Max is an aspiring consultant who is looking to secure an analyst role with one of the top firms for the upcoming recruitment cycle in September 2011. His interest in management consulting was sparked by a failed McKinsey interview last year. In this series of blogs, he will be sharing his background, case preparation process, useful resources, and any breakthroughs or setbacks that he experiences.
Last time I shared with you a case I did regarding a bid for the broadcasting rights to the 2010 Winter Olympics – which I performed fairly well on. Today, I would like to share a case where I fell apart near the end. I hope that you find it useful to see where I made my mistakes, and what I could have done differently.
Interviewer: Our client is German Postal Service. Historically, they have been the sole provider of postal service delivery service in Germany. A few months ago, the government passed a bill to deregulate the German postal service delivery industry. The client is forecasting a 20% drop in revenue, and they would like to know how to proceed.
My Response: I just want to make sure that I understand the problem correctly. Our client, German Postal Service, is facing deregulation in its industry. They are anticipating a 20% drop in revenue, and would like our advice on what they should do.
My Response: I see. Before I structure my analysis, I would like to ask a few clarifying questions. What does this deregulation mean.
Interviewer: Traditionally, any company other than German Postal Service was legislated by law to charge at least 4 times the price of German Postal Service for delivering mail within Germany. This means that if German Postal Service charged $0.25 per letter, then no competitor is allowed to price their service below $1.00 per letter. This regulation has now been abolished.
My Response: I think I understand. So an insurmountable barrier to entry has now been removed, and the 20% anticipated drop in revenue is going to come as a result of competitors entering the industry.
My Response: Great. May I have some time to structure my thoughts?
Interviewer: Of course.
[I would encourage you to do the same, and get some practice with the upfront structuring of cases]
Interviewer: I think I’m ready to begin. In order to understand the problem, I would like to start off by quantifying what the 20% drop in revenue will mean. To do this, I would like to examine the revenues andcosts of German Postal Service. Next, I would like to investigate four key areas to see how our client can respond. To start off, I want to examine the competition. I want to understand who they are, and how they are able to take business away from us. Next, I would like to look at our customers. I want to have a good understanding of who they are, what they look for, and the different segments that are present. Third, I want to take a look at our product offerings, and see if they are in line with what the customers want. In addition, I also would like to see how our offerings compare to our competitors. Finally, I want to investigate thecompany itself, and understand its core competencies, financial situation, and other factors such as organizational structure to see what kind of a response our client is able to conjure.
[The structure of my analysis was basically broken up into two major sections. The first section includes revenues and costs. This section is dedicated to figuring out the quantifiable effects of the revenue drop, and “What is happening” from a quantitative standpoint. The second section includes customers, competition, company, and products. This section is dedicated to figuring out “What to do about declining revenues”, as well as gathering qualitative information.]
Interviewer: Sounds like a reasonable plan. What would you like to know first?
My Response: To start off, I want to quantify the effect of this 20% drop in revenue. Before I dive in, is it our job to verify this revenue forecast?
Interviewer: You can assume that it’s accurate.
My Response: Excellent. May I ask how much revenue our client currently generates?
Interviewer: A billion dollars.
My Response: I would like to take a closer look at the revenue, and break it down into its components. Do we have any information on that?
Interviewer: What do you think are the components?
My Response: There are lots of ways to segment it, but I know that revenue is comprised of the average price per unit times the volume of units sold.
Interviewer: That’s fine. So let’s say that on average, the price per delivery is $1.00
My Response: So if our revenues are a billion dollars, and the price per deliver is one dollar, then our volume must be around a billion deliveries last year. However averages can be deceiving. Is there a big price variation between certain types of deliveries?
Interviewer: Yes, but for this case you can assume all deliveries are made at one dollar.
My Response: You mentioned that our client is anticipating a 20% drop in revenues, and I am interested in know whether this will be due to reduced volumes, or reduced pricing. Do we have any information on that?
Interviewer: They are expecting reduced volumes.
My Response: Interesting. So it seems like the new entrants to the market will most likely be taking business away from us by reducing our volumes. I think I understand enough regarding the revenues. Their revenues will drop from a billion dollars to 800 million dollars due to a drop in volume that is caused by new competitors. I would now like to move over to the cost side of the analysis, and see what’s going on there.
Interviewer: Sure, what would you like to know?
My Response: In the same time period where we generated a billion in revenue, how much were our costs?
Interviewer: 800 million.
My response: Do we have a further breakdown of costs?
Interviewer: How would you like to break them down?
My Response: Let’s go with fixed and variable.
Interviewer: Sure. The fixed costs are 700 million, and the variable costs are 100 million.
My Response: Wow that’s a high fixed cost. Am I right in assuming that the fixed cost will not change at all when our revenue drop 20%? If this is the case, and variable costs drop proportionally with revenues, then it means that our profits will go from 200 million to 20 million – a drop of 90%.
Interviewer: Your math is correct.
My Response: I think I understand everything I need to know about revenues and costs. Our numbers before the deregulation was a billion in revenues, and 800 million in costs. However, due to the extraordinarily high fixed cost, the 20% drop in revenue will actually result in a 90% drop in profits. This is not good at all for the client. In order to see what we can do about this, I would like to move on with the upfront structure I laid out, and examine the competition.
[Up to this point, I thought that the case was going fairly well. There was a bit of a trap with the high fixed cost. If I didn’t segment the costs, and just assumed that they would also drop by 20%, then I would’ve missed a big point.]
My Response: The first thing I would like to understand is how these new competitors are going to take market share away from us. Do we have any information on that?
Interviewer: What do you think?
My Response: Since we are an established player, it’s probably going to take some sort of incentive for our customers to switch. My guess would be that the competitors are going to come in with lower pricing.
Interviewer: You’re right.
My Response: That’s very interesting. The reason I say this is because our client has an enormous fixed cost, and I thought this would provide a pretty significant barrier to entry for new competitors. Do we have any information on how they are able to have a lower price?
[At this point, I realized that I probably should have segmented fixed costs further in my previous analysis. This is where the case started to fall apart for me as it took me a very long time to figure out how the new entrants are able to achieve a lower cost.]
Interviewer: What would you need in order to figure that out?
My Response: I think I would need to know what our costs are made up of, and compare those segments to that of the competition.
Interviewer: What do you think the fixed costs are? Talk me through it.
My Response: Intuitively I would say that there are costs associated with collecting the mail from the customers, processing the mail at a facility, and delivering the mail to the recipient.
Interviewer: You are correct. What do you think is the largest cost?
My Response: Processing the mail at a facility because this requires a large building with lots of sorting equipment.
Interviewer: That’s interesting, but incorrect. Let’s think about this on a per letter basis.
My Response: Sure. If we’re looking at a per letter basis, I would say that the delivery cost would be the highest? This is because the mail sorting facility processes so many letters that the cost for each letter is fairly low.
Interviewer: You’re right.
My Response: Ok great. So do we know if the new entrant’s fixed costs are comparable to ours?
Interviewer: They are much lower. In particular, their delivery cost is much lower than ours.
My Response: Do we know how they are able to achieve this?
Interviewer: What do you think?
[I spun my wheels on this one for about 15 minutes. It turns out that the new entrants focused on mail delivery to large urban centers. In doing so, the workers can deliver many more units per hour – thus saving the new entrants significant cost with regards to worker salaries. I will now jump to the next portion.]
My Response: It seems that in order to compete we need to lower our workers salaries. Has management tried this in the past?
Interviewer: The workers are unionized and will not take a salary cut without good reason.
[I ran out of ideas at this point regarding what to do. It turned out that the key was to renegotiate the service level agreement. Instead of delivering mail six days a week, the new agreement will deliver 4 days a week. At this point we ran out of time. When I practice, we usually keep the cases to a maximum of 40 minutes to somewhat simulate a real interview. Since I missed this key insight, the interviewer gave it to me and asked me to conclude.]
My Response: After preliminary analysis, the team has concluded that German Postal Service should renegotiate the service level agreement with the unionized workers in order to respond to the competitive pressure put forth by the new entrants – which is resulting in a 20% drop in revenue. I believe this to be true for two reasons:
1) The new entrant’s competitive advantage is a low fixed cost due to the fact that they only deliver to urban areas where the workers can maximize their productivity. Since we deliver to all of Germany, we must reduce our fixed costs through lower worker salaries.
2) The unionized workers are willing to take a lower salary for a reduced workload. By reducing the working days by 1/3, we will be able to justify the lower salary.
[I believe that I could have cracked this case by doing the following things:
1) Segmenting fixed costs to see what was the largest portion at the beginning. I did this later on, but it would have helped had I done it upfront.
2) Asked some qualitative questions regarding how the company currently operates. This may have uncovered the fact that they currently deliver six days a week.
The feedback from my practice partner was that this case took some business intuition to solve. The options were basically to increase productivity/mailman or decrease salary/mailman. I feel that the biggest problem with my performance was that it took way too long. For those who have maybe heard this case before, it is an actual case that a candidate received in one of the McKinsey Germany offices. Any feedback or general comments would be much appreciated.]