Entertain Us

Question:

The CEO of a large diversified entertainment corporation (XYZ) has asked our consulting firm to examine the operations of a subsidiary of his corporation that manufactures video game systems. Specifically, he needs to know whether he should approve a $200 million capital request for tripling the division’s capacity. You are a member of the team assigned to this project. Assume you and I are at the first team meeting. What are the critical issues we should plan to examine to determine if the industry is an attractive one for continued investment and why?

The primary issues of the case are to determine if the industry is attractive and especially if the client’s position in that industry is sustainable. The questions you ask must aim to give you a clear idea of the structure of the industry and the company’s competitive position in the industry. Here we will use the external/internal structure. Also note that you are being asked to identify the issues that are necessary for assessing both the industry and the client’s position, but not explicitly solve the problem.

Candidate: First, I’d like to look at the external market situation. Important categories here include the current and potential players, customers, market size and share, sales and pricing. Then, I’d like to assess things internally at XYZ. What resource constraints do we have? At the end, I’d like to pull it together and summarize the top issues and opportunities that I think we will need to attack.

Interviewer: That sounds fine.

Candidate: Let’s begin with some external analysis. Who are the current players in the market, what is the current size of the market, and how much share does XYZ hold in that market?

Interviewer: There are three main players in the market. The XYZ division, though a relatively new entrant into the market, is the third-largest manufacturer of hardware in the industry with 10 percent market share. The top two producers. Boom and Game Fun, have 40 percent and 35 percent market share, respectively. The remainder is divided among small producers. The division sells to a broad range of consumers.

Candidate: You mention hardware. I assume you mean the systems on which computer games are played Does XYZ’s division make games, or software?

Interviewer: You’re correct about what I mean about hardware. No, XYZ does not make games, or other software.

The fact that the other two firms have 75 percent of the market may make it difficult for the division to gain market share and justify increasing capacity. Why does the division have only 10 percent market share?

Candidate: What else do we know about the major competitors?

Interviewer: Both of the two leaders make video games, in addition to the hardware. Also, they set the industry’s hardware standards, and our client simply adapts to them.

Candidate: And who are the customers? Have new customer segments been identified?

Interviewer: The division estimates that much of the initial target market — young families — has now purchased video game hardware. No large new user segments have been identified.

Candidate: How do the products reach the end customer?

Interviewer: The primary outlets of distribution are electronics stores.

Candidate: Do we have an estimate of the annual sales of the industry in general and that of XYZ? What is the general trend?

Interviewer: Well, we know that XYZ’s sales have increased over last year from a relatively small base. We currently estimate annual sales of 500,000 units.

Since you already know that the total market share of XYZ is 10 percent you can infer that the current estimate of industry sales is about 5,000,000 units annually.

In contrast, although overall industry growth has historically been strong, industry-wide sales growth has slowed in recent months.

This could be attributed to lower demand of video games because of the prevailing economic conditions, and you might later test this assumption through discussions with the marketing department.

Candidate: What are sales like in the current market? Have sales slowed for both hardware and game software?

Interviewer: Over the last few years, we have noticed that software, or video game sales, have increased, while hardware, or game system, sales have decreased.

Candidate: What is the price for the basic unit? And how much do our competitors charge?

Interviewer: The division’s current sales price for the basic unit is $150. The competition charges less, but we don’t have specifics on that right now.

Candidate: OK, I believe I have the major external context now. Let’s move internally to XYZ itself and start with costs. What can you tell me about the different kinds of costs for the division?

Interviewer: The main costs are components, assembly and labor. The division estimates that the current cost of production is $120, which includes the costs of marketing and promotion. The requested capacity expansion should reduce the cost by 5 to 7 percent and triple the production of the hardware units. We also know that the top two competitors have an estimated 10 to 15 percent cost advantage at the present time.

Candidate: How profitable is the company, and how significantly does the particular division contribute towards the margins?

Interviewer: The division currently exceeds corporate return requirements, but profit margins have recently been falling. The sales of the division are slightly less than 20 percent of total XYZ sales.

Candidate: This would be a good time to identify what I think would be the top issues here.

Interviewer: That sounds fine. Go ahead.

Something doesn’t seem quite right here. Why is XYZ interested in entering the market if it only has 10 percent of the market and if it doesn’t make games for the system? Why is there any interest in the product at all? You’d better find out.

Candidate: So our system costs more than our competitors.

Interviewer: Yes.

Candidate: And sales are increasing, not decreasing?

Interviewer: That is correct.

Think about it. Why would someone buy XYZ’s hardware system if it’s more expensive and has no dedicated software? Well, if it doesn’t run its own games, it must run others. This gives you an idea.

Candidate: What software does XYZ’s game system run?

Interviewer: XYZ’s game hardware runs games from both its two top competitors, Game Fun and Boom.

Candidate: Does Boom’s hardware system run Game Fun’s software, and vice versa?

Interviewer: No. Boom games are not compatible on Game Fun’s hardware systems, and Game Fun games are unusable on Boom gaming systems.

Now you know why XYZ’ gaming systems are gaining market share. Video game users can play both Boom and Game Fun games on XYZ hardware. In fact, owners of Boom and Game Fun systems may be switching over to using XYZ hardware in order to enjoy games from both companies.

But before you recommend more resources go into XYZ’s gaming division, you need to explore further — other possible sources of revenue, and possible competitors.

Candidate: Can XYZ make its own game software that works just on XYZ systems to provide an added incentive to buy XYZ hardware?

Interviewer: It’s a possibility.

Candidate: How about cloning Game Fun and/or Boom software? That may increase sales as well.

Interviewer: That’s a possibility too.

Candidate: Is it possible that Game Fun or Boom could change their hardware systems to render them capable of using the competitor’s software?

Interviewer: It’s possible, but unlikely.

Candidate: Could another competitor emerge with hardware capable of running both Boom and Game Fun games?

Interviewer: It is possible, but it would take at least a $100 million investment.

This is a fairly high barrier to entry. It seems that XYZ has a unique competitive advantage that is worth financing.

Candidate: Even though software is a growth market and hardware is not, it seems that the fact that XYZ hardware can run a wider range of software (i.e., games) is a major competitive advantage. It seems unlikely that a competitor to XYZ will emerge in the near future. I would recommend making the investment. XYZ should also explore the idea of developing its own software that runs only on XYZ to further enhance its competitive position.

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