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)
The candidate should recognize that, in presence of only one main competitor, it is reasonable to assume that the price is equal to the competitor's one.
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