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

Question

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 weren't willing to pay more than the current 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. Are there additional features which could be added to the product and for which consumers might be willing to pay a higher price?

D. Is there a way to alter the manufacturing or distribution processes in order to reduce the cost to produce the flagship product?

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

vivesomnium · Accepted Answer

1)Does the company have new and profitable products available with which to replace the flagship product?  Will that matter? CEO ONLY wants to produce products whose profit margins are increasing - if there is no such product, he wants to produce none. There is no minimum number of products that they HAVE to produce - and as such the question of replacement doesnt rise 
2)Will the rest of Company X's management team agree with the CFO's recommendation? :  No where does the argument mention whether the management team has a say or not, or who has the larger say if there is a conflict. answer to this question - yes or no- will not help us decide 
3)Are there additional features which could be added to the product and for which consumers might be willing to pay a higher price? -  This seems like a contender, but nowhere does this question answer how much will the cost of production increase if the additional features are added. what is the cost of production would increase far more than what the additional revenue from increased proce would be, and as such the profitability falls even further?? 
4) Is there a way to alter the manufacturing or distribution processes in order to reduce the cost to produce the flagship product? :  Before closing down production, the CEO should look into this - while the prices are fixed, if the cost of production can be reduced, the product might become profitable to produce. 
5)What percentage of Company X's revenues is represented by sales of the flagship product in question?  Irrelevant - product might be 100 % or 1 % of the sales - It is the profitability and not the revenue share which is making the CEO decide whetehr to produce a product or not.

Bunuel · Answer

OFFICIAL EXPLANATION

Profits for a particular product have been going down and the CFO has determined that this is because, on the one hand, the cost to make the product has increased and, on the other, consumers won't pay more than the current price (recall that Profit = Revenues – Costs). The CEO only wants Company X to sell products with increasing profit margins; as a result, the CFO decides the solution is to stop making this product. This decision would make sense only if we can be assured that there is no way to have an increasing profit margin for the product in question.

(A) Whether there are new, profitable products does not address the issue of whether there is a way to achieve increasing profit margins for the flagship product.

(B) Whether the management team agrees with the CFO's recommendation does not address the issue of whether there is a way to achieve increasing profit margins for the flagship product.

(C) This may increase the revenues earned by the product, but this choice does not address the additional cost associated with new features, so we still do not know whether we can achieve increasing profit margins for the product. We may be able to, but we may not: the features may cost more than the increased price that consumers would be willing to pay.

(D) CORRECT.  If the costs for the existing product can be reduced, then the profit margin will increase (again, recall that Profits = Revenues – Costs). If the costs cannot be reduced, then the profit margins will not increase.

(E) The flagship product's revenues as a percentage of total revenues does not address the issue of whether there is a way to achieve increasing profit margins for the flagship product (although it does highlight why the company might find itself with a big problem if it follows the CEO's advice!).

DavidTutorexamPAL · Answer

Let's break down the passage:
1. profits from one product have been declining.
2. (because) inflation has increased production cost (and) 3. customers don't think the features are worth the price
4. (therefore) stop making product, make only products with increasing margins

As the logic between the statements is extremely clear, we'll try to infer our answer directly from the question stem.
This is a Precise approach.

Specifically, we're asked if (4) is a good decision, so we'll try to find facts that will make it a bad decision. In particular, as the CFO says he wants products with 'increasing margins' we'll look for data that would make the margins increase. This is most likely something that negates the original reason they decreased - i.e. (2) and (3). For example, a deflation would negate (2) and something which makes customers more willing to pay would negate (3). Looking at our answers, (D) does exactly this - it negates (3) by saying that additional features can be added at no cost, which negates the reasoning that customers won't pay because there aren't enough features.

(D) is our answer.

Note that (C) is weaker than (D) because (a) it doesn't directly address any of the previously raised issues and (b) it might increase total revenue and overall profit but would not change the profit margins per individual product, as presumably the new customer base still wouldn't want to pay a higher price.

crick20002002 · Answer

D for me.

If the distribution and manufacturing costs can be reduced, the profit can be increased. C on the other hand does not address whether additional features require additional cost to add.

Crick

AtlanticGMAT · Answer

Hi,

One way to attack CR is to make the information manageable by breaking it down the essentials:

1. The products profits are decreasing because consumers are not willing to pay the increased price (do to inflation/production costs) for this product considering the features

2. The CEO only wants to focus on products whose profits are increasing

3. Therefore the CEO wants to discontinue the product

So D is the only one that addresses the above:   if the features can be augmented without increasing the price then perhaps consumers will respond by buying more.  You can justify the idea of price because  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.   So the logic is can we add functionality which will justify the higher price (caused by inflation/production costs) without adding to the price. If we can do this the idea is that consumers will buy more of the product (because it has more features and the price stayed the same) and increase the profit from the product. Also, just because the cost does not increase does not mean that the price to the consumers doesn't increase. The real focus here is that the price is too high considering the features.

I hope this helps!

HG.

greatps24 · Answer

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.   <--- CONCLUSION

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?  Scope: Company X's flagship products. Thus, this is OFS

B. Will the rest of Company X's management team agree with the CFO's recommendation?   Scope: CFO's decision to divest. OFS

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?
 If Yes, than CFO's decision to divest the company of its flagship product is not warranted
If No, than CFO's decision to divest the company of its flagship product is warranted

E. What percentage of Company X's revenues is represented by sales of the flagship product in question?  Scope: Profits for Company X's flagship products. Thus, this is OFS

EVALUATE QUESTION. Do the Variance test:

12bhang · Answer

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.

SVaidyaraman · Answer

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.

12bhang · Answer

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.

SVaidyaraman · Answer

"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.

12bhang · Answer

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?

SVaidyaraman · Answer

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

blueseas · Answer

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

SVaidyaraman · Answer

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.

DudeYou · Answer

This is what attracted my attention in the argument -- CEO only wants products whose profit margins are increasing A. Does the company have new and profitable products available with which to replace the flagship product? Doesn't matter whether new product is present or not. Even if they have the new product, they can always keep both : the flagship product and new product -- OUT B. Will the rest of Company X’s management team agree with the CFO’s recommendation? If I am the CFO...I only care about what the CEO or higher management thinks -- :-)

OUT C. Are there additional features which could be added to the product and for which consumers might be willing to pay a higher price? May be....hold..will revisit D. Is there a way to alter the manufacturing or distribution processes in order to reduce the cost to produce the flagship product? may be..hold..revisit E. What percentage of Company X’s revenues is represented by sales of the flagship product in question? If it represents 90% -- its important. If it represents only 1%, its still important....any revenue is better than none. OUT Revisit C If I add additional features that cost more money...who knows if we can recover the cost -- OUT Answer -- D

Jainavanti268 · Answer

The authors concludes (stated in the question stem) that CFO's decision to divest the company is warranted. The line of reasoning it follows is that the profits are decreasing because of increased cost (due to inflation) and stagnant price and CFO wants to continue with only those products that have increasing profit margin.
Now we know Profit= SP-Cost. Since SP is constant , profit can only change if cost structure is changed. When the author concludes that CFO should divest the business, it assumes that profits will continue to decline and there is no way anything can be done to increase profit. If the Cost is reduced, profits will increase and this will break the conclusion. This is exactly what is stated in Option D

krndatta · Answer

AndrewN

Share your two cents on my reasoning.

Checking with variance test:- 
Option A:- Yes, the company does have new and profitable products. Then the CFO's decision is warranted because the company does have new and profitable products. 
On the other hand a "No" to the above question would mean the company doesn't have new and profitable products. So the decision is not warranted.

Option C:- Yes, there might be some features that could be added to the product, but we don't know what the final price would be. So we can't say whether the decision is warranted or not. 
A "No" would make our conclusion stronger since there are no additional features that can be added, and the consumers are not willing to pay extra. Hence, the conclusion stands strengthened.

Option D:- This is the correct answer.

Option E:- This is incorrect because this option talks about revenues, and our concern is profits. Even if we get to know that the revenues are a 100%, but then too the expenditure or the input costs can be way over. So doesn't impact the conclusion or doesn't tell us whether the decision is warranted or not.

My other thought on this one was if lets say maximum revenue comes from this flagship product, then the decision might not be warranted. But then I thought even if maximum revenue comes from this product, then too this product is a loss making product. So doesn't matter whether the decision is warranted or not.

Share your thoughts on my reasoning above.

Thanks

AndrewN · Answer

Hello again,  krndatta . You have to be careful on  evaluate  questions not to get carried away in an assay of each answer choice. I like the scientific mindset, but I am afraid that a strict variance test analysis such as the one you have outlined above is too much trouble for answering a GMAT™ question. By your logic, (A) is as strong an answer as (D)—if the decision is or is not warranted based on what (A) tells us, then it seems quite useful in evaluating the argument. But there is an overarching problem with (A). Look at the question stem carefully:

The existence or absence of  any other product besides the  flagship product   falls outside the scope of the recommendation made by the CFO. That recommendation is based on the company  producing  this  product  at a profit. Answer choice (A) puts shiny new toys in front of us while effectively sidestepping the issue. Thus, it cannot be the answer we are seeking.

Your read on answer choice (C) is spot on:  we don't know what the final price would be . End of story. (We cannot speculate on profit margins.)

Answer choice (E) reminds me of the same type of answer on another recent question you asked me about, namely in that it invokes a  percentage  or proportion when the issue at stake is much simpler: can the company turn a profit on this flagship product? We do not need to know whether that product comprises 10 percent or 95 percent of company profits... if the answer choice did even discuss profits rather than revenues, as you correctly pointed out.

In short, you seem to be developing a keener eye on these tough questions. Just remember not to caught up in pursuing a side thought when the questions are always designed (that is, when they are official) with a linear, straight-arrow logic in mind.

Thank you for thinking to ask, and good luck with your studies.

- Andrew

rak08 · Answer

how i worked through this is:

A. even if company has new & profitable products to replace, note that the flagship product was also "profitable", just that its profits were declining. so i don't know if the new & "profitable" is "increasing profit margins"

B Agreement can be under pressure or on logical evaluation , hence no basis

C additional features cost is not given. maybe the net effect = 0

D alter to reduce cost -- price remains same. hence margins increase CORRECT.

E % of sales is a concern area however, if a product is lowering my overall profit margins then i would remove it and maybe invest it elsewhere which gives me higher returns. 
+ note it says revenue or units sold. maybe the pricing is high and revenue shoots up , we can increase the price for other products? add new? 
doesn't tell me that CFO is wrong.

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

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GMAT Critical Reasoning (CR) Questions

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

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