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Pepita Disco: Margins and Price Elasticity For nearly six months, you have been the Chief Executive at Pepita Disco PPM (Productos Para Mascotas) SRL, 1 Uruguay's second-largest producer of beef-based dog food, treats, and toys. Pepita's board of directors hired you for one main reason: profits at the firm had been stagnant for several years before your arrival and they wanted you to put the company's financials on an upward trend. During the months since you arrived, you have focused on gathering information Having now become familiar with the 80-year-old firm and its financial situation, you think you are in position to start achieving what the board of directors hired you to do. The board is anxious to know what you have in mind for improving the company's bottom line, and you are considering several options. Here are some of the things you have learned: Uruguay's pet products industry grew in direct proportion to the country's emergence as a global beef producer in 1995, when the World Organization for Animal Health certified its cattle free of foot-and- mouth disease. This certification, combined with political developments in neighboring Argentina that hampered the export of Argentine beef, launched more than a decade of explosive growth in the Uruguayan beef market. Last year, Uruguayan pet product manufacturing totaled 700 million UYU.2 Total production in the Uruguayan pet food market has been growing at 8.2% CAGR for the past five years, and forecasts tend to agree that CAGR for the next five years will be at least 6.5%. Much pet food is manufactured using extraneous cattle parts that are left over after a cow is slaughtered. Pet product manufacturers like Pepita Disco render these parts to produce pet treats. As in the beef market, the vast majority of Uruguayan pet products are exported. The U.S. accounts for more than half of all exports, followed by Canada, Israel, and the EU. Uruguayan pet product manufacturers tend to specialize in higher margin, lower volume products. Their products are sold primarily through specialty retail channels rather than through the hypermarket chains like Wal-Mart or Target, which tend to sell lower-quality bulk dog food and treats made with grain filler and reconstituted animal parts. Pepita Disco produces a wide array of upscale dog toys and treats, such as bully sticks and other chew toys made from muscles and tendons, as well as real beef bones (often cross sections of cow femurs). Pet owners have 1 come to expect premium pet treats to be priced within a relatively narrow bandwidth, so Pepita's products are all priced at a similar level. The company employs more than 52 people in its sole location in Durazno, located three hours from the capital city of Montevideo on the South Atlantic Ocean. The company earns about 200 million UYU annually and earns a 10% margin. Additional financials are reported below: Revenue 200 (based on 100 million units sold) Variable Costs Materials 30 Direct Labor (Mfg., Sales) 40 Operational Costs (Mfg, Inventory, Delivery) 30 Other Variable Costs 20 Contribution Margin 80 Fixed Costs Marketing & Advertising 10 Research & Development 10 Other Fixed Costs (e.g., Head Office) 40 Net Margin 20 As you considered these financials and your prospects for improving the bottom line, you created a spreadsheet with the above numbers, and began to study the impact that different changes might have on the company. For example, what if you cut costs? What about raising price? And, what impact might these decisions have on other aspects of Pepita's financials? Questions 1. What is the impact on Net Margin (both absolute change and % change) if Pepita Disco sells 10% more in unit volume? (hint: keep in mind that variable costs change with units sold) 2. What is the impact on Net Margin (both absolute change and % change) if Pepita Disco raises the price by 10% but there is no change in units sold? 3. What is the impact on Net Margin (both absolute change and % change) if Pepita Disco lowers the price by 5% but there is no change in units sold? 4. Suppose the price elasticity is -1.7. What is the impact on Net Margin (both absolute change and % change) if Pepita Disco raises the price by 5%? 5. Suppose the price elasticity is -1.7. What is the impact on Net Margin (both absolute change and % change) if Pepita Disco lowers the price by 10%? 6. What is the impact on Net Margin (both absolute change and % change) if Pepita Disco cuts all fixed costs by 10%? 7. What is the impact on Net Margin (both absolute change and % change) if Pepita Disco cuts all variable costs by 10%? 8. What is the impact on Net Margin (both absolute change and % change) if Pepita Disco cuts R&D costs by 10% and as a result, unit sales go down by 5%? 9. What is the impact on Net Margin (both absolute change and % change) if Pepita Disco cuts Marketing & Advertising costs by 10% and as a result, unit sale go down by 5%? 10. What is the impact on Net Margin (both absolute change and % change) if Pepita Disco cuts all variable costs per unit by 10% and as a result, unit sales go down by 10%