Our client, HAE Systems, is a large defense contractor based out of the UK. They produce military helicopters. They are in the process of selecting a site for their new production plant. They are evaluating three sites - Ireland, UK and France.
They have hired us to help them with this decision and want us to calculate the profits for each location over the next 5 years.
Suggested case structure
Diagram 1 : Case structure
- Context: In this step, lead the interviewee to think about the key parameters which would help the client take this decision.
- Profitability Analysis: This would be the key analysis segment of the case; the interviewee would need to calculate the profitability of each of the sites.
- Recommendation: Based on the profitability analysis, the interviewee should conclusively recommend one of the three options to the client for the production plant.
Which key parameters would you evaluate in order to make the decision?
- Profitability of the different plants - fixed costs, variable costs, revenues, profits
- Location of the customers and the costs involved in transportation
- Supply chain impact for the three sites - location of suppliers, differences in procurement costs if any
- Availability of skilled labour at the three sites
- Trade restriction if any - export/ import duties and restrictions
2. Profitability analysis
What would be the expected profit from each of the three options over the next 5 years?
Information that can be shared if enquired:
- One of the existing plants of HAE Systems in the UK has space where a new production line can be set-up for the costs of $1,000m
- This new production line in the UK will have the capacity to produce 250 helicopters per year
- If the plants are set-up abroad, they will have the capacity to produce 350 helicopters per year
- HAE Systems has been in talks with the local department of defense in Ireland and France
- Both of them have said that they do not import equipment from other countries
- However, if the plant was set up in their country, they would spend 50% of their local defense budget on procuring from these plants
- The Department of Defense in the UK has indicated that it is open to importing equipment even if the plant is set up abroad. It is indifferent to location and would spend 25% of its budget irrespective of whether the plant is set-up in UK, Ireland or France.
- However, the Department of Defense in UK requires each imported helicopter to be certified by their specialized quality control team. This certification cost amounts to $20m per helicopter
- HAE Systems plans to sell the helicopters at $200m per helicopter
Exhibit 1: Cost Overview
Exhibit 2: Market Size
Now the candidate must try to estimate the profits for each of the plant locations.
Below would be the steps to calculate the profits for each location:
- Total Revenue = 5 (years) * % of local defense budget spent * Total defense budget
- No. of helicopters sold = Total Revenue / Price per helicopter
- Total Cost = Initial set up costs + (Fixed costs * 5) + (Variable costs * No. of helicopters) + ( Certification cost * No. of helicopters)
- Profit = Total Revenue - Total Cost
If the plant is set up in the UK:
If the plant is set up in the UK, then only the local defense budget from the UK would be available, as Ireland and France do not import equipment. Also the certification costs would not be applicable as the helicopters would be produced in the UK itself.
Total Revenue = 5 * $200 B * 25% = $250 B
No. of helicopters sold = $250 B / 200 m = 1250 helicopters
Total Cost = $1000 m + ( $200 m * 5) + ( $20 m * 1250) = $27 B
Profit = $250 B - $27 B = 223 B$
If the plant is set up in Ireland:
Total Revenue = Revenue from sale of helicopters to UK + Revenue from sale of helicopters to Ireland
Total Revenue = 5 * ($200 B * 25% + $40 B * 50%)
Total Revenue = 5 * ($50 B + $20 B) = $350 B
No. of helicopters sold = $350 B / 200 m = 1750 helicopters
Total Cost = $3000 m + ($200 m * 5) + ($30 m * 1750) + ($20 m * 1250) = $81.5 B
Profit = $350 B - $81.5 B = $268.5 B
If the plant is set up in France:
Total Revenue = Revenue from sale of helicopters to UK + Revenue from sale of helicopters to France
Total Revenue = 5 * ($200 B * 25% + $30 B * 50%)
Total Revenue = 5 * ($50 B + $15 B) = $325 B
No. of helicopters sold = $325 B / 200 m = 1625 helicopters
Total Cost = $3000 m + ($200 m * 5) + ($40 m * 1625) + ($20 m * 1250) = $94 B
Profit = $325 B - $94 B = $231 B
The profits from setting up the plant in Ireland would be the highest.
What would be your final recommendation to the client? What additional factors would you ask the client to consider?
- The client should set up the plant in Ireland
- The profits over the next 5 years are the highest from setting up the plant in Ireland
- The client would be able to sell the helicopters in UK as well as Ireland
- The plant in Ireland would function at 100% capacity (350* 5 = 1750 helicopters)
- The client should however consider the following points before making the final decision:
- Potential backlash from labor unions in the UK where the client already has a manufacturing set-up
- Possibility of trade restrictions in the UK in the future for the import of defense equipment