Case

T&M House

Difficulty: Advanced

Topics:

Case prompt

Our client T&M House is a publishing house based out of the US. They are a mid-tier publishing firm with stable sales (both in terms of quantity and price).

They have a central storage facility which is used to store the titles after printing. They are facing a shortage of space in the warehouse which is set to hit its maximum capacity soon. This is leading to operational issues and is affecting service quality.

One of the solutions proposed is to extend the warehouse in order to increase capacity. There is land available adjacent to the current facility. It is estimated that the extension of the capacity would cost $ 10 m.

The capacity extension is likely to relieve the operational hassles and improve service quality, but it is unlikely to result in any revenue increase.

The client has approached you to help them evaluate whether it is neccessary to increase the capacity of the warehouse.

Comments

This is an interviewer led case. The interviewer should guide the analysis by reading out the questions highlighted in the exhibits to the interviewee.

The case is split into two parts. The first part is qualitative; the interviewer should prompt the candidate to brainstorm and detail potential options / solutions.

The second part is quantitative and has been designed to test the number crunching ability of the candidate.

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.

Suggested case structure

Key question: should the company extend its central warehouse capacity?

The structured detailed below gives an overview of the case. Since its an interviewer led case, it is not essential to share the structure with the candidate; however, the interviewer may briefly discuss the case overview with the candidate if required.

1. Context

1. How would you calculate capacity utilisation for the client?

Allow the interviewee to think aloud and list out the drivers of capacity utilisation. If required, prompt him/ her to try to express capacity utilisation as a formula.

Below would be the key levers that impact capacity utilisation:

Unique titles: The number of unique titles that the warehouse stocks woud impact the capacity utilisation. Each title has a specific storage unit (SSU) which is the amount of space required (in cubic centimeters) to store that title.
Volume per title: The number of units or volume per title would impact the capacity utilisation.
Storage capacity available: The amount of storage space available after accounting for safety regulations/ other spaces etc. would also be a key determinant of capacity utilisation.

Below would be the formula for capacity utilisation:

Capacity utilisation = (SSU x Volume)/ Available capacity

2. What could be the reasons for the warehouse to reach its maximum capacity? What are the potential levers to increase the capacity?

Allow the interviewee to brainstorm and list out the potential reasons and solutions.

Here are some potential reasons for the increase in capacity utilisation:

Increase in unique titles: The increase in the number SSU's stocked either due to the addition of new titles or failure to destroy/ dispose the older titles could be one reason for higher capacity utilisation.
Increase in the volume per title: Overestimating potential sales or longer replenishment cycle of books from the press could lead to an increase in the volume stocked per title which in turn will impact capacity utilisation.
Reduction in storage capacity available: A reduction in the storage capacity available would also lead to higher utilisation. This could be due to new regulations / safety norms or usage of space for other purposes.

Some of the ways that capacity utilisation could be tweaked to reduce strain on the warehouse would be:

Reduce unique titles: Elimination of titles which are old/ not performing may help increase available capacity.
Decrease the volume per title: This would be a key lever to increase available capacity. This can be achieved in several ways - reducing initial stock per title, estimating sales better, reprinting books only on request, shorten replenishment cycle from the printing press etc.
Increase the storage capacity available: The capacity can be increased by extending the warehouse or by eliminating usage of the warehouse for other purposes (if any).

Share Table 1 with the interviewee if neccessary

Exhibit 1

Share the following information with the interviewee if enquired:

There have been no new titles added recently by the client
The company also provides storage services to other small publishing houses. This accounts for 50% of the warehouses's flow. The company stores the books, packages and ships them out to the retailers on the request of the publisher
The company charges the other publishers for this service. The company is not tied up in a long term contract with these publishers, so it would be possible to terminate these agreements at a 3 month notice if required.

Key insight:

An option to increase the available capacity would be to terminate some or all of the agreements with third party publishers and free up space.

3. What factors should the company consider while choosing the publishers whose contracts should be terminated?

Third party publishers pay 5% of the average price of the book as storage fee. This fee is paid irrespective of sales and is paid on the gross value of books stored in the warehouse.

The objective of terminating the publisher would be two fold - maximising the space freed up and minimising impact on revenue (fee charged for storage). This has the underlying assumption that the profits made on our own books is more than 5% (which seems reasonable).

Below would be the key considerations for choosing a publisher:

Maximising space freed up - publishers who have bulky titles (SSU is high)
Minimising revenue impact - publishers who have low average price

2. Cost analysis

4. Can you help evaluate the impact of terminating a publisher contract on the P&L of the firm?

Allow the interviewee to think aloud and list out the line items that would get impacted. A great candidate will think about both revenues and costs and would also be specific about the fixed and variable costs.

The P&L impact would be equal to the loss of revenue minus the reduction in costs.

Revenue loss would be a function of the average price of the books stored and the volume stored. This would reduce if a publisher is terminated.
The fixed costs would remain constant - warehouse maintenance, admin staff, IT, etc.
The variable costs would include packaging material, handling personnel etc. These costs are likely to reduce if a publisher is terminated.

5. Can you identify the drivers of the variable costs of the company?

Allow the interviewee to think aloud and list out the potential drivers. Prompt him/her if required and share the cost structure.

Share Diagram 1 with the interviewee if s(he) enquires about the cost structure of the company.

Exhibit 2

There are two key variable costs - handling staff and packaging material. The potential drivers of these costs could be:

Handling staff - The number of times the books are replenished (from the press) or shipped out to the retailers would determine the costs assosciated with handling staff
Packaging material - The SSU and the associated volume would determine the packaging material required when the books are shipped out to the retailers

3. Options

We would now move to the quantitative part of the case.

6. The company has identified Publisher X as the potential publisher whose contract should be terminated. The company has estimated that the space freed up by this termination would be sufficient to tide over the capacity challenge in the foreseeable future. Can you calculate the impact of the termination of Publisher X on the profits of the firm?

Share the following information with the interviewee if enquired:

We know the following details about the publisher. Publisher X accounts for:

10% of the total revenue
20% of the volumes stocked in the warehouse
15% of the order lines in the warehouse

The volumes stocked in the warehouse have a direct impact on the packaging costs.
Order lines are a function of the number of times the books need to be handled during replenishment or outward shipping. This has a direct impact on the handling staff costs.
The current margin of the warehouse is $ 5 m and the margin percentage is 25%

Using the above information, the following can be calculated:

Total Revenue = Margin / Margin % = $ 5m/ 25% = $ 20 m

Total Costs = Revenue - Margin = $ 20 m - $ 5 m = $ 15 m

Using the cost structure shared earlier, the different cost components can be calculated:

Handling staff cost = Costs x 40% = $ 15 m x 40% = $ 6 m

Admin / IT staff cost = Costs x 20% = $ 15 m x 20% = $ 3 m

Packaging cost = Costs x 20% = $ 15 m x 20% = $ 3 m

Maintenance cost = Costs x 10% = $ 15 m x 10% = $ 1.5 m

Depreciation = Costs x 10% = $ 15 m x 10% = $ 1.5 m

Termination of Publisher X would only impact the handling costs, packaging costs and the revenue:

New handling staff cost = Earlier Costs x (1- 15%) = $ 6 m x 85% = $ 5.1 m

New packaging cost = Earlier Costs x (1- 20%) = $ 3 m x 80% = $ 2.4 m

New total cost = $ 5.1 m + $ 3 m + $ 2.4 m + $ 1.5 m + $ 1.5 m = $ 13.5 m

New revenue = Earlier Revenue x (1-10%) = $ 20 m x 90% = $ 18 m

New margin = $ 18 m - $ 13.5 m = $ 4.5 m

Net impact on P& L = Earlier Margin - New Margin = $ 5 m - $ 4.5 m = $ 0.5 m

Key insight:

If Publisher X is terminated then the margins would reduce by $ 0.5 m

4. Conclusion

7. Now that we know the economic impact of terminating Publisher X, what would you recommend to the client - termination of Publisher X or investing in the extension of the warehouse?

Allow the interviewee to think through a structure for this question. A great candidate would immediately calculate the break even point between the two decisions.

There are two choices before the client : Invest $ 10 m now to increase warehouse capacity or terminate Publisher X which would impact the P&L by $ 0.5 m every year.

Assuming that all other factors remain the same and ignoring the time value of money, a break-even point/ time period can be calculated:

Break-even point = $ 10 m / $ 0.5 m = 20 years

In other words, it would be 20 years before the yearly impact on P&L from the termination adds up to the upfront cost required to increase the warehouse capacity. Additionally, we know that the capacity freed up by the termination of Publisher X is sufficient to manage the storage needs in the foreseeable future.

Based on this analysis, the client should not invest in the capacity extension of the warehouse. They should instead terminate the storage contract with Publisher X in order to increase the available capacity.