Case
No Bald
Case prompt
NoBald is an English pharmaceutical company operating solely in the UK, focusing on treatments to avoid baldness. The R&D division has developed a new product, Stronghair, that helps to grow hair again if applied constantly.
The company has already spent £2 million to develop the new product and it would need an additional £20 million to finish the development, conduct the tests necessary for commercialization and purchase the machines needed to industrialize it.
NoBald would like to know whether it is a good idea to go ahead with the development of StrongHair in light of the expected future sales
Detailed solution
Paragraphs highlighted in orange indicate hints for you on how to guide the interviewee through the case.
Paragraphs highlighted in blue can be verbally communicated to the interviewee.
Paragraphs highlighted in green indicate diagrams or tables that can be shared in the “Case exhibits” section.
Suggested case structure
Key question: Will there be enough sales in order to justify the additional investment for the product development?
Suggested steps ranked by priority:
- Breakeven volume: Calculate the number of StrongHair treatments that it is necessary to sell in order to cover both fixed and variable costs
- Payback time: Calculate the payback time and evaluate if it is reasonable for the investment, on the basis of the expected yearly volumes
- Other relevant aspects:
- Evaluate possible initiatives to reduce payback time
- Understand implications of time value of money
Make sure the interviewee builds a solid structure focusing on breakeven volume and understand that the best unit of measure is by single treatment.
If needed, share Exhibit 1 with the candidate
1. Breakeven volume
The interviewee should enquire about the costs related to the production of StrongHair.
The candidate should be able to:
- Understand that the investment of £2 million is a sunk cost; thus, it does not have to be considered in the breakeven calculation leading to the recommendation on whether to go ahead or not with the development
- List the main types of fixed and variable costs, such as:
- R&D (fixed cost)
- Purchase of production machines (fixed cost)
- Material (variable cost)
- Labor (assumed to be a variable cost)
- SG&A (variable cost)
Share Exhibit 2 with the candidate to estimate the breakeven volume
Exhibit 2
- Material: Raw material cost represents the cost per kg of raw material; raw material is then processed and transformed into output through a procedure that has a given efficiency, meaning a given ratio of output produced per unit of raw material used. A given weight of output is used for each treatment
- Labor: Labor cost is the cost per hour of workers' time, assumed completely variable, and production rate is the number of treatments produced per hour of workers' time
- SG&A: Selling, general & administrative expenses are expressed as a percentage of revenues, that is, as a percentage of selling price
Fixed costs: Total fixed costs are equal to the sum of R&D and purchase of production machines. Thus,
£14,000,000£+£6,000,000=£20??
Variable costs: Variable costs per treatment are the sum of material cost, labor cost and SG&A cost; they are thus equal to
In particular:
- Material cost (£/treatment) is obtained dividing the raw material cost (£/kg raw material) by the efficiency of the process (kg output/kg raw material) and then multiplying this number (£/kg output) by the treatment weight (kg output/treatment)
- Labor (£/treatment) is obtained dividing the labor cost (£/hour) by the production rate (treatments/hour)
If the candidate gets lost through the data, you may help by telling him/her to reflect on the units of measure, meaning that the output variable should have with the input variables the same mathematical relationship that the output unit of measure has with the units of measure of the inputs
The only competitor on the market is selling a similar treatment for £30
The candidate should recognize that, in presence of only one main competitor, it is reasonable to assume that the price is equal to the competitor's one.
Thus, variable costs per treatment are the following ones
Breakeven volume:
2. Payback time
The candidate should understand that, in order to compute the payback time, it is necessary to estimate the market size of the treatment in UK, calculated as total number of treatments
Share Exhibit 3 with the candidate to estimate the market size
Exhibit 3
The candidate should know that the UK population is about 60 million and the average life is about 80 years
Knowing these data, it is possible to obtain total people in each age range.
Age 18-30:
Age 31-50:
Age 51-70:
Age > 71:
At this point, it is possible to calculate the number of treatments for each age range.
The candidate could reasonably assume that, as there is only one main competitor, having similar pricing, NoBald could take half the clients that already use the other treatment
Age 18-30:
9,750,000∗0.1∗0.03∗6=175,500
Age 31-50:
15,000,000∗0.3∗0.05∗6=1,350,000
Age 51-70:
15,000,000∗0.5∗0.04∗6=1,800,000
Age >70:
7,500,000∗0.5∗0.02∗6=450,000
Market size is equal to the total number of treatments, which is 3,775,500 treatments/year.
Thus, payback time is equal to the following value.
The candidate should understand that the payback time is not bad with the existing market size, but it could still be improved.
3. Other relevant aspects
Prompt the candidate to focus on potential improvements in order to reduce the payback time and on assumptions made during the estimate calculation
Potential other relevant aspects to be considered include:
- Revenue growth through sale of the treatment in other countries: How could NoHair expand its business abroad? On which countries could it focus more?
- Variable cost reduction through increase of efficiency: Which are the effects of a potential increase in efficiency? How could it be achieved?
- Reduction of fixed costs: Which are the potential actions to be put in place by NoHair in order to reduce estimated fixed costs?
- Time value of money: How would breakeven volume be affected if time value of money were considered? Would it be bigger or smaller? Is it reasonable not to consider it?
4. Discussion
Prompt the candidate to focus on the potential impact on margins of a widespread price reduction in the market
- The candidate should be able to notice that the contribution margin is not high (around 5% of sales), especially if compared to the margins of the pharmaceutical industry, which are usually much higher
- No Bald should ensure that their competitor does not lower prices, forcing them to further squeeze profit margin or sell at a loss. It should be carefully evaluated whether the cost base of their competitor allows them to further reduce prices whilst maintaining a positive contribution margin
- NoBald could “cooperate” with their competitor in order to avoid a price war and possibly increase prices; however, this action could clearly be subject to antitrust regulations
5. Final recommendation
Ask the interviewee to briefly summarize the case, as if he had to make the final recommendation to the CEO of the company
No Bald can recover its investment in StrongHair in 3.3 years, a reasonable time horizon. However, the contribution margin (around 5% of sales) is very thin and measures should be taken to avoid shrinking it further, possibly cooperating with the single competitor and increasing process efficiency, thus reducing variable costs. In order to boost the bottom line, No Bald could also evaluate selling the product in other countries.
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