The Complexity Crisis

Why too many products, markets, and customers are crippling your company--and what to do about it

John L Mariotti

• Publisher: Adams Media
• Year: 2007
• Print ISBN: 9781598692143
• eBook ISBN: 9781605508535
• Topic: Business
• Subtopic: Business General
• Index: Business

Management consultant John L. Mariotti shows you how to evaluate your cost and management systems so you can clear away complexity—and conquer your competition.

Many companies today are in crisis. In the quest to grow their business in flat or declining markets, they have created dozens of new products and services while increasing their customer, vendor, and marketplace relationships. But even as top-line revenues go up, this rising tide of complexity is drowning bottom-line profits.

The Complexity Crisis shows you how to streamline your business for greatest efficiency, effectiveness, and profitability. You'll learn how to:

-Target complexity in your organization and reduce or eliminate it
-Build a simple, effective corporate structure
-Add value to your business by avoiding complexity traps

19

NEW METHODS OF COSTING

When Old Measures Are Inadequate, Create New Ones

”Do not go where the path may lead, go instead where there is no path and leave a trail.”

— Ralph Waldo Emerson

Linking Costs to the Causes

The practice of accounting made great progress in the latter part of the twentieth century when it introduced “activity-based accounting,” which provides considerably better insight into how accounting and managerial behavior are interrelated. Since that time, however, the accounting profession has been taking a “policeman” approach, thanks to the misadventures of Enron, Global Crossing, WorldCom, and others. Being compliant with Sarbanes-Oxley is important, but it no more guarantees success than having an ISO-9000 compliance.

COMPLIANCE WITH REGULATIONS AND CERTIFICATIONS DOES NOT GUARANTEE SUCCESS

Sarbanes-Oxley is the new law passed in 2001, after the widely publicized accounting scandals involving misstatement of earnings. This law requires many new corporate safeguards against financial and accounting fraud/misstatements, including the requirement that a corporare CEO and CFO both sign to certify that financial statements are accurate under risk of criminal penalties. Many additional FASB (Federal Accounting Standards Board) rulings have also been issued in the past few years to support Sarbanes-Oxley.

ISO-9000 is one of a family of International Standards Organization certifications that confirm if a company complies with certain requirements. This particular one deals with documentation of the processes and operations, but has no safeguards that monitor whether the processes documented are good processes. Flawed processes can be superbly documented and the company can be ISO-9000 certified that it does things “perfectly” — even if they are the “perfectly wrong things to do.”

Both simply say that you certify that what you did was done the way you said you'd do it (or in accordance with some standards that apply). Neither says that what was done was done the best way, or even a particularly good way. The blizzard of new accounting and governance regulations, FASB (Federal Accounting Standards Board) standards, etc. continues to focus on the reporting of gains, losses, and asset values. While these regulations add layer after layer of complexity, little attention has been devoted to improving core areas of management through better accounting analysis and reporting.

”God Is in the Details”

As famous architect Mies Van der Rohe said, “God is in the details.”How and where does modern accounting help you better manage those details, especially when they involve the tension between innovation and complexity? How do you know how far to push innovation versus controlling complexity? The only way to know that answer is to understand what complexity costs, where to find its impact, and what effect it has on quality, service, profit, and growth. To accomplish this, you must measure some things that have not been measured. Fortunately, most of the raw data needed is already available somewhere in those corporate computer systems we all know and love — and rely on. The challenge is knowing what to look for in those corporate computer systems. There are four formulas that show the balance of factors that go into the “knowing.”

TAC #8: FOUR FORMULAS FOR SUCCESS

1. Data + Organization = Information
2. Information + Insight = Knowledge
3. Knowledge + Experience = Wisdom
4. Wisdom + Imagination = Genius

As you can see, these formulas reveal a progression from data to information, to wisdom, and finally to genius. At each step, human intervention plays a key role. However, the very first equation is one where some new metrics derived from existing data must be employed. Only then can the human intervention begin to yield progress.

A very important warning is also in order. Mark Twain stated it very well. “It ain't what you don't know that gets you into trouble. It's what you know for sure that ain't so.” Far too many decisions on such delicate matters as innovation versus complexity are being made on flawed understanding or prevailing wisdom and employ information that is either misunderstood or outright wrong.

As we go into this next section, I'll try to offer some examples of how to get better information, create better metrics, and therefore make better decisions — or at least decisions based on sound information and not misinformation.

New Accounting Metrics — Assigning Costs in New Ways

The accounting profession needs to catch up with the maelstrom of global business circa the twenty-first century. There must be new categories of entries and new descriptors that apply to the assignment of costs caused by, among other things, complexity. Variance accounts categorize the entries by the old terms of labor, overhead, and materials, there is little or no segregation as to root causes. Just as standard cost accounting ignored activities, which necessitated the development of activity-based accounting, there must be a new set of entries that capture and assign the costs of complexity where they belong. To start any such process of change, it is useful to identify the likely causes and the places to look.

A PARTIAL LIST OF COMPLEXITY SOURCES — TO MEASURE AND ASSIGN COSTS

• Transactions: orders, invoices, payments, voucher entries, adjustments
• Customers: sales calls, unique products/programs/promotions, record keeping/reporting
• Suppliers: sales calls, unique components/materials/deals, record keeping/reporting, variability, and six sigma
• Competition: market segments, products, regions, countries, and distribution types
• Obsolescence: raw material, components, finished products, marketing/merchandising materials, closeouts, markdowns, scrap, administration
• Forecasting: variety, similarity/shifting, seasonality, geography, Bills of Materials, planning changes, schedule changes
• Shipment: destinations, routings, shipping instructions, manifests/paperwork, confusingly similar numbers/models/packages, DC locations
• Staffing Costs, Learning Curve, and Training Costs
• Information Systems: Electronic-data-interchange protocols, size of database, number of programs, memory, processing, documentation, network management, security
• Currency Risks: number of countries buying, selling, doing business, employees
• Tax Returns: number of states and countries, different tax codes, regulations
• Incorporation and Officer Designations: number of states and countries, governing law
• Regulations: number of states and countries, local codes, industry-related
• Intellectual Property: number of states and countries, patents, trademarks, copyrights

An exhaustive analysis of how to assign costs to complexity depends on a deep understanding of the business, its purpose, structure, processes, and culture/relationships. To get started, there are approaches that are applicable to a wide range of situations.

Measuring the staffing and support costs associated with a function or activity and then dividing by the number of transactions, events, or entities is a good way to start. This kind of measure will yield $ per transaction information like $ per purchase order, $ per customer order entered or shipped, or $ per deduction/claim resolved. These are useful metrics to expose the cost of complexity.

The challenge is to partition and quantify all of the expenses associated with specific classes of complexity-driven costs. To do this requires an insightful analysis of how budgets are organized and where expenses are charged versus where work is done. While this generality sets the stage for the necessary metrics, let's take each category and comment on specifics about how to capture the costs of complexity.

Transactions: Orders, Invoices, Payments, Voucher Entries, and Adjustments

Most companies can identify the number of customer only orders received, how many invoices result from those orders, how many payments are made, and how many claims or adjustments are processed. In fact, those functions are usually relatively segregated into organizational units specialized for those tasks. The personnel budgets — payroll costs, benefits, and support cost — are the easiest to gather. When this is done, the first step of determining the cost of an order transaction from beginning to end is underway. Accumulate the annual department expenses for order entry and order management and divide by the number of orders processed in a year. Do the same thing for the department that processes invoices and applies the cash. If there are separate people assigned to handle claims, deductions, etc., repeat the process.

Once the discrete tasks have all been counted and the expenses associated with doing them have been identified, a series of cost per transaction figures can be calculated and saved separately. They can also be totaled, to yield an end-to-end cost of processing a customer order, including the payment for it. I purposely omitted the fulfillment of the order, since that is a separate, identifiable, and manageable process. Unless your company is different from most I have seen, it will be surprising how much it costs to process a complete order from beginning to end.

Note that I did not encourage you to allocate any “top management costs” to this process. Some are certainly incurred in the process, but this allocation can become arbitrary and contentious and is not usually where the largest costs are incurred. We'll deal with that issue separately.

You might have noted that the topic of benchmarking has not been addressed. That is because the awareness and use of these metrics is so scattered and sparse. As more companies read and adopt this advice, new comparative data will emerge, and professional organizations can develop benchmarks. Until then, my advice is to benchmark against your own metrics and strive for continuous improvement on those.

The outcome of this step will allow you to to know what it costs to process a customer order from end to end.

Customers: Sales Calls, Products/Programs/Promotions, Record Keeping/Reporting

Maintaining good customer contact takes time and effort. This is the part of the organization that gets the orders, calls on the customers, and keeps them actively involved in the business. Whereas in the last metric we divided by the number of transactions, in this one, we will divide by the number of customers.

A customer is the entity that buys something from the company — orders it and pays for it. Customers come in all sizes, large and small. Customers require different kinds of attention, too. Some want to be visited, while others just want to order and receive what was ordered. Once again, go to the departmental budgets for sales and gather the expenses that are incurred by sales (don't forget commissions, which may be accounted for in a different budget). Sales is usually a people-and travel-intensive budget area. Additional sales costs are often found in samples to customers, premium freight, special customer-based trade show costs, and so forth. Find all of these expenses and total them. Don't worry that some customers cause you to incur more of these expenses than others — that is the next step. First, find what an average customer costs you to keep around.

Bear in mind a key point: averages are great for graphs and overall presentations, but they are deadly misleading for taking specific actions. You must identify where causes of the high-dollar items originate. Some customers are known to be high maintenance. Now it is time to identify who, why, and how much. That may or may not mean tracking every minute detail like copy costs and phone calls. It certainly means tracking the big-expense items. Most expense-budget details will show what the big expens...

Table of contents

• Cover Page
• Title Page
• Copyright
• Praise for The Complexity Crisis
• Contents
• INTRODUCTION
• The Problem
• what is the complexity crisis?
• WHY IS IT A CRISIS NOW?
• THE BOTTOM LINE — WHERE COMPLEXITY HURTS
• UNINTENDED CONSEQUENCES
• WHAT MAKES IT WORSE?
• TWO ESSENTIAL STEPS
• HOW TO RECOGNIZE IT, MEASURE IT, AND BEGIN TO FIX IT
• A NEW METRIC FOR TRACKING COMPLEXITY
• The Examples
• SUBS AND SUNDAES
• CARS
• planes and computers
• FAST FOOD
• TOO MANY OF EVERYTHING?
• SAME, BUT DIFFERENT
• SCIENCE VERSUS BUSINESS
• The Solutions
• STRATEGIES AND SOLUTIONS
• A FIVE-STEP FRAMEWORK FOR THOUGHT
• COMPLEXITY'S IMPACT ON ORGANIZATIONS
• NEW METHODS OF COSTING
• THE BIG PICTURE
• CONCLUSION
• WORKS QUOTED AND CITED