After encouraging its workforce to unionize, Egalitarius’ management saw a precipitous decline of 80% in its share price.
With an eye on saving the company and the executive team’s jobs, Egalitarius’ management implemented aggressive cost-cutting measures.
Because Egalitarius’ management cared deeply about its employees, cutting corporate jobs was out of the question. Cutting union jobs would be impossible.
Instead, management focused on cutting the cost to produce a widget. Since 50% of a widget’s cost was from materials and the production process, Egalitarius used lower quality materials to reduce its materials cost by 10%. Now a widget would cost Egalitarius $0.74 to produce rather than $0.77.
Additionally, Egalitarius plans to reduce investment in R&D by 50% over the next two years.
Because this efforts will likely result in a lower quality product, Egalitarius’ management expects to lose 10 percentage points of market share in 2013 as fewer customers choose Egalitarius widgets over Meritocratus ones.
By taking these two measures, Egalitarius is able to raise its market multiple from 9.0x earnings to 9.5x, and increase its 2012 earning to $331 million. While these earnings are higher than Meritocratus’, investors know that Egalitarius is sacrificing its long-term prosperity for short-term gains. They, therefore, value Meritocratus’ stock by $8 million more than Egalitarius’.
Below is a spreadsheet showing a comparison of both companies after unionization of Egalitarius’ workforce and Egalitarius’ aggressive cost-cutting measures.
In the next installment of this series, the Egalitarius workforce goes on strike.