NoBald is an English pharmaceutical company operating solely in the UK, focusing on treatments to avoid baldness. The R&D division has developed a new product, Stronghair, that helps to grow hair again if applied constantly.
The company has already spent £2 million to develop the new product and it would need an additional £20 million to finish the development, conduct the tests necessary for commercialization and purchase the machines needed to industrialize it.
NoBald would like to know whether it is a good idea to go ahead with the development of StrongHair in light of the expected future sales
Suggested case structure
1. Breakeven volume
- Understand that the investment of £2 million is a sunk cost; thus, it does not have to be considered in the breakeven calculation leading to the recommendation on whether to go ahead or not with the development
- List the main types of fixed and variable costs, such as:
- R&D (fixed cost)
- Purchase of production machines (fixed cost)
- Material (variable cost)
- Labor (assumed to be a variable cost)
- SG&A (variable cost)
- Material: Raw material cost represents the cost per kg of raw material; raw material is then processed and transformed into output through a procedure that has a given efficiency, meaning a given ratio of output produced per unit of raw material used. A given weight of output is used for each treatment
- Labor: Labor cost is the cost per hour of workers' time, assumed completely variable, and production rate is the number of treatments produced per hour of workers' time
- SG&A: Selling, general & administrative expenses are expressed as a percentage of revenues, that is, as a percentage of selling price
- Material cost (£/treatment) is obtained dividing the raw material cost (£/kg raw material) by the efficiency of the process (kg output/kg raw material) and then multiplying this number (£/kg output) by the treatment weight (kg output/treatment)
- Labor (£/treatment) is obtained dividing the labor cost (£/hour) by the production rate (treatments/hour)
2. Payback time
3. Other relevant aspects
Potential other relevant aspects to be considered include:
- Revenue growth through sale of the treatment in other countries: How could NoHair expand its business abroad? On which countries could it focus more?
- Variable cost reduction through increase of efficiency: Which are the effects of a potential increase in efficiency? How could it be achieved?
- Reduction of fixed costs: Which are the potential actions to be put in place by NoHair in order to reduce estimated fixed costs?
- Time value of money: How would breakeven volume be affected if time value of money were considered? Would it be bigger or smaller? Is it reasonable not to consider it?
- The candidate should be able to notice that the contribution margin is not high (around 5% of sales), especially if compared to the margins of the pharmaceutical industry, which are usually much higher
- No Bald should ensure that their competitor does not lower prices, forcing them to further squeeze profit margin or sell at a loss. It should be carefully evaluated whether the cost base of their competitor allows them to further reduce prices whilst maintaining a positive contribution margin
- NoBald could “cooperate” with their competitor in order to avoid a price war and possibly increase prices; however, this action could clearly be subject to antitrust regulations