Which profitability structure should one use in specific cases?

Question

Hi preplounge community,

Profitability issue tree can be structured in various ways, especially on the revenue side. Some variations include:

1. Price x Quantity

2. No. of orders X Average order value

3. No. Clients X Avg Revenue per client

and so on..

Sometimes, when business model is such that more than one structure is applicable, which breakdown should I use?

for example, today I did a case on a cheese producer (whose customer is a wholesaler) trying to look for opportunities to increase its profits. I initially came up with structure number (2), however felt that Pounds of cheese sold times price per pound lent me more insights, since I can delve deeper into Pounds sold by talking about maximum output and utilisation rate of machines in the factory, which (2) cannot possibly give me.

Please help me decide on how to decide which structure to use. Thank you so much. Any advice would be really appreciated.

Answer 1

Hi Akanksha,

Please don't use any of these…

If you can help it, you need to be much more robust in your analysis.

Think about it, is the CEO of a multinational cheese company really paying BCG to say “we can improve your profits by either session more cheese or by charging a different price per cheese”

Price x volume and Revenue x Cost are generic and unhelpful frameworks.

Rather, think through the angles/themes/aspects through which you would look at p x v and r x c

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

So for revenue, I’d always start with price and quantity - that’s the fundamental building blocks of revenue. But it’s not always going to get you to the insights that you need.

The other two options you’ve listed are different ways of describing price and quantity - but at that next level of insight. Number 2 is looking at whether there are many small sales or a few big ones. Number 3 is similar, but whether there are many small customers or a few big ones. These are ‘level two’ questions - they are getting to the next level of insight. You may decide to pursue them or, as you found out recently, you may go down different route.

I would always start with the broad price x quantity and then tailor the level two questions from what you learn from that, and what the industry is. There’s no ‘right way’ to learn which framework to use the , you‘ll need to use your judgement based on the question at hand. This is where doing a number of cases can be quite helpful - you’ll start to get an intuitive feel for what to focus on.