The profitability case question is a classic and there’s a very high chance you’ll have to solve some form of profit problem at least once during your rounds of consulting interviews.
Here’s an outline of how best to approach this kind of case question.
Break down the problem
We know that profit is defined as revenue minus cost, where revenue is the quantity sold multiplied by the price of the product and cost is the sum of all the expenses.
For example, your client could be a winemaker looking to increase their profits. In this instance, revenue is the number of bottles sold multiplied by the price of a bottle. As for the cost, it’s the sum of the costs associated with growing and harvesting the grapes, aging and bottling the wine, distributing the product, and the overhead, including sales and marketing.
You should look to divide the costs into fixed costs and variable costs. Fixed costs are those that don’t change with the quantity sold and variable costs normally fluctuate in proportion to the quantity.
This approach is perfectly fine, but it really does not tell you how you can increase revenue or decrease costs—which is really what you want to figure out to crack the case. Let’s look at how you can bring this approach to the next level and nail the profit problem with precision.
Take multiple lines of business into account
Most companies will have more than one line of business, so when looking to improve the profits of a business with several units, product types, or locations you want to look at the profitability of each part of the business separately in order to eliminate the parts that are losing money.
In the winemaker example, if they were producing several types of wines, you’d start by determining the profitability of each product and discontinue loss-making wines. Only once you’ve done that, would you look at opportunities to increase revenue or decrease cost across the business.
Consider the options for reducing cost
Now that you’ve identified the main cost buckets, there are three ways to reduce them.
First, reduce the need for what you’re buying. Second, meet the need with fewer resources. And third, reduce the cost of the resources.
Let’s say you’re looking at reducing call center costs for a utility company.
First, how can you reduce the need? You can do this by either eliminating the need entirely or by reducing the service level.
The second driver is to meet the need with fewer resources. If you keep the volume of calls constant it’s about handling them with fewer operators by eliminating waste and improving productivity.
The third driver is reducing the costs of the resources. You can save costs while keeping the same call volume and number of operators in two ways; either you find cheaper alternatives or you renegotiate the costs. Finding cheaper alternatives might mean offshoring staff to a lower-cost country. Renegotiating costs might involve reducing salaries or benefits.
Consider the options for increasing revenue
Finally, it’s time to turn to increasing revenue.
In the basic structure outlined in the beginning, we thought about increasing revenue as a factor of increasing quantity and price. However, this assumes that you’re going to keep selling the same products and it does not tell you how to increase price or quantity.
Instead, there are two ways to grow revenue: grow in your core business or grow out of your core business.
To grow in your core business, you can focus on growing within your current market segments or you can focus on identifying and pursuing the fastest growing segments in the market.
To grow outside of your core business, you can sell new products to your current clients or leverage your capabilities and assets to launch new products and services.
For example, if your client is a car maker with a strong presence in the SUV market, they could grow within the SUV market, their core product, by making better products, improving marketing, and offering competitive prices.
Or, they could grow outside of the core business by selling new products to their current clients, such as insurance, maintenance plans, and leasing. Or they could use their capabilities to get into new businesses, such as trucks, buses, or motorbikes.
The line of investigation you choose will depend on a number of factors such as the time horizon, market maturity, and the position of the company in its market.
In any case, diving deeper below the basic profit framework is key to drawing out useful insights in order to deliver a strong recommendation to the client.
To see examples of profitability cases make sure to check out the Roko Hotels and Easy Haul cases, along with many others in the Interview Prep Course. You can also practice structuring profitability cases by completing the 50 Structuring Drills inside the course.