Problem Definition
The client, OnlineGo, is a European Internet Service Provider (ISP) that is contemplating entering the North American market. Currently, they hold a dominant position in the European market with two streams of income; a subscription fee and taking a percentage of all e-commerce transactions done by subscribers. After studying the North American market, OnlineGo has concluded that the market is very divided and it is the perfect time to enter. You have been asked to calculate some figures to determine the potential profitability of entering the North American market.
Comments
In this interviewer-led case the interviewee should be guided through the case by the interviewer.
Short Solution (Expand)
Detailed Solution
I. Background
II. Quantitative Analysis
1. Calculate the annual net income in North America, given the current model and all assumptions. What is the annual gross mark-up, measured as a percentage?
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Revenue each year is $2.4B from subscriptions (10 million subscribers x $20 per month x 12 months) and commission will be $540M (10 million subscribers x $1,800 per year x 3% commission), for a total revenue of $2.94B .
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Fixed costs are equal to $1B annually, and variable costs are $1.1B (10 million subscribers x $110/year).
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Therefore, profits are $840 million and the annual profit margin is 28.6%.
2. OnlineGo found that a new entrant is charging $10 per month to gain market share. Can our client do the same?
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If this was done, yearly revenues from subscription would drop to $1.2B (10 million subscribers X $10/month X 12 months), and commission would remain unchanged. The new revenue would be $1.74B, therefore OnlineGo would make a loss of $0.36B.
3. What is the elasticity of demand for this market?
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The elasticity is highly elastic, which means that OnlineGo will not capture enough market share if it charges $20/month.
4. Due to high market elasticity, OnlineGo will charge only $10/month. What would be the amount of online purchases that have to be made by each customer to maintain the same level of profit as at $20/month?
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As costs remain unchanged at $2.1B, revenue will also be held constant at $2.94B. With $10/subscription, revenue from subscriptions would be $1.2B. To remain at $2.94B revenue, commissions must be $1.74B . With 10 million subscribers each one needs to generate $174/year of commission. To keep profits at $840M, subscribers need to purchase $5,800/year.
5. How much would each subscriber have to buy to allow the firm to break even (in the $10/month scenario)?
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Annually, each subscriber would have to purchase $3,000 worth of products online, which is also unrealistic.
6. How many subscribers would OnlineGo need to gain in order to break even (in the $10/month scenario, $1,800 in purchases)?
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Each subscriber brings in $174/year and a profit of $64. These profits must cover the fixed costs of $1B/year so 15.62 million customers must be brought in.
III. Quantitative Analysis
7. How can the fixed costs of investment be reduced?
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Outsourcing capacity
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Leasing networks
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Working in particular geographical areas
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Many other acceptable responses
8. Is there any reason to continue with an investment even if it will lose money?
- Potentially, OnlineGo could do this to enter the internet retailing market and increase its number of subscribers, but it is not a long-term solution based on the calculations.
IV. Conclusion
9. How would you summarize the situation and what are your recommendations?
- There is not one definitive answer, everything is reliant on the interviewee's own ability to explain themselves and their reasoning. Initially, this seems like an attractive market to enter - but if OnlineGo are to expand into North America, they need to find a way to gain much more subscribers or differentiate its product.
Difficult Questions
Are there any other risks or benefits the client should consider?
Very open-ended question based on the candidates own ability to brainstorm ideas.
