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Mece profitability framework?

Carl asked on May 15, 2019

Hi,

I am having some problems with the profitability framework. I will present how I would structure a profitability problem today and what I believe is the problem with that structure, it would be great to hear your thoughts on this.

(Will make this generic, would of course tailor it to the specific case).

In general, in a profitability case I would first draw two branches for two overarching areas: Profits and Execution. Under profits I would then draw one branch for each revenue segment, to see if any of the segments are more profitable. Then I would drill further down in to costs, revenues and mix for the segments.

Under mix I am thinking e.g. Customer segments, product lines etc. The problem I am having is whether or not I should put mix here? Since the mix could also go both under cost and under revenues. Let´s say I start looking at the mix, I find out that one customer segment is more profitable than the others, what should I do with revenues and cost?

In which order do you think that I should look at this and is it Mece, as the mix could go under cost and revenues as well..?

Thank you!

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Sidi
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replied on May 15, 2019
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Hi! "Mix" is not an area in a logic tree! It is just a description of a potential issue that you might find. So it does not make any sense to try and include it in your deeper analyses - especially since you already cover it in your very first disaggregation! You first disaggregate profits into the different segments. Hence, by comparing current profits with historic profits (and the underlying drivers like especially quantity sold) for each segment, you can already see whether the mix has changed and if the problem is particularly driven by one specific segment (e.g., Profits of segment A have remained constant, while Segment B has lost 50% of its profits --> then you need to double click on segment B and see what has changed (check revenues (+quantity & price developments) and costs of the segment). And so on...

Cheers, Sidi

Thank you! Do you think that revenue streams (if more than one) should be covered in the first disaggregation. The problem I am having with not doing this is let´s say the problem is that you are focusing on a less profitable product. Then if you just look at the revenues first they might say "revenues have gone up". I would then think okay so it is not a revenue problem, but it could be a revenue problem in a specific product line.. — Carl on May 16, 2019

Segmentation of revenue streams has to be figured out FIRST, before diving deep. Otherwise you could always argue that there could be further segmentation down the line. Cases can only have a very limited degree of complexity, so more than 1 level of segmentation would be extremely rare anyway. — Sidi on May 16, 2019

And if the case is that a company has a profitablity problem, I ask for revenues and get the answer that revenues have gone up - should I still ask for segments or just conclude that it is not a revenue problem? Then how do I go about cost, should these be segmented based on the revenue streams or on fixed and variable? — Carl on May 16, 2019

You HAVE to ask for segments! Always! This is the FIRST disaggregation to do. Before looking at revenues, you check whether profits have changed across segments. — Sidi on May 16, 2019

Thank you Sidi, and sorry for so many questions. I agree with you and will take that with me in my future cases! — Carl on May 16, 2019

Ian
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replied on May 16, 2019
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Hi Carl,

Sidi said it well!

I think you're getting confused by a "3rd dimension" or slice of Profits/Revenues. You'll probably run into this when solving a case that involves customer segments as well.

Just remember, split Profit into Revenue and Cost. THEN, when solving the case, Revenue and Cost can be looked at from a different angle. I.e., they might go "We have 3 main costs" or "Revenue comes from 4 streams" or "For Product A, our Revenue is x, and Product B our revenue is y". This is when you use a table to organise the math. But, no need to account for this in the framework.

Rather, in the framework, think about WHAT you would look at in this deep-dive.

So, under Revenue, you might say "I'm interested in looking at the Revenue streams for the 3 products. This comes as quantity sold times price, and I'd like to look at the trends for these. So, which products have the most volume, or highest price/margin, or are growing the most? We'd want to enhance this. Then, which products have the least volume, lowest price/margin, or are growing slowly/shrinking? We'd want to consider either cutting these products, or finding wants to reverse the negative trait"

Then, the case would provide those numbers for you and you can dive into "mix" and analysis. Make sense?

Thanks a lot, you are totally right - I got very confused with the 3rd dimension. Basically - How I am thinking right now is that I should look at the revenue streams and follow the process you just presented. Then go through price and quantity, if I find out that maybe price is the problem, I could be looking at the mix - e.g. if we are positioned against customer segments with less willingness to pay. Process: 1. Revenue streams to find out where the issue 2. Revenue or cost problem? 3. Find the root cause (price, volume, specific cost) 4. Based on cause, look at mix (e.g. customer segments). Again, very generic but this seems like an ok approach to me - what do you think? — Carl on May 16, 2019 (edited)

Hey Carl, Yes those are good ways to think about it! It being generic, you'll have to use judgement to see which of those 4 options you should start with. Ultimately, you're trying to FIRST ask the question that has the easiest answer. I.e., what will tell me what I CAN NOT or CAN look at first? — Ian on May 16, 2019

Daniel replied on May 15, 2019
Imperial College PhD, Rolls-Royce Project Engineer, RWTH Aachen Mechanical Engineer and Business Administrator, Software Engineer

Hi Carl,

every math equations, like the profit equation, is in its nature MECE. You can have your proposed segments in both branches as you look in each branch at those from a different angle. In the cost bucket, you analyse costs of each segment, whereas in the revenue bucket, you look at the revenues in each segment. So there is no problem with not being MECE. Only because you use a name twice doesn't mean that the content is repeated. It important to make that clear to your interviewer.

Good luck with your preparation!

Regards,

Daniel

Thank you, that makes a lot of scence! What do you think is the most appropriate way to tackle this, segment directly on profits or first see whether there is a revenue or Cost problem and then segment. It seems as it makes more scence to just segment it first and then go through Cost and revenue in the problem segment? Then the problem is that I would have Cost, revenue and mix in the same level in My issue tree. Sorry if these are dumb question, maybe I am overthinking this — Carl on May 15, 2019

Carl replied on May 16, 2019

I was reading another thread on the topic of profitability cases (https://www.preplounge.com/en/consulting-forum/structuring-profitability-cases-837). Here, the thought seems to be that it is unstructured to ask for segmentation as clarifying questions. Why is that? Isn't it good to understand the business line and then divide profits into the revenue streams in your issue tree or is it something that I am missing here?

Vlad replied on May 15, 2019
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Hi,

Why don't you just ask about the products in clarifying questions?

Then you split into revenues and costs. Revenues you split further into price / qty / mix or customers / av check. Costs you split further into fixed and variables

Best!

Hi, Let´s say I ask in the clarifying questions "what are the revenue streams?" - to get an understanding of the business model. Should I then proactively segment the profit in to the revenue streams or should I just write profit and mix/segment and then during the case ask how the client would like to segment the profits. The reason why I am asking is because it might seem like I do not use the information I get upfront, but then I do not want to assume a segment. So let´s say a company has two revenue streams, but the client wants to segment the revenues in to customer segments, when do I use the revenue streams? — Carl on May 16, 2019

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