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Case

Case prompt

Our client, FACT Telecom, is a telecom (ASDL) services provider in Indonesia. They have already set up infrastructure and provide telephony, internet and television access to their customers. The state regulator is considering bringing in more competition into the sector in order to increase penetration. If this happens, FACT would be required to allow other competitors access to its infrastructure, for a fee.  


Our client has hired us to evaluate the market and answer whether a new competitor (let's call it 'NewCo') would be able to run a profitable business in this market.


How would you approach this problem?



Comments
This case would require the candidate to lead in the initial part. However, in the second half, the interviewer must lead the case by quizzing the candidate on several scenarios in order to test the concepts and qualitative thinking abilities of the candidate.




Detailed solution

Paragraphs highlighted in orange indicate hints for you on how to guide the interviewee through the case.

Paragraphs highlighted in blue can be verbally communicated to the interviewee.

Paragraphs highlighted in green indicate diagrams or tables that can be shared in the “Case exhibits” section.


Suggested case structure

Key question: Can a new entrant establish a profitable business in this market?

Brainstorm with the interviewee on a possible structure to solve the case.

Share Exhibit 1 with the candidate once the discussion on the case structure is over. This would serve as a guide through the case process.


Exhibit 1 

 

Below would be the steps to solve the case:
  1. Context: The candidate should attempt to understand the market, market structure, costs involved etc.
  2. Business case: The candidate in this section should try to estimate whether a new entrant can run a profitable business in this market.
  3. Conclusion: The candidate must give a concrete answer on the basis of the above analysis.


1. Context

The interviewee should at the outset try to understand the market, structure, costs involved etc.

Allow the interviewee to think aloud and ask questions in order to understand the client's current business.

Share the following information with the interviewee if enquired:

    • There are three components of the cost: MDF access (copper wire), ASDL equipment and internet uplink capacity.
    • MDF is the key infrastructure element where our client has monopoly. Any new entrant would be given access to it at $20 per month per customer. This price has been floated by the state regulator. Currently, there are no other feasible options for a new entrant to gain connectivity to the houses. Any new entrant would be required to use the access provided by our client.
    • The ASDL equipment (similar to telecom towers) will need to be set up by each new entrant. This requires a capital investment of $200,000 per location. In order to ensure a good coverage across Indonesia, 600 locations would need to be covered. The ASDL equipment is typically depreciated in straight line over 5 years for accounting purposes.
    • Internet uplink costs are variable in nature and amount to $2 per month per customer.
    • The modems which are needed in each house are typically purchased by the customer themselves. 


 A great candidate would immediately assimilate the above information and realize that a break-even point (in terms of no. of customers per month) can be calculated for any new entrant into this segment. However, if required, prompt the candidate to calculate the break-even point. 


2. Business case

The interviewee should now try to calculate the break-even point and try to form a view whether reaching that point would be difficult or achievable for most entrants.

Some candidates might try to take the opposite approach. They might try to estimate the number of customers a new entrant can hope to get and whether a new entrant would be able to make profits with that customer base.

If the candidate takes that approach, prompt him/her by saying that the information on potential customers is not available and ask in such a scenario what other options might be available to him/her to approach this problem.


The following approach should be taken:


At break even point: Revenue - Costs = 0

Revenue = No. of customers * Price per month

Costs = Variable costs + Depreciation


The variable costs given till now include only the MDF access fee and the internet uplink cost. However, there will be other running costs like salaries, rent, SG&A etc. In addition, the price per month is also not known so far. The candidate must request for these two pieces of information. If required, prompt him/her.

Share the following information with the interviewee if enquired:

    • The other running costs for the competitor are estimated to be $6m per annum.
    • The customer pays $30 per month for this service. 


Now the break-even point can be calculated as follows:

Depreciation per month = ($200,000 * 600 locations)/ ( 5 yrs * 12 months)

Depreciation per month = $2,000,000

Costs per month = ( MDF access fee + Internet uplink fee ) * No. of customers + Other expenses + Depreciation

Costs = ($20 + $ 2) * No. of customers + ( $6 m / 12) + $2 m

Costs = ($22) * No. of customers + $2.5 m


Therefore,

Revenue - Costs = 0

($30 * No. of customers) - ($22 * No. of customers)  - $2.5 m = 0

$8 * No. of customers = $2.5 m ( $8 here is the contribution margin per customer)

No. of customers needed for breakeven = 312,500


Once the break-even point in terms of number of customers has been calculated, the question remains how easy or difficult would it be to achieve this number for a new entrant. Prompt the candidate to think about this.


Share that Indonesia has a population of 40 m customers. However, what would be relevant would be the number of households as each connection is for a household and not individual. If inquired, ask the candidate to assume that each household has 4 people on an average.


Therefore, Indonesia would have 10 m households (40m/4). This would mean that the NewCo. would have to acquire 3.125% ( 312,500/10 m) of the market in order to break even.


Prompt the candidate to gauge the feasibility of achieving this number. In order to understand that a great candidate would ask the following questions:

    • What is the market share of ASDL vs. other forms of internet connectivity (dial-up, broadband etc)?
    • What is the growth rate of the market?
    • Is ASDL priced higher compared to the other forms of connectivity?


Share the following information with the interviewee if enquired:

    • Dial-up and broadband are the other forms of internet connectivity.
    • The market is growing as more and more households are getting connected.
    • ASDL is priced competitively to the other forms. ASDL connections were launched 5 years back (it's the newest form of technology) and now forms 30% of the market.


Share Exhibit 2 with the candidate.


Exhibit 2

 

Some of the key conclusions that can be made using the above information are:

    • ASDL connections captured 30% of the market in 5 years and it is the latest form of technology.
    • If we assume that the same growth rate would continue, then it is likely that an additional 30% of the market could potentially be captured by ASDL in the next 5 years. This assumption holds ground as this technology is priced competitively to the older forms of technology.
    • In that case, 3 m (30% of 10 m households) new ASDL connections will be taken in the next 5 years.
    • Let us assume that the time horizon for NewCo. to break even is also 5 years.
    • These new connections will be split between the incumbent (our client) and the new competitors.
    • Therefore a new entrant would need to capture only ~10% ( 312,500/ 3 m) of the new customers.
    • This does not seem like a daunting task, even if 2-3 new entrants were to join the fray.


Different scenario

In this section, we need to test the candidate on a few other qualitative scenarios. Tell him/her that it is likely that once new competitors enter the market, the prices would drop. They are expected to drop to $26 per month. What would be the business case for NewCo. in such a scenario?

In case the prices drop, the contribution margin would drop to $4 ($26 - $22). This is half of the contribution margin per customer calculated in the earlier scenario. In such a case, the break-even point would double. NewCo. would need to capture 20% (2x of 10% calculated earlier) in order to break-even in the new 5 years. This would be much harder to achieve if 2 or 3 new entrants were to come in.


If NewCo. wants to achieve the market share required to break-even, what options are available to the company?

In order to gain a significant part of the market, the company would need to focus both on new customers as well as try to switch some customers from the other modes. In order to do this, it needs to differentiate the service. Price differentiation (offering a lower price) can be ruled out, as the contribution margin per customer is already very low at $4.

The other option is to differentiate on quality and service - quicker installation, better customer service, bundled service offerings (telephone + internet + television) etc.


Is there a way for NewCo. to reduce the fixed costs?

The fixed costs are primarily the investment on the ASDL equipment at 600 points across the country. Instead of covering the entire country, NewCo. could choose some geographical pockets where it could compete. It would be prudent to pick pockets where the population density is high, so that a larger segment of population can be covered with minimal investment.


What would you advise your client to do in such a market scenario?

Some possible ways in which the incumbent can flank itself are:

    • Lobby with the regulator to increase the access fee and thereby reduce the potential contribution margin per customer for a new entrant.
    • Leverage its brand name to capture new customers (upgrading to ASDL connection) especially in high density areas, as this would be the first place of attack by the new entrants.
    • Upsell the ASDL connection by providing bundled services (telephony, data and television).

3. Conclusion

The candidate must now succinctly conclude the case.

    • The market is quite attractive for new entrants, as break-even point can be reached at 312,500 customers only.
    • This would mean that NewCo. could focus only on new customers (instead of poaching customers from our client) and still reach break-even by capturing ~10% of new customers.
    • The client should try to flank the competition by leveraging its brand name to capture new customers, bundle products and even lobby to increase access fee.


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