Download Critical Loss Analysis

Critical Loss
Analysis
Energy Drinks are NOT a
Relevant Product
The Loss vs. The Gain
The Two Effects of Raising Price:

a. Loss in  from losing energy drink sales that earned

b. Gain in  from higher prices on energy drink sales
positive margins
that still get made
“Critical Loss” is the amount of lost
sales required for a net reduction
in profits.
Critical Loss Graphically
Price, Cost
Gain in 
Pnew =
Loss in 
(1.05)*Ptoday
Ptoday
MC
D
Qnew Qtoday
Quantity
Energy Drinks Critical Loss



Pre-merger margins on retail sales of
energy drinks are approximately 50%
(see Appendix 1).
Losing only 10% of these sales means
that a 5% price increase is unprofitable
(see Appendix 2).
Therefore, Critical Loss is about 10% of
sales.
Energy Drinks A Market?

Will actual loss in sales resulting
from price increase be greater than
critical loss (I.e., 10%) in sales?
 If yes, not a market.
 If no, a market.
Energy Drinks Actual Loss
 Actual loss would be greater than 10%
 86% buyers first time users, 76% of that from
soft drinks – no loyalty
 Energy drink demand elasticity = -5.75
 Fast growth suggests fast decline possible
 Conclusion: energy drinks not a relevant
market.
Appendix 1




Chief Variable Costs of Manufacturing and
Selling energy drinks are Raw Inputs,
Labor, Energy, Packaging
Total Revenue/Total Quantity (Average
Revenue) is roughly 2 per half-litre
Total Variable Costs/Total Quantity
(Average Variable Cost) is roughly 1 per
half-litre
Margin = (P-C)/P = (2-1)/2 = .5 or 50%
Appendix 2
The Critical Sales Loss is < 10%


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Raise the price of energy drinks 5%
If the loss is (.1Q) x (.5) [losing 10% of
sales that had earned a 50% margin],
then
Then gain is (.9Q) x (.05) [keeping 90%
of sales and earning an extra 5% on each]
Loss is .05 Q > Gain is .045 Q
Conclusion: Critical Loss is about 10%