The most common case type in consulting interviews: the profitability case
Profit questions are the number 1 reason for most consulting projects
Start with a profitability problem. Examples are falling sales, rising costs or both. Your task will be two-fold: performing a structured and quantitative analysis of the data to isolate the problem and then finding a promising solution for the problem.
We will explain the procedure along a profitability case example just like one you might encounter in a consulting interview: Your client is a chewing gum manufacturer (you can find the entire case here). The CEO of the manufacturing company is concerned because his company is experiencing declining profitability. Please investigate the reasons for the decline and give suggestions for improvement.
The five steps to crack a profitability case problem
1. Clarify the problem
Remember the 4 commandments!
Take notes! Start with restating the problem: “Just so we are on the same page, our main objective is to determine the reasons behind the decline in profitability for a chewing gum manufacturer and provide recommendations to improve the profitability of the business, is that correct?”
2. Prepare your structure
“Thank you, may I take a minute to prepare my structure?”
As mentioned in the introduction, the terms “declining profitability, falling sales or rising costs” hint at a profitability case. You now have to isolate the problem and quantify it. A good start to analyze a profit problem is by using the profitability equation:
When profits go down, you either have a decline in revenue, raising costs or both. The best way to find the root cause is to sketch the problem as an issue tree. Start with the more promising part, for instance revenues - because the market is highly competitive. Obviously you would share that thought with your interviewer and be on the lookout for hints. E.g. ‘I am going to look at revenues first since in a competitive market like the chewing gums I’d expect this to be a big driver’.
You can further break down the profit tree like below:
Now you can start with one of the branches. Let's take the revenue side.
3. Analyze the revenue side
Whenever you get the information that something has changed: quantify it! Ask by how much and in what time period. And very importantly: SEGMENT the revenues streams! You can ask the interviewer whether you can segment the revenues into its component parts. If the interviewer prompts you to do the segmentation, you can think about different customer segments (small business / large business etc., age group, sex etc…), product lines or regions (South America, Asia etc). This segmentation will help you isolate the root of the problem. You'll be able to develop better and more targeted analyses.
For example, when helping a chewing gum manufacturer improve his profitability, you may ask: “What are the revenue sources?”. The interviewer tells you that all revenue comes from two products: Flavored and non-flavored chewing gums. At this point, you might want to know the development of sales over the past couple of years. “How have sales figures developed over the years for both products?” He shares the following diagram with you:
It now becomes clear that revenue is not the problem because it has grown steadily in recent years. Therefore, it must be costs that rose significantly, leading to a drop in profitability.
If you’ve found the biggest driver of the problem, you often times have to switch to a more qualitative framework like the 4 Cs to find the underlying root cause! Example: when you have less revenue, but the price is the same and units sold dropped you have to find out why. Is there a new competitor on the market? Do you have quality problems, or did you just stop a marketing initiative that you ran for years prior to this drop.
4. Analyze the cost side
Now explore the cost side. You know that costs can be broken down into direct and indirect costs. You can then inquiry about the break down of costs: "Please tell me about the direct/indirect cost split for the products.” The interviewer hands you the following graph:
As we know that there are two different product lines, it is advisable to calculate their margins to check if there is a more profitable product line. You calculate the margin for both products based on the following formula:
“I'd like to calculate the margins for both products; do you have information on the different prices and costs for each of them?” The interviewer hands you the following graph:
Based on this, you calculate the margins:
5. Close the case
“Analyses show that the product whose sales have increased (flavored chewing gum) is also the one with lower margins due to the added flavor. Therefore, total profit margins have decreased while sales have increased.”
After you have determined the root cause, you must develop a good logical solution (e.g. developing a competitive response, starting a marketing initiative etc.)
It is important to stay structured even if you think you have reached a final stage. Therefore, categorize your approaches for instance by short-term/ easy to implement solutions and long-term ones.
- Negotiate with current suppliers
- Look for other suppliers (form partnerships or buy greater amounts with batch discounts)
- Vertical integration
- Release new products with better margins (e.g. low calorie flavor gum or tooth cleaning gum)
- The client could also increase the price of the flavored gum, risking decreasing sales if customers do not see any added value with the price rise (high price sensitivity).
Profitability cases - Key takeaways:
Profitability problems are frequent in consulting case interviews. To solve a profitability problem:
- find the root cause using the profit formula
- use a tree structure
- go down one branch at a time and segment it
- quantify and look for trends
- locate the biggest driver
- find out why through qualitative analysis and additional analysis (e.g. using the 4 Cs Framework)