Olive Oil Company
Olio di Francesco (OF) is a mid-sized, Italian olive oil producer, which has been in operation for over more than half a century, but has seen steadily declining profits in recent years. We have been engaged to reverse this change and increase profits.
The client should attempt to examine both costs and revenues for OF. However, costs here will be largely immutable, so the case will focus on revenues.
This case will be primarily conceptual rather than quantitative. The candidate should ultimately be guided to come up with suggestions to increase OF’s revenues.
The candidate should begin by asking rational, structured questions to gather salient information about OF and its product.
OF simply makes one kind of extra-virgin olive oil, which it sells in different sized containers.
OFs factory currently operates at 70% of its potential capacity.
All three sizes of product are sold to the same collection of wholesalers and retailers, from where they will eventually be sold on to domestic consumers.
There are no distinct customer segments for OF’s product.
The olive oil market has become highly commodified.
In recent years, OF and the industry as a whole have significantly increased total units sold.
OF has seen a decline in revenue selling its olive oil.
However, the fact that this decrease in revenue has accompanied an increase in the volume of sales implies that the price has declined.
As such, the candidate can identify price as one driver of OF’s profitability problem. Note that there may be more such drivers.
Profit = Revenues – Costs
The candidate should seek understand both components of profit. As such, the candidate should ask structured questions to gather data about the following aspects of both:
We already have some information on revenues from gathering information above. We already know that declining price has caused declining revenues. However, the candidate should ask further questions to dig a little deeper.
OF has seen declining revenue right across the different product sizes it offers.
Revenues have declined across the industry as a whole.
The candidate should ask structured questions to gather more information on OF’s costs.
The candidate should be shown EXHIBIT 1
The raw material for olive oil is a highly commoditized good, with the overall market dictating a fixed price.
Most employees are paid at or around minimum wage, so cannot have their pay reduced. Unions are also very strong in the industry and would implement costly industrial action where any possible pay decreases were attempted.
In principle, this could be decreased but would be very likely to cause a decrease in sales, which would cost more than was saved.
OF has already ensured these costs were optimised before engaging us. No further cuts are possible in this area.
This is already handled by the cheapest provider on the market.
As with SG&A, OF has already ensured that these costs are optimised. No further cuts are possible here.
The candidate should also be told that, for OF and across the industry, costs have remained stable in recent years.
Cost per unit has not increased in recent years and cost components are generally optimised and/or unable to be changed. We can infer that costs have not caused OF’s fall in profitability.
We already know that falling revenues have been driven by falling prices. The fall in profitability must, therefore, have been exclusively due to reductions in price.
The candidate should ask structured questions to gather information about OF’s competitors.
Specifically, they should ascertain whether price decreases have also been made by other firms as well.
The candidate should make enquiries about OF’s main competitors, their size and cost structure, the products they sell and the prices charged for those products.
The olive oil market is fairly fragmented, with many firms of various sizes. OF is approximately average-sized.
All firms in the market have had the same issues around profitability, regardless of those firms’ size.
A sustained price war in the industry has led to a steady reduction in profit margin over time as players seek to gain or maintain market share by reducing prices.
The candidate should now systematically discuss different ways in which OF might increase their profits.
The following options should be considered:
This option is not viable as any increase in price would likely lose OF’s entire current market share as buyers simply move to a cheaper competitor.
We have already seen that all cost components have either already been optimised or are not amenable to change.
There are other ways to increase revenues other than to increase prices. The candidate should consider the relationship between product assortment and customer base. A matrix structure would be appropriate here and might be employed by more advanced candidates. Here, though, we will simply run through the options in linear form.
- Sell more of the current product to current customers
The only clear way to accomplish this in the market OF operates in would be to reduce prices, which we have already seen is not feasible.
- Sell the current product to new customers
This is unlikely to be feasible when selling such a commodified good.
- Sell new products to new customers
This kind of diversification would be difficult to get right and is generally too radical a step for OF.
- new products to existing customers
Before pursuing both new customers and new products, OF should work on just one of these categories. Since we have already ruled out the idea of finding new customers for the existing product, this will mean developing new products aimed at existing customers. Some of these products might also be less commoditised goods and thus able to command larger profit margins.
The only viable solution to OF’s profitability issue is to seek to sell a diversified range of products to its current buyers. These might be able to command higher margins.
The candidate should provide a final recommendation. This should concise and structured.
The level of detail in their suggestions of possible new products etc is likely to vary according to their familiarity with this area in the real world, but a structured, creative approach – from whatever their starting knowledge might be – is the crucial factor for assessment.
A possible recommendation would be:
To increase profitability, Olio di Francesco should boost revenues by offering new additional products to its existing customer base.
Other options, such as cutting costs and increasing sales of the existing products to old or new customers were found to be untenable.
Various olive-oil-based products might be easy for the firm to manufacture and leverage its established brand in offering closely related products. Some examples might include olive oils infused with various herbs etc, olive-oil-based salad dressings and even olive-oil based, margarine-type spreads.
The products could be made using the current surplus 30% factory capacity.
These products might well be able to sustain higher profit margins as less commodified product types.