Would you prefer to increase prices by $10 or cut cost by $10?
I got the above in an interview. I would think price is better though not 100% sure. Any idea?
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It's cost I think. Say we have $100 in revenue and 50% gross profit margin, then we have $50 gross profit. If we increase $10 we have $55 gross margin; if we decrease costs by $10, we have 60% gross margin and $60 gross profit. At least that's how I think about it on first glace.
Deleting my question, response below explains it
As the above said, cut costs by 10. Part of this is operating leverage. Being able to cut costs shows the you have lower operating leverage and it is much easier to control cutting costs rather than increasing price. Also, the market can respond negatively to a 10 dollar increase and cause volume to decline. If you're in a competitive or undifferentiated market where price is the biggest purchasing consideration you're going to loss business
Agree w/ some, disagree w/ others. Right answer (cost > top-line) but I've never liked the blanket answer of "easier to control cutting costs rather than increasing price" - usually a very fluid situation and highly variable w/ industry. IMO an overused adage. I like the point on price/volume elasticity though and if you gave that as an add-on to what I have written below, I think that shows great foresight.
I think the simplest, most logical answer is that all items have pass-through costs so getting +$10/item on price doesn't translate 100% to +$10/item on gross profit. Conversely, -$10/item on costs does trickle directly, with little to no exceptions. Most businesses require supply chain/distribution/wholesale so no matter where you are in the value chain, you're getting not taking the full top-line increase for yourself (ex. you are a screwdriver manufacturer; if KOHL's now charges +$10/your screwdriver, they need to make a margin so in the situation where your wholesale price is ~70% of retail price, you're only taking +$7/item on price). And, even if you do have a business where an incremental unit has zero COGS (say, software), cutting costs would still be at least equal to the full potential of a top-line increase.
I agree with Shockattack11 on the price / elasticity point. However, I don't get the point on increase in price doesn't translate a 100% to gross profit.
Take for example a unit item is priced at $100, COGS is $70, so we have gross profit of $30
If we increase price to $150, the COGS will still stay at $70, so we have a gross profit of $80, so this is fully reflected in profits? Am I missing something
Well said, I couldn't agree more. Although I cannot guarantee that I would be able to think of in on spot, during the interview,
That’s not what operating leverage means
It's exactly what operating leverage means. Operating leverage is how much your fixed costs comprise of your total costs. If you have high operating leverage that means you have high fixed costs and vice versa. If you have high fixed costs them it is much more difficult to cut costs than a company with low operating leverage
If the scenario were to add assumptions that both all $10 accrues to you AND your customers accept the $10 increase with no loss in volume, would that change the answer in favor of raising price?
Theoretically there is no limit on price whereas there is a floor to cutting costs which you end up hitting eventually.
Unsure exactly but curious on any thoughts.
If I was told that, it would be too hard to continue thinking about hypotheticals so I would try to crystalize as a real-world example.
For instance, one of the only situations where you accrue the entire benefit yourself is if you're fully vertically integrated amongst the value chain. Having customers accept pricing power could mean you're either in an industry that lacks competitive tension (monopoly) or you're in an industry where you can pass-through increased supplier costs to the consumer.
The combination of both variables I imagine looks like a phone/internet carrier like AT&T in a dense, rural area with no real competitor. Variable costs are already pretty low in this type of business (customer acquisition?) so I would opt in to increasing pricing
Questions like these have no real answer anyways - just want to test your ability to think on your feet and see if you can apply what you've read in a study guide, etc to a real world application. As a poster below mentioned, you can lean into either option as long as you have rationale behind it
I think there is an economics question part of this too. If you're raising costs, you're inviting new entrants into your sector. If you're lowering costs, you're beating the competition and securing your foothold. Hence, I would rather lower cost.
You should clarify a couple things with the interviewer before answering:
If COGS -
On one hand a COGS decrease improves margins more than a price increase. On the other hand, passing through a price increase (assuming no decrease in demand) demonstrates customer stickiness and some sort of differentiation, accelerates revenue growth, and is a necessary part of combating inflation. The factors associated with a price increase are better predictors of long-term growth and staying power.
If SG&A -
I’d rather take the price increase instead of saving $10 on [utilities, etc] expenses, for the reasons stated above.
Agreed w/ both comments but it would be pretty silly for 2) to be SG&A when I was entertaining this thought in my head as well. A one-time decrease of SG&A for $10 is so significantly inferior that it's not even remotely comparable to a price increase of $10/unit.
But, if the question is more general (no numbers) in relating "would you prefer to have an increase in price/unit or cut down SG&A such that they would have the same forecasted magnitude in year 1", etc, I think we can get somewhere with that. Namely, if we expect to scale significantly (J-curve, quickly growing TAM, growth of your share of TAM), would take SG&A cuts; otherwise, would go w/ top-line increase.
As a style point, I would say it's better to give a fulsome answer that considers both of those points rather than asking the interviewer to choose one. You get to show off your knowledge more and you come across as a more creative / independent thinker.
I agree with this take. This is the way I always answered this q in interviews
Am I tripping or is how a business valued not relevant here? If you’re talking about a company in an industry often valued off of revenue (software for example), you’d want the $10 in revenue, no?
Really good point. Need to tailor the answer to what the interviewer focuses on - if he's a software guy then talk about this in a SaaS context / if industrials talk about widget manufacturing.
All of the above responses are legitimate ways to answer the question -- it really comes down to what assumptions you make (or the interviewer expects you to make).
Also, just because the question was phrased as: Would you rather (a) or (b) .. don't be afraid to offer up (c) and say "I'm indifferent as both increase my profits by exactly the same amount."
I really wouldn't say (c). Demonstrates a lack of ability to think creatively and is just a painful answer to receive as an interviewer.
Agree with what's already been said. I think it also depends on why... and this would help justify your interview answer when the question is so open-ended. E.g. you could say something like, "while the net profit impact is the same... if current demand > supply a price increase makes a lot of sense as it would relieve some stress on the business, but during a normal cycle a cost reduction makes a lot of sense as you focus on finding efficiencies within the business without potentially negatively affecting volume"
“You should do both. Now please pay us $10mm” — Some guy at Mckinsey
The answer is increase price by $10.
Most of the answers above are making additional assumptions that you weren't asked about and aren't relevant to answering this question (for interviewing purposes, certainly in the real world you'd think hard about all of those items).
Assume you sold 10 widgets a year for $20 each (revenue of $200) and had $100 of costs to produce those widgets, so a 50% Profit Margin.
(1 - Increase Price $10) - 10 widgets at $30 each (revenue of $300) and still $100 of costs, so $200 of profit and a 66.7% profit margin.
(2 - Lower Costs $10) - 10 widgets at $20 each (revenue of $200) and now $90 of costs, so $110 of profit and a 55.0% profit margin.
You'd always rather increase price as it flows directly down to your bottom line (again ignoring asking about the price elasticity of demand).
Agree with this if the cost referred to here are Fixed Cost.
If it is VC then there should be no difference?
It doesn't matter if your costs are fixed or variable. If you raise PRICE $10, you are not changing your UNITS made which would drive your costs.
This is an apples to oranges comparison. You're comparing a $10 PER WIDGET increase to a $10 TOTAL cost decrease.
Let's break down the apples to apples comparison scenario, which is per widget break down.
Let's say base case 10 widgets. They sell for 100 each and cost 50 each to make. Gross Profit margin per widget is 50%.
Increase price $10 per widget: 110-50=60 (54.5% margin)
Decrease cost $10 per widget: 100-40=60 (60% margin)
It's an apples to oranges question and I'm telling you this is how they want you to answer it.
Your answer directly conflicts with the question because they aren't asking you on a per unit basis your costs decrease by $10. They want you to understand the point that they are wanting you to realize that raising price (which is by unit) has a higher flow through than just cutting costs by an arbitrary amount normally.
Your math above is all valid and I agree with it, it's just not the question that's being asked.
Most of the answers above are making additional assumptions that you weren't asked about and aren't relevant to answering this question (for interviewing purposes, certainly in the real world you'd think hard about all of those items)
I couldn't disagree more. The question is a springboard for you to show off your understanding of commercial dynamics. A purely arithmetic answer demonstrating that you can add or subtract $10 is not going to impress anyone.
price increase leads to volume decrease, as you see with inflation crisis now
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