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Case

Knit and Eat


Case prompt

KnitAndEat (KAE) is a large chain of farms based in the southern United States. They raise sheep, primarily for wool, but also producing meat from the older ewes.  


The chain has been expanding but has noticed a decline in profits in the past couple of years. The CEO has hired us to investigate the cause and provide a solution.


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.

Identify the problem 

The issue is why KAE’s profits have been declining. The candidate should start by structuring their approach. They should understand that profit is determined as a function of revenues and costs: 

 

Now, the candidate should ask appropriate questions to understand the company, its products, revenues and costs.


The following information can be provided:


The company has three products:



Woollen yarn for knitting: this is sold directly to consumers


Worsted yarn: used to produce fine garments. The same quantity is sold each year to a suit manufacturer on a contractual basis. The contract is due to expire at the end of this year


Mutton: produced from the older ewes and sold to supermarkets



Both the mutton and wool markets are highly commodified.


The market as a whole is growing.


Takeaways: 


Since the market is growing, the profitability issue could come from:


a decrease in revenue due to losing market share to one or more competitors

a decrease in prices

an increase in costs

- some combination of these factors


Leading the analysis 


The candidate should ask questions to understand both the revenue and cost structure of the company in order to proceed with the analysis. 


Revenues 


The candidate can be presented with Exhibits 1 and 2 indicating revenues from different products.


Takeaway 

Sales of mutton and woollen yarn have increased, whereas worsted yarn sales have remained the same (as per contract). This means KAE has not been losing revenues to competitors. 


In Y3 and Y4 the revenue on woollen yarn has not increased despite volume increasing. This indicates either an increase in costs or a decrease in prices.


Therefore, the candidate should next aim to understand both of these factors. Prompt the candidate to start with pricing.


Pricing


The candidate should be presented with Exhibit 3, detailing prices


As suspected, the price for woollen yarn has been decreasing, which is one reason for the decrease in profits.


The candidate should hypothesize as to why this might have happened and confirm his hypothesis with the interviewer.


A decrease in demand is unlikely since we know the market is growing and sales are going up. Thus, the most likely scenario is a price war.  


The interviewer will confirm that a new competitor has entered the market and they have been driving down the prices of woollen yarn.


However, the candidate should not stop here and should continue on to investigate costs as well.


Costs


The candidate can be presented with Exhibit 4, detailing costs.


Again, the problem is woollen yarn, for which fixed costs have increased periodically.  


The candidate should inquire which portion fixed costs have increased and why. Potential costs would be: 


  • Rents 

  • Salaries 

  • Utilities  


A good candidate will note the correlation between the increase in costs for woollen yarn and the decrease in costs for worsted wool and inquire about it. 


The interviewer will communicate that rent and utilities have not increased. However, KAE has gradually re-tasked combing machines to produce worsted fabric, which has the best margins out of all their products. This has lowered production costs for worsted significantly.


However, it also means that the process of making woollen yarn was left to individual craftsmen themselves, who now have to hand-comb the wool. The process is more painstaking to do manually and, therefore, craftsmen have repeatedly requested raises.


Takeaways


It is now clear that the reduction in profits comes from the combination of a decrease in prices and an increase in fixed costs in woollen yarn. 


The following calculations for woollen yarn can be made to confirm: 


Revenue    


Y1: 30 x 2m= 60m  

Y2: 30 x 3m= 90m 

Y3: 25x 4m = 100m 

Y4: 20x5m = 100m  

Y5: 20x6m= 120m 


Costs 


Y1: 15 x 2m = 30m 

Y2: 15 x 3m = 45m  

Y3 20 x 4m = 80m  

Y4 25x5m = 125m 

Y5 25 x6 = 150m  


Profits  


Y1: 60-30 = 30m 

Y2 = 90- 45 = 45m 

Y3 = 100-80 = 20m 

Y4 = 100-125= -25m 

Y5 = 120 – 175 = -55m  

Total profits = 5m 

 

Delivering the recommendation 


The candidate should advise the client as follows: 


The decrease in profit is due to the increase in costs and decrease in price for woollen yarn.  


The increase in costs comes from re-tasking combing machines to produce worsted fabric, which resulted in woollen yarn being produced manually and craftsmen repeatedly asking for raises due to the difficulty of the process. 


The decrease in price comes from a price war created by the entry to the market of a new competitor. 


Next steps could include: 


  • - Investing in further equipment, which would reduce the need for manual labour and drive down costs from salaries  

  • - Stopping production of woollen yarn altogether and focus existing resources on producing worsted yarn, since it yields the highest margins. Since a contract is due to be renegotiated, KAE can attempt to increase the quantity bought by suit manufacturers by offering a slightly lower price, which would be sustainable by creating economies of size.

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