The Declining Market Share
A company's revenue in Year 1 was $10 million. In Year 2, revenue increased by 20% to $12 million. However, the overall market grew by 30% in the same period, from $50 million to $65 million. In Year 3, the company's revenue decreased by 10% from Year 2, while the market grew by another 10%. The company's fixed costs are $4 million per year, and variable costs are 60% of revenue. The company is concerned about its declining market share and is considering two strategies: Strategy A: Increase marketing spend by $1 million per year to boost revenue growth by 5 percentage points above the market growth rate. Strategy B: Reduce variable costs to 50% of revenue by improving efficiency, but this requires an upfront investment of $2 million in Year 3 (in addition to fixed and variable costs).
1. Calculate the company's market share in Year 1, Year 2, and Year 3. What is the percentage change in market share from Year 1 to Year 3?
Read the worked answer
Year 1: Company revenue = $10M, Market = $50M → Market share = 10/50 = 20%. Year 2: Company revenue = $12M, Market = $65M → Market share = 12/65 ≈ 18.46%. Year 3: Company revenue = $12M * 0.9 = $10.8M. Market = $65M * 1.1 = $71.5M. Market share = 10.8/71.5 ≈ 15.10%. Percentage change from Year 1 to Year 3: (15.10% - 20%) / 20% = -4.9/20 = -24.5%. So market share declined by approximately 24.5%.
2. Calculate the company's operating profit in Year 3 under the current cost structure. Then, evaluate the financial impact of Strategy A and Strategy B in Year 3, assuming the market grows by 10% and the company's revenue under Strategy A grows by 15% (5 percentage points above market) from Year 2, while under Strategy B revenue remains at the Year 3 level (10.8M) but variable costs are 50% and the $2M investment is incurred. Which strategy yields higher operating profit in Year 3?
Read the worked answer
Current Year 3: Revenue = $10.8M. Variable costs = 60% * 10.8 = $6.48M. Fixed costs = $4M. Operating profit = 10.8 - 6.48 - 4 = $0.32M.
Strategy A: Revenue grows by 15% from Year 2: $12M * 1.15 = $13.8M. Variable costs = 60% * 13.8 = $8.28M. Fixed costs = $4M. Marketing spend = $1M (additional). Total costs = 8.28 + 4 + 1 = $13.28M. Operating profit = 13.8 - 13.28 = $0.52M.
Strategy B: Revenue remains $10.8M. Variable costs = 50% * 10.8 = $5.4M. Fixed costs = $4M. Investment = $2M. Total costs = 5.4 + 4 + 2 = $11.4M. Operating profit = 10.8 - 11.4 = -$0.6M (loss).
Strategy A yields $0.52M profit, Strategy B yields -$0.6M loss. So Strategy A is better in Year 3. However, Strategy B's investment is upfront; in subsequent years, the $2M is not repeated, so profits would be higher. But for Year 3 alone, Strategy A is superior.