Profitability Case - Analysis of market and some company aspects before profitability issue tree?

Hi Anonymous! 

Given the underying premises of your question, and the many inaccuracies that have been spread by “case preparation books” over the last decade, I need to explain a couple of absolutetely crucial points here.

Your described initial approach corresponds to what is outlined in the usual case preparation books, youtube videos, etc. (mostly created by authors who have been still very junior when they left Consulting or did not even work in Consulting!). But as a matter of fact, this approach is not how a real consultant should tackle such questions! At least not in MBB.

Firstly, the term "profitability case" is nonsense!

Now, please read the above sentence again... This is super important to understand, because practically the entire "case preparation literature" is teaching this crap. What we are actually looking at here is a class of strategic problems that can be called "Diagnostic situations" - and it can comprise any observed phenomenon (a decrease in profit is just one out of hundreds of possible variations). All of these problems can (and should) be attacked by the same core logic.

Before delving into rather qualitative and contextual analysis (such as understanding market or industry phenomena), you should ALWAYS first isolate the numerical driver of the problem. This means that you have to turn around your approach! First you do a numerical analysis to unerstand what is MATHEMATICALLY driving the profit decline. Once you have isolated this problem driver, then you do a qualitative analysis to understand the UNDERLYING REASONS for this negative development of this specific driver. If you don't do it like this and stick to what is recommended in the books, you will always be extremely inefficient in your analysis, since this approach is essentially the definition of "boiling the ocean". First narrow down what area you have to understand, and only then try to understand it!

In your concrete case, knowing market details and whether it's and industry problem or not is more or less useless at the start! This information has ZERO impact on your first layer of analysis if done rigorously. First you have to understand what is numerically causing the problem. Only once you have found out the problem driver, then investigating on whether competitors have the same problem is effective and helpful (because you now already know WHAT the root cause is - you just need to find out why it has emerged)!

Generalized approach:

1. Firstly you need to identify the numerical driver of the below-benchmark profits of the company (the WHAT?-question). --> Identify the different income streams of the company; then for each income stream, draw a driver tree to find and isolate the core of the problem (compared to industry average: less customers? less revenue per customer? lower margin products sold? lower pricing? higher operational costs? etc.) If you find a below-benchmark driver, you need to dig deeper to isolate the sub-driver who is responsible for this negative performance --> the numerical problem dirver!
2. Once the numerical problem driver is isolated, you need to understand the WHY?-question. For this, the analysis depends on what the actual problem is. If it is a cost problem, you may want to go through the entire value chain to diagnose where the difference/disadvantage lies. If it is a revenue or sales mix problem, you may want to scrutinize underlying trends and developments, competing offers, substitutes etc.
3. Based on your quantitative (WHAT?) and qualitative (WHY?) analysis, you can develop/brainstorm strategic measures to address the qualitative reasons.
4. Do not forget to outline potential risks of your strategic recommendation

This is how such problems are typically structured and tackled in top strategy consulting. NEVER start with qualitative questions - it is the most inefficient approach thinkable! First narrow down the (sub-)area that mathematically causes the problem (quantitative analysis) and THEN start asking qualitative questions to understand the underlying reasons.

Cheers, Sidi

_______________________

Dr. Sidi Koné 

(Former Senior Engagement Manager and Interviewer at McKinsey | Former Senior Consultant and Interviewer at BCG)

Great question! When you're looking at a profitability case it is often really helpful to look at what's going on in the broader market so that you know if this is a challenge for the company alone or the industry. 

The overall problem that you're facing though about this particular company. So the first thing that you need to do is understand the revenue / costs of that company. It is helpful to then have a third bucket on external influences - to check if this really is a problem related to this particular company or if it's an industry-wide problem. 

So your initial tree will look something like:

• Revenue: revenue per unit; number of units sold
• Cost: cost / unit (fixed and variable)
• Outside factors: performance compared to the rest of the industry; overall economy performance

The challenge you have in your structure is that you are diving into second / third order questions before you know that you need to go there:

• Market trends / growth - why do you need to know this at the start? It may be relevant if you can see that there are some product lines that are declining and you want to know if this is an industry wide problem; or if you're thinking about entering a new market. But first off you just need to understand whether this is an internal problem with the company or an external market problem. To do that you just need to do a quick benchmark on performance
• Company - you don't need any of these questions first off. You need to identify where the problem is (which you'll get to with a revenue / cost breakdown) - then then these types of questions may become valid as you start to deep dive into how to fix the problem
• Profitability enhancement measures - you won't know where to go with this until you know where the problem is. Is it a cost growth problem? Is it a revenue problem? This will come in later in the case

I hope this helps! Remember to focus on the problem at hand or else you risk ‘boiling the ocean’.

Hi there, 

If it is profitability case you need to understand 1st: is it revenue or it is cost issue? The industry wise question, I dont see wrong asking before even breaking the problem down, as my natural question to the interviewer would be:

•Why the client is coming to the consulting NOW (why not last year for example? What is the trigger?)

Usually this question unfold the cause problem (e.g. cost of the material has increased in the last year by 30% due to the Ukraine war or our provider of raw material went out of market and we were unable to secure the same price we had for the last 30 years… then you know if it is  issue only for your client or industry wise issue)

Once you know if it is cost or revenue, you are breaking it down further:

Revenue = Price * quantity

Breaking down by revenue streams, market segment, channels, etc.

Cost breaking down in different way: classical PL, by department, fix vs. variable, direct vs. indirect. 

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(edited)

You are boiling the ocean with a generic approach with “areas of investigation”. 

This should be solved using an issue tree of hypothesis.
Is this coming from lower volumes or lower margins. What is causing lower volumes - lost market share or lower demand? Are lower margins from lower prices or higher costs? And then keep deep diving on why.