Is the assumption "The gross margin will remain the same since the industry structure did not change" common practice?

Question

In general, it seems to me a bit bold to say; moreover, in the specific case, it says that the nearest competitor has the same share as our client, and does not mention any other bigger competitor. So I assume that there are no big economy of scale effects and the cost structure of the other players shouldn't be too different from our client's. This would mean that with a 3,8% gross margin everyone would become unprofitable with the new technology (or at least there is this possibility, that is not considered in the case solution)

Also, I have some doubts about the time frame; it seems completely unrealistic that prices drop "instantenously". When looking at the investment for new technology, it is relatively small: it's 1M, while our client's costs of labor is 5000*5000*90%=22,5M per year, and the consequent saving would be 60%*22,5M=13,5M per year, meaning that the investment would be repaid in less than 1 month (or selling about 370 gravestones of the yearly 5000), and would generate 1+M more for each month that prices take to fall (of course this margin would drop accordingly to prices). In any case it would be difficult to understand the rate at which prices would drop, but the result could span from losing money instantly to make 100x money with respect to the past; how could this situation be tackled?

Answer 1

Hello Luca,

I completely agree with you, the solution proposed is at least questionable.The hypothesis is basically that the price war following the adoption of the new technology will result in setting the price to have the same gross margin. As you were mentioning, the solution doesn't consider that it's likely that most of the players have similar fixed costs, This would mean that the price will not fall down so much, because no one wants to be unprofitable.

Regarding the second part, you are right but the case would become too complex, so it considers only the "final situation". In these cases my advise is always to share your reasoning with your interviewer: he will appreciate a lot your criitical reasoning and he will telll you which hypothesis to consider to continue the case.

Feel free to contact me for any further discussion about this,
Luca

Answer 2

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Answer 3

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Answer 4

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