Idea 13 - Costs of complexity (50 Management ideas you really need to know)

Idea 13 -  Costs of complexity

The customer rules. If businesses have learnt anything in the last 50 years, it's to stay laser-focused on the customers and their needs. Give them innovation, give them choice, right? Well, up to a point. Some of those businesses have twigged that rich novelty and variety leads to complexity, and that complexity costs.
Keep it simple. This is not a new idea. Its most famous advocate, though not its first, was the English Franciscan friar, William of Occam. 'Occam's razor' said, essentially, that the simplest solution was usually the best, and that was in the 14th century. Sadly, Occam is silent on the profit implications of his principle. Rather more recently, however, consultants Bain & Company found that the 'lowest complexity' companies grew revenues nearly twice as fast as their peers, among the group of 75 it studied across a dozen different industries. It added that revenue growth appeared far more closely linked to levels of complexity than to company size.

The more complex a business becomes, the higher its Costs. Added complexity may come from many different directions, often associated with expanding the business in some way. It may arise as a result of innovation, extending the product line, or adding new customers. Adopting new technologies and skills adds complexity almost by definition. This kind of market driven complexity may pay for itself, but the business needs to allocate and determine the added costs correctly in order to decide. It may discover that the benefits of expansion are less than it anticipated or, indeed, may even be negative.

More machine time One consultant tells of a packaged food company that tried to defend its market share through an aggressive innovation program. The more it added to its product line, however, the more costs mounted. The marketing team had to be increased by 20%, and inventory levels shot up. On the factory floor, over 30% of available machine time was taken up by changeovers for yet another product. To compensate, the company did longer runs of the low-volume items - which then grew stale before they got to the consumer. The company's innovation strategy, by means of the additional complexity associated with it, threatened to wipe out its cost position, not to mention its market franchise.
Complexity creeps in beneath other disguises. Mergers and acquisitions can deliver all kinds of complexity. An overlarge portfolio of businesses may distract attention from the core activities. Complexity may be too many suppliers or keeping in-house a process that could be more efficiently or effectively outsourced. Fiddly, complicated product designs or process flows add complexity and cost. More levels of hierarchical management equals more complexity. Writer and former strategy consultant Richard Koch believes that about half of all the value-added costs in the average company are complexity-related, and that half of that half offer opportunities for radical cost reduction. 'Waging war on complexity can lead simultaneously to stunning cost reductions and improvements in customer value', he says.

In their 2004 book, Conquering Complexity in Your Business, consultants Michael George and Stephen Wisdom offer three simple maxims:

Ø  Eliminate complexity that customers will not pay for;
Ø  Exploit the complexity that customers will pay for;
Ø  Minimize the costs of the complexity you offer.

George and Wisdom note that the most common situation is for companies to carry more products and services than their customers really want. Getting rid of some not only removes a source of unnecessary costs - muda, or 'waste', as the Japanese would say - but can also lead to competitive advantage. They point to low-cost carrier Southwest Airlines, which remains competitive in a commoditized industry, partly because of its low costs and unique culture, but also thanks to low complexity. This was designed in when it chose to operate only one type of aircraft - the Boeing 737. American Airlines, by contrast, historically operated up to 14 types, with 14 spares depots, 14 kinds of mechanic and pilot training, 14 different FAA certifications, none of which adds value for the customer and none of which the customer wants to pay for. American, to be fair, has since latched onto this and has been rationalizing its fleet.
Dealing with complexity needn't mean getting rid of it. Just make sure you charge for it. Baskin-Robbins has over 1000 different ice cream flavours, which is fairly complex, but customers pay a premium for them. Conquering complexity, George and Wisdom say, is either to have a very low level of it in the marketplace, or to target customers who are willing to pay an adequate premium for higher complexity delivered at a low cost.

Find the fulcrum Bain's Mark Gottfredson maintains that cutting complexity can raise revenues as well as reduce costs, but that slashing it to zero is clearly not the right answer. Henry Ford made that mistake, producing black cars only. General Motors came along, added colours (and complexity), and overtook Ford as market leader - a position Ford has never recovered. All the same, most companies have not found their 'innovation fulcrum', Gottfredson says. 'That's the point where products or services fully meet customer needs with the lowest possible complexity costs.' He advocates choosing one average product for the company and asking what costs would be if it made only that. Do research into what kinds of complexity customers really value, and then add them back one at a time - for as long as the customer is prepared to pay what it costs to add them back.

The innovation fulcrum should be fairly easy to spot. Rationalizing product lines can get more best-selling products on retail display, raising sales. 'Let's say you have 17,000 SKUs [stock keeping units] in your catalogue, but your average retailer is carrying only 17. What's the probability that the right 17 will be there?'

Eric Clemons, Wharton professor of operations and information management, also advocates finding a balance. 'Complexity management isn't the same as cost management', he points out. 'It's about giving every customer exactly what he wants without your cost structure killing you.'

Reference: 50 Management Ideas You Really Need to Know

Book by Edward Russell-Walling

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