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Case help

 
#1 Case help
04/07/2007 18:16

student

Hi, for my strategy class I need to work on a business case. The objective is to perform profitability analysis. Since I don't have experience with this type of projects can I ask you guys for the help with the following issues:

Background: Say my company operates in 2 markets worldwide: market A (big market) and market B (small market). Let's assume also the following income/cost structure:

Market A - Year 1: Sales income = 40 units, Other income = 20, Staff cost = 30, Marketing cost = 10.

Market B - Year 1: Sales income = 3, Other income = 4, Staff cost = 3, Marketing cost = 0.

Let's also assume that the differences in the income/cost structure can be explained by historical factors, competition structure, client base, etc.

Q1: Now, if I'm supposed to run profitability analysis, should I:

a) identify key profitability drivers for each market separately and do not conclude anything on the combined (both markets taken together) basis?

b) identify key profitability drivers based on arithmetic average basis (e.g. sales income market A represents 40% of total absolute value, sales income in market B makes 30%, therefore I conclude that sales income drives 35% of the model)?

c) identify key profitability drivers based on weighted average basis (e.g. sales income market A represents 40% of total absolute value, sales income in market B makes 30%, market A is 10 times bigger than market B, therefore I conclude that sales income drives 39% of the model – i.e. 40%*10/11 + 30%*1/11)?

Q2: The example above is done for Year 1. If I have such figures also for years 2-5, should I do the profitability analysis for each year separately and then take averages, of for example only for cumulative year 5 figures?

Q3: Is there any specific type of the analysis I should do when analysing profitability?

Many many thanks in davance for help!

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#2 RE: Case help
04/07/2007 20:43

Taxman to student (#1)

Occams razor:

B is more profitable on a % basis than A

if B had 10 units of marketing, could it grow by a factor of 10 and be larger than A?

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#3 RE: Case help
04/07/2007 21:20

student to Taxman (#2)

Taxman - thank you for your input.

However, before I answer more sophisticated questions (what if), the case is asking or basics: 'identify ket profitability drivers'. And therefore I need your help Taxman - or anybody else on this Forum - in terms of my Q1 and Q2.

Thanks again in advance

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#4 RE: Case help
05/07/2007 09:36

student to student (#3)

Dear Consultants - please advise... especially on Q1 and Q2.

The more I think about it, the more confused I get and the paper deadline is tomorrow...

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#5 RE: Case help
05/07/2007 14:13

Taxman to student (#1)

No straight answer but really you should understand the basics of profitability analysis and thus form your reply.

Market A - Year 1: Sales income = 40 units, Other income = 20, Staff cost = 30, Marketing cost = 10.

Market B - Year 1: Sales income = 3, Other income = 4, Staff cost = 3, Marketing cost = 0.

Price (unknown)

Fixed costs (staff)

Variable costs (sales)

sales volume (income)

sales volume (income not directly attributed to sales)

Price has a 2x or 3x impact of other drivers and has greatest impact because every additional dollar goes straight to profit.

By comparison, an increase in sales volume will be accompanied by an increase in variable costs, so the gain will be smaller.

A decrease in variable costs will increase the margin but will not increase overall revenue.

Finally, a reduction in fixed costs (i.e. overhead) has no impact on revenue and therefore will always have the smallest impact of all.

The strategic implications of this analysis are very important.

Many business people are preoccupied with getting more revenue, often from new customers. However, they often pay little regard to the customers they already have and usually adopt the view that price is something over which they have very little control because of competitive pressure (classic mistake #1).

They also believe that reducing costs is the most effective way to building a profitable business (classic mistake #2)

Even though it makes intuitive sense that cutting costs leads to improved profitability, there is a big qualifier to this. If a cost is necessary for you to do business (for example, customer service costs, or foreign offshoring), then reducing it may reduce your capacity to do business.

Furthermore, the costs that can be reduced most easily are usually those of a "discretionary" nature, and these tend to be the ones geared toward building the future of your business (marketing, team training, R&D, etc.).

As far as pricing is concerned, you might be thinking to yourself: "That's all well and good in theory but if I increase my prices, how much business would I lose?"

That's a good question but a far better one is, "How many customers could I lose and still make the same amount of profit?"

The answer might surprise you. For example, it is entirely possible that a company could raise its prices by 10%, lose 25% of its customers, and actually make more profit.

In other words, the company could lose a quarter of its customers and still be better off. Furthermore, if that were to happen, which customers do you think the company might lose? We suspect that it might be those customers who are most price-sensitive and cause the greatest amount of stress for you your team.

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#6 RE: Case help
05/07/2007 15:01

Consultant to Taxman (#5)

Agree with Taxman's analysis.

Also, to answer your question more specifically I'd:

Q1 - use proposal c)

Q2 - make the analysis on 5yrs cumulative.

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#7 RE: Case help
06/07/2007 01:05

student to Consultant (#6)

Dear Taxman - many thanks for help and your detailed reply!

Dear Consultant - thanks for input as well.

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