Critical Loss Analysis

1
Critical Loss Analysis

• Energy Drinks are NOT a Relevant Product

2
The Loss vs. The Gain

• The Two Effects of Raising Price
• a. Loss in ? from losing energy drink sales that
  earned positive margins
• b. Gain in ? from higher prices on energy drink
  sales that still get made
• Critical Loss is the amount of lost sales
  required for a net reduction in profits.

3
Critical Loss Graphically
Price, Cost
Gain in ?
Loss in ?
Pnew (1.05)Ptoday
Ptoday
MC
D
Quantity
Qtoday
Qnew
4

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.

5
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.

6
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.

7
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

8
Appendix 2The Critical Sales Loss is lt 10

• 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 gt Gain is .045 Q
• Conclusion Critical Loss is about 10