MOCK INTERVIEW CASE

CHEMICAL COMPANY

Interviewer Discussion Guide/Tips

This is a case that has multiple dimensions -- analytics, tactical considerations, and
strategic considerations. The interviewer can pretty much take it wherever he/she
wants to go, in a series of higher level questions/discussions. Three suggested levels
of discussion might be:

1. Pure analytics -- can the candidate handle a fairly straightforward breakeven

calculation in order to reach a conclusion about the outlook for the company?
2. Sensitivity/parametric analysis of the calculation above to drive further discussion of
potential strategies in response to the conclusion from #1 above.
3. Broader strategy discussion of Chemical Company’s environment and potential
strategic future.

Analytics

Current Profitability

1. Revenue:
a. Chemical X: 100,000 tons * @150/ton = $15MM
b. Chemical Y: 100, 000*1.5 = 150,000 tons*$175/ton = $26.25MM
c. Total revenue = $15MM+$26.5 = $41.25MM

2. Variable costs -- since variable costs are calculated only in terms of X produced, the
calculation is: 100,000 tons X*$50/ton = $5MM

3. Fixed costs = $20MM

4. Profits: (revenue-variable costs = contribution margin) - fixed costs = profits

($41.25MM-$5MM = $36.35MM) - $20MM = $16.25MM in profits

Future Profitability

1. Revenue
a. Chemical X: 100,000 tons*$100/ton = $10MM
b. Chemical Y: 150,000 tons*$100/ton = $15MM
c. Total revenue = $10MM + $10MM = $25MM

2. Variable costs: 100,000 tons of X* $95/ton = $9.5MM

3. Fixed costs = $20MM

4. Profits: ($25MM - $9.5MM = $16.5MM) - $20MM = ($4.5MM)

So the business swings from a healthy profit of over $16MM to a loss of $4.5MM. Note
that Step 1 above, calculating current profitability, isn’t strictly necessary though it helps
the candidate make the case that Chemical Company is facing a severe decline in
profitability and needs to consider dramatic steps in response.

Sensitivity/Parametrics Analysis

The obvious next question that should be discussed is what Chemical Company can do
in response. A potential framework to consider is “pressure testing” each of the
variables used in the profitability calculations above.

1. Revenue: Simply put, can Chemical Company grow its way out of its profit dilemma,
assuming fixed and variable costs remain where they are? It needs to find $4.5MM
in contribution margin in order to break even. It will generate in contribution margin
$145 per ton ($250/ton of revenue, expressed in tons of X produced - $95/ton of
variable costs/ton of X produced). $4.5MM of needed contribution divided by
$145/ton of contribution margin = approximately 30,000 tons of additional production
needed. This means an additional 30% in volume which would probably very difficult
to achieve in a commodity market in the down portion of its business cycle.
Moreover, an attempt to grow that magnitude of additional volume would probably
trigger a price war, which in turn reduce contribution margin, which in turn would
increase the volume required to break even, etc.

2. Variable costs: Again, $4.5MM in incremental profits are required to break even.
Reducing variable costs by $4.5MM means returning variable cost back to current
levels (100,000 tons* ($95/ton-$50/ton) - $4.5MM. Again this seems unrealistic,
though the candidate should bring up several ways to reduce variable costs as much
as possible -- eg, switching to cheaper raw materials if possible, investing in process
improvements that can lower variable costs, etc. A frequently proposed solution is to
backward integrate into raw materials. This may be something to consider, but it is
usually not the solution in that it can tie up large amounts of capital, and prudent
transfer pricing requires that captive produced raw materials be transferred at market
price. duPont learned the downside of this approach after it acquired Conoco in order
to “protect” its raw material requirements for its downstream chemical business. Oil
prices declined precipitously and duPont’s ownership of the capital intensive oil
production/refining business significantly destroyed duPont shareholder value.

3. Fixed costs: Needing $4.5MM to break even, finding the answer through fixed cost
reduction can be considered. $4.5MM is almost 25% of fixed costs. Most people
consider a 10% reduction in fixed costs to be very ambitious and certainly difficult to
sustain. Thus, again while efforts to reduce fixed costs (including labor costs, given
that this is probably a union environment) should be explored, it is not likely to solve
the problem in and of itself.
The interviewer should feel free to explore any combination of the above factors. It is
unlikely that any single approach will take care of the problem and that several
initiatives will be required.

Broader Strategic Considerations

Several additional areas can be discussed, including:

1. Moving into new, higher value products that are less subject to commodity swings.
Parallel to that is exploring changing the customer mix toward those with with end use
applications where our product has higher value and could command a higher price.
2. Acquiring one or more of our competitors to reduce the industry’s competitive
intensity and “race to the bottom” pricing tendencies.
3. Engage the candidate in a discussion about whether this pricing/profit cycle is “just
another price war” or whether there is a structural change in the industry. How could
you tell whether you just need for the industry cycle to return to more favorable times,
or whether the game has changed? Factors that could suggest a structural change
mostly center around whether there are important new entrants, new technologies, or
whether our customers are using our product differently or have changed their own
technologies. duPont, again, is a good example of someone who changed the rules -
- in this instance in the production of titanium dioxide, a white industrial pigment that
is used in many downstream products. The traditional industry-wide production
process had low fixed costs and high variable costs. duPont introduced a new
process that had high fixed costs, lower variable costs, and better product quality.
This structurally changed the business economics, incentivized duPont to price
aggressively to cover its fixed costs, and essentially drove other competitors out of
the business.