In Profitability cases, when analyzing the cost side, how to decide the cost structure breakup?

Question

Sometimes it is easier to solve the problem by dividing the costs into Direct & Indirect Costs and sometimes it is useful to divide them on the basis of Fixed and Variable costs. How to decide which one to use

Answer 1

In my experience as an interviewer most of the time it doesn’t matter how you will divide the costs. What matters is breadth and depth of how you approach the problem. What do I mean by that?

Let’s take an example of fixed costs for the restaurant industry to keep things simple. Your answer should include as many of the fixed costs in each category as possible + possible interdependencies between them (breadth). So, an average candidate would name the following things for fixed costs:

Rent
Utilities
Salaries

And an excellent candidate could also mention:

Depreciation of equipment
Insurance
Interest expense

An excellent candidate could also get creative and mention possible interdependencies, e.g. an insurance amount could depend on rent (what state the space is in, if there are safe vaults or CCTV cameras installed by the landlord, etc.) or that depreciation of equipment could depend on salaries (more qualified people would cause less equipment failures, therefore equipment can be depreciated slower). The broader you go here, the better.

Then you go and try to put depth into your structure. For example, you start with rent and break it down on what it depends on:

Where is it located
What state is the space in (is it run-down or has it been recently renovated?)
Who are the neighbors (high-end restaurants or shady establishments?)
How much competition is around?

The deeper and more creative you go, the better.

So, overall: be structured and logical and try to always be as broad and as deep as possible. What breakdown you use (fixed vs variable, direct vs indirect, internal vs external, etc.) is then less relevant. And if your interviewer will want you to break down the costs in some specific way, she will say so – so, don’t worry about that.

Answer 2

Hi,

At the beginning of the case, you can put Fixed and Variable

Once you get to the costs side, there are two options:

The interviewer has some cost structure and will give it to you when you ask
The interviewer can ask you to brainstorm and come up with a list of costs

Best!

Answer 3

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