9/10/2007

PRICING PRODUCT / LINE MIX

•Estimate demand (pricing is largely demand driven) •Understand the product mix and features -- variety, design, packaging, substitutes, product cross-
•Analyze customer’s willingness to pay for company’s product / service elasticities.
•Target customer segment(s) •Identify the size of the product portfolio mix -- could the company be spreading its resources too thin
•Price elasticity across a large product portfolio?
•Price of substitute products / services
•Analyze product profitability mix:
•“Value-added” of company’s product / service (either real or perceived)
•Profit margin of each product line
•Consider costs, but don’t let costs dictate the outcome.
•Adjust for anticipated competitor response. •Product breakdown as a % of revenues, cost, profits, growth rates, etc.
•Analyze company’s strategy: •Consider discontinuing unprofitable products in the mix
•Premium vs. value product / service
•Explore possibility of introducing new products
•Niche vs. large market share
•Capabilities in positioning product / service •Consider issues of cannibalization and effect on brand equity

•Consider various pricing strategies: •Evaluate pricing strategy -- premium vs. value products (see PRICING card)
•Price discrimination
•Examine company’s core competencies, ability to leverage economies of scope and scale, potential issues
•Two-part tariff of capacity constraints.
•Bundling
•Analyze market direction and threat of new entrants
•Warranties

GENERAL CASE TIPS ECONOMICS

•Repeat the question •GNP = C + I + G + X

•State your hypothesis / key decision criteria •C = personal consumption

•Explain the framework to be used •I = corporate investment

•Walk the interviewer through your analysis •G = government purchases

•X = net (exports - imports)

•Draw visuals if possible -- charts (e.g., waterfalls, bubbles) 2x2 matrices, pies, etc.
•Market equilibrium: Price -- Quantity point where demand equals supply (does not change unless
•Summarize conclusions and explain what additional analyses may be relevant
demand or supply shifts).
•Generate options and alternatives
•Marginal Costs < Average Costs implies economies of scale
•If you get stuck, restate what facts you know
•Marginal Costs = Average Costs implies constant returns to scale

•Marginal Costs > Average Costs implies dis-economies of scale

REMEMBER: •Price elasticity of demand = (% change in Quantity / % change in Price)
•Try and make the interview an interactive dialogue between you and the interviewer. The interviewer is •if > 1 implies elastic
not an adversary; you are working together to solve the client’s problem.
•if < 1 implies inelastic
•Relax and have fun!
•Consider diminishing marginal utility and diminishing returns

CUSTOMERS COMPANY ANALYSIS

•Conduct segmentation of customer base -- who is the target customer? •Consider the company’s vision / mission / stakeholders
•Existing customers (company’s or competitors) •Examine the company’s capabilities:
•New customers •Firm resources (people, capital, technology, etc.)
•Profitability of target customer segments vs. other potential segments •Core competencies (economies of scope)
•Identify what the customers’ needs are and what they value •Capacity issues (e.g., manufacturing, distribution, human resources) -- how flexible are
•Commodity vs. premium products facilities / labor?
•Assess needs and perceptions against company’s product mix •Understand the company’s cost structure:
•Market trends •e.g., how is the marginal cost impacted by building new capacity (i.e., marginal costs will
increase if new capacity is not fully utilized OR marginal costs increase if capacity is
•Analyze relative buying power -- most powerful when:
greater than minimum efficient size)
•few customers exist and they purchase in large volumes
•Economies of scale
•products are standardized and represent high % of final product’s total costs
•Analyze the company’s financing options:
•profits of buyer are low
•Access to capital / financing capabilities
•buyers present credible threat of backward integration
•Alternatives to internal financing
•Consider other key issues:
•Product substitutes / complements and switching costs •NPV of alternative options

•Demand elasticity •Consider the impact of external factors (e.g., technology, regulation, competitors, likely competitive
responses, etc.)
•Cost of retaining and acquiring a customer (e.g., use of loyalty programs because it’s cheaper to
retain customers than to acquire new customers)

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DISTRIBUTION PROMOTION
•Understand current structure -- is it overly complex? •Analyze segments (who, what, where, how, value)

•Draw a map (e.g., show plants, distributors, customers) •Understand audience needs / perceptions (conjoint surveys, trends, etc.)

•Outline the value chain (suppliers, manufacturers, distributors, wholesalers, retailers, •Benchmark with other industries
customers, etc. -- break down each as a percentage of total costs) •Estimate potential per segment
•Analyze the objectives of distribution chain for specific case •Demand •Price •Profitability
•Channels •Growth •Competition
•Coverage •Consider various issues in company’s advertising and PR strategy including:
•Flexibility •Differentiation and sustainability of promotion
•Speed •Dilution of message
•Barriers to Entry •Use of specials, discounts, etc.
•Consider various tradeoffs: •Sales force effectiveness
•Cost vs. proximity •Identify opportunities to differentiate product (based on dimensions of quality, design, location, service,
•Service vs. product implications advertising, price, etc.) in order to:

•JIT vs. inventory •Expand feasible set of strategies (not limited to 1 dimension / product attribute)

•Internal vs. external distribution issues •Make demand less elastic

•Evaluate impact of trends (IT, deconstruction of value chain) •Avoid price warfare

•Consider cost-benefit analysis of alternative distribution methods REMEMBER: The goal is to send the right message to the right people in the right way!

REGULATORY FRAGMENTED MARKET

•Understand key regulatory issues: •Understand why the market is fragmented
•low barriers to entry and / or high barriers to exit
•Pricing guidelines (e.g., as % of costs) --> no monopoly pricing
•absence of economies of scale or learning curve effect
•Tariffs
•high transportation costs
•Anti-trust •high inventory costs or erratic sales fluctuations
•Patent infringement, intellectual property rights •diverse market needs (i.e., need for customized offering)

•Assess regulation as a barrier to entry (through procurement, as well as environmental and safety •high product differentiation
standards •government prohibition of concentration / local regulations

•Prohibitive costs of compliance for new entrants •newness of industry

•Control of licenses by a public authority (“approved supplier” status)
•Trade barriers
•Analyze impact on the company as well as the competitors
•Leverage regulatory asymmetries (in your own market, other countries, etc.)
•Look to the past for precedents
•Examine whether or not fragmentation can be overcome
(Is consolidation feasible? See CONSOLIDATION card)
•Determine if overcoming fragmentation is profitable for the company
•If fragmentation is inevitable, identify best alternatives for coping with it
•tightly managed decentralization
•increased value added
•specialization by product type, product segment, customer type, region, etc.
•backward integration

GLOBAL ISSUES BUSINESS ESTIMATION STATISTICS

•Consider key issues in developing a global competitive strategy:
•Outline your overall logic, identify key assumption drivers, use round numbers, show your work and
•Factor cost differences among countries write it down! (be careful not to get too detailed)
•Differing circumstances in foreign markets (i.e., 4 P’s) •United States
•Different roles of foreign governments •US population -- 270 million
•Differences in goals, resources, and ability to monitor foreign competitors •US households -- 60 million
•Evaluate various mechanisms for participation in global activities:
•World population -- 6 billion
•Licensing •Private labeling •Mergers and acquisitions
•North America -- 450 million
•Exporting •Joint ventures •Foreign direct investment
•South America -- 300 million
•Assess market conditions
•Europe -- 500 million
•National, economic, social, and political conditions and circumstances
•Asia -- 3.5 billion
•Competitive landscape and competitive reaction (signaling?)
•Key cities
•Analyze cost - benefit of participation (does it add shareholder value?)
•Economies of scale •Tokyo, Japan -- 27 million

•Transportation or storage costs and cost of labor, energy, raw materials, etc. •New York City -- 16 million
•Access to established distribution channels •Los Angeles -- 12 million
•Ability to leverage value chain asymmetries •Buenos Aires , Argentina -- 12 million
•Consider management structure (i.e., multinational, centralized, transnational) •Beijing, China -- 11 million

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VALUE CHAIN NEW MARKET ENTRY

•Compare value chain to that of competitors and identify sources of differentiation •Ask if this fits the company’s mission / culture -- e.g., why does the company want to expand?
•Construct value chain for the firm and the customer and identify drivers of uniqueness in each •Invest excess cash flow
activity
•Increase market share
•Support : Infrastructure, IT, HR, procurement
•Decline in existing market (shrinking sales, higher costs, lower margins)
•Primary : Suppliers, inbound logistics, operations, manufacturing, outbound logistics, •Assess the firm’s resources and capabilities:
marketing and sales, support
•Economies of scope and scale
•Identify primary activities such as:
•Ability to leverage current value chain components (infrastructure needed)
•Outbound logistics: activities needed to convert inputs to outputs OR outputs to final
•Capital, labor, and capacity constraints (see CAPACITY card)
destination
•Evaluate market conditions
•Sales and marketing: activities necessary to inform / persuade customers to but outputs and
order-taking processes necessary to complete sales (e.g., sales force effectiveness, •Size and growth rate of new target market
customer satisfaction, use of ads to enhance brand image) •Competitive profile / trends and likely competitive responses
•Rate relative importance of each activity •Barriers to entry (and how to overcome them) and regulatory considerations
•Analyze cost drivers and cost interactions •Consider complements with current product / markets, potential issues of cannibalization, and market
cross-elasticities
•Identify possible outsourcing opportunities
•Analyze cost - benefit of new market entry
•Select attributes that promise high differentiation between cost and price premium
•Niche vs. large market share
•Break down each activity as a % (i.e., as % of every incoming dollar)
•Consider methods of entry (e.g., JV, direct investment, exporting, acquisition)
•Locate linkages between value chain and customers

INFORMATION TECHNOLOGY FORMULAS

•Evaluate cost - benefits of IT investment •TOTAL ASSETS = Current assets + PPE + Investments + Other Assets

•Is the project a strategic necessity? If so, don’t evaluate IT investment based on current project
•BALANCE SHEET = Assets = Liabilities + Stockholder’s Equity
evaluation methods (i.e., 5 year payback, ROI criteria, etc.)

•Outsource vs. develop in-house •STOCKHOLDER’S EQUITY = Shareholder’s Equity + Common Stock + Retained Earnings

•Understand that IT infrastructure determines what a company will be able to do and not do in the future
•REAL INTEREST RATE = Nominal Interest Rate - Inflation
•Defines a company’s organizational capability
•PROFIT BEFORE TAXES = Gross Revenue - Returns & Allowances - COGS - SG&A - Depreciation -
•Must have close link between strategic planning and IT infrastructure planning

•Assess competitor strategies with respect to IT investments Interest Expense

•Consider impact of current IT issues (e.g., the Year 2000 problem) on the company’s costs and •GROSS MARGIN = Gross Revenue - Returns & Allowances - COGS
profitability

•Avoid over-investing •NET WORKING CAPITAL = Current Assets - Current Liabilities

•Make sure that employees are prepared to learn and adopt new system
•BREAKEVEN VOLUME = Fixed Costs / (Price - Variable Costs)
•Identify the impact of IT infrastructure on redefining the value chain

MARKET SHARE COSTS

•Consider changing market characteristics: •Analyze main cost components as a % of Total Costs (and % of Total Sales): Direct Labor (union vs.
non-union), Direct Material, Allocated Overhead (including SG&A and Depreciation),
•Long-term growth rate of existing •Entry or exit of major firms Distribution Costs, Financing Costs
markets and new segments not currently •Diffusion of proprietary •Consider potential flaws in the company’s cost accounting method

being served knowledge •Break down total costs into fixed and variable cost components
Fixed Cost Issues: Variable Cost Issues:
•Customers and how they use the product •Regulatory changes
- Capacity utilization (if it’s low, identify - Suppliers (consolidate?)
•Product, process, and market innovation •Changes in cost structure
cause, e.g., demand vs. efficiency) - Cost control
•If the market is growing, the number of entrants increases and it’s easier for all players to achieve
- Break-even analysis mechanisms and
improved performance (non-zero sum game); therefore it’s easier and cheaper to take
market share. Strategies include: (BE volume = FC / (Price - VC)) incentives in place?
- Economies of scope and scale - Outsourcing alternatives
•Maintain prices as costs  and achieve high profitability (price effect)
- NPV of fixed cost investment with - Impact of horizontal or
•Drop prices as costs  to increase market share (market share effect)
sensitivity analysis vertical integration
Note: in a growing market you want to increase market share over the long-run
•If the market is slowing, one firm’s gain is another firm’s loss (zero-sum game) •Determine slope of industry cost curve
•Price competition increases especially when there are large economies of scale, low marginal •Compare cost structure to that of competitors
costs, and learning curve effects •Identify and leverage potential cost advantages (e.g., raw materials, labor, energy sources,
•Check that  market share is not from turnover of most profitable customers infrastructure, patents, location)

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MERGERS & ACQUISITIONS VALUATION

•Assess goals and objectives for such consideration
•Understand common methods of valuation:
•Increase market access
•Discounted Cash Flow (DCF) - projection of future earnings and selection of appropriate
•Diversify horizontally or vertically discount rate (be prepared to estimate revenues and costs!)
•Pre-empt competition •Comparable Multiples - apply multiples of income or revenues of comparable companies to
•Achieve operating synergies (e.g., economies of scope or scale) establish purchase price
•Achieve financial synergies (e.g., lower cost of capital) •Asset-oriented Approaches - fair market value, fair value, book value, liquidation value
•Realize tax gains (e.g., acquirer transfers tax losses of target to offset income) •Consider the following factors in valuing a closely-held or private company:
•Consider impact on acquirer’s financial condition •nature and history of the business
•Comparison of margins •Ability to finance the acquisition •economic and industry conditions
•Issues of accretion / dilution on EPS •Tax issues •book value of target company and it’s financial conditions
•Evaluate impact on competitive environment
•earnings capacity of the company
•Competitive trends and likely competitive responses
•dividend-paying capacity
•Legal and regulatory implications (anti-trust)
•evidence of goodwill or other intangibles
•Consider post-merger integration issues
•other sales of stock
•Strategic fit •Exit strategies
•prices of comparable stocks
•Culture implications
•Assess means of financing the transaction
•Discuss M&A alternatives (e.g., outsourcing, JV, corporate restructuring, etc.)

COMPETITION COMPETITOR INTENSIFICATION

•Analyze the competitors’ strengths, weaknesses, opportunities and threats (SWOT analysis) •Consider various responses in an intensified competitive environment:

•Firm resources •Use resource advantages to raise barriers to entry

•Management profile and style •Raise switching costs for customers

•Product line (i.e., substitutes) •Step up marketing effort
•Clout and leverage with buyers and suppliers
•Increase promotional efforts (e.g., implement customer loyalty programs)
•Industry trends
•Consider price signaling (e.g., lower your price in a smaller market)
•Determine if there are any Barriers to Entry ?
•Leverage customer information to identify and steal most profitable customers away from
•Economies of scale •Product differentiation
competitors (“cream-skimming”); likewise, protect your most profitable customers
•Existence of learning curve effects •Capital requirements
•Grow market share through mergers or acquisitions
•Access to distribution channels •Governmental actions
•Avoid price wars and other irrational behavior; remember that accommodating your competition
•Examine the cost structure of competitors (especially as it relates to the client’s cost structure) -- cost
differences may be based on the degree of vertical integration (see COSTS card) sometimes makes the most sense

•Consider likely competitive responses to the client’s actions and potential cooperative strategic •Establish long-term contracts to lock in customers
options

PROFITS AND MARGINS REVENUE

•GROSS PROFITS = REVENUES - COSTS •REVENUES = PRICE x QUANTITY
•Identify root causes of decline in profitability (e.g., margins vs. quantity) •Break down factors which influence Price (see PRICING card):

•Break down Revenue component (see REVENUE card): •Analyze customer’s willingness to pay for company’s product / service

•Price •Target customer segment(s)

•Quantity
•Break down Cost component (see COST card):
•Fixed Costs vs. Variable Costs
•Direct Labor, Direct Material, Allocated Overhead (including SG&A and Depreciation),
Distribution Costs, Financing Costs -- all as a % of Total Costs and Total Sales
•Analyze product profitability and product mix (I.e., look at volume shifts)
•Break down factors which influence Quantity (see MARKET SHARE card):
•Identify mix of customer segments and associated segment profitability
•Explore trends in overall industry profitability (competitors’ profitability?)
•Examine the impact of any unusual charges (e.g., one-time capital outlays, contingent liabilities,
litigation charges, environmental charges, etc.)
•Consider changing market factors (demographics, tastes, economy, changes in technology, regulatory
actions)
•Price elasticity
•Price of substitute products / services
•“Value-added” of company’s product / service (either real or perceived)
•Evaluate product mix and ability to differentiate product (based on dimensions of quality, design,
location, service, advertising, price)
•Consider competitors’ pricing strategies and relative market pricing power
•Consider market share vs. market demand (and growth patterns)
•Explore inability to meet market demand based on capacity constraints (demand vs. capacity
utilization vs. throughput)
•Analyze types of customers gained / lost (protect most profitable customers)
•Evaluate impact of product substitutes vs. complements
•Consider the cyclical or seasonal nature of the business, if applicable

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CONSOLIDATION OUTSOURCING
•Analyze the “make vs. buy” decision
•Examine feasibility and objectives of industry consolidation
•Ignore fixed and other sunk costs, only consider variable costs
•create economies of scale or learning curve effects
•Examine the company’s cost allocation method
•standardize diverse market needs
•Assess benefits of outsourcing:
•make acquisitions for critical mass
•lowers cost
•recognize industry trends early •increases flexibility and access to external capabilities
•Evaluate impact of consolidation •benefit from economies of scale and specialization of third-party provider

•achieve operational and financial synergies •may reduce new product development cycle

•capacity utilization vs. demand •Assess costs of outsourcing:

•cultural fit •loss of control over manufacturing process, quality, turnaround time, etc.

•increased difficulty associated with integrating different technologies and knowledge bases (may
•Assess implications of vertical vs. horizontal consolidation
diffuse the concept of core competencies which results in loss of a company’s ability to
•Understand regulatory issues innovate and develop)

•Analyze cost - benefit to the company •costs of monitoring the contractor and contract specifications may outweigh lower unit costs

OPERATIONS EFFICIENCY SUPPLIERS

•Segment suppliers on basis of client’s needs (e.g., quality, cost, value-added, timeliness, JIT, service,
•Consider three components when evaluating plant efficiency:
etc.)
•Utilization: percent of total available time that plant is actually running •Identify key decision criteria in evaluating suppliers (e.g., low cost, high quality control, low defect
rates, quick turnaround times, etc.)
•Identify causes of loss (e.g., lack of demand, labor problems, line breakdown)
•Evaluate company’s relative bargaining power with suppliers based on % of supplier’s total sales
•Throughput rate: compare actual production rate to maximum potential rate
•Analyze supplier power -- greatest when:
•Identify causes of loss (e.g., calibration, labor performance, poor maintenance, other plant •dominated by a few suppliers
functions) •product is differentiated (high switching costs, few substitutes)

•Waste: measure what percentage of raw material inputs is lost in producing output •supplier poses credible threat of forward integration

•Examine ways to lower overall supply costs:

•Identify causes of loss (e.g., calibration, quality of inputs, machinery breakdowns)
•consolidation of suppliers increases capacity utilization of suppliers which lowers suppliers’
costs and thereby could lower the company’s costs and prices (however, be careful of
supplier concentration)
•REMEMBER: When asked to analyze “capacity utilization” of a plant, consider ALL three of the
•economies of scope among suppliers
above points!
•inventory vs. JIT

ALLIANCES & JOINT VENTURES DIVESTITURES & SPIN-OFFS

•Assess benefits of such a strategy: •Evaluate reasons for a divestiture:
•Ability to exploit critical internal resources and gain access to resources of partner quicker, at lower •Poor strategic fit and/or poor performance of a division
cost, and with less uncertainty •Parts of a company are worth more than the whole (reverse synergy)
•Gain access to markets and technology in much shorter time than would result from firm going at it •Capital market factors (greater access to capital markets post-divestiture)
alone
•Immediate infusion of cash from the sale
•Share management responsibility •Evaluate reasons for a spin-off:
•Assess potential problems and costs: •Redefinition of core business
•Agreement on the value of each partner’s contribution to the JV / alliance •Parts of a company are worth more than the whole (reverse synergy)
•Ability to achieve cooperation between firms that are also competitors •Capital market factors (greater access to capital markets post-divestiture)
•Conflicting objectives / divergent management styles •Impact on cost of capital
•Disputes over quality and labor practices •Assess market conditions
•Potential lack of control •Is timing right to sell?

•Recognize that the sharing of benefits will depend on: •Competitive response (i.e., lead to price  or quality  )
•Conduct cost - benefit analysis
•Strategic intent of the partners
•Can subsidiary inefficiency / high costs be turned around?
•Ability of each partner to capture and appropriate the skills of the other
•Effect on quality of product / service
•Company’s receptiveness to the partnership
•Impact on economies of scale and scope
•Identify alternative strategies (e.g., outsourcing, M&A, etc.) -- explore as needed
•Current / future cost breakdown (fixed costs vs. variable costs, transition costs)

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DIVERSIFICATION CAPACITY
•Examine existing business situation and understand motivation behind diversification (invest free cash
flow?) •Assess overall fixed asset effectiveness (see OPERATIONS EFFICIENCY card)
•Utilization
•Avoid diversification strategy solely to smooth earnings
•Throughput against its theoretical potential
•Analyze different types of diversification
•Product acceptance and waste levels
•Expand geographically (local, regional, national, international)
•Compare to industry averages and recent trends
•Integrate vertically (offsets power of suppliers, smoother production flow, better accessibility to
markets, distribution cost advantage) •Identify causes of utilization loss
•Lack of demand
•Expand into related markets (product, business, distribution, managerial skill)
•Plant breakdowns
•Expand into unrelated markets ( risk, benefits from economies of scale, acts as “informal”
market when external markets e.g., labor or capital, are weak) •Staffing issues

•Evaluate ability to leverage existing resources, value chain, infrastructure and economies of scope and •Issues to consider in adding new capacity
scale •Demand considerations
•Consider competition and likely competitor response (e.g., impact on pricing) •Ties up capital and may result in excess capacity
•Conduct cost - benefit analysis of diversification strategy •Evaluate company’s minimum efficient plant size (MES) relative to total market output (it’s
easier to enter if MES as % of total market is smaller)
•Economic conditions
•Estimate slope of industry cost curve -- it’s easier to bring a new plant on-line below capacity if
•Market supply / demand the cost curve is flat
•Regulatory issues
•REMEMBER: Importance of utilization  as fixed costs  as a % of total costs