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Case study · Judge a company
A tariff hits a drinks maker
A case study for the economics side of "Judge a company": a tariff on imported cans raises a drinks maker's costs, and the answer to "absorb it or raise prices?" depends on how much pricing power the company has.
General education, not financial advice.
Brookside Drinks sells a canned soft drink. The company and figures are made up, but the reasoning is the one analysts use when a tariff is announced. It is an exercise in analysis, not a view on any real company.
The numbers, per can
| Item | Before the tariff |
|---|---|
| Price to retailers | 1.00 |
| Cost of the can | 0.10 |
| All other costs | 0.50 |
| Profit | 0.40 |
The news. The government puts a 25% tariff on imported aluminium cans. Brookside's cans are imported, so each costs 0.025 more.
Two possible markets
- Market A: Brookside is a strong brand. Analysts estimate the elasticity of demand for its drink, at today's price, at about −1.5: a 1% price rise loses about 1.5% of volume.
- Market B: Brookside is one of many similar store brands. Elasticity for its drink is about −3.
(These are estimates at the current price. The case doesn't ask whether the old price was the best one; it asks what to do about the tariff.)
Your task
- If Brookside absorbs the tariff, what happens to profit per can?
- If it raises its price by 2.5% to pass the tariff on, what happens to volume, revenue and profit in each market?
- Which choice is better in each market?
- Who bears the cost of the tariff: Brookside, its customers, or both? Who gains?
- What would you look for in a real company's annual report to judge this?
Solution
Try the task first, then open one step at a time and compare.
Step 1: absorbing the tariff
Profit per can falls from 0.40 to 0.375, down 6.25%. Volume is unchanged, so total profit falls 6.25%.
Step 2: passing it on
Price rises 2.5%, to 1.025, so profit per can is back to 0.40.
- Market A (elasticity −1.5): volume falls about 1.5 × 2.5% = 3.75%. Revenue changes by 1.025 × 0.9625 − 1 ≈ −1.3%. Profit, relative to before: 0.40 × 0.9625 ≈ 0.385 per original can, better than absorbing (0.375). Revenue falls, but profit rises: revenue and profit are not the same test.
- Market B (elasticity −3): volume falls about 3 × 2.5% = 7.5%. Revenue changes by 1.025 × 0.925 − 1 ≈ −5.2%. Profit: 0.40 × 0.925 = 0.370, slightly worse than absorbing (0.375).
(These use the simple rule "volume change ≈ elasticity × price change", which is fine for small changes.)
Step 3: the better choice
Passing the tariff on keeps 0.40 a can but loses volume; absorbing it keeps the volume at 0.375. The two break even when volume falls by 6.25%, which here means an elasticity of about −2.5. Less sensitive than that (market A), raising the price wins; more sensitive (market B), absorbing the cost is slightly better, because a price rise drives customers to rivals. This is what analysts mean by pricing power: the ability to pass on higher costs without losing many customers.
Step 4: who bears the tariff, and who gains
The burden is shared, and the side that is less able to switch bears more of it. For Brookside's own drink: in market A, its customers are slower to switch, so they bear more of it through higher prices; in market B, the company bears most of it through lower margins. The government gains the tariff revenue, 0.025 on every imported can, and domestic can makers gain too: they can now charge more or win orders. The tariff also creates a deadweight loss: some drinks that were worth making and buying no longer are.
Step 5: what to look for in a real report
- Gross margin over several years, especially after past cost rises: did it hold?
- The revenue bridge: how much growth came from price and mix rather than volume?
- Where the main inputs come from, and any hedging or supply contracts described in the notes.
- The risk factors on trade and tariffs, and the competition section.
Check yourself
Nothing here is graded or saved.