28.1 Revenue Versus Cost
The natural starting point for most profitability cases is:
Profit = Revenue − Costs
If profit has declined, determine whether revenue decreased, costs increased, or both.
This first split is useful because it immediately narrows the investigation. If revenue is stable while profit falls, costs deserve greater attention. If costs are unchanged but profit declines, revenue is likely the main problem.
Best practice: Quantify the change whenever possible. Do not simply conclude that both revenue and costs moved. Determine how much each contributed to the profit decline.
28.2 Price Versus Volume
Revenue can usually be decomposed into:
Revenue = Price × Volume
If revenue has declined, determine whether the company is charging less, selling fewer units, or experiencing both.
Then go deeper. A volume decline could result from fewer customers, lower purchase frequency, smaller transactions, lost distribution, or reduced capacity. A price decline could reflect discounting, competitive pressure, or changes in product mix.
Key question: What changed operationally or commercially to cause price or volume to move?
28.3 Fixed Versus Variable Costs
Costs can often be divided into fixed and variable components.
Fixed costs: Costs that do not change significantly with short-term volume, such as rent, corporate overhead, or certain salaried employees.
Variable costs: Costs that generally increase with output or sales, such as materials, shipping, commissions, or transaction fees.
This distinction helps explain how changes in volume affect profitability.
For example, a factory experiencing declining sales may still carry most of its fixed costs, causing profit to fall faster than revenue.
Important: Use the cost structure that fits the actual business rather than forcing every expense into an overly simplistic classification.
28.4 Segmenting Profitability
Company-wide averages can hide the real problem. Once you understand the overall movement, segment profitability to find where the change is concentrated.
Useful dimensions include:
- Product: Which products are gaining or losing profit?
- Customer: Are certain segments substantially more profitable?
- Geography: Is the decline concentrated in particular regions?
- Channel: Do online, retail, or distributor channels have different economics?
- Time: When did profitability begin to change?
Goal: Identify where the problem exists before spending too much time explaining why it exists.
28.5 Understanding Mix
Profitability can change even when total price, volume, or costs appear relatively stable because the mix of business changes.
Suppose a company sells a high-margin premium product and a low-margin basic product. If customers shift toward the basic product, total unit sales might remain unchanged while profit declines.
Mix can involve products, customers, geographies, channels, or services.
Useful question: “Has the composition of what we sell or whom we sell to changed?”
Mix effects are particularly important when averages appear stable but overall profitability is moving unexpectedly.
28.6 Diagnosing the Root Cause
Identifying that revenue declined or costs increased is not enough. Those are intermediate findings. You need to determine why.
If volume declined, investigate possible causes such as:
- Customer demand: Have needs or preferences changed?
- Competition: Did competitors gain share?
- Pricing: Did higher prices reduce demand?
- Product: Has quality or attractiveness deteriorated?
- Distribution: Has customer access declined?
If costs increased, investigate wage rates, material prices, supplier terms, productivity, utilization, logistics, or overhead.
Root-cause discipline: Continue asking “why?” until you reach a driver the client can potentially act on.
28.7 Developing Improvement Options
Once the root cause is understood, develop actions that directly address it.
Revenue improvement options might include price optimization, customer retention, product improvements, new channels, stronger sales execution, or better product mix.
Cost actions might include supplier negotiations, process improvements, automation, footprint changes, productivity improvements, or overhead reduction.
Evaluate possible actions based on:
- Impact: How much profit could the initiative create?
- Feasibility: Can the client realistically implement it?
- Timing: How quickly will benefits appear?
- Investment: What resources are required?
- Risk: Could the action damage customers, quality, growth, or operations?
Final principle: Profitability cases become much easier when approached as a sequence: determine whether the problem is revenue or cost, isolate the relevant drivers, segment to locate the problem, diagnose the underlying cause, and then develop targeted improvement actions. Do not stop when you identify where profit was lost. The real objective is to understand why it happened and what the client should do about it.
