Case Study - Moldovan Coffin Maker

A. Problem:

Moldovan Coffins is a high-end coffin maker in the country of Moldova. Moldova, officially the Republic of Moldova, is a landlocked country in Eastern Europe located between Romania to the west and Ukraine to the north, east, and south. Moldova declared itself an independent state from Soviet Union in 1991.

The owner of Moldovan Coffins business has seen substantial change in his market in recent years and is contemplating the future of his business. Up until now, he has been in the business of building high-quality, handcrafted coffins largely by hand with a skilled labor force. Recently, however, he has become aware of a new technology that would allow him to build machine-made coffins with much less labor. Should he invest in this new technology? And should he even remain in the coffin-making business in the first place? Why or why not?

B. Questions:

1) What strategic alternatives should the owner of the coffin business consider?

• Option 1: Sell the business to a third party

• Option 2: Sell the assets of the company and shut it down

• Option 3: Keep operating as is

• Option 4: Keep operating and invest in the new technology

2) How would you figure out the current value of the coffin business?

• Provide the following additional information if the candidate asks for it clearly and directly.

• Calculate from the market’s total population, population growth, and birth rate.

• Review of death records for a period of time.

• Take sample of the number of obituaries in paper serving given population base.

• Calculate from total population, average life expectancy.

3) How to determine the Market Size?

• Population of Moldova: 3.5 million

• Population Growth: -0.08%

• Average Life Expectancy: 70 years

• Age Distribution: assume a flat age distribution, i.e. same number of people at every age.

• Burial Customs: 75% of deaths are buried in coffins.

Calculation: (3.5 million) x (1.26%) * (75%) = 33,000 coffins purchased per year.Every year, 1/75th of the total population will turn 76 and therefore die.

4) Calculate the value of Moldovan Coffins’ businessPrice:

• Coffins are priced at $5,000 for a handmade high-end coffin.

• Costs: Material accounts for 10% of the direct cost, while labor accounts for the other 90%. COGS is $4,800 per coffin. Fixed costs for the business are $700,000 per year. Assume all assets are fully depreciated and ignore taxes.

• Competition: The client Moldovan Coffins has a 10% market share and a relative market share of about 1 (relative market share is the ratio of the company’s market share to that of its nearest competitor.)

Possible Answers:

• Margin per coffin = $5,000 – $4,800 = $200

• Contribution Margin = $200 per coffin x 40,000 coffins x 10% market share = $800,000

• Profit = Contribution Margin – Fixed Costs = $800,000 – $700,000 = $100,000

Assuming a discount rate of 10% (candidate can assume anything reasonable here as long as they are consistent later), a perpetuity with cash flows of $100,000 per year has a present value of $100,000 / 0.1 = $1 Million. So the current business is worth $1M whether they keep it or sell it.

5) What would the value of the company be if the owner invests in the new technology?

• Investment: Investing in the new technology will cost the firm $1M.

• Cost Savings: Material costs remain the same, but labor costs are reduced by 50%.

• Proprietary Nature of Technology: The new coffin-making technology is being offered for sale by a machine tool company, who holds the patent.

• Not exclusivity Competitive Threat: Unknown if the competitors have acquired or are planning to acquire this new coffin-making technology.

• Customer Preferences: While the machine-made coffins are not “hand made”, the quality perceived by the customer is the same or better. It is believed that the customer will be indifferent between the quality and appearance of a hand-made and a machine-made coffin.

Since Moldovan Coffins has no proprietary control over the technology, it is likely that competitors will also acquire it, resulting in an overall lowering of the industry cost structure. Price will also fall as competition cuts price in an attempt to gain share.

• Gross Margin = $200 / $5,000 = 4%

• Labor Cost = (4800 x 90%) x 50% = $2,160

• Material Cost = 4800 x 10% = $480

• COGS = $2,160 + $480 = $2,640

• Price = $2,640 / (1 – 4%) = $2,718

• Contribution Margin = $2,718 – $2,640 = $78 per coffin

• Profit/Loss = $78 * 4,000 – $700,000 = -$388,000

6) If the owner has an offer to buy his business, should he sell it?

Given the credible threat of the industry becoming unprofitable due to the introduction of this new technology, the owner should look to sell the company as soon as possible. Since the assets of the firm and the present value of the expected cash flows of the business itself, he should attempt to liquidate the business and to sell the assets for around $1.6M.If the owner is unable to sell the business now, he can continue to operate the business as a cash cow, but should not invest in the business above what is necessary to keep it operating at its present level. He should expect the business to become less profitable as the industry moves to mechanization, and should eventually look to sell the assets of the company and close the firm.