Profitability Framework
The Profitability Framework is one of the most common and versatile. It helps diagnose a company's profitability and identify causes and solutions when profits, revenues, or costs change.
Components
Revenue
Number of units sold × price per unitCosts
Variable costs: directly linked to production or sales
Number of units produced × unit cost
Fixed costs: independent of production or sales volumeProfit
Revenue – Costs = Gross Profit
Approach
Break down profits using the Profitability Framework (blue box)
Adapt
Customize according to context, for example:
- Retail: number of in-store customers, conversion rate, average price per customer
- Software: number of subscribers, ARPU (Average Revenue per User), churn rate
Identify the factors that have the greatest impact
80/20
This step is crucial. Typically, you will need to formulate hypotheses and verify them with available data and quick estimates.
Break down the selected factors into sub-factors (red box) and estimate their quantitative or qualitative impact
Define concrete actions: pricing, operational efficiencies, marketing, product mix, etc., and prioritize based on estimated impact and feasibility
Example
An e-commerce company notices that profits dropped by 20% last quarter, despite an increase in website traffic. You are asked to analyze the causes and suggest actions.
Break down profits
Revenue
- Number of orders: 100,000 (+2% vs previous quarter)
-Average order price: 50€
Costs
- Variable costs: 2,800,000€ (+12% vs previous quarter)
- Fixed costs: 1,000,000€
Identify main factors
From preliminary data, the main impact on profits comes from the increase in variable costs.
Hypothesis: since there was no significant increase in orders, the main cause of the profit drop is the rise in operational costs related to materials and logistics.
Break down into sub-factors
Typically, you will receive data to base your analysis on. You should direct the data request, for example asking for materials and logistic costs. This is what you could get:
From here, you can calculate the increase in cost for each sub-category.
Total increase in variable costs: 300,000€
- Materials: 150,000€ → 50% of profit drop
- Logistics: 150,000€ → 50% of profit drop
The profit decline is significantly driven by both the increase in material costs (raw materials) and logistics (shipping, warehouse).
Define concrete actions
Reduce variable costs
- Materials: negotiate with suppliers, optimize purchasing
- Logistics: reduce shipping costs, optimize warehouse, improve delivery efficiency