Wharton Consulting Club

Case Interview Study Guide

Fall 1995

INTRODUCTION TO CASE INTERVIEWS Consulting firms use case interviews primarily to assess two qualities that are important in the consulting field: 1. Logical Reasoning 2. Business Acumen In addition to these two qualities, there are, of course, many other qualities consulting firms look for in a candidate such as creativity, maturity, leadership, and communication skills. All of these are evaluated during the resume review as well as the case interviews, and you should keep all of them in mind in presenting yourself. There are three major types of cases: 1. Estimation Cases 2. Business Cases 3. Mini Cases The estimation cases and some mini cases are used to test your logical reasoning skills, while some mini cases and most business cases are used to test both your reasoning skills and your business acumen.

ESTIMATION CASES In estimation cases you are asked to come up with an educated guess of some number, such as the all-time classic: How much does a Boeing 747 weigh? While the questions may sometimes seem off the wall, this is an important skill to possess in consulting work. As a consultant, you will often have to make decisions based on incomplete or unavailable data, in which case it becomes important to generate reasonable estimates. For example, there may be no direct data available on the number of gas stations in the state of Pennsylvania, but this may be of great importance to your client in the oil and gas industry. You will have to make an estimate based on data that you can get (number of cars sold, population, average gas mileage, just to name a few) and use logical inference to estimate the number you are looking for. Making Assumptions In these types of exercises it is not important whether your assumptions are right or wrong (in the real world you have a research department to find that out for you), but make sure that your estimates are at least reasonable based on common sense. For example, if one of the assumptions you make is about the US population, do not say that you assume it is 10 million. It is important that you use easy numbers for your assumptions because you will have to do some arithmetic off the top of your head. If you start out with an estimate of the US population of 237 million, you

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will probably start sweating profusely when you have to divide or multiply this number. Use 250 million, it is a lot easier to work with. Logical Reasoning Estimation problems are based on logical reasoning applied to a number of known data points (your assumptions) to arrive at the desired answer. Since your logic is what is tested, lay it out clearly for the interviewer. Before you start making assumptions, tell the interviewer what your logic is going to be to figure out the answer. Once you have done that, make the assumptions and do the math. To come up with a logical approach to answer an estimation problem, start with the answer and reason backwards about causal relationships. Think of this as a tree diagram. For example, if you are asked to estimate the number of basketballs purchased by the NBA and its teams each year, start out by thinking what basketballs are used for (the cause for purchasing basketballs). Most likely, they are used for games and practice. These are then the first two branches of your tree diagram. To continue to solve this problem, attack one branch at a time. Do not try to move down different paths at the same time, it will only lead to confusion. To continue with the basketball example, lets take the games branch of our tree diagram. We know that the number of balls is a function of the number of games and the number of balls per game (the causal relationship). What does the number of games depend upon? It depends on the number of teams and the length of the season (See, it doesnt take a rocket scientist or basketball coach to figure this out, common sense is sufficient). You can make an assumption about the number of teams and length of the season or you can continue to go down the tree to find the root causes for those numbers. Make sure, however, that you do not make the problem too complicated. If you have a reasonable idea of the numbers, go with the assumption and start filling in the equations. Examples of digging deeper into the drivers of the number of games are estimating the number of teams by the number of major cities in the US, or estimating the number of games by the length of the season in weeks and an estimate of the average number of games per week per team. Once you have figured out the first branch, do not forget to do the second one. It is easy to get wrapped up in a long chain of reasoning and completely forget about the practice branch in this case. Write the number you came up with for the game balls on a piece of paper so you do not have to use valuable brain space to remember it. Most interviewers wont mind if you take simple notes. A similar reasoning approach as above for the practice balls would try to estimate the number of teams, the number of players who practice on each team, the number of practice sessions, and the average life of a ball. Doing the Math Once you have come up with the logical approach, you have to fill in the numbers. Again, choose easy numbers for your assumptions. Even though the length of the NBA season might be 82 games, choose 80 because it is easier to use. It is important that you use the right equations to Page 2 Case Interview Study Guide

calculate your answers. The number of games, for example, was determined to be a function of the number of teams and the length of the season. Say that there are 25 teams (easy number) times 80 games in a season, that makes 25 x 80 = 2,000 games played per year, correct? Wrong! Since one game takes two teams to play, you have double counted the number of games. The correct answer is 1,000. Since most of us are used to calculators and dont often add up large strings of numbers in our heads, it is useful to practice your arithmetic. Calculators are generally not allowed, and it can be quite embarrassing to stumble on a simple calculation in an interview. This danger is especially prevalent since you will probably be a bit nervous, and thus less able to think clearly. The only way to get better at it is by practice; lots of it. Sanity Check When you have come up with a final answer, do a quick check to see if it is reasonable. You dont want to say with a big smile on your face that you have calculated the number of basketballs in the NBA to be 10 million. Think first whether it sounds reasonable, and possibly do a quick check. For example, you could multiply the number of balls by an estimate of the average price for a basketball, and see if the resulting figure is reasonable in relation to what you would estimate the total NBA budget to be. If it turns out to be around 50%, you have probably made a logical or calculation error somewhere along the way.

BUSINESS CASES Business cases are generally longer than mini cases (20 to 30 minutes typically), and test your business skills in addition to your logical reasoning skills. Much of your core course work is applicable in these cases. Consulting firms rely heavily on general business knowledge and expect you to be able to integrate the concepts from your different core courses in analyzing a business situation. Gathering Information A case interview is typically an interactive process, and most likely the interviewer will volunteer additional information as the interview progresses or when you ask questions. It is important to gather as much information as you need. The amount of information you receive up front can differ greatly depending on the style of the interviewer and the type of case you get. Some interviewers will give a lot of detailed information up front and will volunteer relatively little additional information later. In such cases, it may make sense to write down some quick notes to help you remember the pertinent facts. Other interviewers start out with a simple two sentence summary, and expect you to probe for more information by asking thoughtful questions. Remember, it is OK to ask questions; one of the most valuable skills of a successful consultant is the ability to ask the right questions. On the other hand, be careful not to spend too much time Case Interview Study Guide Page 3

asking a lot of factual questions. It may become difficult for the interviewer to follow your logic, and you may seem to be taking a shotgun approach to solving the problem, which is exactly what you dont want to do. Keeping that in mind, always make sure that you think out loud so the interviewer understands where your questions are coming from. Analyzing the Problem When you have gathered your initial information, think clearly about what the problem is you are being asked to solve. When the case is about reversing a trend of declining sales, do not start to evaluate the companys debt to equity ratio. In consulting, as well as in the interview, focus and time are of the essence. The critical skill being evaluated in the business case interview is whether you can solve a business problem in a logical and coherent fashion. It is important not to ramble and jump from one hypothesis to the next, but rather to use a logical framework to attack the problem. One term consultants love is MECE, which stands for Mutually Exclusive and Collectively Exhaustive. This means that your framework should provide you with a number of different options that do not overlap (the ME of MECE) and together account for all possible causes (the CE of MECE). For example, if you are being asked to solve a problem about declining profitability, do not just look at the expense side of the income statement. Profitability is a function of revenues and expenses, and these two factors are separate while together they make up the entire formula for profitability. An important fact to remember is that your framework does not have to be some cook book chart you learned in one of your core classes. While these are sometimes useful, they do not always fit the problem, and blindly applying Porters five forces to any problem may make you seem like a robot in an interview. Just keep in mind that creativity is also a skill highly valued by consulting firms. Think logically about what a good way to approach the problem would be. You can take some time on this. It is no problem to be silent for a moment while you are thinking about your approach. This makes you look thoughtful and is much better than starting to ramble and run around in circles. Some examples of frameworks and possible problems to which they apply are given below. Income Statement Used for analyzing changes in profitability. A simple income statement is often a very valuable framework to use. By analyzing profitability through its component factors such as revenues, cost of goods sold, and operating expenses, you can quickly pinpoint in which direction you should focus your analysis. For example, if the reason for declining profitability is a decline in revenues, you will look closer at the marketing side of the company, and if the reason for the decline is an increase in expenses, you look at the operations and financing side.

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A company can potentially increase profits three different ways: Increase unit price Increase the sales volume Decrease total costs In analyzing these three drivers, you may want to look at the following: Price Demand elasticity Market power Product differentiation Is a premium justified? Sales Volume Increase sales to current customers with current products Increase sales to current customers with new products Increase sales to new customers with existing products Increase sales to new customers with new products Cost What costs are fixed and what costs are variable To what extent and in what time frame are costs avoidable How are costs allocated

Fixed vs. Variable Cost Used to analyze cost structures and changes in profitability. Also important to assess economies of scale and scope. The distinction between fixed and variable cost is extremely important, and you are bound to encounter at least one case centering around this issue during your consulting interviews. Make sure you understand the cost structure of a company in analyzing its profitability. Capital intensive industries such as manufacturers typically have high fixed cost which makes capacity utilization a crucial part of their business. When fixed costs are high, there are often opportunities for economies of scale or scope. Use your common sense to understand what the important input factors are for a company, and whether these are likely to be fixed or variable. Carefully analyze the allocation of overhead expenses in this framework.

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Four Cs A general tool for analyzing a company and its environment. To analyze a companys strategy in terms of its chosen market position, you have to evaluate the different factors that will determine its success. Customers needs have to be known and the firms capacity and cost structure need to be able to satisfy those needs at an acceptable level of profitability. This capacity and cost structure should be difficult to imitate by the firms competitors in order to sustain the profitability. Customers What do the customers want and need? How will we satisfy those needs? What is most important to them? How much will they pay for it? Competitors What are your competitors doing? What are their strengths and weaknesses? How are they meeting the customers demands? What is their cost structure? Capacity What is your companys capacity in terms of: financial? organizational? production? marketing? What are your strengths and weaknesses? Costs What is your cost structure? How is overhead applied?

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SWOT Another general tool for analyzing a company in its business environment. This tool is similar to the Four Cs above. It is important not only to analyze what the firm can and cannot do, but also how these capabilities can help the firm take advantage of any opportunities, or ward off any threats that occur in the environment. Strengths Weaknesses Opportunities Threats Used to analyze the capabilities of the company Used to evaluate the companys environment

Four Ps Useful for marketing related cases such as: New product introductions New market developments Market share increases Everyone should be familiar with the four Ps of marketing. They are used as a framework for putting together a marketing plan. Remember that the four Ps are the implementation of a strategy that first depends on the selection of a target customer segment and a product positioning. Product Price Place Promotion

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Porters Five Forces Framework Used to evaluate the attractiveness of an industry in terms of the ability to earn high returns. The ability to earn above market returns depends on the degree of efficiency of the market. In a perfectly competitive market, no producer will be able to earn super natural returns. Porters framework is a way to assess the competitiveness of a market, and thus the ability to earn super natural returns.

POTENTIAL ENTRANTS

Threat of new entrants INDUSTRY COMPETITORS SUPPLIERS Bargaining power of suppliers BUYERS Bargaining power of buyers

Rivalry among existing firms

Threat of substitute products or services SUBSTITUTES

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Value Chain Analysis Useful to analyze how value is created for the customer and which parties are involved. Often used to determine which party extracts the highest returns in creating the goods or services for the end customer. Another one of Porters contributions, the value chain analysis is helpful in trying to understand how an industry is structured. A prime example is the personal computer industry. The good that the end customer receives is a combination of hardware, software, and support services. Intel supplies components, IBM builds the case and provides the services, and Microsoft supplies the operating software. Since the component supplier Intel and the software supplier Microsoft both operates in more or less of a monopoly position, they are able to extract most of the value added which goes into the final product. IBM has to compete in a market place with many competitors and low barriers to entry, and will thus receive a much smaller portion of the cumulative value added. MARGIN = TOTAL VALUE TO BUYERS - COST OF PRODUCING VALUE Firm infrastructure Human resource management Technology development Procurement Operations Outbound Marketing logistics & sales

Inbound logistics

Service

m a r g i n

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Seven S Framework Useful in determining sources of competitive advantage for a company. Peters and Watermans Seven S framework helps you understand the factors internal to a company that can create a source of competitive advantage. It emphasizes that all these attributes need to form a network in order to reinforce and sustain each other. While it may be possible to duplicate any one of these attributes, it will be very hard to copy the entire network. Hardware Strategy Structure System Software Style Staff Skills Shared Values

Structure

Strategy

Systems

Shared Values

Skills

Style

Staff

Applying the Framework Enough about frameworks. Once you have selected one, you need to apply it. The same rules as in the mini case apply: lay out the framework for the interviewer, and start analyzing it branch by branch. Listen carefully to any clues the interviewer may give you. When you go down the Page 10 Case Interview Study Guide

wrong path (or a different path from what the interviewer had in mind), you will often be redirected by comments from the interviewer. For example, when the interviewer says: Are you sure about that? or Is that the only possible solution? you should probably reevaluate your analysis. If you learn from the comments that the type of framework you have chosen does not fit the problem, do not be afraid to discard it and use another one. For example, if you interpreted the problem to be a marketing problem from the initial information you received, but you realize from subsequent information the interviewer has provided you that it is really an operations problem, just say that you will use a different approach to probe deeper into that aspect of the case. As in any interview, it is important to just be yourself and be relaxed when analyzing the problem. When you get stuck, you can summarize what you have found out up to that point. That helps the interviewer trace your line of thought and buys you some time to think about where to go next. Consulting firms value intellectual curiosity. You should appear to be interested and excited about the challenge of solving a business problem. (If youre not, you should reconsider whether consulting is the right field for you.) Always think out loud so the interviewer understands your train of thought, and state your assumptions. When you need a piece of factual information to help you along with your analysis just ask. The interviewer will realize its relevance if she is able to follow your logic, and should be willing to volunteer the information. Summarizing your Findings When your analysis has yielded a number of different possible causes for the problem at hand, list the alternatives and suggest empirical research that may be helpful in practice to test which causes are indeed to blame. For example, if you find out that machine failure accounted for a shortage of supplies which led to decreased sales and loss of profitability, suggest that the company research the maintenance procedures, raw material supplies, and physical condition of the machines. Then make a suggestion about what could be done to alleviate any of these problems. While finding the cause for a problem may be very important, it is equally important to find a solution. Because of the complexity of some of the cases you will be presented with, it may not be possible to get to the point where you start making suggestions for improvements in the time frame allotted. This does not matter, as long as you demonstrated your ability to think clearly and to apply the correct business tools to get to the causes of the problem. The firm probably took weeks rather than just thirty minutes to get to the point where you stopped in the interview. Just summarize what you have found out up to that point, and how you would proceed with your analysis if youd had the time.

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MINI CASES Mini cases fall somewhere in between estimation cases and business cases. They are typically short and focus on a single problem. While not true for all mini cases, many focus on solutions to a problem rather than on finding out the underlying causes of a problem such as in business cases. To find a solution to such a case, it is useful to think in terms of a decision tree which covers all the possible courses of action. Define the Decision Criteria First establish what the qualities of the desired outcome would be. For example, if the problem you are presented with is: How can DeBeers respond to fake diamond manufacturers, the desired outcome could be that DeBeers maintains its market position and does not experience heavy price pressures while avoiding high expenditures. Formulate the Different Choices The next step is to formulate the first level of your decision tree. In the DeBeers example, some possibilities could be to (a) purchase the fake diamond manufacturers, (b) try to establish legal or trade group certification criteria for diamonds, (c) pressure distributors not to sell fake diamonds, (d) start a public relations campaign to convince consumers not to buy fake diamonds, (e) lower the price of diamonds to force the fake diamond manufacturers out of business, and (f) close the business and retire. This type of case is an opportunity to show your creativity; try to think of novel approaches to a problem. Evaluate Outcomes of Choices Against Decision Criteria Once you have formulated the choices, go down each branch, making assumptions, and evaluate the merits of the decision in light of your decision criteria. For example, choice (a) would allow DeBeers to either use the fake diamond technology itself to profit from the technology or would allow it to shut it down and continue business as usual. The cost of this option may be prohibitive, however, and if there are numerous companies who possess this technology it may be altogether unfeasible. Therefore it will probably fail under the Avoid high expenditures criterion. Option (b) may allow DeBeers to pursue a successful differentiation strategy, especially when coupled with a public relations campaign decrying all those cheap men who buy their loved ones an el cheapo fake diamond, which of course means that their love for them is fake as well. This option satisfies the first two decision criteria, and probably is not unduly expensive given the sales volume retained. Choose an Option Select which decisions meet all the criteria, and make a choice from those based on which one satisfies them best.

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HOW TO PREPARE FOR THE INTERVIEW There is only one good way to prepare for a case interview, and that is PRACTICE! Use the resources available to you such as mock interviews offered by CD&P, helpful second years, interview workshops organized by the Consulting Club, and most of all your class mates. Get together with some of your friends interested in consulting and give each other cases. You may even want to tape your interviews on a camcorder so you can watch your body language and your reactions to the interviewers comments and questions. There are a number of practice cases provided in this guide, but it is also easy to make up some of your own. Almost everyone can use the company they have worked for, or maybe a company that a friend of theirs has worked for, as the basis for a business case. Another great source of practice material is the Wall Street Journal. Just read an article about a company and use it as a case. You can simply make up some of the facts to fill in the picture. Several consulting firms organize case interviewing work shops on campus. You can attend these or watch the video tapes at CD&P. When interviewing with a firm, try to keep in mind the type of work that they do. Most likely, the interview cases will reflect the particular companys area of expertise. Talk to second years who have interviewed with the firm before, and ask what type of questions they were asked.

PRACTICE CASES Below, we have compiled a number of cases that were used in the 1995 recruiting season as well as some cases from last years study guide. They are divided in estimation cases, business cases, and mini cases. Five estimation cases are worked out for you as examples, and ten more cases are given for you to practice with. We have also worked out five business cases and supplied you with a list of additional cases you can use for practice with your class mates. Possible scenarios are given for the person playing the interviewer in the exercise to help guide the discussion. You can make up additional facts as the case goes along. Finally, two mini cases are worked out and a few more are given as examples. As in any case interview, no one solution is the right one. These are merely examples of applying frameworks to problems and following through on the logic.

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Estimation Cases How many gallons of ice cream are sold in the US each year? Ice cream can be sold through retailers and restaurants. First, lets analyze the retail sales. Assume that of 250 million people in the US, 80% like to eat ice cream. That makes 200 million possible consumers. Ice cream sales are likely to be somewhat seasonal, especially in Northern States, so assume an average selling season of eight months in the North and ten months in the South, for an average of nine months for the whole country. During the season, assume that people eat ice cream twice a month, and assume that the average serving is one pint. Since there are eight pints in a gallon, retail sales will be: 200 million people x 9 months x 2 servings per month x 1 pint / 8 pints per gallon = 450 million gallons. Assume that 80% of the US population frequents restaurants, and that they do so at a pace of twice per month on average. That makes 250 million people x 80% x 12 months per year x 2 visits per month = 4,800 million restaurant visits per month. Assume that 50% of these restaurants offer ice cream. That makes 4,800 million x 50% = 2,400 million possible purchases. Now assume that one out of ten times, the customer will order ice cream. That adds up to 2,400 million x 10% = 240 million purchases. Now assume that the average serving is half a pint. Since there are 16 half pints in a gallon, the total restaurant purchases come out to be 240 million purchases / 16 servings per gallon = 15 million gallons. Total purchases of ice cream are 465 million gallons per year. Do a quick sanity check by dividing this number by 250 million people, which means that the average annual ice cream consumption is 465/250 or a little less than 2 gallons per head of the population. That seems to be reasonable.

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How big is the US market for Band-Aids? (the brand) Band-Aids are used to cover up minor cuts. Assume that Band-Aid holds 75% of the US market for bandages. The market can be segmented into two main categories of users: kids 16 and under who tend to get cuts more often, and adults over 16 who are a little more careful. Assume that the average life of a person is 80 years, and the population is evenly distributed. That means that kids 16 and under represent 16/80 = 20% of the population. Assume that they get a cut once every two months on average. If the US population is 250 million, 20% equals 50 million kids. Once every two months equals six times per year, for a total of 50 million x 6 cuts = 300 million bandages. Assume that it takes on average three days to cure a cut and bandages are replaced once a day. That makes for 900 million bandages. The adults represent 80% of the 250 million people in the country, or 200 million. Assume that they get a cut once every six months which lasts three days, with bandages being replaced every day. That is 2 cuts per year x 3 days per cut x 200 million people = 1,200 million bandages. The total number of bandages, then, is 900 + 1,200 = 2,100 million bandages. Assume there are approximately 20 bandages in a package, and a package sells for $2. The total size of the market expressed in Dollars is therefore 2,100 million / 20 x $2 which is approximately $200 million. Band-Aid holds 75% of this market which is equal to $150 million.

How many pairs of skis do you expect to sell in the US market as an up-market new entrant? Assume 250 million people in the US. 10% of those people ski, which equals 25 million people. Assume a pair of skis lasts five years on average. This means that every year 1/5th of the skiing population buys a new pair of skis. That is 5 million pairs of skis per year. Now assume that 10% of the skiing population belongs to the up-market segment. Also assume that given the fanaticism and riches of this market segment, they replace their skis twice as often as the average person. That means that the market segment is 5 million x 10% x 2 = 1 million skis. Assume there are five major manufacturers in this segment at this time. That means that each sells 200,000 pairs of skis each year. Assume that as a new entrant, you will be able to attain 10% of the average sales volume in the first year. That is 10% x 200,000 pairs of skis = 20,000 pairs of skis.

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How many horses are there in the US? Assume horses are used for the following purposes: (1) riding schools, (2) personal pets, (3) racing, (4) carriages, and (5) police. Assume 80% of the population of 250 million is physically able to ride a horse. Assume that of this 80%, one out of 100 rides horses at a riding school. That makes for 2 million riding school customers. If each person rides a horse once a week for an hour, and a horse normally rides two hours a day, five days a week, then one horse is sufficient for 10 riders. That means that there are 200,000 horses for 2 million riders at riding schools. Now assume that for every five people taking riding lessons, there is one person that owns her own horse. That is 2 million riders / 5 = 200,000 horses. Assume that there is one race track for every 2.5 million people in the population. That means that there are 100 race tracks in the country. Assume that there are races on six days per week, and that each day has 8 races. That is approximately 50 races per week. If there are six horses per race, and every horse races once per week, there are 50 x 6 = 300 different horses per race track. 300 horses x 100 race tracks = 30,000 race horses in the country. Assume that the city of Philadelphia has 1.5 million people, and that it has approximately 100 carriages to move people around. That is approximately 15,000 people per carriage. If this holds for the US as a whole, there must be approximately 15,000 carriages in the US. Assume each carriage is drawn by one horse. That makes for 15,000 horses. Assume that the Philadelphia police has 100 horses. That is the same ratio as the carriages. Repeat the math for the population as a whole, and you get another 15,000 horses on the police force. The total number of horses in the country is 200,000 + 200,000 + 30,000 + 15,000 + 15,000 = 460,000. A quick sanity check: 250 million people for 460,000 horses is approximately one horse for every 500 humans. That is plausible.

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Estimate the annual demand for golf balls in the US. There are 250 million people in the US. Lets assume that of those, 80% is physically fit enough to play golf. Of those 200 million people, lets assume that one out of ten plays golf. That is 20 million golfers. Lets assume that the average golfer plays ten times per year. That is 200 million games per year. Assume that during every game, the golfer loses three balls. That is 3 x 200 million = 600 million balls per year that need to be replaced.

Additional Estimation Cases 1. How large is the market for Cool Whip brand dessert topping in Mexico? 2. How many tennis balls were sold in the US last year? 3. How many hospitals are there in the US? 4. How much wine is consumed each year in the US? 5. Estimate the number of Louisville Slugger baseball bats produced for the Major Leagues each year. 6. Estimate the number of Porsches that will be sold in the US this year. 7. How much does a Boeing 747 weigh? 8. I own a shopping mall. How many pennies are in it at any time? 9. How would you estimate the number of gas stations in the US? 10. Estimate the number of practicing medical doctors in Philadelphia.

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Business Cases Text after the symbol ! represents additional information supplied by the interviewer. A computer manufacturer was gaining market share but experienced declining profits. Why? What should it do? This is an example of a case where you can apply the general income statement model. Since we already know that volume is increasing, prices must be declining or costs must be going up, or a combination of the two. ! Prices are falling and expenses are edging up. First analyze the decline in prices since that appears to be the major factor contributing to the declining profits. There are two possibilities. Either the company has decreased its prices unilaterally to gain market share or it is following the market. ! The companys pricing policy is to match the lowest price in the market. If competitors are lowering prices, there must be an over-supply of computers or they must have lower cost structures which enable them to lower prices. It is necessary to compare the cost structure of our client with that of its competitors. ! New low cost producers have entered the market and are trying to under-cut existing manufacturers. The company has two choices. It has to either lower its cost structure to be competitive with the new entrants or it has to focus its attention on different customer segments in order to avoid the head-on competition. These strategies are equivalent to Porters generic strategies of low cost production or differentiation or focus. Try to find out more about the type of product and the customers. ! The company manufactures personal computers and currently sells most of its products through a direct sales force to large corporations. A possible segmentation of the personal computer market could be (1) large corporate buyers, (2) small and medium sized corporations, and (3) consumers. These segments are likely to have different needs and different price points. You hypothesize that large corporate buyers are likely to value strong after-sales support, have a need for advanced machines, and are somewhat less price sensitive than the other two segments. You need to find out how your clients product/service bundle matches these needs, and what the new competitors are offering. ! It turns out that your client has a very strong service department and its products are consistently at the cutting edge of technology. The new competitors are also at the forefront of technology but distribute their products through retail outlets and offer little support. Page 18 Case Interview Study Guide

It appears that the company may be pricing its products the wrong way. It is not directly competing with the new entrants, yet is matching their aggressive prices. The increase in market share is probably the result of the fact that its price point is lower than that of its traditional competitors in its market segment. Given the declining profitability, it appears that the demand is fairly inelastic, because the increase in sales is not making up for the decreased margins. The company may want to raise its prices. The second part of the equation is the expense side. You need to find out where expenses are increasing. ! The major increases in expenses are on the sales side. The company has aggressively added new sales and support people to keep pace with its growth. While the sales and support staff give the company an advantage in servicing its market segment, it has to be careful that this service does not become too expensive relative to the price premium it allows the company to charge its clients. The company may want to do a time study to find out what the staff is doing, and what services are valued most by the customer. Some functions may add little value while costing a lot of money. Also, there may be opportunities for automating sales support functions in order to make sales and service personnel more productive.

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How would you develop a pricing strategy for a large hotel chain? Pricing is one element of the marketing mix. It is an attribute of the product or service that you sell, so you will first need to find out what you sell and to who. Does the hotel chain cater to vacationers or business travelers? Is its product/service consistent with a low budget, medium, or up-market positioning? ! The hotel caters to both vacationers and business travelers, depending on the location, and its service and amenities are considered to be in the middle of the spectrum. Since the hotel caters to different clients at different locations, you may want to consider a differentiated pricing policy. You hypothesize that business travelers are likely to be a little less price sensitive than vacationers. You have to check what travelers value in their choice of hotels, and how they make purchase decisions. ! We conducted a survey of business and vacation travelers and found out that business travelers value service and convenience above other things within a given price range, while vacation travelers are mainly concerned with price. To start with, you can create a differentiated pricing scheme by giving discounts to guests who stay over a Saturday night or who stay longer than 4 days or so, since these are likely to be vacation travelers. Now that you have learned in which markets the hotel competes, you have to identify what its competitors are. The range of possible prices you can charge will be limited by the pricing policies of your direct competitors, and by the pricing of substitutes such as up-market or budget type of hotels. ! Every location has a number of competitors within close proximity. These hotels serve the same market segment. Our clients amenities are a bit better than those of its competitors, (i.e. modem data lines and coffee makers in the room) while service levels and location are similar or slightly less than those of its competitors. The competitors prices for a week-day stay range from $90 to $120 per night and from $75 to $95 per night on the weekends. Lets assume that the prices currently charged by our client and its competitors result in a supply and demand equilibrium at a certain occupancy rate that is less than 100%. In other words, there is sufficient capacity to meet customer demand. Our client has a choice of charging more than the market clearing price, charging the same, or charging less. The choice depends on the price elasticity of the market and the likely reaction by competitors. Since hotels will likely have high fixed cost associated with the operation of the real estate, there will be an incentive to lower prices to increase demand because marginal costs for a hotel room are minimal. This is much like the airline industry. Much like in the airline industry, however, price competition may erode industry profits because competitors will likely match any decreases in price by one hotel. A price war, therefore is not a good idea. Lowering prices only makes Page 20 Case Interview Study Guide

sense if demand is elastic, and a new lower equilibrium price could be established which leads to sufficiently increased demand to offset the margin losses. Think about whether business travelers demand would be very elastic; probably not. Vacation travel would be somewhat elastic, but it is not known whether it is elastic enough. Charging higher prices would probably lead to decreased demand because our service level (which is important to business travelers) does not justify the premium over competitors prices. The remaining choice, then, is to charge market prices. One possible way to improve yields is to utilize a more sophisticated market segmentation, and rather than having two price classes (business and vacation), establish more segments with different price points. Through yield management techniques, the chain may be able to better manage its fixed capacity and increase average yields.

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A small biotech company has come up with a revolutionary new seed for sugar beets which are exactly the same as regular beets but yield twice as much sugar. The company wishes to sell the patent (which is valid for twenty years) so that the inventors can pay off their venture capitalist and retire to an island with lots of sun and palm trees. What is the value of the patent? The price of a product is determined by the market. Lets assume that there are no inputs for the new seed technology (its already produced and can simply be cloned), and that agricultural goods are commodities sold to a dispersed market of buyers who individually can exercise little power over the price. The price, then, will be based on the value of the product to the buyer, and by competition from similar and substitute goods. To start out with the competition from similar goods: since this is a patent, there are no similar goods, and therefore no competition. Substitute goods are regular seeds and possibly seeds for sugar cane. ! Sugar cane is grown in entirely different climates and is not considered to be a competing product in this market. That rules out one possibility and makes the solution easier. The only possible competition, then, is from regular sugar beet seeds. The value of that product should be compared to the value of our new seeds. Seeds need to be grown into beets which requires land and labor. The farmer using our new seeds has two possibilities: he can grow twice as much sugar with the same amount of land and labor or he can grow the same amount of sugar with half the land and labor. (Lets look just at land for simplicity here.) ! Do you believe the farmer can sell twice as much sugar? Remember that MGEC course? One individual farmer in a commodities market should be able to sell all his increased output at the market price, but if every farmer uses the new technology and doubles his output, the price will have to fall. The question then becomes whether the demand for sugar is elastic. Using common sense, would you expect anyone to consume more sugar (bake more cookies or make more lemonade) when the price of sugar drops? Probably not, because sugar is already a pretty cheap staple product and rarely the most expensive ingredient in something. You might want to think about other uses for sugar such as making alcohol to use as a substitute for gasoline. This markets demand would probably be elastic. ! That is a good point, but lets assume demand for sugar is fixed for now. This is an example of a clue where the interviewer does not want you to pursue this any further. Having established these facts, get back to the original line of the argument and continue. If demand for sugar is fixes, then the only possibility for the farmer is to use only half the land to grow the same amount of sugar. You need to determine the value of the land saved. This could be determined by the market price of agricultural land times the area saved. ! Thats a bit of a problem. There is a glut of land available, and it is unlikely that the farmers will be able to sell their land at all within a period of a few years.

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Oops! Now what? Another possibility is to see if the farmer may have other uses for the land. Maybe he can grow a different crop? ! It is possible to grow other crops on that type of soil. For instance, cabbage grows well in those types of climates. The problem is that the profit margins on cabbage are only 20% of those on sugar beets. The beach and palm trees are seemingly starting to slip away from our inventors. It seems that the farmers will not derive a whole lot of benefit from the new seeds. You have looked at the end consumers of refined sugar and at the producers of the beets now. What other players could possibly gain from the new invention. A good way to approach this is to use a value chain or process flow. How does the sugar finally reach the consumer? ! Sugar beets are produced by the farmer, then shipped to the sugar refinery by truck. The sugar refinery makes sugar crystals from the beets and packages them. The packaged sugar is then shipped to retailers where it is distributed to the end consumer. The sugar that reaches the end consumer is the same sugar and the same amount that would be shipped if old seeds were used. Therefore, there are no cost savings there. From the farmer to the refinery, however, the amount of beets shipped would be only half the traditional amount. Trucking expenses should drop by 50%. The question is whether the refinery also realizes any production benefits from the reduced number of beets. ! As it turns out, the processing cost of the new beets will be 25% higher per beet than the old ones. If the number of beets is reduced by 50% and the cost per beet is only 25% higher, there will be a 25% production cost savings to the refinery. The refinery should be willing to pay the farmer a higher price for the new beets. The total savings from the new seeds can be summed up as follows: farmers gain 10% on their profit margins from the opportunity to grow cabbage on half their land (100% is original profit. 20% of this 100% on 50% of the land equals 10%.); trucking expenses from the farmer to the refinery are cut by 50%; and production costs are reduced by 25%. Next you need to find out how much each step contributes to the final price of sugar. ! Growing the sugar is 40% of the cost, trucking 10%, refining 30%, and distribution 20%. The savings are 10% x 40% = 4% in growing; 50% x 10% = 5% in trucking; and 25% x 30% = 7.5% in refining. This adds up to a total savings of 16.5%. Multiply this number by the annual sugar demand and you get a dollar value of annual savings. ! How would you estimate the annual demand for sugar? At this point you drop your head in exhaustion for you will have to do an estimation case within a business case. See some of the examples above on how to do this. Assume that the resulting figure is $2 billion. Next you have to take the net present value of twenty years (the length of the Case Interview Study Guide Page 23

patent) of 16.5% x $2 billion. Dont worry, they wont expect you to actually calculate this off the top of your head, as long as you tell the interviewer that this is the approach you would take.

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A battery manufacturer in the UK is experiencing declining sales. Its product is superior in lifetime and quality to its competitors. How would you approach this issue as a consultant. A decline in sales can be caused by two factors: declining market demand or loss of market share. Loss of market share can be due to competing products or substitute products. First lets analyze the market. You want to know who the customers are, what the product is, and who the competitors are. ! The company sells batteries for fork lifts. Sales are made to OEMs (i.e. fork lift manufacturers) and for replacement purposes to large manufacturers and distributors who use fork lifts. The majority of sales are to the latter. Customers are located throughout Europe. There are five or six other European manufacturers which are of similar size to our client. What is the trend in market demand? ! Demand tends to be very stable, growing at approximately 3% per year. If that is the case, our decline in sales must be due to declining market share. Are there any new substitute products or new competitors? ! There have been no major changes in technology. The only large change in the market place is the emergence of a new Portuguese competitor. This company has managed to grow to approximately the same size as our client in a relatively short period of time. Next, we would like to find out how this company has been able to take market share so quickly in an otherwise stable industry. It is necessary to evaluate the companys price/product proposition to compare it to ours. ! Our clients product is superior in lifetime and quality to that of the Portuguese competitor. Our price is higher as well, however, but we feel the additional quality more than makes up for this differential. Now that we have established the different value propositions of the two companies, we need to find out what the customer is looking for when purchasing a fork lift battery. Reliability and pricing are the most likely factors for an industrial buyer, and while we outperform our competitor on the former, we are lagging on the latter. The next step would be to evaluate the trade-offs among these two attributes, and to verify our clients claim that the increased quality is worth the price. We know that our clients product lasts longer; we need to know how much longer. ! Our battery lasts for a total of five years while our competitors only lasts for four years. Next we need to know what the price differential is.

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! Our battery costs 1,500 while that of our competitors costs 800. That means that the cost per year is 1,500/5 = 300 for our product and 800/4 = 200 for the competitors. That is not looking good on the surface. Maybe our client should reduce its prices. Does their cost base enable them to do so while maintaining an acceptable level of profitability? ! Our clients cost base is substantially higher due to the higher quality of its products. In addition, labor expenses are significantly higher in Great Britain than in Portugal. Our client is not willing to leave his lukewarm Guinness and jellied eel behind, however, so moving is not an option. Therefore, lowering costs is not an option. Lets look a little bit further into the cost/benefit trade-off. So far we have only considered the purchase price as a cost of the product. It is possible that there are additional costs involved. To find out, we need to evaluate the use of the batteries. (You dont need to be an engineer to figure this out, just use your common sense.) Fork lifts will most likely ride around a plant or warehouse moving goods around. The battery powers the fork lift, so will need to be recharged periodically. While the battery is recharging, the fork lift will be out of commission or the battery will need to be switched which takes time. Is there any difference in charging time or efficiency between the competing batteries? ! It takes 8 hours to fully charge our battery which will then last for 12 hours. Our competitors battery takes 10 hours to charge and can be used for ten hours. The batteries draw the same amount of electricity per hour while charging, but due to the better design of our battery, output efficiency is higher. This efficiency difference needs to be translated into costs and value for the customer. Value is derived from lower energy requirements, faster turn-around time, and fewer switching operations. Given the fact that our clients are large industrial companies, they will probably work around the clock. Therefore, lets assume a 24 hour a day need for the fork lifts. First, evaluate the energy savings. We need to know the price of electricity drawn per hour. ! The hourly rate is 0.10. If the fork lift will be used 24 hours per day for say 350 days in a year, it will require 24/12 x 350 = 700 charges of 8 hours each for our battery. That is 5,600 hours at 0.10 or 560 per year. For our competitor, the battery requires 24/10 x 350 charges of 10 hours each per year. This equals 8,400 hours or 840 per year. The difference is 280 per year. Next, evaluate the switching costs. You need to know how long it takes to switch the battery. ! This only takes a couple of minutes. For simplicity, lets assume the time is negligible. That means that we can assume switching costs to be negligible. Since the batteries are out of commission while charging, however, we will need to evaluate how many batteries we need per Page 26 Case Interview Study Guide

fork lift. Assume that our clients operate fleets with multiple fork lifts which can all share the same batteries. For our battery, each fork lift requires one battery to move while another is charging for 8 of the 12 moving hours or 2/3. That means that we need 1 2/3 batteries per fork lift. For our competitors battery, the battery is charging for the entire moving time. That means that there are two batteries required for each fork lift. The annual purchase cost per fork lift is therefore 300 x 1 2/3 (500) for us and 200 x 2 (400) for the competition. That is a cost differential of 100 per fork lift. The purchase cost of our battery is 100 higher per fork lift per year, but the energy savings are 280 per year. That means that our battery is a better value than that of our competitors. Next we need to find a way to relay this information to the customer, because they apparently do not know about this benefit given our loss of market share. We may want to consider using a direct sales force to explain these benefits given the complexity. Printed materials may also be useful to describe the benefits in detail.

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A client has bought a Russian satellite after the break up of the Soviet Union. A large company has offered your client (an entrepreneur) $10 million for the satellite, and he wants to know whether he should accept the offer and sell it. This case is an example of one where you are asked to use your creativity and generate some ideas. The purchase price of the satellite is unimportant. Taking this into account would be an instance of the sunk cost fallacy. To determine the value of the satellite, it is necessary to assess the cash flows it can generate at its most productive use, and discount these cash flows at an appropriate discount rate to calculate the net present value. Therefore, we first need to find out what the most productive use is. Satellites can be used for transmission of data such as telephone, TV, or computer data. They may also be used for taking pictures of the earth (including spying activities) or to do research by observing events on earth and in space. ! This satellite is of the data transmission variety. Knowing that, we can assess the use of the satellite for different data transmission purposes. Take for example telephone services. We could evaluate the demand for telephone services and compare the costs of alternative transmission technologies such as wire and land-based radio transmission. Another alternative is to evaluate the cost of launching a new satellite. ! Good idea. There is only one problem. Due to the orbit of the satellite, it can only send and receive signals during twelve hours of the day; from 3:00 pm until about 3:00 am. That is a problem, because it will eliminate a lot of possible uses unless this limitation is somehow offset. We might want to investigate the possibility of launching a second satellite with an opposite pattern to cover the full twenty-four hours. This cost would need to be compared to that of launching a satellite in an orbit that would allow twenty-four hour a day transmission. ! The cost of launching a 24 hour satellite is $5 million more than launching a 12 hour one. That means that the value-added of our satellite would only be $5 million. Looking at alternatives, one possible opportunity which may not be unduly limited by the time frame is television broadcasting. Most television shows are watched during the late afternoon and evening hours. We can evaluate the demand for television in the former Soviet Union and determine what the costs of alternative transmission technologies such as cable or non-satellite transmission would be. Another possible use is for transmitting computer data. Given the time frame that the satellite is available, it may be possible to transmit data during the evening and night. This way, it is possible to update computer systems on a daily basis. This may be useful for companies like banks who update their records daily.

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Additional Business Cases Your client is a large hardware chain. Develop a growth strategy? Possible Scenario: 50% of the market is in the hands of small independent retailers, some of them in cooperatives such as True Value, and the other 50% is held by large chain stores. The share of large chain stores has been growing rapidly. The market is expected to grow slowly. Customers are primarily consumers, and can be segmented as advise seekers and price seekers. The former makes up 40% of the market and the latter 60%. There are four large national hardware store chains. Chain stores compete among themselves based primarily on price and selection. Primary costs consist of COGS, rent, and inventory holding costs. A community of 50,000 people in a 5 mile radius around the store can sustain one large hardware store.

Your client operates a steel mill and is concerned about vulnerability to market cycles. What should it do? Possible scenario: Fixed costs are 50% of total cost. Demand for steel is highly cyclical. Demand in the trough of a recession can be as low as 70% of the demand at the peak of the business cycle. The market pressures the company to pay out excess cash in the form of dividends during upturns in the economy. Labor unions are inflexible with regard to work rule changes. Increased competition from mini-mills and foreign competitors.

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The CEO of a large international manufacturer of aircraft engines wants long-term strategic recommendations. What do you tell him? Possible scenario: The market is an oligopoly with four major producers of airline engines. The market consists of civilian passenger and cargo airlines and governments who purchase planes for their military. Aircraft engines are typically purchased separately from aircraft. The buyer of the aircraft specifies the engine, purchases it, and has it delivered to the aircraft manufacturer for installation. The civilian airline industry has approximately 30% over-capacity at this time. 10% of this capacity is not fuel efficient enough to operate at current average load factors. Demand for flights in the civilian airline industry is expected to grow by 8% per year for the next 15 to 20 years as more and more third world countries grow their economies. Demand for military use is expected to decline by 2% per year for the next 5 years as the result of the end of the cold war, and then grow by 3% per year thereafter. The economic life of an engine is approximately 15 years while the physical life is 25 years. Engines represent 20% of the cost of a new aircraft.

You are the head of a large car manufacturer in Europe. All cars are produced in one major plant and are distributed all over Europe. You have the choice to transport the cars by train or truck. Which mode of transportation do you choose? Why? Possible scenario: Cars are currently shipped by train to central distribution points in the different European countries. From there they are shipped by truck to the various car dealerships. The distribution points are owned by the manufacturer. Trains require a minimum load of 100 cars. The cost of shipping one car by train to a distribution point is $100. Trucks have no minimum load and can transport up to 10 cars at a time. The cost of transporting one truck load to any point is $1,500. Trucking cost from the distribution point to the dealerships are $200 per load of up to ten cars. Average truck load shipped to a dealer is 6 cars. There are ten European countries including the one where the factory is located. The factory also serves as a distribution point for that country. Operating expenses of a distribution point are $1 million per year. Total demand for the manufacturers cars is 1 million vehicles per year. 50% of car buyers do not take delivery from dealer stock, but wait for factory delivery.

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A US auto-part manufacturer plans a market entry in Europe. How would you go about it? Possible scenario: A typical car manufacturer uses 5,000 different suppliers. The trend is to reduce this number, and work closer with the suppliers. Purchase decisions are based on price, ability to adhere to quality standards, and speed and reliability of delivery. Car makers are dispersed over Europe, with most of the plants being located in Germany and France. Your company has a reputation for high quality. Your pricing is competitive, but at the high end. Governments offer tax incentives to locate manufacturing plants in their countries. All your manufacturing capacity is currently located in the US. Exporting products would be 50% cheaper than setting up new manufacturing sites as a result of avoiding fixed costs and increasing economies of scale and learning curve opportunities. Car sales are expected to grow modestly over the next ten years, while being subject to fluctuations in the economy.

You are the head of a large steel group. You notice that one of your five product lines is losing market share. What are the possible sources? What would you do? Possible scenario: All of your five product lines are sold to car manufacturers. The products are: thin plate steel for body panels, beams used for structural support in doors, bumper attachments, steering column parts, and engine attachments. The decline in demand is for the structural beams. Low cost mini-mills are taking over market share. It would be extremely difficult for our client to match the cost structure of the mini-mills. Mini-mills are only able to manufacture lower grade steel. They would be able to manufacture any of the five products mentioned above with the exception of the thin plate body panels. Car manufacturers are trying to reduce the number of parts suppliers and forge closer ties with suppliers. In addition to price, quality and speed and reliability of delivery are important purchasing decision factors.

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A California electric utility is contemplating entry into the electric car market. California law mandates that by the year 2000, 10% of all cars sold have to be powered by electric engines. Should the utility enter this market, and if yes, how? Possible scenario: Utilities are in a heavily regulated market with very stable demand. This market is expected to be deregulated by the year 2000, which means that utilities will have to compete in an open market. The standards for electric cars being developed by the Big Three are not dependent on any particular energy supply. Therefore, any utility will be able to supply electricity needed to recharge car batteries. The core competencies of the utility are in building and operating large scale generators of both fossil fuel and nuclear varieties. Market demand for the electric cars is expected to fall far short of the mandated 10%.

A paper producer is contemplating adding capacity. Should it? Possible scenario: The manufacturer is currently operating at 90% of capacity. The industry is operating at 80% capacity. Demand for paper is expected to grow by 4% per year and is very inelastic. The total paper market is 100 million tons per year. The minimum scale for a new plant is 1 million tons of productive capacity. The company currently sells 9 million tons of paper per year. A new plant comes on-line, two years after the decision to build it is made. Competitors are contemplating adding 10 million tons of capacity in two years. 5 million of this has been committed to already. The break-even operating level of a new plant is at 70% of capacity.

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You are the Number 2 aluminum manufacturer in the country. Although your unit costs are competitive with the market, your profit margins are declining every year. What should you do? Possible scenario: Demand for aluminum is growing slowly and prices have been stable. Demand is elastic in the short-run as users will take advantage of low prices to make forward purchases, but is inelastic over the medium to long run. The supply of bauxite, the ore for aluminum, has been declining which has driven up world prices. The industry is very capital intensive and currently operates at 75% capacity. Aluminum is sold on world markets at world prices stated in dollars. The dollars value has been declining relative to other currencies. 70% of your output is currently sold in the US.

A group of doctors has just discovered a new medical diagnostic technology for diagnosing cancer. The doctors want to maintain proprietary ownership of this technology, yet offer it to physicians across the country. In order to perform the new test, blood samples have to be given to the enterprising doctors, who can then do the diagnosis and return the results to the referring physician. How should the doctors promote their technology? Think about payments and devise an operational plan? Possible scenario: 90% of payments are made by insurance companies which tend to pay slowly. Physicians are widely dispersed throughout the country. The transport of blood samples is heavily regulated and needs to be done by special couriers.

The hospital industry is experiencing a large over-capacity of beds. Your client is a hospital bed manufacturer and is experiencing declining demand as the result of the governments new health care policy. What would you recommend? (Overthrowing the government is not an option.) Possible scenario: The companys steel bending technology is highly fungible and can be used to manufacture many types of steel products. Fixed costs are a high percentage of total costs.

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A customer has a problem with lots of incoming customer calls. How should they handle this? Possible scenario: Calls can be segmented into four main types: sales inquiries and requests for catalogs, customer support for product failures, inquiries on shipping dates for ordered products, and customer support for operating instructions. The division of calls among these types is: 50% sales, 10% failures, 20% shipping, and 20% instructions. The average length of each call is: 60 seconds, 300 seconds, 45 seconds, and 90 seconds.

A waste management company is considering whether it should invest in new land fills. What do you think? Possible scenario: An alternative waste disposal option is an incinerator, which has high up-front costs to build but has a longer useful life than a land fill. Total book costs are roughly equal. It takes five years to fill up a landfill. Both land fills and incinerators are heavily regulated. Communities do not want land fills near their homes, but dont mind incinerators due to the employment opportunities offered. Most waste is generated by households. Trucking costs are 30% of the cost of waste disposal. Environmental pressures have led to liability suits against waste management companies. The reserves set aside by waste management companies for future landfill clean-ups are 10% of disposal costs. Actual future costs are unknown.

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Mini Cases You have a hot dog stand in front of your office. It serves the workers in your building and two neighboring office towers. You want to buy it. How much is it worth? Valuing a company is done by calculating the net present value of the cash flows at an appropriate discount rate. Therefore, you will first need to estimate the cash flows. The cash flow depends on revenues and cash costs. To estimate the revenues, you need to multiply volume by price. The estimation of volume is identical to the method used in estimation cases described above. Assume there are 500 workers in each building; that is 1,500 potential customers in total. If 80% of these workers likes hot dogs, there are 1,200 potential customers. Assume that on average each of these potential customers eats a hot dog once every two weeks. If there are 50 working weeks in a year, each customer eats 25 hot dogs per year. In total, the hot dog stand will sell 30,000 hot dogs per year. Now assume that one hot dog costs $1.50 and each customer also purchases a soft drink at a price of $1.00. Total revenues for the cart will be 30,000 x ($1.00 + $1.50) = $75,000 per year. Now we need to estimate the costs. Total costs will include cost of goods sold: hot dogs, buns, condiments, soft drinks, and napkins and straws. Additional costs are wages for the operator of the stand, electricity for the heater and refrigerator, depreciation expenses for the hardware, and insurance. Assume hot dogs cost $0.25 a piece and buns cost $0.10. Add $0.10 for condiments, straws and napkins. Cans of soft drink will cost $0.30 wholesale. That means that the total cost of goods sold is $0.75 per order, or 30,000 x $0.75 = $22,500. Assume wages of $5.00 per hour. If the stand is open eight hours a day, one year will have 50 weeks of 40 hours, or 2,000 total hours. Wages, then, are $10,000 per year. Add 10% employment taxes to that for a total of $11,000. Assume electricity is $100 per month for a total of $1,200 per year. Assume the hardware of the hot dog stand costs $10,000 and will last for 5 years. That is $2,000 depreciation per year. Finally, assume insurance is $800 per year. Total cost is $22,500+$11,000+$1,200+$2,000+$800 = $37,500. That means that profits are $75,000 $37,500 = $37,500 per year. If we assume that annual capital expenditures are equal to depreciation, this figure is equal to the annual cash flow. The final step is to estimate an appropriate discount rate and to discount the cash flows. Assume that there will be no growth in the company, and it will continue operations indefinitely. That means you can use a perpetuity to estimate the value. Take a risk free rate of 7% (long government bonds) and add a business risk premium. In this case, say that is 6%. That means that the appropriate discount rate is 13% per year. Divide the annual cash flows by this discount rate and you get the value of the perpetuity. In this case, that would be approximately $300,000 ($288,000 to be precise). This is the maximum price you should be willing to pay.

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You are a manager of a residential high rise building? Tenants have complained about the slowness of the elevators. How would you solve the buildings problem? To solve this problem, you can take two approaches: you can change the reality by speeding up the existing elevators or adding more elevators, or you can change the perception by making the wait less aggravating. First explore opportunities for the first approach. If adding elevators in unfeasible due to space limitations, you can try to decrease the waiting time by changing the moving speed of the elevators or by changing the algorithm used to move them. Possible options are: setting the default wait state to the middle floor in the morning (when most people will be leaving their homes to go to work) and to the first floor in the evening (when most people return from work). Another option would be to always have one elevator waiting on the first floor while another is waiting in the middle. A few of the elevators could also be turned into express elevators which serve only the bottom half or the top half of the building. One elevators could be programmed to stop on only every third floor, so that tenants could walk up or down the last floor. Elevators could be programmed to learn what patterns prevail at what time of the day, and could optimize their wait states based on that knowledge. Examples of the second type of remedy are to place mirrors in the lobbies so that people can look at themselves while waiting which may make the waiting time seem shorter. Other options are to place television sets in the lobbies (the Wharton Reprographics CNN approach), play music, install lights that show where the elevators are at, put coaches and magazines in the elevator lobbies, etc. The best solution is likely to be a combination of both types of approaches.

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Additional Mini Cases 1. The subsidies of the Springfield Opera House have been discontinued by the City of Springfield. How will you make sure the opera house survives? 2. Your client has developed a new material for bathing suits and wishes to launch it. It is priced presently about twice as high as a regular suit. What do you tell him? 3. A cube composed of 8 x 8 x 8 small cubes is put in a bucket full of paint. How many cubes are painted? 4. How would you forecast the appropriate number of branches for a local bank after deregulation, which removes all restrictions on inter-state and intra-state branching for banks? 5. How do you determine the optimal allocation of your next advertising dollar? 6. Estimate the annual demand for golf clubs in the US? If you were a metal fabricator with excess capacity, would you enter the market? How? 7. What would happen if the price of oil went to $zero?

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