I hear often the entrepreneurs' lament – “it was all so easy and simple in the good old days when we were small and just made money so much more easily than we do now.”
There is a theory of complexity that states that the number of connections in an organization rises by the square of the size of the organization. In other words, linear growth in size leads to exponential growth in complexity. Organizations (or production processes) that become complex tend to exhibit certain characteristics. These include scheduling problems and late due date performance, lost or misplaced items, the need for increasing number of expeditors, indirect and supporting staff, and all of this increases cost or reduces efficiency and effectiveness of the workforce.
We all want to grow, so how do you fight the inevitable scourge of success? Three general strategies are available to the business owner to take action to fight or at least better manage complexity:
- Simplification through segmentation
- Rationalization through elimination
- Value Capture Changes
The simplification via segmentation is based on the idea of breaking the business into smaller self-contained units where each can be simplified to operate independently or at least quasi independently. The critical insights are usually built around a thorough analysis of what are the key performance elements of different segments that the overall business serves and how do you organize to serve them. A classic example comes from the industry of subcontract manufacturing. Customers and their requirements can usually be broken into distinct segments. One segment can be those that order in volume, with longer lead times, and work with a very sharp pencil. A second is customers who order with little planning, are always in a rush, and value a high service level over a finely honed price. An organization can be broken into pieces sometimes with splitting physical arrangements as in a manufacturing operation or dedicating staff in a service operation. The high-volume segment may have a very low ratio of indirect to direct staff and the high service the reverse. The managerial challenge is teasing out what the financial performance of these two segments working from the basis of the current blended cost and staffing structure. The simplification analysis can show both segments are good businesses and sometimes one is just a drain on the other excellent segment. In that case move to Rationalization.
An effort to understand the economics a business segment can lead to the conclusion that overall average profitability is really the result of one segment showing strength and the other weakness. Should the weak segment be poor enough that corrective action and cost reduction in a segmented and focused organization is not possible that segment becomes a candidate to be discarded or removed from the business. Rationalization requires a sharp attention to detail and understanding direct and shared costs before exiting a business segment. Sometimes a lousy performance segment is in itself untenable but acts as an overhead absorption for costs that are not possible to segment. These non-segmental costs can be large fixed costs, regulatory costs, or even supply contracts that require large volume of purchasing power.
Value Capture Changes
A third avenue that can flow from either as a consequence of understanding the economics of simplification or rationalization is changing the business pricing model. Typically, unsegmented businesses are driven by a pricing and costing model based on averages that can bias quoted prices both up and down. A clear understanding of actual segment costs can lead to opportunities to increase prices to capture value or in some cases to lower prices to capture increased sales that contribute to fixed costs and improve the overall business performance.
Sometimes a competitor arrives on the scene and serves only a narrow segment and by reducing complexity, reduces costs, or increases service level and eats away at their larger complex competitors. These disruptive competitors often emerge from the “internet space” where technology is used to simplify major elements of the cost chain and allow price-based disruption.
Growth is usually considered a core strategic goal of most organizations. Carefully understanding the consequences of growth that has created divergent cost performance when mixed inside a single organization, factory, or business model should be on the agenda for a periodic strategic review. The analytical process is complex, and often messy and imperfect, and requires sound business judgment and care. Ignoring complexity challenges, however, is a dangerous game where the next guy not burdened with current inertia carves away your business while you are tangled in your self-made web of success driven complexity.
A better option: consider engaging help from a trusted advisor who understand the complexity and will help you avoid those business-killing assumptions and disruptions.
Todd Peter is a FocusCFO principal, based in Cleveland, OH.