Welcome back to our series on using frameworks to break down consulting case interviews. In our first article, we provided an overview of frameworks and how you can use them to solve any case that gets put in front of you. In our last article, we took an in-depth look at Market Sizing. Today, we’re looking at profitability frameworks, which are probably the most important.
Why are the profitability frameworks most important, you ask? Think of it like this: if business is like our solar system, then profit (also known in simple circles as cold hard cash) is the sun, around which the celestial bodies revolve. As hard as it may be for some of you to admit, without the sun (the green stuff, Benjamins, clams, coin) everything falls to pieces – quickly. It’s not that we’re saying money makes the world go round…except when it comes to business, we kinda are).
With that in mind, nailing the profitability case that gets put in front of you is an absolute must; so without any further delay, here are the 4 situations in which you can be sure to apply the profitability framework.
4 Ways To Use The Profitability Framework:
This seems like a bit of a no-brainer here; don’t all companies want to grow, all the time?
But what’s likely true about the case interview you will be presented with is that your client is ready to launch an all-out, no-holds-barred attack on the future in the hopes of seeing significant growth in a short period of time, rather than just incremental growth over a longer period.
It could be that your client wants to grow revenues, market share, profits, or all of the above, but just increasing revenues won’t be enough, because increasing revenues often means increasing costs. You need to demonstrate an understanding of which operating costs are going to be increased for the new initiative, any costs to the client for launching the new initiative, and maybe even calculate the payback period to demonstrate the true impact on the business.
Here’s a rule for profitability – every time revenues are included (growth usually implies revenue growth), cost should also be included. Even if you get pointed squarely towards either cost or revenues by your interviewer, make sure you keep the other in your mind (and in your structure) at all times.
This is every CEO’s biggest nightmare, but just observing declining profits won’t do you any favors. You’ll be expected to present a plan that will:
- Stop the decline in its tracks
- Get the business going in the right direction
If you get a case that deals with declining profits, the first question you should ask is “why?” Declining profits can be caused by one or both of the following:
The basic question here is, “why have sales gone down?” It may be that the customer needs have changed, or it may be that some new fierce competitor has come on the scene. Whichever it is, you need to figure out what is happening and then why it is happening.
Either the variable costs or the fixed costs have gone up. The goal here is to once again figure out what has happened and why it has happened.
These types of questions often revolve around disruption, where potential benefits are either increased revenues or decreased expenses. In these questions, the cost is often investment costs; how much is needed to facilitate the new idea. They are often used for non-profit clients whose ultimate success is based upon profitability. A good example from our book, The Consulting Interview Bible is:
“The City of New York is considering shifting their parking meters from coin-operated to digital. Is this a good idea and why or why not?”
However, in a world of increasingly high profile disruptors like Uber, Netflix, and Dollar Shave Club, these questions may not necessarily apply exclusively to non-profits.
Your client is looking at option A vs option B, but needs the benefit of your top level analytical skills and insight before making their decision. In this situation, you need to quickly assess the revenues and costs associated with each option, ascertain which is the more profitable, and provide your recommendation based on your findings.
How to Use the Profitability Framework:
The first thing you need to do is identify which question you’re addressing.
Next, determine the revenue/revenue drivers. Remember, as a consultant, you will need to look at revenue by segment. This means that instead of doing a simple revenue calculation of:
Average Price x Quantity = Revenue
In reality, with more complicated software (or at least Excel), you’ll do it as follows:
(Price Segment 1 x Quantity Segment 1) + ( Price Segment 2 x Quantity Segment 2) = Revenue
Aside from knowing the profitability equation, you should also be aware of factors that impact profitability:
Factors That Impact Profitability:
Overall market demand
- “Are there a lot of companies providing an identical service?
- Is the market declining?”
- “Are they driving prices down?”
Customer (remember, customer does not necessarily equal final consumer)
- “How much buying power do they have?”
Overall market demand
- “Is it decreasing? Is this industry-wide?”
- “Are they stealing customers?”
- “Are their needs being met?”
- “Are we marketing through the best and most effective channels?”
That was a brief look into revenues, now let’s look at what can affect the costs side of the equation in the profitability framework.
Factors That Impact Costs:
- Fixed Labor
- Other fixed costs, e.g insurance
- COGS (Cost of Goods Sold)
- Variable Labor – Have wages increased without a corresponding increase in price?
- Distribution Costs
- Other Variable Costs
As long as you solve the profitability framework cases using simple structures in 2 levels (what is changing and why), you’ll be well on your way to acing the case. See our introduction to case interview frameworks.
This is just a brief look at the profitability framework, but it’s enough to get you started. If you’d like more help, book an Interview Prep Session with us.