Student: Thanks. Based on the graph, there is nothing systemic that could be impacting our sales growth. It’s clear that the cup category is growing, as evident
by the growth in total sales from $90M in 2012 to $200M in 2015. Moreover, it appears that the category’s growth is being driven by Competitor A and B’s sales – and not our client’s. That is, while our sales have flattened after 2014, our competitors’ sales numbers have accelerated. In some ways, their growth is coming at our client’s expense. So, while it’s clear that our client still enjoys category leadership, its share is dwindling.
What can you tell me about our competitors’ cups? Are they superior in quality?
Do our competitors have better distribution channels? Better pricing? Is there anything about them that would encourage a consumer to purchase a competitor’s cup rather than ours?
Interviewer: Good questions. Actually, there is nothing unique about our competitors’ cups. They are virtually identical to our client’s cups in terms of quality, pricing, and appearance, and all three competitors have the same distribution channels.
Student: Okay. Cups come in all sizes. How many different sizes are there? Is there growth in all sizes?
Interviewer: All good questions. Cups come in three distinct categories based primarily on size and material. The “Casual” category consists of the traditional 8-ounce paper cup. Next is the “Party” category, which includes both 12-ounce and 16-ounce cups that are usually red in color and made of plastic. The third category is called “Special” and the cups there are also red and made of plastic, but just larger in size – usually 20 ounces. This chart illustrates our client revenues each year in the various categories. Are there any immediate conclusions you can draw from this?
Student: There are a couple of conclusions I can draw from this. First, there is a
seismic shift in what’s driving our growth. From 2012 to 2014, there was steady growth in the Casual category, but from 2013 onward, growth is largely the result of the Party and Special categories. Next, the decline in the Casual category revenues from 2014 to 2015 leads me to believe that there is something going on with consumption patterns. In other words, people need and want bigger cups as evident by the growth in the Party and Special categories. To validate this inference, I’d have to see how revenues trended in these categories for our competitors.
Interviewer: Okay. That’s a good idea. Here’s a table with this data.
Competitor A Competitor B
Casual Party Special Casual Party Special
2012 0 20 0 0 20 0
2013 0 25 0 0 25 0
2014 0 40 0 0 30 0
2015 0 60 0 0 40 0
Student: I think my inference might be correct. Neither competitor offers a cup in the Casual category – perhaps because they might have anticipated growth coming in the Party size. What’s interesting to me is why neither offers a cup in the Special category. Based on our client’s growth, there appears to be an opportunity there.
Interviewer: You bring up a good point. What do you think our client should do?
Student: Well, I think there are several things. In terms of manufacturing, I think they should investigate phasing out the Casual offering and ramping up production of the Party and Special category cups. They will have to understand the economics of the decision.
Interviewer: That’s an interesting strategy since casual cups are still the client’s biggest revenue source, although shrinking. And if they phase out casual cups one of the competitors will pick up the market. But let’s explore the economics of that decision since you brought it up. What data would you need to evaluate whether the client should completely replace Casual cups with the Special cups rather than taking a gradual phase-based approach?
Student: I would first like to understand our cost structure: fixed and variable.
How many 8-ounce cups do we sell annually? What is the unit price for the 8- ounce and the 20-ounce cups? Last, I’d like to know if I should assume the same
volume of the larger cups, or does shelf space dictate a smaller quantity?
Interviewer: All great questions. First, the fixed costs would remain the same at
$10M. The variable cost for the Special cup is 3 times the variable cost for the Casual cup ($0.001 vs. $0.003). The smaller cup has a unit price of $0.02 whereas the larger cup has a unit price of $0.05. Assume that because the Special cup is larger, replacing the Casual cups with the Special cups cuts the volume of Special cups by half.
Student: This is very helpful. So based on this information, since we did $50M in revenues in 2015 for the Casual cups, we sold 2.5B cups ($50M / $0.02). Our total cost of producing these was $10M (fixed) + 2.5B x $0.001 (variable) =
$12.5M. The total cost of producing the Special cups requires determining the quantity of cups we can shelve. You said we can shelve only half the number of Casual cups, so that means 1.25B cups (2.5B / 2). So, our total cost of producing these will be $10M (fixed) + 1.25B x $0.003 (variable) = $13.75M. It looks like making the replacement could increase our costs by $1.25M ($13.75M - $12.5M).
Let’s look at the revenue side. With 1.25B cups at $0.05, that means we would achieve $62,500,000 in revenues. In other words, our revenues would increase from $50M to $62.5M. So making the switch from Casual to Special makes sense from an economics perspective.
I think another key consideration is distribution. We have to consider what the shift in mix will mean in terms of distribution. I know in retail, shelf space is critical. Would retailers allow our client to swap out the Casual cups for Party and/or Special cups? Stepping back a bit, where are consumers even purchasing the larger cups?
Interviewer: These are good questions. Let’s assume that the economics of manufacturing are not an issue. Let’s focus on distribution. Here is a graph that shows distribution by category by distribution channel for 2015.
Student: This is interesting.
[She takes a minute to make her own chart and turns it toward the interviewer.]
So based on the graph, the underlying data looks like this:
2015 Revenues ($M)
Casual Party Special
Grocery 40 30 10
Drug 10 0 0
Warehouse 0 100 10
One obvious conclusion is that Party cups are bought either in the grocery or through the warehouse channels, which makes sense given the quantities usually needed for a party and the value proposition of warehouses selling large quantities of most products. Because our client is the only competitor with Casual cups, our client exclusively has shelf space in the Drug channel and sizeable distribution in Grocery. It might be possible for our client to swap out the Casual cups for Party or Special cups in the Grocery and Drug channels. Is that a possibility?
Interviewer: Sure. What else would you like to know before you sum things up?
Student: I would like to know our shelf space in the warehouse channel. One way would be to know what percent of the $100M of Party revenues is our client’s and what percent is our competitors’. Knowing this would allow us to estimate what share we have to take.
Interviewer: Why don’t you sum things up? What is your recommendation to our client?
Student: I would recommend that our client reduce or eliminate manufacturing of Casual cups and accelerate manufacturing of Party and Special cup sizes, given consumer demand and revenue growth. We’ve seen that replacing the Casual with Special cups generates an incremental $12.5M in revenues. To support growth in these categories and maximize their chances of success, I’d leverage our current distribution channels and expand our shelf space through promotions, better pricing, and better cup design.
( Case Takeaways )