Case 9: Chickflix.

com
Introduction
93

P bl St
Problem Statement
t t narrative
ti
The last period financial figures just came out, and Chickflix.com’s gross profit margin has decreased for two years in a row. The CEO has
hired you to recommend a solution.

Overview for interviewer Information to be provided upon request

The unique feature about Chickflix is that its variable cost are not Chickflix.com is a online website similar to Netflix. What’s
a function of sales volume, but of other drivers (such as average unique about Chickflix is that it targets only women and carries
number of movies returned p per month)) a majority
j y of titles that could be described as ‘chick flicks’

Interviewee should show understanding of the revenue and cost
structure, identify the increase in cost and recommend a course of
action
Case type: profitability
Clients sign up online, order online, receive the movie and mail
it back
More specifically, Chickflix.com offers 3 subscription models (1,
2 or 3 movies at a time)
 Case 9: Chickflix.com
Potential Issue Tree & Approach
94

Wh has
Why h gross profit
fit margin
i decreased?
d d? H
How can this
thi be
b reversed?
d?

Is it a revenue issue, cost issue or both? What caused it? Systemic / Chickflix specific?

Chi kfli RRevenues

Chickflix Chi kfli C
Chickflix Cost M k
Market C
Competition
ii
ƒ Changes in key revenue ƒ Key cost drivers: ƒ Changes in demand? ƒ Changes in supply?
drivers: • Fixed costs • Market size • New competition
• Price • Administrative • Demographics • More rivalry
• Subscription mix • Variable costs: • Technology / new • Less movies sold
• Number of • Distribution substitutes by studios
customers • DVD amortization

Follow-up and guidance
• 1 movie at a time
subscription model
introduced 1.5 yrs ago
• Growing # of customers
and revenues
• Unchanged prices
Follow-up and guidance
• Insignificant fixed costs
• DVD amortization
considered variable
• Distribution cost flat on a
per unit basis
Follow-up and guidance
• No changes in overall
demand or in demand from
target audience (women)
• No changes in customer
preferences
Follow-up and guidance
• No other competitor in
Chickflix’ niche
• Margins for competitors
like Netflix are not
decreasing
• Studios keep selling
 Case 9: Chickflix.com
Exhibit A – Revenue growth and mix
95

Revenues (M$) Subscription models

ƒ Subscription 1:
ƒ 1 movie at a time
ƒ $9.99 / month
ƒ Subscription 2:
ƒ 2 movies at a time
ƒ $14.99 / month
ƒ Subscription 3:
ƒ 3 movies at a time
ƒ $19.99 / month
 Case 9: Chickflix.com
Exhibit B – Variable cost per unit
96

Variable cost per unit ($) Components of variable cost

ƒ Distribution:
ƒ Primarily Mailing cost
ƒ Content amortization
ƒ Straight line amortization of movies (30 rentals =
useful life)
ƒ Considered variable because DVD library is a
function of rental volume
ƒ Allowances
ƒ Allowance for movies lost in mail
ƒ Other
ƒ DVD cases repair, etc..
 Case 9: Chickflix.com
Interviewer guide
97

Interviewee should identify takeaways from Exhibits A

Interviewer should then request analysis
&B

ƒ Revenues are growing for all subscriptions
ƒ Variable costs are not a function of subscription volume,
but of number of movies returned per month
ƒ Therefore, the 2 key gross profit drivers are:
ƒ Subscription mix
ƒ Average rentals per month
ƒ Evaluate gross profit margin for each Subscription type
ƒ Calculate price required for subscription 1 and 2 to
provide a gross profit margin equal to Subscription 3’s
ƒ Data for interviewee:
ƒ Provide Exhibit C
 Case 9: Chickflix.com
Exhibit C – Revenue and rentals data
98

Revenues # Customers

S1 S2 S3 Total S1 S2 S3 Total
2008 - $12M $8M $20M 2008 - 67K 33K 100K
2009 $5M $16M $10M $31M 2009 42K 89K 42K 172K
2010 $13M $18M $11M $42M 2010 108K 100K 46K 254K

Average rentals per customer per month

S1 S2 S3
2008 - 7.5 8.2
2009 5.6 7.3 8.1
2010 60
6.0 75
7.5 80
8.0
 Case 9: Chickflix.com
Interviewer guide - Calculating price
99

Q2: Calculate gross profit margin for Subscription 3 Q3: Calculate required profit margin for S1 & S2 /
(using 2010) Identify S1 is at a loss

ƒ Revenue per month per customer ƒ Subscription 1:

= $20 ƒ Average rentals per month
= 6 movies
ƒ Average rentals per month
ƒ Required subscription price:
= 8 movies (P-1.85*6)/P = 30% Æ P=$15
ƒ Revenue per rental or: P = $2.5*6 = $15
= $20/8=$2.5 ƒ Subscription 2:
ƒ Cost per rental ƒ Required subscription price:
P = $2.5*7.5 = $18.75
= $1.85
ƒ Bonus: identify that Chickflix is selling S1 at a loss:
ƒ Gross Profit margin
ƒ Gross profit margin:
= ($2.5 - $1.85) / $2.5 = 30% = ($10-$1.85*6)/$10 = -5%
 Case 9: Chickflix.com
Interviewer guide
100

Interviewee should identify takeaways from price

Interviewer should then request analysis
calculation

ƒ Subscription 3 is more profitable than the other models
ƒ Subscription 2 is still profitable,
profitable but Subscription 1 is not
ƒ But, increasing prices may lead to a drop in customers
ƒ Challenge interviewee to critically evaluate the client’s
financial performance
ƒ Revenues have grown but:
ƒ Subscription 2 is less profitable than 3, and
ƒ Subscription 1 is selling at a loss
Æ Chickflix is subsidizing its own growth (selling at a
loss)
ƒ What recommendation would you give the client to
improve?
 Case 9: Chickflix.com
Brainstorming solutions
101

Healthy Revenue Growth Cost Rationalization

ƒ Re-evaluate the subscription models ƒ Negotiate volume discounts to decrease distribution cost
ƒ add maximum monthly returns
ƒ Restructure S1 into a profitable model ƒ Encourage
E S2 & S3 customers
t to
t mailil more th
than one movie
i
ƒ Test customers price elasticity between S1, S2 and S3. Use together
findings to price each subscription correctly
ƒ Promote rentals of older movies (with a lower content
ƒ Targeted advertising to increase customer base amortization cost)

ƒ E
Expand
d into
i t other
th niches:
i h men & children
hild movies
i ƒ N
Negotiate
i with
i h movie
i studios
di to reduce
d DVD cost
 Case 9: Chickflix.com
Final recommendation
102

R
Recommendation
d ti

ƒ Chickflix has grown revenues by adding customers in S1 & S2. It has subsidized S1 with proceeds
from S2 & S3 as S1 earning negative margins.
ƒ Chickflix
Chi kfli needs
d to restructure S1 to return iti to profitability.
fi bili
ƒ Adjusting price is an alternative. Chickflix should also rationalize cost and start by focusing on the 2
main cost components: distribution cost and content amortization.
ƒ Moving forward, Chickflix should evaluate entering other market niches.
Risks

ƒ Adjusting prices could lead to cannibalization with customers from S3 switching to S2 and those from
S2 to the newly restructured S1.
ƒ Chickflix needs to identify the premium offering that S2 and S3 have.
ƒ Chickflix should be cautious when restructuring S1, so that customers are not lost
Next Steps
ƒ Analyze customers’ price elasticity for different subscription types
ƒ Renegotiate contracts with distributors and movie studios