Johnson Controls to Increase Profit of HVAC Control Systems

Case Type: improve profitability.
Consulting Firm: Siemens Management Consulting (SMC) 2nd round full time job interview.
Industry Coverage: industrial equipment; electronics.

Case Interview Question #00942: Our client Johnson Controls, Inc. (NYSE: JCI) is a leading manufacturer and distributor of HVAC equipment and control systems. HVAC (stands for Heating, Ventilation and Air Conditioning) equipment needs a control system to regulate the operation of a heating and/or air conditioning system. Usually a sensing device is used to compare the actual temperature with a target value. Then the control system draws a conclusion what action has to be taken, e.g. start the blower.

The client Johnson Controls Inc. (JCI) produces, installs, and services HVAC air temperature control systems. Historically the company enjoyed rapid growth for over 20 years and became the clear market leader. More recently, however, it has been losing profit at a rate of about 2% a year. JCI has asked your consulting firm to help them understand what’s going on and how to increase profitability. How would you go about it?

Additional Information: If requested, share the following product information

* The air temperature control systems consist of two primary components: digital readers and remotely controlled flaps that are placed in air ducts.
* JCI bundles their air temperature control systems with installation.
* JCI sells service plans (i.e. warrantees, maintenance, and repair) separately from the monitoring system.

Possible Answer:

1. Suggested Structure

The candidate should provide an approach that includes at least the following elements: Competition, Customers, Profitability, and Product Mix.

2. Competition

Interviewer: Provide the following information, when prompted:

* There is little differentiation among manufacturers of air temperature control systems. The market is evenly split among several national players.
* The competition tends to be more profitable than JCI.
* JCI’s air temperature control systems can be serviced by JCI, by customers (in house), or by a 3rd party.
* JCI cannot service a competitor’s air temperature control system. The opposite is also true.

3. Profitability

Interviewer: At this point, ask the Candidate to talk about why they believe that the competition tends to be more profitable, despite the fact that there is not great deal of differentiation among air temperature control systems.

Candidate: The ideal response from the candidate will include at least the following:

* Mix of product versus service
* Mix of customers
* Relative profitability or costs for each

Interviewer: Once the interviewer has identified product/service mix as a possible driver, provide the following information:

* JCI Mix: 70% Product (air temperature control systems/installation) and 30% Service.
* Competition Mix: 60% Product and 40% Service.

Interviewer: Ask the Candidate what they think about the product/service mix.

Candidate: The Candidate should observe that product/service mix may be a driver of JCI’s lower profitability – JCI derives more revenue from products on a percentage basis – But we can’t know for certain that this is true without knowing what the relative profitability of Product & Service is.

A savvy Candidate should hypothesize that services margins should be higher than product margins, because there is keener competition between products (little differentiation) than between service providers (since services are tied to respective manufacturers’ product installed base). Once the Candidate recognizes this point, provide the following information:

* JCI Product Margin: 4%
* JCI Service Margin: 15%
* Competition’s Product Margin: 5%
* Competition’s Service Margin: 15%

Interviewer: Now ask the following: Based on this information, can you tell me what the overall profitability is of JCI relative to the competition assuming that the margin percentages reflect the full cost of their businesses, respectively? (if the Candidate does not calculate it on his/her their own, hint him/her to)

Candidate：

JCI Profit Margin = (4% * 70%) + (15% * 30%) = 2.8% + 4.5% = 7.3%
Competition’s Profit Margin = (5% * 60%) + (15% * 40%) = 3% + 6% = 9%

Interviewer: So based on this information, (1) why does JCI have a lower profit margin than the competition and (2) what if JCI could focus on one area, where should it focus?

Candidate:

Candidate’s answer to part (1) of the question: JCI has an unfavorable mix of product/service and profit margin on their product side of the business is lower.

Candidate’s answer to part (2) of the question: JCI should focus on improving its service margins since that will provide a greater boost to profitability than improving product margins. Also, its service provides 4.5% points of its overall profitability of 7.3%.

4. Customers

Once the Candidate identifies service as the area of focus, let them know that there are two types of services we provide: Break/Fix and Long-term Service Contracts.

Now inform them that we’ve spoken with two of our customers’ CFOs who stated the following:
– CFO A: “Purchasing a long-term service contract makes perfect sense”
– CFO B: “Purchasing a long-term service contract make no sense at all”

Interviewer: Assuming that both statements are correct, how is it possible that the two CFO’s statements are so contradictory?

Candidate: The candidate’s response may include several possibilities such as financial reporting/metrics or CFO financial incentives. However, the interviewer should cue the candidate to think strategically. In this case, the correct explanation is that the CFO’s are supporting facilities that have varying degrees of tolerance for air temperature control system downtime (i.e. break/fix agreements). For example, office buildings versus hospitals.

Interviewer: Once the Candidate gets to this point, inform them that the majority of JCI’s service business is Break/Fix (as opposed to Long-term Service Contracts). Now ask them to think about why this might be the case.

Candidate: The ideal answer will reference the fact that customers will be drawn to service contracts depending on their business model. Businesses for who continuous temperature control is critical will likely gravitate toward long-term service contracts that prevent downtime. Businesses willing to endure temporary outages will likely opt for break/rix agreements. JCI does a much better job of selling service to customers with a high risk tolerance (such as office buildings) as opposed to those that have a low risk tolerance such as hospitals and pharmaceutical companies) due to the tremendous cost that temperature variations could present for their businesses.

Interviewer: Ask the Candidate to think about how JCI could address this other group of customers that is more averse to risk (downtime).

Candidate: Good answers could include:

* Hire or build relationship with thought leaders in the industry
* Retrain sales personnel to help push service contracts (educate them on value proposition)
* Retrain service personnel to ensure they know how to service new group of customers
* Advertising

5. Recommendation

The recommendation should at least provide a response to both questions utilizing the findings from the case:
(1) Why has JCI’ profitability gone down?
(2) What should they do to rectify the issue?