing prices for their dishes.
Final question – Summary: Imagine this was your first day on the project. Your client, the CEO of the venture capital firm comes into the room, can you please summarize your interim results?
- As regards the overall trends for the next 5 years, VegDigi has a lot of potential, with biggest being 1) strong appeal to trendy consumer preferences (vegan) and 2) strong value proposition for franchisees (digital management)
- We looked at some internal economics of the one restaurant of VegDigi as compared to the competitor and we found out that VegDigi has worse cost/revenue ratios for all the dishes – this can be however fixed through pricing. Hypothesis: price premium vs competitor is possible, because of higher quality.
- Overall, VegDigi seems like an interesting target. We are not able to give a final recommendation on investment yet, but definitely something to look into further.
Difficult Questions
How shall VegDigi organize its franchising model? Shall it organize a "factory kitchen" and sell ingredients (e.g. pizza dough, sauses) and drinks to franchisees or shall it play a role of an intermediary between its franchisees and suppliers of ingredients? What are the benefits and the drawbacks of both models?
Possible answer
Benefits of a "factory kitchen" and selling to franchisees:
- Full control over quality of ingredients
- Easier to produce to should-cost (due to full transparency of cost structure)
- Faster reaction to price increases in the food market (swap of ingredients)
Drawbacks
- Potential conflict of interest – selling to franchisees creates an impression of not being "in the same boat" / not playing for the same team
- In case of the problems it would be the easiest lever to pull ("just increase prices on the ingredients, which we are selling to the franchisees") and that is why it's dangerous
Hypothesis: Due to the fact that VegDigi wants to establish itself as a franchisor, the best way would be not to assume role of a seller, but rather to assume a role of an intermediary (i.e. negotiate framework contracts with the individual suppliers on behalf of the whole franchise network).
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