Beer Manufacturer

I: Your client is a beer manufacturing company, it is witnessing a decline in profitability over past 3 years, the client wants you to find out the reasons for the same and suggest possible solutions.

C: Besides the declining profitability problem, does the client have any other objectives or constraints that we need to keep in mind while formulating the solution?

I: No, you can just focus on profitability.

C: I would like to start by exploring a bit more information about the company and its business environment to get a better context for the problem like how does the sales figures and market position of our client’s company look like and what part of value chain does it operate in?

I: The company has annual sales of Rs. 7000 cr. and enjoys a 30% share of the Indian beer market. The client focuses on purchasing raw materials, manufacturing beer and marketing, for sales it passes on the product to its distributor network. For simplicity, you can assume the company produces just one product.

C: The company seems to have a significant presence in the market, further I would like to know if the declining profitability is being driven by industry-wide issues and are faced by our competitors as well or if only our client is facing this issue?

I: This does not seem to be an industry wide issue; the declining profitability issue is faced by our client only.

C: I think I have enough information to begin my analysis. I would like to begin by breaking down profit into revenue and cost and understand the magnitude of change that happened in the two over the past 3 years.

I: Seems like a fair approach, the client has witnessed a 15% increase in costs over the last 3 years.

C: The increase in costs might have been due to a fixed investment 3 years ago which is being depreciated year over year now or might be due to increase in variable costs, do we have more information surrounding the same?

I: The variable costs have increased.

C: We can break down the variable costs into 5 broad categories – raw material costs, labour & manufacturing costs, packaging costs, storage costs and transportation costs. Have we observed any unexpected surges in any of the above 5 components?

I: Yes, the packaging costs seems to be unusually high over the past 3 years.

C: There can be 2 types of packaging that are generally used – direct & ancillary. With direct packaging being the bottles/cans in which the product is contained, and the ancillary packaging can be the one in which multiple units of the product are stored for transportation and inventory holding purposes.

I: The direct packaging costs have increased, and the company uses only glass bottles and not cans.

C: Since bottles are recyclable and they pass through multiple nodes in a supply chain, I would like to construct a circular value chain for the bottles to quickly and accurately identify the cost center and the allied issue in the same that is causing the increase in costs.

I: Sure, go ahead.

C: Our client must be sourcing fresh bottles and recycled bottles in some proportion. The packaged bottles then go to the distributors who may supply it to retailers and/or restaurants & hotels. The end consumption pattern for these 2 locations is very different, for a retailer, a consumer who would purchase the product and take it home will lead to a situation where proper disposal of beer bottles back to recyclers will be very less thereby creating a major leakage point in the cycle, whereas there might be proper collection mechanisms from restaurants and hotels owing to the volume of bottles, so the leakage from this sub-cycle will be minimum. Finally, once the bottles reach the recycler, they might sterilize the bottles and send it to manufacturers or might crush the bottles and reform it in the desired shape by beer manufacturers.

C: Finally, once the bottles reach the recycler, they might sterilize the bottles and send it to manufacturers or might crush the bottles and reform it in the desired shape by beer manufacturers.

I: The issue lies in last leg, and the recyclers crush the bottles and reform it, can you think of the possible reasons at this stage that might raise costs for our client?

C: I have some observations:

Since bottles are crushed and reformed, there might be no issues around damages or design compatibility.

Apart from that if there might be any regulatory issues, it might apply to all the players in the industry, but this is not an industry-wide issue.

There might be some supply-demand frictions between the client specific suppliers and our client.

Are there any other possibilities that I should look into?

I: No, this looks exhaustive enough. You have correctly identified, for the past 3 years, the demand for the glass bottles has skyrocketed in the pharmaceutical industry and our partner recycler receives better equivalent prices from pharmaceutical clients for the bottles. Here is some data on the same. Can you analyze the numbers and suggest what should be done?

Price quoted from recycler - ₹ 4

Price quoted from manufacturer - ₹ 12

(Fresh : Recycled) proportion right now - 60% : 40%

(Fresh : Recycled) proportion before 3 years - 25% : 75%

Equivalent price paid by pharmaceutical clients to recycler - ₹ 4.25

C: Below is my calculation:

Right now, we are paying ₹ 8.8 (0.6*₹ 12 + 0.4*₹ 4) for an average bottle.

Since, this price is leading to 15% cost increase, our client can afford to pay ₹ 7.65 (₹ 8.8/1.15) on avg. for a bottle.

Assuming we go back to earlier proportion of sourcing, the maximum price we can pay to the recycler is ₹ 6.2 (from 0.25*₹ 12 + 0.75*₹ x = ₹ 7.65).

This max. price of ₹ 6.2 gives us a lot of headroom for further cost saving.

Our client can easily pay around ₹ 4.5 - ₹ 5/bottle to restore the initial supply volume from the recycler by outbidding the pharmaceutical clients.

This is my recommendation driven by the above pricing calculation, would you like me to look into other non-price driven recommendations?

I: No this is what I was looking for! This looks great! I think we can close the case now.