11 September 2009

Complexity Reduction For Structurally Improving Profitability

For most of you, the complexity of your business has increased over the last ten years. Key reasons for this include increased competition, the need for segmented offers for meeting specific customer requirements, new technologies, etc. While this may have lead to higher revenues, it has more often than not also lead to structural increases in capex and higher operational costs through-out the supply-chain. In addition, I have seen numerous companies where increased complexity has lead to difficult and slow innovation processes, seriously hampering the companies’ abilities to meet new competitive threats and/or market opportunities.

Today, I see that many companies believe that complexity reduction is a fairly easy way to reduce costs. A project is started to carry out a Pareto analysis of revenues across products, and typically sees that the 80/20 rule holds, and that the tail is not profitable. The project then suggests that the 10% of the product portfolio having the lowest sales are terminated. In spite of protests from marketing & sales this is then carried out. Results, however, are more often than not disappointing, or even non-existent.

In my experience, complexity-reduction is a critical activity for a majority of businesses. While complexity-reduction in the restaurant business appears to be fairly easy, in most companies I consult to it needs to be carried out in a structured and well thought out manner where:

• It is understood that not all complexity is bad, and that the crux is to get and keep the right level of complexity for your specific company situation

• It is realized that the process is complex, will take time, and will result in only limited “low-hanging fruit” opportunities

• It is possible to put a well-organized and broadly supported project team in place to carry out the project.

If you believe that your company is suffering from too high complexity, my experience is that you will need to put in place a project to carefully consider a number of inter-linked aspects related to complexity. The first step in the process will be to understand the complexity in your organization. This will involve understanding the true complexity drivers of your current business. Typical examples include number of customers, number of products (at the lowest level of detail), number of packaging variations, number of ingredients, number of technologies, etc.

You will also need to understand the value of your market-facing complexity (i.e. those aspects which your customers see). This will involve understanding the reasons for the variations in your market-offering, analyzing the value that your customers place on the variation offered, and deciding what the consequences would be of reducing the variety you offer to the market-place. The final analytical activity will involve understanding the costs of complexity by going through a detailed activity-based costing exercise to allocate costs to the different complexity drivers (products, customers, etc).

The next step will involve carrying out a direct pruning of the product portfolio based on the preceding analytics. This portfolio reduction will not focus on the tail of the product portfolio, but will rather seek out products where the strategic value is low and costs can truly be reduced either due to a negative margin or through specific opportunities to reduce overhead through the removal of one or more products from the portfolio.

In addition to reducing the complexity that is visible to your customers, the project team will also need to look at opportunities to reduce below-the-skin (i.e. not visible to your customers) complexity. At one of my large telco clients, this is one of the key issues they are facing. They currently provide many services that are similar from a client perspective, but which are delivered through different technologies. The company is now going through a process to move delivery of all services to one platform, and expects that this will result in major savings. However, it is finding this process challenging as it requires a broad coordination across the commercial and technical organizations.

While these activities related to reducing customer-facing and internal complexity will provide you with considerable benefits through the one-off reduction in complexity, my experience is that complexity will quickly creep back if structural changes are not made to key processes. The most important process to change is the innovation / new product development process. The key goal of the changes to this process is to ensure that only complexity that truly adds value is allowed in new products. A key change to enable this is to ensure that all complexity costs are included in the business case for the new product. In addition, the improved innovation process should ensure that the production of the new product minimizes internal complexity by pushing for the use of modular designs, re-use of components, etc.

Finally, the complexity-reduction team will need to put in place (or improve) a portfolio management process to ensure that an overall portfolio view is taken in decisions related to new products, and that regular reviews are carried out to discontinue low-value / end-of-lifecycle products.

While the described process is intense and requires a substantial investment in time and resources the returns are also substantial both in reduced costs and extra revenues through faster time-to-market for critical new products. Follow the links if you are interested in more information on project planning or project management training.

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