Critical Loss Critical Loss AnalysisAnalysis

Energy Drinks are Energy Drinks are NOTNOT a a Relevant ProductRelevant Product

The Loss vs. The GainThe Loss vs. The Gain

The Two Effects of Raising Price:The Two Effects of Raising Price:

a. a. Loss Loss inin from losing energy drink sales that earned from losing energy drink sales that earned positive marginspositive margins

b. b. GainGain in in from higher prices on energy drink sales from higher prices on energy drink sales that still get madethat still get made

““Critical Loss” is the amount of lost Critical Loss” is the amount of lost sales required for a net reduction sales required for a net reduction in profits.in profits.

MC

Ptoday

Pnew = (1.05)*Ptoday

Gain in Loss in

Critical Loss GraphicallyCritical Loss Graphically

Price, Cost

QuantityQtoday

D

Qnew

Pre-merger margins on retail sales of Pre-merger margins on retail sales of energy drinks are approximately 50% energy drinks are approximately 50% (see Appendix 1).(see Appendix 1).

Losing only 10% of these sales means Losing only 10% of these sales means that a 5% price increase is unprofitable that a 5% price increase is unprofitable (see Appendix 2).(see Appendix 2).

Therefore, Critical Loss is about 10% of Therefore, Critical Loss is about 10% of sales.sales.

Energy Drinks Critical LossEnergy Drinks Critical Loss

Energy Drinks A Market?Energy Drinks A Market?

Will Will actualactual loss in sales resulting loss in sales resulting from price increase be greater than from price increase be greater than critical loss (I.e., 10%) in sales?critical loss (I.e., 10%) in sales? If yes, not a market.If yes, not a market. If no, a market.If no, a market.

Energy Drinks Actual LossEnergy Drinks Actual Loss

Actual loss would be greater than 10%Actual loss would be greater than 10% 86% buyers first time users, 76% of that from 86% buyers first time users, 76% of that from

soft drinks – no loyaltysoft drinks – no loyalty Energy drink demand elasticity = -5.75Energy drink demand elasticity = -5.75 Fast growth suggests fast decline possibleFast growth suggests fast decline possible

Conclusion: energy drinks Conclusion: energy drinks notnot a relevant a relevant market.market.

Appendix 1Appendix 1

Chief Variable Costs of Manufacturing and Chief Variable Costs of Manufacturing and Selling energy drinks are Raw Inputs, Selling energy drinks are Raw Inputs, Labor, Energy, PackagingLabor, Energy, Packaging

Total Revenue/Total Quantity (Average Total Revenue/Total Quantity (Average Revenue) is roughly 2 per half-litreRevenue) is roughly 2 per half-litre

Total Variable Costs/Total Quantity Total Variable Costs/Total Quantity (Average Variable Cost) is roughly 1 per (Average Variable Cost) is roughly 1 per half-litrehalf-litre

Margin = (P-C)/P = (2-1)/2 = .5 or 50%Margin = (P-C)/P = (2-1)/2 = .5 or 50%

Appendix 2Appendix 2The Critical Sales Loss is < 10%The Critical Sales Loss is < 10%

Raise the price of energy drinks 5%Raise the price of energy drinks 5% If the loss is (.1Q) x (.5) [losing 10% of If the loss is (.1Q) x (.5) [losing 10% of

sales that had earned a 50% margin], thensales that had earned a 50% margin], then Then gain is (.9Q) x (.05) [keeping 90% of Then gain is (.9Q) x (.05) [keeping 90% of

sales and earning an extra 5% on each]sales and earning an extra 5% on each] Loss is .05 Q > Gain is .045 QLoss is .05 Q > Gain is .045 Q Conclusion: Critical Loss is about 10%Conclusion: Critical Loss is about 10%