Categories
Case Prompt:
Our client is a large national retailer whose music segment has been experiencing declining profits over the last couple of years. You have been hired to help deal with this problem.
Exhibit:
• Profits used to be $80M but are currently very low.
• Suppliers sell directly to us. No logistics costs.
• There are 4 big players in the market all similar in size to us. We do not know if they are making money. Two are similar large retailers and two are specialised music suppliers.
• Market has been shrinking over the last couple of years
• We hold both new releases and catalogue CDs.
• Income Statement:
Revenues from New CDs - $704M
Revenues from Catalogs - $444M
Total COGS - $900M
Store rental overhead - $150M
Labour expense - $90M
Profit - $8M
• The price of a new CD is $12 and the price of a catalogue CD is $15.
• The cost to us of either type of CD is $ 10 and is similar to another playerís cost. We hold minimal inventory
• 90% of our space is catalogued and 10% is used for new CDs.
Background:
Our client, a large national music retailer, is facing a problem of declining profits in their music segment for the last couple of years. The client holds both new releases and catalogue CDs and has a total revenue of $1.15 billion. The cost of either type of CD is $10, and the price of a new CD is $12, while the price of a catalogue CD is $15. The client has been facing stiff competition from four big players in the market, two of which are similar large retailers, and two are specialised music suppliers. The market has been shrinking over the last couple of years, and the client is holding minimal inventory.
To solve the management consulting case studies, visit theconsulting.io
Analysis:
We can allocate the costs using Activity Based Costing. With $704M in revenues from new releases, the client sells around 60M new CDs and around (404/12) 30M catalogue CDs. The new CD business is profitable for the client, but the catalogue business is unprofitable. The reason for the low profitability is that the catalogue CDs are losing money. The new CD business is still profitable, and the team will investigate whether the client can optimise the space used for catalogue CDs, whether the client would lose any cross-selling opportunities if they reduce/remove the catalogue CDs, and what product they can best place in the space previously occupied by catalogue CDs.
Frequently asked questions
Why is the music retailer’s profit declining?
The primary issue is the unprofitability of catalog CDs. Despite high prices, catalog CDs use 90% of the store space but generate fewer sales, leading to poor margins. The fixed costs remain high, and the market itself is shrinking, amplifying the pressure on profitability.
How do new CDs compare to catalog CDs in profitability?
New CDs are sold for $12 at a $2 margin and generate $704M in revenue, making them profitable. Catalog CDs, despite a $5 margin on paper, don’t perform well due to low sales volume and inefficient space utilization, contributing to overall losses.
What is the recommended strategy for the retailer?
The retailer should optimize or reduce space allocated to catalog CDs, potentially replace them with more profitable products, and evaluate whether any cross-selling or brand value would be lost by downsizing catalog CD inventory.
What financial strategy can be applied to analyze product-level profits?
Using Activity-Based Costing (ABC) helps allocate overheads more precisely between new and catalog CDs, revealing that catalog products are draining resources and not contributing effectively to profit margins.
Can the retailer remain competitive in a shrinking music market?
Yes, by focusing on profitable segments like new CDs, exploring digital offerings, optimizing retail space, and reducing operational costs. A strategic shift away from low-margin products can help maintain competitiveness and stabilize earnings.
Join 5,00,000+ Subscribers
Be a part of our ever growing community.
