Imagine this, your company’s profits have taken a hit from last year and you don’t know why or how to respond. This is a problem that you should be solving immediately, to ensure you know why and so that it doesn’t happen again.
Where do you look first? Is there more competition in the market? Is there an economic downturn or is it a customer confidence issue? It could be any of those things, but where to start?
Taking a structured approach to the problem here is key. This is to ensure we get to a root cause that is the significant driver of the problem, so we can determine the most value adding response as quickly as possible, based on good rationale to solve the problem.
Drivers: The secret here is to understand what drivers are influencing profit, then the drivers of those drivers, then the drivers of those drivers and so on, until you get to your root cause.
Usually a problem needing to be solved will have a chain or sub components that in turn cause an effect on the problem. It’s really about taking a logical approach to the significant drivers of the problem. Based on our profit problem, we know that profit= revenue – costs. Because of the make up, we know that these are the two key drivers significantly influencing our profit.
By comparing these two drivers against last year’s performance, we can understand which component part needs to be further looked in to and where the root cause may lie.
For example, if we know that revenue remained relatively static this year compared to last and that costs actually went up, we can initially deduct that the root cause may lie within the costs space.
With this valuable information, we can further break the costs down in to its sub drivers to understand why costs may have changed. This could be where you review fixed vs variable costs, which could include your office costs, staff costs or variable, which could include the costs of fluctuating things you may be buying based on sales volume or some other variable that changes that in turn influences how much you buy of something e.g. parts, ingredients, materials etc.
By understanding the drivers of each component part of profit and beyond, we will ultimately get to the root cause of the problem and for this example, it may be that variable costs may have gone up as a result of a specific supplier considerably increasing costs relative to last year.
You see, It’s just a matter of repeating this until you get to the root cause.
The information you come away with will usually influence or form the basis of a strategic decision, which for example, could be to find another supplier, sourcing products from a cheaper manufacturer or renegotiating existing agreements. Whatever the solution, it will be the right one, based on a logical, rationale and methodical approach, that will ultimately solve your business problem.
By completing analysis of the problem in this way, we get to our root cause much more efficiently, as we are in the first instance, tackling the drivers that directly influence the problem. Yes it may be the problem may be something else not in the profit calculation for example, but that’s secondary to the drivers directly influencing profit and therefore, should be tackled later.
This structured approach is nothing new and is typically used by consultants as a starting point. Naturally, this may lead you down a path that is heavily focussed on revenue and costs and this may not always be where the problem lies, but it is certainly a good starting point and 8/10 times solve the bulk if not all of the problem – 80/20 thinking.
So next time you have a problem, the first question you should ask is, what are the most significant influencing drivers of the performance of the problem? and what are the sub drivers to that driver? And so on. For us, it was revenue and costs and then fixed/variable costs, resulting in a supplier disproportionately increasing costs over last year, but next time it could be the problem of a declining sales volume of a certain product sold, where the most significant influencing drivers may be other options available to the customer on the market, or a cheaper alternative and therefore, you would need to respond to that, which may result in an analysis piece on your value chain to create or manage that competitive advantage or even review the value offered by your product in the current market and update the product or reconsider the price accordingly.
In business analysis, you may have heard of the five why technique, where some say, “it usually takes five why’s to get to a root cause” – this is inefficient and does not offer a wider understanding of the business problem and usually results in asking why of the variables that need not be questioned. Breaking the problem in to component parts or their drivers and then repeating this process offers efficiency, context, technical understanding of the problem and proper targeting of the root cause.
Problems are easy and there are a range of frameworks that can be used to structure thinking and problem solving, which I’ll talk about in future posts. Remember however that this is something that anyone can do and by taking a structured approach based on drivers and sub drivers will usually yield in (a) the correct root cause; (b) the problem being solved effectively and (c) result in good insight and data to base strategic decisions on.