Profitability Framework: Master This Case Interview Structure

Profitability Framework. Image is of a man counting up money with a calculator.

When you first start preparing for consulting case study interviews, coming up with a structure for analyzing the problem can seem intimidating.

It doesn’t have to be.

The profitability case framework is a simple yet flexible framework that you can apply to many types of case interview questions.

S
tart your practice here, and you’ll soon have the confidence to expand to other case interview frameworks and begin creating ones that are all your own.

In this article, we’ll discuss:

  • What is a Framework?
  • Why You Want to Use a Framework to Answer a Case Interview Question,
  • The Profitability Equation – the Basis of the Profitability Case Framework,
  • A Profitability Framework Example,
  • Types of Case Interview Questions that Can Be Answered Using the Profitability Case Framework, and 
  • Tips on Using the Profitability Framework.

Let’s get started!

What is a Framework?

A framework is the high-level set of topics that must be addressed when answering a case question or business problem. Frameworks break down a business problem into the component parts that need to be analyzed in order to:

  1. Identify the root cause of the issue that needs to be solved, and
  2. Develop a solution that will work for the client’s business.

Framework Example: The 3Cs – Company, Customers, and Competition

The 3Cs framework is helpful when addressing a wide variety of case questions, including competitive strategy. This framework requires you to consider issues around Customer, Company, and Competition when analyzing the business problem.

For more on the 3Cs framework as well as other frameworks such as the BCG 2 x 2 Matrix, SWOT analysis, the 4Ps, or other frameworks, see our Case Interview Frameworks article.

Why You Want to Use a Framework to Answer a Case Interview Question

A man analyzing the progression of revenues  in his company
Consultants use case interviews to assess candidates because cases mimic the work that a consulting team does over the course of a 3-month client engagement. Cases go through a simplified version  of the work in 25-30 minutes.

Every client is different and so the solutions to their problem are different. Because of this, consulting interviewers aren’t looking for candidates to have an immediate solution to the business problem. 

Instead, they’re looking for candidates who are good at structured problem-solving.

Structured problem-solving allows someone who has general knowledge of business to direct their analysis to the relevant aspects of the client’s problem so they can solve it. 

A framework is a useful tool to help you structure your problem solving because it highlights the key topics to be addressed in your analysis.

The Profitability Equation – the Basis of the Profitability Case Framework

At the highest level, the profitability framework is a simple equation:

Profits = Revenues – Costs

At this high level, the equation does not provide a tremendous amount of insight, but both costs and revenues can be broken down further. 
The profitability formula
Revenue depends on how much of its products and services a company sells and at what price. Costs depend on fixed costs and variable costs. 

Quantity sold is the amount of goods or services sold in a period of time. The pounds of bananas, hours of personal fitness coaching, or number of cell phone screen repairs sold to customers.

Price is the amount of money charged for the product or service sold.

Fixed costs are the costs that don’t change based on the quantity of goods sold (or at least don’t change quickly). They include things like: property costs (rent for offices, factories, warehouses, or retail space), depreciation of equipment needed to make the product or provide the service, the cost of salaried employees/management, property taxes, etc.

Variable costs are the costs that depend directly on the quantity of goods or services sold. Example: if you sell more cars, you need to buy more tons of steel and more tires in order to manufacture the cars. Variable costs include: materials used to make the product, the cost of hourly employees (those directly involved in making the product or producing the service), shipping, credit card transaction costs, etc.

To use the profitability equation to solve a case interview question, you start with either cost or revenue and ask questions about how the components of each are changing until you find the issue(s) which is(are) hurting profitability. 

Once you know what is causing the profitability problem, you can move on to brainstorming how to fix it.

Using  the Profitability Framework to Drive Deeper Analysis

There are several ways you can dive deeper into a profitability case. They involve segmenting the business into its component parts or benchmarking.

Segmenting: Comparing one segment of a client’s business to another for the purposes of identifying key differences. You can segment a businesses financial performance by comparing:

  • One business segment to another,
  • One geographic unit to another,
  • One distribution channel to another, or
  • One customer type to another.


Benchmarking: Compare the client’s business or a segment to:

  • Key competitors, or
  • The client’s own performance in prior periods.

 

Here’s how.

Breaking Down Profitability by Business Segment, Geography, Distribution Channel or Customer Type

Breaking Down Profitability by Business Segment

Some case questions will involve the relative profitability of different parts of a company such as by business segment,  geographic unit, distribution channel, or customer type. 

Suppose a computer company is competing successfully in the retail market but losing business to the competition in the corporate and education markets. To better understand the business problem they face, you should look at the profitability of each business segment separately.

Retail PC Profits = Retail PC Revenues – Retail PC Costs

Corporate PC Profits = Corporate PC Revenues – Corporate PC Costs

Educational PC Profits = Educational PC Revenues – Educational PC Costs

When you dive into the revenues and costs of each division separately, you may find that the cost structure that allows the company to be successful in the retail market does not provide the level of standardization needed by corporate IT departments, resulting in lost sales to those clients. Or the client might not be able to hit the price point needed to compete in the price-sensitive educational market.

Breaking Down Profitability by Geography

Now suppose this same computer company sells computers all over the world. To understand whether the heart of their profitability problem stems from with differences in the geographic markets it competes in, you can compare the profitability of the different geographic units and analyze what is driving the differences you see. 

North American PC Profits = North American PC Revenues – North American PC Costs

Latin American PC Profits = Latin American PC Revenues – Latin American PC Costs

European PC Profits = European PC Revenues – European PC Costs

Asian PC Profits =Asian PC Revenues – Asian PC Costs

African PC Profits =African PC Revenues – African PC Costs

By drilling down into the revenues and costs by region, you may find that the cost structures in the different markets are fundamentally different due to differences in government regulations, labor rates, and pricing/the level of competition, etc.

Looking at each segment of the business separately helps to identify what makes one part of the company profitable and others unprofitable.

You can look at profitability by sales channel of customer type as well as by business unit or geography. 

The best comparison to you depends on the individual case. You might need to break down profitability a couple different ways to find the one that is most relevant to solving the case.

Benchmarking Profitability Relative to the Competition

case interview profitability framework. The image shows a business woman reading a pie chart.

Sometimes the change in a business’s profitability isn’t caused by the actions of the company itself. It’s caused by actions the competition has taken.

This can happen if the competitor takes actions to increase demand for their products and services such as:

  • Reduces its costs,
  • Reduces prices, 
  • Increases advertising spending,
  • Increases sales staff, or
  • Opens new store locations.

Benchmarking Profitability Over Time

If a client’s competitors haven’t changed their business strategy and the profitability problem isn’t focused on any one product segment or geography, the next thing to analyze is the client’s cost and revenue structure over time.

Costs that aren’t carefully managed will increase over time. New employees will be hired, head office facilities expanded, or component costs increasing with inflation.

Flat revenue combined with rising costs will put pressure on profits.  Even if revenue isn’t  flat, cost increases outpacing revenue increases will cause a profitability problem.

If profits are squeezed by continually rising costs, the client can resolve its profitability problem by:

  • Managing costs better,
  • Raising prices,
  • Gaining market share, or 
  • Doing all of the above.

How Do You Know Which Profitability Analysis Is Right to Use?

Sometimes you’ll get a hint in what type of profitability benchmarking you should do from the case question.

If the question says that a North American company is experiencing low profitability in its sales in China – compare the cost structure of the North American business unit to that of the Chinese business unit. If you identify differences that explain the problem and help you find a solution, that’s the right comparison.

If there are no differences in the cost or revenue structure of the 2 geographies, look at the profitability of the Chinese business unit to competitors in China or to its own past performance. Try different benchmarks until you find differences that explain the problem with profitability.

If the question asks about how to improve the profitability of a particular product, compare that product’s cost and revenue structure to the profitability of their other major products.

Profitability Framework Example: Frozen Heaven Ice Cream

profitability framework example. the image shows two people discussing a graph in a presentation.

Case Introduction:

Our client, Frozen Heaven, makes small-batch ice cream. They serve the ice cream in the company’s restaurants as well as selling pints and quarts to go. Frozen Heaven has been experiencing a decline in profits and wants to turn this trend around. 

What should they do?

Analysis:

Start by exploring either costs or revenues. 

Question: How have revenues been trending over time?

Revenues are down by 5% versus the prior year.

Question: I’d like to understand what’s going on with revenue by looking at price and the quantity of ice cream sold. First, has the price of Frozen Heaven’s ice cream changed?

There’s been no significant change in either the pricing of either the packaged ice cream or the ice cream served in the restaurants.

Question: So the problem has been with the quantity of ice cream sold. 

Yes, the quantity of ice cream sold is down 5%. The decline has been about the same across both the packaged and restaurant-served products.

Question: I’m interested in understanding possible causes for the decline in ice cream sales. Are there any new competitors in the market?

No.

Question: Have existing competitors changed anything about their business? Price, advertising, opening new restaurants?

Both our client and the competitors have added new stores over the last 12 months at about the same rate. Pricing and advertising haven’t changed.

Question: Has our client’s product changed?

The client hired a new head of operations 15 months ago. She has over ten years of experience with one of the biggest mass-market ice cream manufacturers in North America. She was given latitude to make changes to improve the company’s efficiency and profitability. In fact, she’s reduced costs but 3%. Unfortunately, that’s not enough to offset the reduction in revenue.

Question: I’d like to understand the change in costs. Was the cost reduction in fixed costs, variable costs, or both.

Variable costs.

Question: Was the reduction in labor, the cost of ingredients, or something else?

The cost of ingredients.

Question: What ingredient costs went down? 

Dollars spend on milk have been in line with the reduced quantity of ice cream sold, as were the costs of flavorings like chocolate, vanilla, etc. 

The biggest change has been in the cost of mix-ins to the ice cream. The client creates specialty flavors by adding in things like chocolate chips, caramel, and crushed up Oreos and Heath Bar, etc. These costs are down 30%.

Question: Has the reduction in mix-ins made a difference to the client’s customers?

That’s a good question. We haven’t studied this, but a quick review of the client’s reviews on Yelp shows there are comments from customers suggesting that they’ve noticed the reduction in mix-ins and don’t like the change.

Conclusion/Recommendation:

Frozen Heaven has seen a decrease in profitability resulting from a reduction in the quantity of ice cream it sells both in packages and served to customers in its restaurants. Frozen Heaven’s variable costs have gone down. That would seem to be good for profitability at first glance, but the cost reduction resulted from smaller quantities of mix-ins being used in the ice cream. 

From a quick scan of Yelp, it sounds like the customers don’t like the changes to Frozen Heaven ice cream. I’d recommend using customer focus groups to gain a deeper understanding of what Frozen Heaven’s customers want in their ice cream. If it turns out that the mix-ins are important to their customers’ buying decision, they should return to former mix-in levels even if it means spending more money. It will be worth it in terms of increased sales.

It’s possible the client’s head of operations won’t like this recommendation because she made the change to the amount of mix-ins used, probably because she thought that it would increase profitability. But the results of focus groups will persuade her that this recommendation will improve profitability.

Types of Case Interview Questions that Can Be Answered Using the Profitability Framework

Profitability framework. The image shows a consultant writing a presentation with several graphs.
  • A retail apparel client’s profitability has declined over the last year. What is the source of the decline and how can we turn it around?
  • An airline outsourced the food service on its planes several years ago. Now they are unhappy about the quality of the food served to customers and are thinking of bringing it back in-house. How would that impact the cost of food service? The cost structure of the airline overall?
  • A client that makes and markets beauty products through department stores has seen sales decline in the European market. How can they reverse this decline?
  • The public school system in a city is facing a significant budget shortfall. How can they reduce costs to close the budget gap?
  • A hospital supplies provider is experiencing a rise in the cost of its products. This has resulted in a squeeze on margins. How can it improve its profitability?
  • A restaurant holding company recently launched a new brand of restaurants in a few test markets. These new restaurants are popular with customers but not as profitable as their existing restaurants. What should they do?

6 Tips on Using the Profitability Framework: Segmentation & Benchmarking Options

1. Segment by Business Unit.

Identify key business segments. If the profit margin differs substantially from one business unit to another, analyze their individual revenue and cost structures to identify the problem.

2. Segment by Geography.

Identify the geographies the business operates in. If profitability differs substantially from one geography to another, dive deeper into this to identify the problem.

3. Segment by Sales Channel.

If a company has more than one sales channel, such as a direct sales force and sales through distributors, compare the profit margin of one to the other to identify problems.

4. Segment by Customer Type.

Compare profits of products sold to different industries or of specialized/high-end products to mass market/low-priced products to look for differences and opportunities for improvement.

5. Comparison to Key Competitors.

Look for differences in the cost structure and pricing between the client and key competitors. If there are differences, look for opportunities to correct disadvantaged cost structures or raise prices.

6.Comparison Over Time.

Analyze cost and revenue trends over time to see if they have been moving against the client and find opportunities to improve results.

In this article, we’ve covered:

  • What a Framework is,
  • Why You Want to Use a Framework to Answer a Case Interview Question,
  • The Profitability Equation – the Basis of the Profitability Case Framework,
  • A Profitability Framework Example,
  • Types of Case Interview Questions that Can Be Answered Using the Profitability Framework, and
  • Tips on Using the Profitability Framework.


Still have questions?

 

If you have more questions about the profitability framework, leave them in the comments below. One of My Consulting Offer’s case coaches will answer them.

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