Clues to solving a case study

Alice answers your bleeding heart questions on milkround interviews.

Dear Alice,

I am going for interviews in investment banking, asset management and consulting and being asked to demonstrate my business acumen in verbal case studies where I have to analyse a company suggested by the interviewer.

The problem is I have not heard of half of these companies, and even when I have, I don't know much about them apart from the products they sell to people like me.

Last week, I had to do a case study in a retail consulting interview where I had to comment on the business model of "The Gap" and I did not really know where to start. Help!


Law Student

Dear Melissa,

So you were asked to explain 'The Gap' were you? I have had to explain a few gaps in my time. Usually the gap in style, intellect and social sophistication between me and some hopeless interloper bidding for my romantic affections. I don't know why they bother. Alice is never going to dilute the gene pool of her (as yet) unborn children by bridging such a gap.

As far as the clothing retail version of 'The Gap' is concerned, Alice has heard of it but would never set foot in it.

Often when I am on my way to Armani Casa in New Bond Street the limousine has to take a detour past the unwashed masses in Oxford Street, and it is always an interesting social study to watch the proletariat filing in and out of the high street the doors, throw in a few handfuls of grain, advertise an end-of-season sale, and watch the social and commercial equivalent of feeding time at the zoo.

Of course, I have never set foot in such a workaday establishment myself - Alice adorns herself with couture infinitely more fashionable than chinos and hoodies in every variation of khaki - but I could explain its business model - just as I could explain the business model of any company in the world if asked, even if I had never heard of it before.

How? Not because I know everything about every company but because I use a framework to analyse the company step by step, from the top down.

How can you do the same? The key is to develop a framework that works for you in the same way that mine works for me.

My suggestion is to envisage an inverted triangle and then work your way down it, starting with general factors that affect all companies and then drilling down, deeper and deeper into the factors that are specific to the company in question - like its management and financial performance.

1. General Factors

All businesses have to operate within the wider world so factors like the general economic cycle play their part. Case study questions are not really designed to test macro-economic knowledge (as attractive as it is to possess it) so I suggest you confine yourself to a few observations about consumer confidence, whether incomes are rising or falling, the availability of finance and credit, interest rates, tax rates etc

You should also consider any factors relating to the locations and geographies in which the company operates. The Gap is an American company but it sources its clothes from China. So as hitherto cheap Chinese labourers ask for wage rises, The Gap will face rising costs and pressure on profit margins, although the appreciation in the value of the dollar will help by making raw material imports cheaper and increasing revenues from exports.

2. The Industry

The next step in analysing any company is to consider the industry in which it operates.

Who are its customers? Who are its suppliers? Who are its competitors? Who sells complementary products?

A useful device here is Michael Porter's "Five Forces" model which analyses the level of competition within an industry. He looks at a company from the perspective of (1) customers (2) suppliers (3) existing firms (4) possible new industry entrants (5) possible substitutes.

Clothing retail is a highly competitive business where the consumer is king. There is an almost infinite choice of substitute products from rival firms, so sourcing cheap supplies to maintain profit margins is important.

A second device is to plot the company's industry position on a compass-shaped cross with the vertical line running north to south being the firm's supply chain. Who does it sell its good and services to? To the final consumer? A retailer? A wholesaler? In other words, who is 'due north' of the company on its supply chain and what selling / marketing / distribution challenges does it face?

And from where does it source its products, or create its value, and what are its key factors of production? In other words, who is 'due south' on the supply chain and what sourcing / production / logistics challenges does it face?

The horizontal line - running east to west - is the firm's immediate rivals and collaborators at the same stage of production - those companies making substitute or complementary products.

3.The Company Itself

This is where it gets tricky without direct knowledge of the company. However, things to comment on are: (a) its marketing and branding - quite clever in the case of The Gap (b) the quality of its management - no idea (c) its locations - high street shops and out-of-town retail parks (d) its operating systems and processes.

Marketing is crucial to create consumer demand and brand loyalty, while retail space - whether rented or owned - is the other main factor of production.

One thing The Gap does well (according to my young nephew who shops there) is that it carries every item of clothing in every colour and every size and is rarely out of stock. How does it do that? It must have a good stock ordering system and rigorous processes to ensure that all stock is quickly displayed on the shelves.

4. Financial Analysis

Ultimately, the quality of a business will be expressed in its financial performance. If you are presented with financial information about company, things can get confusing.

On the Profit and Loss Account - which shows income and expenditure - the key numbers to look for are sales revenue (turnover), direct and indirect costs and profit. Try to segment income by product type, customer type and geography. Which carry the highest and lowest value?

Now look at it costs. On what does it spend most money? What does that tell you?

On the Balance Sheet - which shows assets and liabilities - what is the value of its fixed assets? A service business usually has little need for plant and equipment, whereas manufacturers will need to invest in expensive machinery.

Now look at its working capital. How much money does it have tied up in stock and debtors? How much cash does it have? How much money does it owe suppliers? The Gap will have to carry a large amount of stock, although its debtors will be minimal - its customers pay in cash.

Step into the shoes of the company's owners. The key devices here are ratios like P/E and EV/EBITDA. Let's examine each one....

"¢ Price / earnings ("P/E") ratio - in this equation "price" is the value of the company, expressed either as the value of all shares, or of one share, while "earnings" is the company's profit AFTER tax (and by extension AFTER all other costs - interest, tax, depreciation and amortisation) or the profit proportionate to each share. In other words, P/E is "Value divided by Profit". So, if a company worth £100m produces a profit of £10m then its P/E ratio is 10. And put another way, it is also the number of years it would take to repay a purchase of any of the company's shares. Finally, because in P/E the profits after tax and interest are those left for the equity holders, while the value is the value of the shares, P/E is a view of a company solely from the perspective of its equity holders

"¢ Enterprise Value / Earnings before Interest, Tax, Depreciation and Amortisation ("EV / EBITDA") ratio - phew - bit of a mouthful this one - something Alice usually likes - and this equation is no exception. 'EV' means Enterprise Value and is the company's total market value irrespective of how it is financed - its equity AND its debt. Think of a house. Its value is the total price someone would pay to buy it, not the deposit they would pay (the Equity) or the mortgage they would raise (the Debt). EBITDA is the company's profit BEFORE interest and tax are paid, as the former relates to how to the company is financed (the level of debt and we have already said that is irrelevant to this equation), while the latter relates to the tax regime of the country in which the company is based (which is not directly relevant to how good a company it is).

Depreciation and amortisation are just accounting entries - not real cashflows - and relate to the write-down in net book value in the accounts of fixed assets - tangible assets in the case of depreciation and intangible assets in the case of amortisation. EV / EBITDA is a view of the company from everyone's perspective

Finally, consider any specific ratios that particularly relate to the company in question. In the case of The Gap look at EV / Sales or Sales / Square Foot of Retail Floor Space.

Anyway, the one thing you can't explain about The Gap is how it........The phrase "Mind the Gap" has never been more apt.