Let us start by reviewing the case again:
The ABC company is a company which provides construction carpentry services. Its two main branches of business activity are:
- plastic doors and windows production
- wooden interior doors production
Last year the company recorded loss of $3 million. In order to increase the revenue of the company, the CEO is considering investment into modernization of its present production lines. He employed you as a consultant to help him decide whether his idea is worth implementing.
Below you will find a sample conversation between a Candidate and a Recruiter, which could take place (I will mark my explanatory comments red). A few frameworks have been used and you will find more on this topic at the end. It is only the beginning of the conversation, since describing the entire case would take too much place. Nevertheless, I think that even through this excerpt I will be able to show you the essence of solving such business problems:
C: As far as I can see, my customer is a company called ABC, which deals with construction carpentry. The company has two main branches of business activity. Last year it recorded losses of $3 million, so the CEO is considering an investment option to boost revenue.
C: I would like to make sure that I have understood the problem right – the business aim that the CEO wants to achieve is increasing the company’s revenue or increasing its final profit? (it is not the same, increase of the profit can be achieved by raising the revenue, reduction of costs or both solutions combined)
R: The aim is to increase the revenue.
C: OK, thank you. Could I ask for a few minutes to collect my thoughts?
R: Of course, take your time.
a few minutes later…
C: OK. The company suffered a loss of $3 million last year. Firstly, I would like to find out what constitutes the loss – i.e. what were the revenues and costs last year.
R: The company recorded the revenues of $5 million and costs of $8 million.
C: I see, and what are the data from the previous years? (I’m examining whether the problem of the loss has been related to decreased revenues or increase of costs; I’m also looking for a trend and checking whether the situation has been constant or it was a sudden phenomenon)
R: The company’s standing in the previous years was quite stable, it had a more or less constant profits of $2 million, where revenues always stood at $10 million and costs at $8 million.
C: I see. The data I have suggest that last year the company recorded a decrease in revenues of 50%, since in the previous years it was 10M and now it is only 5M. (every time you receive any kind of data from the recruiter you should sum up everything that follows from them)
C: OK, it is very worrying that the company’s revenue over 1 year dropped by half. Before I move on to the further analysis of this phenomenon, I would like to ask you about the competitors – do we have any data that would depict similar trends at the company’s competitors? I am simply trying to understand whether this problem is related to the company, its structure, organization, employees or perhaps general trends in the market in which the company operates and is less dependent on the company itself. (it is good to explain why you need a certain package of information and what you will use it for)
R: Yes, we do have such data. It turns out that the industry in which ABC operates has also suffered serious drops in revenues.
C: Do we know how big the decreases were? (always try to quantify information, a serious drop in revenues is an unknown, it could well be 20%, 50% or even 80%)
R: In most cases it was 40-60%, we can therefore assume the average of 50%, as in the case of ABC company.
C: OK, this means that the problem of the revenue decrease concerns the entire market and is not ABC company specific. I would now like to ask you about the investment that the company’s CEO is considering – modernization of production lines. In what way would this affect the company’s operation? (intuitively we could understand it as increasing production capacity in order to manufacture more, but at the same time, this could be misinterpretation – it could as well be modernization, which will offer the same volume but lower unit costs)
R: Modernization of production lines involves automation of a number of things in addition of optimization of the production process. As a result, the maximum production capacity should increase by 50%.
C: OK, I understand. I believe that I have sufficient data to begin formulating my initial hypothesis. I think that modernization of production lines is not a good answer to the problem of decrease in the company’s profits. The market in which the company operates has suffered a dramatic decline over the last year, revenues fell on average by 50%, which implies possible market problems and a drop in demand. This investment increases production capacity by 50%, which, given the current market condition, may not make much sense. This is my initial hypothesis. In order to verify its correctness I would like to conduct a further analysis – I’m going to take a closer look at the two branches of ABC’s business activity and then consider the company’s activity in terms of a few aspects – customers, products, competitors and finally, the company itself. (a clearly defined hypothesis has been stated along with the methodology of testing it – thus, it has been given a certain framework, which will allow to set a certain order and avoid ‘jumping’ from one question to another – about the product, then about customers, followed by a question about competitors, procedures in the company, only to finally be asked the awkward question – ‘What is the hypothesis that you are trying to test?’, to which the answer would be ‘I don’t know’)
R: Alright, where would you like to start?
C: From breaking down the revenue into different economic activities. I know that ABC company has 2 branches of economic activity – plastic doors and windows production as well as wooden interior doors production. How much revenue did each of them contribute to the company last year?
R: Each brought in around $2.5 million of revenue.
C: What were these values in the previous years when the company’s revenue stood constant at $10 million?
R: At that time plastic doors and windows production generated the revenue of $7.5 million, whereas wooden interior doors production the revenue of $2.5 million.
C: Very interesting, it seems that the entire drop in revenue is related only to one branch of the company’s business activity – plastic doors and windows production. Could we break it down to basic factors – I would like to find out whether this drop has been caused by decreased sales, changes in prices of products or perhaps a combination of both? (each time you see something unexpected – such as a drop related to only one branch – try to break it down further)
R: The prices of products dropped by around 20%, whereas sales fell by 37.5%.
C: Do we know whether the same happened among our competitors? (the fact that our competitors recorded a similar drop in revenues could have been caused only by changes in prices or sales volume, I am examining whether a similar combination of factors is specific to the entire industry or only to ABC company)
R: Yes, we do have such data. It turns out that similar tendencies can be observed in all of our competitors – similar decreases both in terms of product prices and sales volume.
C: OK, I understand that the downward trends as far as product prices as well as sales volume are concerned, are common in this branch of the market. Do we know as to why? (the figure itself is rarely sufficient – it is clear what the situation is in terms of figures, now we have to examine it in terms of quality and see whether we can change it)
R: Market collapse. The main customers purchasing plastic doors and windows are developers building office blocks, who due to the market slowdown limited their plans of constructing new buildings and those in progress have been partially withheld.
C: Do we have any reliable economic forecasts for the next years available?
R: Yes, the company has ordered such analyses – they suggest that in the next few years the economic situation will not improve, therefore, it is hard to expect any recovery as far as construction of office blocks is concerned.
C: I see. It seems that it is difficult to expect the return to the product prices and sales volume from before the crisis. It partially confirms the initial hypothesis that increasing production capacity is not a good idea. In order to be sure I would like to move on in my analysis.
R: Which area will you delve into now?
C: I would like to take a closer look at the other business activity of ABC company, that is wooden interior doors production.
R: What information would you like to obtain?
C: I already know that the revenue has been constant so far, amounting to $2.5 million, regardless of the economic crisis. Do we know what is the competitors’ situation compared to the company in question?
R: The company has only one main competitor in the wooden door industry, i.e. DEF company, which also generates stable revenues from production of wooden doors.
C: And do we know their market share? (always try to quantify the obtained information)
R: Both companies have around 45% market share. The remaining 10% is taken up by local carpenters who produce customized wooden doors. However, as far as industrial production is concerned, there are only 2 companies in the market.
C: Interesting. I have established that in the case of plastic doors and windows modernization of production lines is pointless. As far as production of wooden doors is concerned, the situation is not that simple. The economic slowdown has not affected this branch of ABC’s business activity, therefore, I would like to take a closer look at it to evaluate validity of modernization of production lines in this case. I am going to analyze this branch through the prism of 4 areas – customers, product, competitors and the company itself. (a few things have appeared in one fragment – first of all, a breakdown of the initial question about modernization of production lines into two sub-questions, separation into each branch of economic activity; secondly, clear observation that those branches differ in terms of their reaction to the same factors, which requires a different approach in their analysis; thirdly, establishment of the structure of the problem solving process – clear identification of areas to be tested)
R: Alright, where would you like to start?
C: I’d like to begin with the customers – who are they? Can we distinguish certain customer segments? (note – always ask about segments, it is not a rule, but in most cases, you cannot find the answer to this question in a given area as such, but in one of its segments)
R: We can distinguish 2 main groups of customers. The first group consists of regular people who renovate their house or apartment and wish to replace their doors for new ones. The second group is made up of renovation companies, which during the economic crisis seized an opportunity and now they adapt used apartments in good locations to suit office blocks, including replacement of doors. Each of those groups constitutes 50% of customers of ABC as far as production of wooden interior doors is concerned.
C: I see, but was there any research that would state whether what we deliver to our customers is what they actually expect? Was such consumer research conducted?
R: Yes, it was. It turns out that what ABC provides is exactly what customers expect.
C: And what does the pricing strategy look like for those 2 customer segments? Are there any differences in the prices of products offered?
R: No, the prices of all products are the same for both segments.
C: Was there any market research on a change of prices? How would the customers react to such a change? Would higher prices result in a drop in sales? Would a price reduction cause an increase in sales?
R: Such research was conducted. We managed to establish that an increase in prices by 10% would result in a drop of demand by 30%, whereas a decrease in prices by 10% would cause an increase in demand by 30%.
C: That’s very interesting. I would like to stop here for a while to delve further into this topic. I know that ABC generates $2.5 million a year on production of wooden interior doors and this represents 45% sales in the market. Therefore the total revenue from this type of products amounts to $5.55 million per year. Do we have any information on whether this sales fully satisfies the demand?
R: Yes, such market research was conducted. It turns out that the maximum revenue from this type of products at current prices is estimated at around $7.55 million.
C: That’s very useful information. It turns out that – without going too much into the structure of products, their individual prices and demand for individual products – we can say that there is a large difference between the market demand for wooden interior doors and the supply offered by manufacturers.
R: Yes, that’s a justified conclusion. What, in your opinion, does it suggest?
C: It significantly affects my initial hypothesis. I assumed, based on the information about the economic crisis that modernization of production lines resulting in the growth of production capacity by 50% is pointless and I tried to obtain data confirming my assumption. In the course of my analysis I divided the initial question into 2 separate questions – separately for each production lines. I have managed to establish that modernization of the plastic doors and windows production line does not have any business justification, since in the next few years we cannot expect the economic situation to return to its previous state and developers will not be inclined to construct new office blocks. A different situation exists in the case of the second branch of ABC activity – production of wooden interior doors. It turns out that at current product prices throughout the entire market the supply meets only 73.5% of the demand. It is an unusual situation, since given the current market share of ABC in this product segment, i.e. 45%, it means that an increase in production capacity by 50% will translate into additional 16.5% of market overall, which will not satisfy even the whole market demand. I think that it is the right moment to reformulate my hypothesis – on the basis of the data I managed to collect, I believe that modernization of at least one production line – manufacturing wooden interior doors, may make sense from the business perspective and it is worth to implement it, i.e. it will help ABC company to increase revenue, because that was the initial question. We could even venture a far-reaching conclusion – that ABC should think through the option of changing its business profile and focus only on production of wooden interior doors due to the high level of unsatisfied market demand in this product segment. At this moment, it is obviously just a hypothesis. (2 aspects are crucial here, first – every now and then try to do a mini summary of what you have managed to establish, always check how the data you collect during the analysis affect your hypothesis; second – modify the hypothesis if you realize that it is necessary – the purpose of stating a hypothesis is not being right, it should only give a certain structure to the examined problem and help you conduct an analysis, therefore, if the data suggest that the hypothesis you are testing has become invalid, simply modify it)
R: Alright, what data would you need to verify it?
C: I’d surely like to get a better insight into the areas I mentioned and still have not had a chance to ask about – that is the products, competitors and the company itself.
In the case of products, I would like to become familiar with their structure, what types of products ABC offers, what the pricing strategy for each segment of products is and what distribution channels for each product type are used by the company. I would also like to become acquainted with the supply and demand aspects, since part of the products may be more popular among customers, it may be a good idea to think e.g. about modifying the production line to a certain preferential type of manufactured product (I will also examine whether such a change is possible at all).
As far as competitors are concerned, I will be interested in obtaining information whether (in the case of wooden interior doors) DEF has a comparatively similar situation and what steps it takes (if any), what products and what pricing strategies it offers and most of all – I will try to find out whether they do anything we DON’T DO in terms of wooden interior door production that could, in fact, increase our productivity.
As far as the company itself is concerned, I would like to obtain information on its capacity and skills of employees as well as their influence on the range of products the company offers (e.g. whether the current disproportion of revenues from plastic doors and windows production and wooden interior doors production results e.g. from the fact that we don’t have a sufficient number of qualified employees to increase the production and how much, if possible, would their retraining cost). I will also be interested in knowing the company’s cost structure, in particular, the comparison of fixed costs to variable costs and how modernization of the production lines can affect costs or what impact replacement of a plastic door and windows production line by another wooden interior doors production line would have on the company’s cost structure.
R: OK, I understand the structure of your analysis. Where would you like to start?
Here I have decided to cut the conversation, as it may take a long time. Depending on what data the recruiter would present to you (or in your actual job – what data you would be able to gather and identify yourself), you could change the scenario of such case in any way you want. But there is only one basis – putting forward a hypothesis you want to test and then asking questions that will bring you closer either to proving or disproving it and reformulating it if necessary.
This case, in fact, constitutes only an outline of an aspect connected with management consulting. It surely does not present all of the possible approaches and does not exhaust the subject, in fact, it barely touches upon it. It is impossible to present the entire issue in detail in this entry.
However, if you became interested in it or the way of analyzing business cases, and you think it would be a good idea to expand your knowledge in this field as well as techniques of analyzing business problems, I recommend you the following materials available on:
- http://masterthecase.com/ and http://www.youtube.com/watch?v=GFjWkJQ4rk8&list=PLLD5kl9CjNF7ycll3xnOjDZCm6I2ajG5m
- http://www.caseinterview.com/ and http://www.youtube.com/watch?v=fBwUxnTpTBo&list=PLAFDCCB346DBA95B0
- http://www.preplounge.com/ and http://www.youtube.com/watch?v=k-3FNu7lm5M&list=PLOq4bj9w5QhnUfYIgaFtEB5Avh1uTPeUt