How to structure a profitability case?

Hi Anonymous,

As for your first question, you can analyse a profitability case looking at 4 key areas: clarify goal and situation, identify the problem, identify the solution and analyse risks.

Step 1: Clarify goal and situation. You should understand at least three things:

1. Specific goal in terms of amount and timeline
2. Business model
3. Whether it’s an industry or client problem

Step 2: Identify the problem. You can proceed through the following steps:

1. Segment by profitability/revenue channels. Ask the interviewer how the client segments its profitability channels. In your case, that may be related to the different type of clients (business/residential) or distribution channels.
2. Identify which channel is the priority. Ask for the change in profitability for each channel. Then start from the one that had the biggest decline in profits.
3. Identify whether it is a revenue or cost issue. Ask how revenues and costs changed for the channel that you have identified. Start from the area which has the major negative change in absolute amount
4. Analyse the components of revenues and/or costs. According to what you found in step 3, you should further segment revenues in price and volume or costs using fix or variable costs
5. Identify the component that is underperforming. You can do so comparing the client performance with its past performance, or benchmarking competitors on that area.
6. Identify the reason for the problem. Usual areas to consider are:

• Customers issues
  • eg revenues: changes of preferences of the customers for different products
  • eg costs: requires expensive addons which do not lead to increase in revenues
• Suppliers issues
  • eg revenues: can’t deliver in time, leading to less sales
  • eg costs: increased prices for suppliers
• Competitors issues
  • eg revenues: decreased prices for competing product
  • eg costs: lobbying strikes/ regulations against us
• Client issues
  • eg revenues: stopped to do marketing campaigns
  • eg costs: wrong process development/budgeting

Step 3: Identify the solution. You can structure a solution based on increasing revenues or decreasing costs as follows. The area where to focus on will depend by the problem previously identified.

• Revenues increase strategies
  • Work on current products
  • Work on new products
• Costs decrease strategies
  • Decrease the cost of each unit
  • Decrease the number of units of cost

Step 4: Analyse risks. Present all the elements that could be risky and should be analysed further before a complete recommendation, according to what you found. Eg: it may be necessary to launch a pilot marketing campaign before the main one, or consider whether reducing benefits for sales people may lead to resignations, etc.

As for your second question, I would ask whether the problem is industry or client related upfront (Step 1.3), leaving though the analysis of what is creating the issue (eg competitors, customers, suppliers) to a later stage (Step 2.6), once you understood in which specific area the problem lays (price, quantity, fix or variable cost, and for which segment).

Best,

Francesco

Hi,

I would recommend the following approach:

1) Ask clarifying questions:

- Clarify the business model (i.e. how the business works and what are the revenue streams / core products or business lines). Why do you need to know the revenue streams? Because it's one of the most critical pieces in understanding the business model. An example is Oil&Gas with up-, mid- and down- streams that are completely different businesses.

- Clarify the objective both in money terms and timeline (e.g. Our objective is to increase profits by 5M in 5 years). When you have a to select from several options in a case - clarify the selection criteria

- Clarify other possible limitations if you feel that it's necessary

2) You make a classic profitability structure adapting it to the case. Sometimes cases are not that easy as just declining profits. For example, if the profits are lower than planned, it is either because we have problems with profits or we have problems with planning. Try to be MECE here.

3) While you do your structure and split revenues into price and quantity - add proactively the 3rd box with the "Mix". Thus you show your business sense and demonstrate that you know the most common case traps. Pls note that the "mix" can be anything - geography, customer, product, etc. You split the costs into fixed and variable.

3) Costs I would split into Fixed and Variable

4) I would start the case by checking whether its increasing revenues, declining costs, or both - so that you could eliminate the part that is irrelevant

5) If it is the quantity problem I would further analyze whether it's the external market problem or internal one

Best!

I suggest to do 2 things while solving these types of cases:

You proactively ask in the beginning, even before drawing the structure (something like "What kind of products / revenue sources do we have) and then split the structure into price, qty, product mix. Distribution and customers I usually check within qty part

1) In the beginning of the case, you should ask the clarifying question: "Could you pls tell me more about the business model and what are the revenue streams?". I suggest to ask this question with any case, even if it is not a profitability type.

2) While you do your structure and split revenues into price and quantity - add proactively the 3rd box with the "Mix". Thus you show your business sense and demonstrate that you know the most common case traps. 

Pls note that the "mix" can be anything - geography, customer, product, etc.

Good luck!

Hi,

If the whole industry has a profitability probelm, I would firs try to understand where does the problem come from and then offer suggestions (depending on the root causes) :

- Does it come from sales ?: drop of volume (substitution, no more demand, new competition from other geographies), drop of price (price war started by a specifc player)

- Does it come from cost ? : increase of raw material costs, high exposure to one supplier with limited bargaining power, ...

- As a company do we have options to stay profitable within this industry ? Change operating model, change scale, create alliance with other players of the industry... If not consider switching to an industry where to current asset are valuable.

Hope this helps

Best
Benjamin

Hey Anonymous,

There's several different ways of approaching the same case (and they can all be right!), that said, below you can find the one I often prefer:

1. Analyze the external factors/market (I do like to know what's going on in the market before even understanding what's going on with the company; as you can imagine it's different if a company wants to grow revenues by 10% in a market growing 20% vs. a market that is even declining!)

- Evolution of market (previous and future)

- Competitive landscape

- Consumer tastes and trends

- Regulation

2. Analyze the internal factors

- profitability tree (try to avoid simply stating Price * Quantity, try to give some tailoring to the industry you're talking about; e.g., for gyms you can say the number of clients who have a monthly pass * the monthly fee.. it will positively impress your interviewer!); if company is multi-product you should take that into consideration here and open multiple revenue streams in the branches! >> includes both the revenue and cost branches, then you should open sub-branches

- sometimes I also include company capabilities as a separe point, depending on the specifics of the case and goal

Hope this can be helpful, any query on it just let me know :)

Best

Bruno

I think if you take Francesco’s suggested approach and substitute the “channel” step (steps 1 and 2) with a broader “mix” analysis suggested by Vlad you have a solid, comprehensive, albeit lengthy, approach.

One more tweak would be to try to identify whether is a price, quantity, fixed or variable cost problem overall earlier in the structure and then probe whether it’s driven by a segment or affects the whole company.

hope it helps,

andrea

I would probably use the classic profitability tree to figure out the drivers causing the decline. 
e.g. 

Revenue assessment:

- P or V declined? 

Cost asseessment:

- FC or VC increased? 

Once I figure out what drivers, dive deeper into whats causing them. E.g. Volume = utilisation problem or perhaps ineffective marketing etc. Then ask for data and so on. 

Hi,

I would recommend the following approach to profitability cases:

1) Ask clarifying questions:

- Clarify the business model (i.e. how the business works and what are the revenue streams / core products or business lines). Why do you need to know the revenue streams? Because it's one of the most critical pieces in understanding the business model. An example is Oil&Gas with up-, mid- and down- streams that are completely different businesses.

- Clarify the objective both in money terms and timeline (e.g. Our objective is to increase profits by 5M in 5 years). When you have a to select from several options in a case - clarify the selection criteria

- Clarify other possible limitations if you feel that it's necessary

2) You make a classic profitability structure adapting it to the case. Sometimes cases are not that easy as just declining profits. For example, if the profits are lower than planned, it is either because we have problems with profits or we have problems with planning. Try to be MECE here.

3) While you do your structure and split revenues into price and quantity - add proactively the 3rd box with the "Mix". Thus you show your business sense and demonstrate that you know the most common case traps. Pls note that the "mix" can be anything - geography, customer, product, etc. You split the costs into fixed and variable.

3) Costs I would split into Fixed and Variable

4) I would start the case by checking whether its increasing revenues, declining costs, or both - so that you could eliminate the part that is irrelevant

5) If it is the quantity problem I would further analyze whether it's the external market problem or an internal one

6) If it is the internal problem you have to understand what we are doing differently now, that our volumes are declining. Which structure to use? Depends on the industry. You may look at the classic marketing structure - Product / distribution / marketing / pricing to identify what is driving the decline in sales. Be aware that this particular structure will work in retail, while in the other industries it may be different (e.g. sales process instead of distribution, etc.)

Best!

Not exactly a structure, but in an industry wide profitability issue, there are a number of typical potential "answers" which you should explore and use your structure to narrow down / verify.

- Focusing on a segment: Overall industry may be declining, but a specific segment of it may be growing - for example, the overall "soft drinks" market might be shrinking, but health drinks in specifically is a growing market.

- Move into new, high growth industries/markets: if margins are under pressure in your home market (e.g. due to regulation, competition), you may look to expand into different industries/markets - either starting operations in a different geography, or "pivoting" into a related industry (with higher growth/margins).

- Put pressure on costs: If margins are tight industry wide, firms often end up having to compete on costs to survive - so answer is often a cost based one

- close up shop: this is always an option to remember, especially in a case where you might be looking only at a subsidiary of a larger parent firm. If you find there's no realistic way to fix profitability issues (assuming profits are negative), the best course of action may be to liquidate.

This is not necessarily an exhaustive list, and none are things you should recommend off the bat - rather, they are areas to explore further to determine if they are feasible.

Hope this helps!

Alessandro

On the top of what has been said, I would recommend you to check this profitability case for beginners, where you can follow the structure and the solving

https://www.preplounge.com/en/management-consulting-cases/interviewer-led-mckinsey-style/beginner/laundry-chain-revenue-increase-215

If you need any further help, feel free to reach out. 

GB

Dear A,

For structuring I would recommend you the main formula of what profitability is about. 

Profitability = revenues - costs. 

There are 3 typical ways on how you can structure the revenues and segment them:

1.  by customers, 

2. by products 

3. by geographical markets

Regarding the costs you may structure them either in the fixed and variable cost, or may also structure them by different kinds of cost - like personell cost, material cost, etc. The other way to look about it is to structure the cost along value chain. 

So, depending on the case you might use different approaches and segment your revenues and cost side. 

Recently I've uploaded a profitability case “Deep Water rescue” (available in English & German) here on Preplounge:
https://www.preplounge.com/en/management-consulting-cases/candidate-led-usual-style/advanced/deep-water-rescue-206

I used similar cases when I was interviewing candidates on my own in Central Europe (Germany & DACH Region), Eastern Europe (Ukraine & Russia) as well as Middle East (Dubai, KSA, Lebanon, and Qatar). So, this case is very advanced and could be typically used in the 2nd or 3rd interview rounds by the leading consulting firms.
 

Try, whether you can crack it. 

Best,
​André