Structuring revenue and profitability problem

Question

I have encountered many cases in which the issue is "we want to understand why are revenues/profits declining and what to do". I have found useful to structure the first part of the problem (cause) by trying to understand external and internal factors.

I would like to know if I should address the second part (what to do) in the initial strucure or do this once the cause has been identified? also what alternative structures are there to frame these kind of cases?

Answer 1

Hi!

The purpose of a structrue is to clearly explain how you will answer the precise question that has been asked by the client.

The question is: "What is the cause of the revenue issue?"

Structuring a case means to explain, HOW you will answer his concrete question. In order to do this, you have to outline the LOGIC according to which it can be answered.

Hence, you should outline a clear logic that will ultimately and invariably lead to the root cause of the revenue problem.

For this, you first need to isolate what (sub-)driver causes the decline. Revenue is too high level, you need to find out whether it is an issue with pricing, or the product mix, or the quantities. If, e.g., lower quantity is the problem, then you drill deeper to understand the concrete numerical driver (e.g., the average number of items per purchase has not changed, but the number of purchases has gone down --> then you drill deeper to understand what is driving this (the "sub-driver") --> e.g., the number of customers has not changed, but their average frequency of purchasing has gone down --> this is the numerical problem driver! You isolated it just by means of a driver tree).

Once you have isolated the problem driver (WHAT is the problem?), then you check on the qualitative reasons that might have caused this very problem driver to develop negatively (WHY does the problem exist?). You exclude all other areas of the tree because they are not relevant! This is how you run effective and efficient diagnostics. This second step of qualitative analysis might indeed require some extra structuring once you reach it!

What aspect that is very important (and usually violated in Case Coaching books) is the principle of first isolating the numerical problem driver, before asking qualitative question. Never start your analysis with asking qualitative questions ("First I would like to get a general understanding of the market development", "I would like to look at internal/external factors" and such phrases)! This is practically the very definition of "boiling the ocean", i.e., working in an extremely inefficient way. First, you should seek to narrow down the area that you need to qualitatively understand - and this can be done very quickly by doing a numerical analysis as described above. Once you know where the problem comes from, THEN you can start to understand the qualitative reasons that underlie the negative development of this driver, and this analysis will be far more focused and concrete than if you would have tried to do it at the start.

Cheers, Sidi

Answer 2

Hi!

My take on this is that despite the question involving two parts - the why and the what - the idea of the profitability structure is that it involves determining the drivers for the why. So it should be all encompassing to cover the why and the what.

The structure I recommend using is one that involves a horizontol and vertical approach (essentially a matrix).

At the top (horizontally), I would draw out the typical profitability formula. From left to right I would write revenue = P X Q and cost = unit cost X Q.

Vertically, I would detail the various ways those drivers affect proftiability:

For P - price change ; and new price

For Q - existing volume change; and new volume change

For both P & Q - mix of product change (you could sell a different mix of your own product that delivers different levels of profitability...think average price)

For unit cost - you have the effect of fixed and variable costs

For Q (from a cost perspective) - you have inventory management

Now that you have detailed the structure and matrix quite comprehensively (MECE). You can then use this to allocate the reasons why. I can prove to you that this covers all aspects.

Possible reasons for Revenue change:

1. Competition (old or new)

2. Consumer preference change

3. Other market share drivers (sales and marketing efforts, customer relations, new customers etc...)

4. M&A activitiy

5. Increased market size - whether it is natural growth, new method of use for products, non-customers becoming customers etc...

6. product mix

Reasons for cost changes

1. economies of scale

2. fixed costs upgrades

3. poor forecasting

4. product mix

5. sourcing changes (better or worse vendor, vendor bankrupt, vendor price change, shortages etc...)

6. supply chain or other forms of integration (vertical or horizontal)

7. logistics (change in geography of customers, outsource vs. insource, batches shipped at a time etc...)

etc...

Each of those reasons could be traced to one of the structure drivers or levers. Whether factors are internally driven or externally driver, the why could be placed into one of the matrices.

DM me for more information and on how to identify why reasons and levers are more likely than not the case. I can help with practicing the model and detialing it out.

Best,

Rakan Bilbeisi

Answer 3

Hi there,

You have it all wrong!

Implied within a very framework is that you will then "do something to fix it all"! This should never be a bucket.

Rather, inherent in any framework is root cause identification and opportunity/solutioning. They are not seperate buckets.

In terms of alternativue profitbatlity structures you can also use contribution margin. When to use R vs C split and contribution is very nuanced so drop me a line and I'm happy to talk through it more.

Answer 4

Personally,

I like to get a quantitative picture of the situation first. For a profitability case this means that I will first figure out wether or not it is an rev/cost problem. Then dig deeper (say it is an revenue problem) to price/volume.

After that I think it makes sense to look at external/internal factors to get a more qualitative picture of why this issue has occured.

Answer 5

I would probably say the McKinsey M & A framework as it gives you a breakdown of all the buckets you would probably c... (read entire answer)

I would probably say the McKinsey M & A framework as it gives you a breakdown of all the buckets you would probably choose anyway but with a bit more math when it comes to finan... (read entire answer)