What Interviewers Want 3 Cases

Case 1: Maldovian Coffins McKinsey, 1st Round About This Case This case was given by McKinsey in first-round interviews and is a Òcommand and controlÓ case. In this style of case, the interviewer allows the candidate to drive the case initially to explore possible routes to a solution. However, once the candidate has laid out a plan, the interviewer takes control and asks the candidate to solve a few specific problems before coming to the final conclusion. When giving this case, allow for some initial planning and brainstorming by the candidate, but then firmly take control of each of the ÒmodulesÓ described below. Try to move the candidate along through each of them, since in the actual interview only those candidates that complete all of the sections will be considered to have done well. This case tests mental horsepower and the ability to move to conclusions quickly. The Problem Our client is a coffin maker in the Eastern European country of Maldovia. He has seen substantial change in his market in recent years and is contemplating the future of his business. Up until now, he has been in the business of building high-quality, handcrafted coffins largely by hand with a skilled labor force. Recently, however, he has become aware of technology that would allow him to build machine-made coffins with much less labor. Should he invest in this new technology, and should he even remain in the coffin business in the first place? Information Gathering Read this information well before you give the case. Note that this case requires you (the interviewer) to drive key points in the discussion. Allow the candidate to formulate a plan and then prompt him/her to consider each of the topics listed below. Prompt: What strategic alternatives should the owner consider? Good Answer: If the candidate doesnÕt get all of this, help them along since we need to lay this foundation for the rest of the case - We need to decide firstly whether to stay in business at all and if so, whether he uses the new technology: x x x x Option 1: Sell the business to a third party Option 2: Sell the assets of the company and shut it down Option 3: Keep operating as is Option 4: Keep operating and invest in the new technology Prompt: How would you figure out the current value of the business? Provide the following information if the candidate asks for it clearly and directly. Market Size Ð If the candidate asks for the size of the market, first make him/her brainstorm about different ways to determine market size. A good candidate should come up with at least 4 different ways, such as: x x x x Calculate from population growth, total population, and birth rate Review of death records for a period of time Take sample of number of obituaries in paper serving given population base Calculate from population, average life expectancy Now make them calculate the market size, giving them the following data: Population of Maldovia: Population Growth: Avg Life Expectancy: Age Distribution: Burial Customs: 4M 0% 75 years assume a flat age distribution (i.e. same number of people at every age) 75% of deaths are buried in coffins. Right Answer: 40,000 coffins purchased / year. Note that the candidate needs to quickly realize that every year, 1/75th of the population will turn 76 and therefore (on average) will die. Price Ð Coffins are priced at $5,000 for a hand-made coffin. Costs Ð Material accounts for 10% of the direct cost, while labor accounts for the other 90%. COGS is $4,800 per coffin. Fixed costs for the business are $700,000 per year. Assume all assets are fully depreciated and ignore taxes. Competition Ð Maldovian Coffins has a 10% market share and a relative market share of about 1 (if asked, you may explain that relative market share is the ratio of the companyÕs market share to that of its nearest competitor.) Market Trends, Regulation, etc. Ð If asked about any exogenous factors, simply tell the candidate to assume that the market is expected to continue as it currently is. The candidate needs to calculate the value of the business now. This is a mathematical exercise. Correct Answer: Contribution Margin = $200 / coffin x 40,000 coffins x 10% market share = $800,000 Profit = CM Ð Fixed Costs = $800,000 - $700,000 = $100,000 Assuming a discount rate of 10% (candidate can assume anything reasonable here as long as they are consistent later) a perpetuity with cash flows of $100k / year has a PV of $100,000 / .1 = $1M. So the current business is worth $1M whether they keep it or sell it. Prompt: So now what is the value of the company if it were shut down and the assets were sold? Information to give if asked: Assets Ð Since the firm has been building coffins by hand, the fixed assets are essentially only the land and improvements. These are owned outright by the company. When the candidate asks for the value of the land, have them brainstorm ways that they might determine this. They should come up with at least 3 good ways, such as: x x x Look for comparable real estate and determine recent selling price Find comparable commercial real estate and determine the rent per square foot, then discount the cash flows generated by renting the property Determine rate of appreciation for property in the area and then apply to book value of current land and improvements Give the candidate the following information and have them calculate the value of the property: Book Value of Land: $20,000 Book Value of Improvements: $80,000 Years Owned: 48 Avg. Real Estate Appreciation: 6% / year Right Answer: Using the Òrule of 72,Ó a 6% growth rate will double the investment every 72/6 = 12 years. Since the property was held for 48 years, the current value will be $100k * (2 ^ 4) = $1.6M. Since the assets ($1.6M) are higher than the value of the discounted cash flows ($1M), then it would make more sense to liquidate the business and sell the assets. Prompt: What would the value of the company be if he invests in the new technology? Provide the following information if asked: Investment Ð Investing in the new technology will cost the firm $1M. Cost Savings Ð Material costs remain the same, but labor costs are reduced by 50%. Proprietary Nature of Technology Ð The new coffin-making technology is being offered for sale by a machine tool company, who holds the patent. They are not offering exclusivity to any customers (i.e. they will sell to Maldovian CoffinÕs competitors if possible). Competitive Threat Ð It is not known whether the competitors have acquired or are planning to acquire this technology. Customer Preferences Ð While the machine-made coffins are not Òhand madeÓ, the quality perceived by the customer is the same or better. It is believed that the customer will be indifferent between the quality and appearance of a hand-made and a machinemade coffin. Brand Impact Ð The candidate may argue that a machine-made coffin might negatively impact Maldovian CoffinÕs brand. If so, ask them how they would test this (e.g. consumer research), but tell them to assume that it would have negligible impact. Good Answer: Since Maldovian Coffins has no proprietary control over the technology, it is likely that competitors will also acquire it, resulting in an overall lowering of the industry cost structure. If this is the case, price will also fall as competition cuts price in an attempt to gain share. If we assume that gross margins remain the same, since the industry competitive structure has not changed we can calculate the new margin contribution as follows: Gross Margin = $200 / $5,000 = 4% Labor Cost = (4800 x 90%) x 50% = $2,160 Material Cost = $480 COGS = $2,160 + $480 = $2,640 Price = $2,640 / (1 - 4%) = $2,718 Contribution Margin = $2,718 - $2,640 = $78 Loss = $78 * 4,000 - $700,000 = -$388,000 So the introduction of the technology to the market might be expected to reduce industry profits, making this business completely unprofitable. Candidates could argue other scenarios, by assuming that the industry would be able to maintain higher margins than we have assumed here, so the answer may be different. They should recognize, however, that the introduction of this non-proprietary technology will significantly reduce industry pricing in the absence of some other form of price support (such as branding, collusion between players, etc.) Conclusion A star candidate will see that his/her time is nearly up and will present a recommendation for the client without prompting. If the interview is within 3 minutes of the end, ask: ÒThe owner just called and said he has an offer to buy his business. He needs to know whether he should take it right now.Ó Good Answer: Given the credible threat of the industry becoming unprofitable due to the introduction of this new technology, the owner should look to sell the company as soon as possible. Taking into account the assets of the firm and the present value of the expected cash flows of the business itself, he should attempt to liquidate the business and to sell the assets for around $1.6M. If unable to sell the business now, he can continue to operate the business as a cash cow, but should not invest in the business above what is necessary to keep it operating at its present level. He should expect the business to become less profitable as the industry moves to mechanization, and should eventually look to sell the assets of the company and close the firm. Case 2: HardHead Helmets Bain, 2nd Round The Problem Our client is private equity firm considering taking private a leading manufacturer of bicycle helmets. Should they? Information Gathering Read this information well before you give the case. Share this information in each bullet only if the candidate asks for it in a clear and deliberate way. For bullets with ÒExplore with candidateÓ sub-points, make the candidate answer the associated question completely. Market Share Ð The company is the clear market leader with 60% share. Competition Ð Existing competitors have small share. However, there are some new entrants that are still small but growing quickly, including Nike and Reebok. Channels Ð Historically, HardHead has sold primarily through the Mom-and-Pop specialty bike retailer channel. Channel mix has recently moved to 50% discounters (e.g. Wal*Mart) and it looks like discounters will dominate in future. Explore with candidate: How are these changes in distribution channel going to effect the companyÕs future prospects? Good Answer: Margins will come under pressure from discounters. But more importantly, competitors such as Nike will have a tremendous advantage in the discounter channel due to greater scale and leverage in distributor relationship. Also, a recognizable consumer brand (especially with the sports image of Nike) creates competitive advantage in discounter channel where an expert bike-shop salesperson is not there to push the HardHead product. Cost Position Ð HardHead and all competitors are manufacturing in Asia, so costs are very low. No competitor is likely to be able to realize any greater cost advantage. DonÕt let the candidate get distracted in finding cost savings Ð this is not that kind of case. Regulatory Issues Ð In the last 5 years, most states passed helmet laws. Explore with candidate: What impact does this fact have? Draw a graph of revenue over the past five years and projecting into the next five years. Good Answer: This drove a significant increase in sales as helmets were purchased for the first time. This event will not be repeated, so sales will level off. Customer Segments Ð The customer segments that HardHead sells to primarily are the Adult Cycling Enthusiast segment, the Casual Biker segment, and the Under 18 segment. Explore with candidate: How would you expect the purchase behavior to differ between these segments? What does each segment want in a helmet? Good Answer: Adults purchase a new helmet infrequently (only after a crash or significant wear) while children must have new helmets every few years as their head size grows. Adult Cycling Enthusiasts are more concerned about having the coolest gear and tend toward more fashion-forward designs. The Casual Biker is more conservative in their fashion but still wants something that looks cool. ChildrensÕ helmets are purchased by their parents who care about safety but influenced by the kids who care about cool. For strong candidate, explore: What would you expect the size of each of these segments to be? What are the implications for HardHeadÕs future earnings? Good Answer: Let the candidate come up with all of the assumptions and then work the math. Actual numbers donÕt matter much as long as the assumptions are reasonable and the math is done correctly. Note that 100M households is the standard assumption in consulting. Assume 100M households, 50% have children with 2 children per household, 75% of children ride bicycles, therefore: 75M Under 18 customers. Assume 2% of adults are Cycling Enthusiasts, or 2M. Assume 20% of adults are Casual Bikers, or 20M. Since the helmet laws created a large number of one-time purchases, we need to rely on the Under 18 market and new entrants to the adult segments for ongoing sales. Product Ð From a safety standpoint, there is no new innovation in design. From a fashion standpoint, there is much innovation, especially by the new entrants. If the candidate is having trouble exploring all of the above topics, provide some direction to help them along (e.g. ask ÒDo you think that there might be any government regulation that would impact past or future sales?Ó) Conclusion A star candidate will see that his/her time is nearly up and will present a recommendation for the PE firm without prompting. If the interview is within 3 minutes of the end, ask: ÒThe partner from the PE firm just walked into the room and wants to know if he should do the deal.Ó Good Answer: The short answer is ÔNo.Õ x HardHead has been experiencing exceptional growth due to the one-time market expansion caused by new helmet laws and its historically strong market share. This unsustainable growth would result in an overvalued acquisition price. x New market entrants by Nike, Reebok and others will quickly steal share as consumers gravitate toward the general sports-affiliation of these well-known brands. x Bike helmets have been largely utilitarian, but the sports brands are likely to quickly move helmets into the fashion arena, putting HardHead at a significant disadvantage. x Furthermore, with the channel shifting strongly away from the specialty bike retailers and toward the mass discounters, the national sports fashion brands will have more leverage with the retailers, possibly commanding better margins, placement, assortment, and advertising support. x The only scenario in which the firm might consider the acquisition is if they have interest in another fashion brand that might be combined with HardHead to allow it to compete against the new fashion helmet brands such as Nike. Case 3: Verizon Security Services Mercer, 2nd Round About This Case This case was given by Mercer in second-round interviews. This is a broad, qualitative strategy case and was given in a very open and conversational manner. No hard data was provided Ð instead, the interviewer asked the candidate to come up with assumptions and estimates to drive the case forward. Therefore, there is no ÒrightÓ answer, but the candidate must be able to come up with reasonable assumptions and then follow them logically to a conclusion. The Problem Verizon is the nationÕs largest provider of local telephone services. They are considering entering the home security market. Should they? Information Gathering Read this information well before you give the case. Give this case in an open-ended manner. Make the candidate come up with his/her own assumptions and estimates for everything. One set of reasonable assumptions is listed below Ð use these to steer the candidate back on track if they seem to be off the reservation. Market Size Ð If the candidate asks for the size of the market, make him/her come up with assumptions and calculate the total market size. A sample calculation based on sample assumptions follows: Total Households in US: 100M % Households Serviced by Verizon: 50% % Households That Can Afford Service: 50% Annual Subscription Price: $250 Total Addressable Market: 100M x 50% x 50% x $250 = $6.25B Cost Structure Ð Ask the candidate to discuss what the cost structure might be for Verizon to enter this market. What are the fixed costs? Variable costs? Does Verizon have a cost advantage over other players? Good Answer: The business has very little fixed cost beyond the infrastructure already installed in potential customersÕ homes (i.e. the existing phone wiring). Customer would need door / window / motion sensors installed, which could be done by a third-party installer and billed to the customer at cost + markup and owned by the customer. Variable costs are also very small Ð essentially just the cost to maintain enough call center operators to dispatch police when alarms are tripped. Verizon does not seem to have much or a cost advantage over other players, since they are all using the common carrier phone network. Verizon might have some economies of scale in operating the call center, but this effect would be slight. Competition Ð The market is composed of a large number of mom-and-pop alarm company operators. No firm has over 5% market share overall, although there are some strong regional players. Customer Segments Ð Ask the candidate to speculate on the various customer segments and their relative importance, size, and value. Good Answer: We can reasonably divide the customer base into urban and suburban customers, having different needs and different price sensitivities. Urban customers are likely to have lower incomes but a high willingness to pay due to the increased crime rate of the city. Suburban customers are likely to have a higher income but a lower perceived threat due to a lower suburban crime rate. By first-degree price discrimination, it may be reasonable to charge the suburban customers a higher price because they are presumably less price sensitive. We can assume that 50% of customers are urban and 50% suburban. Pricing Ð Have the candidate come up with a pricing scheme and prices for each of their identified customer segments. There is no right answer, but they must justify why they are setting the price they are. Some areas they might consider: x x x x Insurance companies generally give breaks on homeownerÕs insurance for having an alarm. This will increase the EVA to the customer and can inform pricing. What other services to homeowners pay for monthly? Cable, phone, DSL. How are the values of these services perceived compared to the value of the alarm? Pricing will need to be competitive with other market players. The candidate might assume a net margin based on the competitive landscape and use this with assumed market size to determine attractiveness rather than determining an end-consumer price. Regulation Ð The market is not regulated and government regulation is not expected to play a role. Marketing Ð Ask the candidate what advantages Verizon might have in marketing vis a vis its competitors. Keep points the candidate should identify include: x x Verizon has monthly customer contact with a large pool of potential alarm services customers through its phone bills. Verizon already has brand loyalty for phone service, why not alarm service? x Shear size of the company (and deep pockets) make it more able to achieve scale economies in marketing and reach a broad audience. Conclusion A star candidate will see that his/her time is nearly up and will present a recommendation for the client without prompting. If the interview is within 3 minutes of the end, ask: ÒSo, should Verizon enter into the home security market?Ó Good Answer: Yes. Verizon possesses several small but important competitive advantages for entering into this new market. It has economies of scale in call center operations that will enable it to be highly cost-competitive in operating a security network. It has an established brand that the consumer associates with reliability as well as with networking and communications Ð the primary function of a home security system. More importantly, Verizon already reaches 50M households every month through its phone services bill that it could leverage to launch and market this new service. Also, the company has deep pockets and the ability to advertise such a service far more effectively than the small, regional competitors. The size of the opportunity is large enough for Verizon to consider. Assuming a potential market size of $6B in VerizonÕs territory, even at only a 10% share, Verizon can add $600M in revenue. Given the low cost structure of this business and the high perceived value to the customer, this is likely to be highly profitable revenue as well. With VerizonÕs marketing clout and customer reach, the company should be able to gain significant market share and become the national leader in this space.