Profitability Structuring

Question

I know this question has been asked before but I am wondering when you look at a profitability case whether you think it makes more sense to take a top-down (existing operations, market dynamics, competition, etc.) or a bottom up (i.e. focus on key revenue/cost drivers and how to improve them.

For example a recent case I did was structured in the following way:

1. The owner of a movie theater wants to increase its profits by some arbitrary amount and has $50m to spend on theatre upgrades ONLY. What projects/areas should he focus on? Let's say they don't care if you increase revenues or decrease costs or both so long as profits go up and that the timeline is 1-2 years; furthermore, assume that the theatre is operating at or near full capacity in terms of tickets sold.

For a question like this I am unsure if it makes more sense to start at the bottom with specific revenue/cost drivers i.e. number of tickets sold x price per ticket, amount of food sold x average price per order, advertising revenue, etc. and looking at what factors drive the unit economics of it and then looking at the marginal cost to marginal revenue of various projects that would change these drivers.

OR

Start at the top and look at from a more “traditional” Customer, Company, Competition, etc. view where you would inquire about (i) Customer behavior (price sensitivity, what they value for when choosing what theatre to go to), (ii) Competitors (how they are performing, what type of services they offer, how they are adapting), and (iii) Company (what it currently offers, what revenue streams are growing fastest/most profitable, etc.)

Sorry for the long post but any advice would be appreciated.

Answer 1

Hi Avery,

Emily is completely right here. This is not a profitability case…it is an investment case.

You read the word profits and assumed…this is extremely dangerous (this can happen across all case types). Always be objective-driven in your frameworking.

Now, in terms of your question regarding profitability…it depends. You need to interpret the context of the case (clues/hints, industry, trends etc) and adjust your framework accordingly.

GENERAL PROFITABILITY APPROACH

You need to understand the industry + company context from the prompt itself to figure this out...cases and case types cannot be memorized...you have to adjust every single time!

Example: LOOKING FIRST at Economy/Industry

In my Hot Wheels case, you're a Korean OEM with falling profits. You operate in the US and Japan. The FIRST thing you have to look at here is the general market AND how competitors are doing. Otherwise, you will never learn that US OEMs are doing well in the US while Korean OEMs are NOT doing well in the US. Then, you'll never solve the crux of the case which is that transport times+costs are prohibitively like (Just in Time delivery is the #1 product characteristic).

If you don't look at economy/industry first here, you will not solve the case in a time effective manner.

https://www.preplounge.com/en/management-consulting-cases/candidate-led-usual-style/intermediate/hot-wheels-186

Example NOT looking at Economy/Industry

Take my "Chinese Airline During Covid" case example. We know that the airline is in trouble due to covid. We can make the deduction that this is caused by a reduction in demand. As such, we don't really need to look into rest of market/industry

So, we want to "repair" existing revenue streams as much as possible. So, first let's see what we can do. Then, whatever "gap" is remaining, we want to fill it with alternative revenue streams. Finally, whatever we can't make up for, we have to fix through cost cutting (ideally cutting unused capacity). See the logic here?

And it'll change every time based on the case itself...think critically!

https://www.preplounge.com/en/management-consulting-cases/candidate-led-usual-style/intermediate/chinese-chess-airline-business-during-covid-19-191

GENERAL PROFIT DRIVERS

Volume Down: Competition reduced prices or improved their product (outcompeting you), competition just launched effective marketing, regulation has slowed you down, economic decline, environmental disaster, tarrifs, suppliers disrupting your production, your product no longer applies to the customer (i.e. decline has been happening for a while)...and so on and so forth...

Price Down: We're in a price war, costs have gone down so we're realising this, regulation has created a price cap, we ran a discount program

Variable Costs Up: Raw materials costing more, inefficient contracts, ageing workforce, deteriorating workforce, regulations, quality control

Fixed Costs Up: Recent large investments

================================================

REVENUE ISSUES/IMPROVEMENTS

Remember, you need to apply your revenue improvement ideas to the specific case at hand. You cannot be generic.

That said, some major ways companies boost sales include:

SAAS (software as a service)
(Relatedly) Subscription revenue
- Get people onot subscription plans (i.e. Netflix)
Behavior-changing "memberships" - i.e. Amazon Prime
- When people enter Prime membership, they actually actively spend more than they did before
Bundling
- I.e. sell a few things together
Radiation
- Sell products similar to the current one
Low-price entry
- Get someone in with a super cheap/good deal, then, now that you have them as a customer, sell additional, higher-margin products (insurance companies do this, for example)

==================================================

COST ISSUES

In general, for determining cost issues, you need to break down the problem into a tree/root-cause analysis and ask the highest level (but specific) questions first! In this way, you essentially move down the tree.

How do you identify where to look? Well, you need to look into whichever of the following 5 make the most sense based on where you are:

What's the biggest? (i.e. largest piece of the pie...most likely to change the end result)
What's changing the most? (I.e. could be driving the most and most likely to be fixable)
What's the easiest to answer/eliminate? (i.e. quick win. Yes/No type of question that eliminates a lot of other things)
What's the most different? (differences between companies, business units, products, geographies etc....difference = oopportunity)
What's the most likely? (self-explanatory)

https://www.preplounge.com/en/consulting-forum/structure-breakdown-for-costs-7963

https://www.preplounge.com/en/consulting-forum/inventory-costs-how-to-segment-6861

https://www.preplounge.com/en/consulting-forum/direct-and-indirect-instead-of-fixed-and-variable-6272

https://www.preplounge.com/en/consulting-forum/when-should-i-break-down-costs-as-fixed-and-variable-as-opposed-to-over-the-value-chain-5990

Major Costs - Areas to Cut

FC

Rent
Labour (salaried employees)
Transport (if we own the trucks, etc.)
Capex
Utilities (for the office, warehouse, etc.)
Cbsolescence (wrong word...this is amortization/depreciation)
Stolen objects (but shocked you heard this in a case)

VC

Labour (hourly employees)
Transport (if we pay a company per load)
Fuel/truckers (if we own our own trucks etc. for transport)
Utilities (if you need more energy to make more widgets)
Raw Materials (why wasn't this included? Big one to miss)

Answer 2

Hi there,

So I wouldn’t go for either structure. The question being asked is ‘how should the client spend the $50M to drive profit improvements’.

If you look at a traditional profit issue tree it’s not going to get you to any insights:

Cost per ticket. So you may be able to use the investment to buy more expensive films / put in upgrades to the theater which allows you to charge more. But looking at cost per ticket is not going to give you any insights into what they should do.
Number of tickets sold. This is where investment could make a big difference. But what are you going to invest in? This lever doesn’t get you there
Costs. There may be some costs where you need an upfront investment to lower costs (e.g., putting in a more energy efficient air con). You could get some insights from this but less your cinema infrastructure is really run down, it’s unlikely to get you there

So the other framework you suggest is customer, company, competition etc. This is generic, but ok.

Competition - you’d see what they offer and if our offering matches it ( or alternatively doesn’t differentiate at all); where they’re located and if it’s right on our doorstep; how they price
Customer - you’d want to know what they want according to different segments, where they’re located and if we’re located in the right places
Company - do we have the right talent, what are our facilities like

But I think that you can make a more specific framework. They way that I like to do this is by running through the things that you do when you’re both a customer, and an owner of a company and decide to watch a movie.

Customer:

Decide what film you want to see -> customers, what are our segments, what films do they want to see?
Decide where to go to see the film -> marketing, location and viewing times and potentially viewing mode (do they want to watch films at home?)
Get to the movie theatre -> transport links, parking
Buy the ticket -> purchasing systems (online and in person), sales reps, pricing
Buy popcorn -> ancillary sales
Sit in the theatre (and maybe go via the bathroom) -> facilities
Watch the movie -> quality of the theatre and the other people in the movie theatre (do you want to ban children from some films?!), security
Leave and tell all your friends how great it was -> referral programmes, online review centres

Company: All of the above plus:

Pay the bills for the theatre -> cost reduction opportunities
Ensure that you’re complying with all regulation -> regulatory environment

You then want to look at all the levers and bring them into buckets:

Customers: What are the segments, what films do they watch, what mode do they watch them in, where are they and what times do they want to watch films, what other clientele do they want to be around?
Venues: Where are they and how does this compare with competitors, what are the transport links, what state of repair are they in and what facilities do they have?
Product: What films are we showing (and does this match what customers want?), what ancillary sales do we have
Marketing: What review platforms do we have, what marketing do we do, how does this compare with competitors?
Costs: Are there fixed or variable costs which require an upfront investment to reduce?
Regulations: What is there regulatory environment and are there revenue / cost opportunities (e.g., do we pay a particular licensing fee to sell alcohol but actually alcohol sales are v., low?)

Hope that helps!

Answer 3

So the investor wants to upgrade the theaters.

My suggestion would be to first consider the potential upgrades you can do. Then setup a framework to consider the impact in terms of revenues and costs.

To consider the potencial upgrades I would think about the assets the theater has (usually considering a kind of customer experience or process tree): you buy a ticket at the counter, you buy some popcorn, you pick a movie, you watch some commercials, etc. All of these involve assets that can be upgraded.

You can also think about revenues and costs. Revenues would be capacity x occupancy x average spend (ticket + extras). Some advertising revenue as well.

So you go and think about upgrades that can increase capacity (adding chairs), occupancy (better billboard, better ticket purchase experience, redesigning the theater layout so you have more rooms, or more capacity at the “premieres”), or sell more extras sold (change layout so you can have more stuff, or that you can have more people selling thus reducing the waiting lines).

Then think about costs (types of labour, energy, maintenance, distribution fees, …).

I think the 2nd approach (going through revenues and costs, but one won't do a good job without actually thinking about the specifics of the theathers assets, which is the 1st approach I suggested).

Please note the difference between what I've done and what you are suggesting. You are suggesting approaches to improve profitability. I am suggesting approaches to improve profitability by investing in theater upgrades. Meaning that you are not answering the case's specific question , which would ultimately lead you to fail the interview.