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Case

Case prompt

Our client is a successful manufacturer of water proofing solutions. A new player recently entered the market pricing its products at a lower price compared to our client’s. Our client is evaluating reducing their prices by 10% to match those of the competitor. 


The client has hired us to advise him on whether it is a good idea to reduce prices.


Comments

In this interviewer-led case the interviewee should be guided through the case by the interviewer.


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 reduce prices by 10%?

This is an interviewer led case, and through the interview, the interviewee would be led towards different aspects of the case. The first question is to evaluate what is the impact of the price drop.


Below would be the steps to solve the case: 
  1. Impact analysis: The primary reason the price cut is being evaluate is to defend market share. Therefore the interviewee should compare the impact of cutting prices to maintain sales or keeping prices unchanged accepting a reduction in sale volumes
  2. Market analysis: The interviewee should attempt to analyse the market to understand what the entry of a lower price competitor does to the market dynamics– products, customer segments and response, price sensitivity trends etc.
  3. Recommendation: Based on the analysis, the interviewee must succinctly lay down the next steps for the client.


1. Impact Analysis

The interviewee should at the outset try to ascertain the impact of a 10% price cut.

Prompt the interviewee if required by asking what the impact of a 10% price cut would be and share the information given below.

Share Exhibit 1 with the interviewee to calculate the impact.

Exhibit 1 


 

Allow the interviewee to think aloud and lay out a long list of factors/ additional information that he would need to consider in order to answer the question.

Share the below information if enquired:

    • The price cut will not affect the sales volume
    • The client sells only one product
    • There is very little difference between the client’s products and other products in the market; including the product of the new entrant.

Current profit (before the price cut)

𝑃𝑟𝑜𝑓𝑖𝑡 =𝑅𝑒𝑣𝑒𝑛𝑢𝑒 −𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡−𝐹𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡


𝐹𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡: 300,000×6$ =1.8 𝑚$


𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡 :300,000×8$=2.4  𝑚$


𝑅𝑒𝑣𝑒𝑛𝑢𝑒: 300,000×20$=6  𝑚$


𝑃𝑟𝑜𝑓𝑖𝑡=6 𝑚$−2.4𝑚$−1.8𝑚$


𝑃𝑟𝑜𝑓𝑖𝑡=1.8  𝑚$


Profit (after the price cut) 
  1. The fixed costs will remain the same
  2. The units sold will also remain the same


𝑁𝑒𝑤 𝑃𝑟𝑖𝑐𝑒 =$20 ×(1−10%)=$18


𝐹𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡:1.8 𝑚$

𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡 :300,000×8$=2.4  𝑚$

𝑅𝑒𝑣𝑒𝑛𝑢𝑒: 300,000×18$=5.4 𝑚$


𝑃𝑟𝑜𝑓𝑖𝑡=5.4 𝑚$−2.4𝑚$−1.8𝑚$

𝑃𝑟𝑜𝑓𝑖𝑡=1.2 𝑚$


Loss of profit

𝐿𝑜𝑠𝑠 𝑜𝑓 𝑃𝑟𝑜𝑓𝑖𝑡 =𝑂𝑙𝑑 𝑃𝑟𝑜𝑓𝑖𝑡 −𝑁𝑒𝑤 𝑃𝑟𝑜𝑓𝑖𝑡


𝐿𝑜𝑠𝑠 𝑜𝑓 𝑃𝑟𝑜𝑓𝑖𝑡 :1.8 𝑚$ −1.2 𝑚$=0.6 𝑚$


Impact




Key insight 
  1. A price cut of 10% will leads to a 33% drop in profits

Once the interviewee reaches this point, ask him to calculate : “How much % drop in sales can the client afford, before he must drop the price by 10%?”


To calculate this the following logic applies: 
  1. The fixed costs will remain the same
  2. An immediate drop of 10% in prices will lead to a 33% drop in profits and the profit would become 1.2 m$
  3. Therefore, the client can find drop in units volume that makes him indifferent between dropping prices or keeping them unchanged
  4. The fixed costs would remain 1.8 m$ irrespective of units sold
  5. Let’s assume that the volume at such point of time are ‘x’


Therefore

𝑅𝑒𝑣𝑒𝑛𝑢𝑒=20𝑥

𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡=8𝑥

𝑃𝑟𝑜𝑓𝑖𝑡=20𝑥−8𝑥−1.8 𝑚$


Replacing “Profit” with the reduced profit after the price cut (1.2m$), we find the number of units that makes our client indifferent between cutting prices and keeping prices unchanged.


Therefore

20𝑥−8𝑥−1.8 𝑚$=1.2 𝑚$

12𝑥=3 𝑚$

𝑥=25,0000

Therefore

𝐿𝑜𝑠𝑠 𝑖𝑛 𝑠𝑎𝑙𝑒𝑠=300,000−250,000

𝐿𝑜𝑠𝑠 𝑖𝑛 𝑠𝑎𝑙𝑒𝑠=50,000


=16.67%


The client can afford to wait till he loses 16.67% of his sales, before he must make the decision about the drop in profits

It is important that the interviewee states this.

Once the interviewee reaches this point, make him think further by asking : “ What additional information would you like to know before you make a complete recommendation to the client?”


2. Market analysis


The interviewee should ask about the market.  The following factors must be considered:

    • Market structure – No of competitors, market share
    • Customer preference, price sensitivity, buying behavior
    • Any competitive advantages that the new entrant has
    • Client’s position in the market

    Allow the interviewee to lay out a long list of points. If (s)he misses any key points from the above list, prompt him/her. 

    Share Exhibit 2 with the interviewee to show the market structure


    Exhibit 2


     

    If enquired, share the below information verbally with the interviewee:

      • The new entrant is a small company with previous background in this space
      • The primary customers for this product are home owners or contractors who buy directly from our retail distribution network in the city.
      • Customers are brand conscious and prefer known and trusted brands
      • The client is not sure about the price sensitivity of the customers
      • The client has a well known brand in this space and has been in the market for over 50 years.

     

    The interviewee must use the above information to make the following observations:
    1. The client is the number 2 player in a relatively fragmented market
    2. The client’s brand is well known and trusted as he has been operating for a long time in the market
    3. The new entrant is a small company and would need to establish its brand
    4. The products in the market are similar and the new entrant does not have any competitive advantage
    5. The new entrant is likely to compete with the 29 other fragmented players and maybe get 1.67% market share (50/30) in the market.


    3. Final recommendation

    Prompt the interviewee to sum up his recommendations for the client. 

    The interviewee should sum up the recommendations for the client:
    1. The client must not drop the prices by 10% as it would lead to a drop of 33% in profit
    2. It makes sense for the client to not drop prices at least till the sales drop by 16.67%, as at that point it would make sense from an economic point of view to drop prices
    3. It is unlikely that the new entrant would threaten our client, as the customers prefer trusted brands and our client is the No. 2 player in the market with long standing trust
    4. Given the fragmented market structure, the new entrant is likely to compete with the smaller players, as it does not have any competitive advantage over our client

    A great interviewee would highlight the following risks:

      • Possibility for one of the other 2 large competitors of reducing their prices in response to the entry of the new competitor
      • Possibility of the new competitor becoming bigger than our estimates using innovative methods (marketing, distribution innovation) to gain market share over and above what we have estimated

     

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