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Profits for one of Company X's flagship products have been

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Profits for one of Company X's flagship products have been [#permalink] New post 07 Aug 2013, 01:34
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Profits for one of Company X's flagship products have been declining slowly for several years. The CFO investigated and determined that inflation has raised the cost of producing the product but consumers who were surveyed reported that they felt the product’s functionality didn’t justify a higher price. As a result, the CFO recommended that the company stop producing this product because the CEO only wants products whose profit margins are increasing.

The answer to which of the following questions would be most useful in evaluating whether the CFO's decision to divest the company of its flagship product is warranted?

A Does the company have new and profitable products available with which to replace the flagship product?

B Will the rest of Company X's management team agree with the CFO's recommendation?

C Can Company X sell the flagship product to new markets to increase its customer base?

D Are there additional features that could be added to the product without raising the unit price?

E What percentage of Company X's revenues is represented by sales of the flagship product in question?


The CFO wants to withdraw this product as the CEO wants only those products whose profit margins are increasing.

Profit margin= Profit/Revenue per unit of the product.
Sp->Selling price of the product
CP->Cost price to produce the product

I am not sure what unit price means in choice D. Does it mean the cost of production to the company or the cost to the buyer in the market?
Unit price should generally mean cost of the product in the market i.e the SP from the manufacturer's side.

Let us take this scenario:

SP CP Profit margin Sales Net profit Year
200 100 0.5 100 10000 1
200 120 0.4 100 8000 2
200 142 0.29 100 5800 3
272 170 0.6 50 5050 4

So, assuming that the costs of production go up by 20% each year, and that the manufacturer cannot increase his selling price, for he fears that he will lose sales, we can see that the profit margins continue to fall(in the first three years).

In the case that the manufacturer does increase his selling price to counter the loss in profit margins, the people will stop buying his product as they feel that spending so much for the features on offer is not worth their money.

So, if the CFO wants to increase his margins, he must only reduce his internal manufacturing cost or add new features to the product(without increasing his own production cost) so that he can command a higher price for his product.


Case 1: unit price=cost of production
If he is able to add new features to this product,without adding on his own costs, and people are willing to spend more for those new features, then this plan will be a success. In this case , maybe the year 4 scenario will not happen.
The CFO will probably be able to increase the profit margins, and everyone is happy(including me).

Case 2:
unit price=cost to buyer or selling price from the manufacturer

Now, if unit price is kept constant(i.e the his selling price), then perhaps his sales will go up , but how will his margins increase?

In this scenario, I see no difference between choice C and D.

In the end, it all boils down to the trivial matter of what unit price means in this context. In hindsight, maybe it was too obvious.But , that was what made me choose choice C.
In my knowledge unit price has always meant the price that a product sells for.

If, choice D had said, the unit price of production, then it would have been a clear picture.

Please help me with this.

Thanks.
[Reveal] Spoiler: OA
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Re: Profits for one of Company X's flagship products have been [#permalink] New post 07 Aug 2013, 03:11
The CFO's objective is to not have a product whose profit margins are decreasing. There were two inputs to the CFO that made him to stop the production of the flagship product: (i) the production cost of the product was increasing and so the products profit margin is decreasing (ii) the consumers perceive the product as too costly. So the company has to reduce the price if it has to sell the product well. But this again would reduce the profit margins. Thus the above two reasons made the CFO to stop the production of the product in accordance with his objective. But the rise of cost due to inflation is less of an issue because the price of the product is increased in accordance with the inflation.

The question is which of the additional information would help in assessing whether CFO's decision is correct or not?

The best choice is D because if it were analyzed whether the functionality of the product could be enhanced so that consumers feel that it is rightly priced and the company did not have to reduce the price, then that would say what the CFO did was right or not. That is, if it is the case that the functionality could not be increased without increasing the price what the CFO did was right. This is because the consumers might still feel it is too expensive. On the other hand if the functionality of the product could be enhanced without increasing the price, then the consumers would feel it is rightly priced and the price need not be reduced. Then the profit margins does not decrease and what the CFO did was wrong.

So the assessment that is important is that mentioned in choice D as it directly evaluates the rationale on which the CFO made his decision.
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Re: Profits for one of Company X's flagship products have been [#permalink] New post 07 Aug 2013, 03:33
SravnaTestPrep wrote:
The CFO's objective is to not have a product whose profit margins are decreasing. There were two inputs to the CFO that made him to stop the production of the flagship product: (i) the production cost of the product was increasing and so the products profit margin is decreasing (ii) the consumers perceive the product as too costly. So the company has to reduce the price if it has to sell the product well. But this again would reduce the profit margins. Thus the above two reasons made the CFO to stop the production of the product in accordance with his objective. But the rise of cost due to inflation is less of an issue because the price of the product is increased in accordance with the inflation.

The question is which of the additional information would help in assessing whether CFO's decision is correct or not?

The best choice is D because if it were analyzed whether the functionality of the product could be enhanced so that consumers feel that it is rightly priced and the company did not have to reduce the price, then that would say what the CFO did was right or not. That is, if it is the case that the functionality could not be increased without increasing the price what the CFO did was right. This is because the consumers might still feel it is too expensive. On the other hand if the functionality of the product could be enhanced without increasing the price, then the consumers would feel it is rightly priced and the price need not be reduced. Then the profit margins does not decrease and what the CFO did was wrong.

So the assessment that is important is that mentioned in choice D as it directly evaluates the rationale on which the CFO made his decision.



Thanks for the response.
However, I had a very specific doubt about how choice D is worded.

Unit price??
Unit price =Selling price to the consumer
OR
Unit price=Production cost of the manufacturer

I enumerated this in the 2 cases that i wrote down.

Would appreciate the help
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Re: Profits for one of Company X's flagship products have been [#permalink] New post 07 Aug 2013, 03:37
12bhang wrote:
SravnaTestPrep wrote:
The CFO's objective is to not have a product whose profit margins are decreasing. There were two inputs to the CFO that made him to stop the production of the flagship product: (i) the production cost of the product was increasing and so the products profit margin is decreasing (ii) the consumers perceive the product as too costly. So the company has to reduce the price if it has to sell the product well. But this again would reduce the profit margins. Thus the above two reasons made the CFO to stop the production of the product in accordance with his objective. But the rise of cost due to inflation is less of an issue because the price of the product is increased in accordance with the inflation.

The question is which of the additional information would help in assessing whether CFO's decision is correct or not?

The best choice is D because if it were analyzed whether the functionality of the product could be enhanced so that consumers feel that it is rightly priced and the company did not have to reduce the price, then that would say what the CFO did was right or not. That is, if it is the case that the functionality could not be increased without increasing the price what the CFO did was right. This is because the consumers might still feel it is too expensive. On the other hand if the functionality of the product could be enhanced without increasing the price, then the consumers would feel it is rightly priced and the price need not be reduced. Then the profit margins does not decrease and what the CFO did was wrong.

So the assessment that is important is that mentioned in choice D as it directly evaluates the rationale on which the CFO made his decision.



Thanks for the response.
However, I had a very specific doubt about how choice D is worded.

Unit price??
Unit price =Selling price to the consumer
OR
Unit price=Production cost of the manufacturer

I enumerated this in the 2 cases that i wrote down.

Would appreciate the help


Dear 12bhang,

When you say unit price it is the selling price to the consumer, cost of making a unit is called as the unit cost.
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Re: Profits for one of Company X's flagship products have been [#permalink] New post 07 Aug 2013, 03:49
Dear SravnaTestPrep,



SP CP Profit margin Sales Net profit Year
200 100 0.5 100 10000 1
200 120 0.4 100 8000 2
200 142 0.29 100 5800 3
272 170 0.6 50 5050 4


As you can see from this table, if the unit price of the product does not go up , then how will the profit margin increase?

If the CFO increases the unit price of the product,while adding some new features , then perhaps the consumers will feel that the product is worth the higher price.

The argument states that "the consumers who were surveyed reported.....".

The company is considering whether to increase price or not. But, without further features the consumers will not accept the price rise.Thus, it will introduce further features that justify the higher price, but without increasing its production cost.

If we speak in terms of the sample data- if the company can increase its unit price to 272, then the profit margins will increase,keeping in mind the increasing cost of production.

Though choice D will ensure that the consumers are ready to buy the product, by saying that the unit price remains the same ,it nullifies the scope for increase in profit margin.
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Re: Profits for one of Company X's flagship products have been [#permalink] New post 07 Aug 2013, 03:52
The table isn't coming out properly.

Please refer to the attachment for the data.
Attachments

sample.xlsx [9.65 KiB]
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Re: Profits for one of Company X's flagship products have been [#permalink] New post 07 Aug 2013, 04:12
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"has raised the cost of producing the product but consumers who were surveyed reported that they felt the product’s functionality didn’t justify a higher price."

Consider the above. What the above means is that the price is indeed fixed in accordance with the inflation i.e., the price is being raised but the consumers are not accepting the higher price. The consumers will accept the increase only if there is more functionality to the product. So here we are talking of two types of increase , one is the increase due to inflation which anyway any company will do and which is not the issue here and the other is the increase in cost and therefore in price, due to the addition of functionality. If the company is able to add functionality without affecting the cost and therefore the price, the product will indeed sell at the inflation adjusted higher price.
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Re: Profits for one of Company X's flagship products have been [#permalink] New post 07 Aug 2013, 04:37
If the price has already gone up to a level that the profit margins have been taken care of, but the main problem is the lack of customers, then why is choice C incorrect?

I mean, as you said, the price at which the product is selling is going up because of the corresponding increase in production costs, but the customers have stopped buying the product.

Increasing functionality will bring back the customers who stopped buying the product because of lack of functionality.

In this case, why won't exploring new markets that are ready to accept the product as it is be a good idea, as in choice C?
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Re: Profits for one of Company X's flagship products have been [#permalink] New post 07 Aug 2013, 04:45
SravnaTestPrep wrote:
The CFO's objective is to not have a product whose profit margins are decreasing. There were two inputs to the CFO that made him to stop the production of the flagship product: (i) the production cost of the product was increasing and so the products profit margin is decreasing (ii) the consumers perceive the product as too costly. So the company has to reduce the price if it has to sell the product well. But this again would reduce the profit margins. Thus the above two reasons made the CFO to stop the production of the product in accordance with his objective. But the rise of cost due to inflation is less of an issue because the price of the product is increased in accordance with the inflation.

The question is which of the additional information would help in assessing whether CFO's decision is correct or not?

The best choice is D because if it were analyzed whether the functionality of the product could be enhanced so that consumers feel that it is rightly priced and the company did not have to reduce the price, then that would say what the CFO did was right or not. That is, if it is the case that the functionality could not be increased without increasing the price what the CFO did was right. This is because the consumers might still feel it is too expensive. On the other hand if the functionality of the product could be enhanced without increasing the price, then the consumers would feel it is rightly priced and the price need not be reduced. Then the profit margins does not decrease and what the CFO did was wrong.

So the assessment that is important is that mentioned in choice D as it directly evaluates the rationale on which the CFO made his decision.


Hi sravana

i have doubt regarding option C and D

My undersstanding for C is:
C Can Company X sell the flagship product to new markets to increase its customer base?
if it is possible to sell the flagship product to new markets to increase its customer base===>then obviously the profit will stabilize.
so IMO this was the contender ..PLEASE suggest where i am wrong?

FOR OPTION D:
D Are there additional features that could be added to the product without raising the unit price?
How we can assume that additional feature is going to fetch back the consumers.

please suggest
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Re: Profits for one of Company X's flagship products have been [#permalink] New post 07 Aug 2013, 05:02
Dear 12bhang, blueseas,

The point is the price of the product has to increase because of inflation whether it be sold in the existing market or the new market. But we know the existing market is not accepting the increase in price.

Assume we evaluate as in C whether the company can sell the product in new markets? And assume we conclude we can sell. But we still do not know whether we can sell it at a price where the profit margin increases. So it is not the sales that is the focus but the margin according to the CFO.

The additional features are likely to fetch back the customers because, it is given that it is for the lack of additional features that the customers are resisting the higher price
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Re: Profits for one of Company X's flagship products have been [#permalink] New post 07 Aug 2013, 05:11
SravnaTestPrep wrote:
Dear 12bhang, blueseas,

The point is the price of the product has to increase because of inflation whether it be sold in the existing market or the new market. But we know the existing market is not accepting the increase in price.

Assume we evaluate as in C whether the company can sell the product in new markets? And assume we conclude we can sell. But we still do not know whether we can sell it at a price where the profit margin increases. So it is not the sales that is the focus but the margin according to the CFO.

The additional features are likely to fetch back the customers because, it is given that it is for the lack of additional features that the customers are resisting the higher price


price is already increased and now if we are able to increase the customer base then surely profit will also increase.
it is not written that we have to reduce price for selling in new market.

moreover option D:
D Are there additional features that could be added to the product without raising the unit price?
IT Seems that this additional feature can be any type...may be it may not attract(actually the wording of this choice is not very supporting)
might be some flaw in my approach.

thanks
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Re: Profits for one of Company X's flagship products have been [#permalink] New post 07 Aug 2013, 05:36
blueseas wrote:
SravnaTestPrep wrote:
Dear 12bhang, blueseas,

The point is the price of the product has to increase because of inflation whether it be sold in the existing market or the new market. But we know the existing market is not accepting the increase in price.

Assume we evaluate as in C whether the company can sell the product in new markets? And assume we conclude we can sell. But we still do not know whether we can sell it at a price where the profit margin increases. So it is not the sales that is the focus but the margin according to the CFO.

The additional features are likely to fetch back the customers because, it is given that it is for the lack of additional features that the customers are resisting the higher price


price is already increased and now if we are able to increase the customer base then surely profit will also increase.
it is not written that we have to reduce price for selling in new market.

moreover option D:
D Are there additional features that could be added to the product without raising the unit price?
IT Seems that this additional feature can be any type...may be it may not attract(actually the wording of this choice is not very supporting)
might be some flaw in my approach.

thanks


The CFO has discarded the product because he knew he cannot increase the price. Choice C talks only about increasing the customer base and not about the price. I do not think it directly addresses the question. Choice D specifically talks about price because evaluating it would give the information that the price in fact need not be increased and it is enough to increase the functionality and still increase the profit margin. So it gives a more definitive information on which the CFO could have acted given the other facts.
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Re: Profits for one of Company X's flagship products have been   [#permalink] 07 Aug 2013, 05:36
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