A healthy business
A healthy business has two value chains:
- Business as usual (generates operating profit)
- Growth (generates growth in operating profit)
It should not be controversial to suggest that both chains should be optimized for speed.
However, in most businesses, these two value chains do not exist in any meaningful sense. You have one big bucket of responsibilities rather than two discrete processes.
And, rather than speed, this bucket of responsibilities is optimized for cost (or efficiency).
A typical business
The result of pooling business-as-usual (BAU) and growth activities is that the former takes automatic primacy over the latter, meaning that the latter goes to zero.
In practice, this means that salespeople are busy managing customer transactions rather than hunting for new business. It also means that new product development, acquisitions, and other forms of expansion are neglected.
Optimizing for cost rather than speed results in the organization generating significantly less operating profit than it could.
This latter point warrants closer examination.
Why “efficient” means less profitable
Here’s what efficiency means in practice.
A critical machine is operating at 80% utilization. A consultant suggests that the provision of an assistant for the machine operator would enable utilization to go to 90%, generating an additional $30,000 a day in contribution margin.
The management team immediately responds that the assistant would spend 70% of their time idle, implying that their addition would be wasteful.
This is not a joke.
We (yep, we’re the consultants) have some variation of this conversation every day of the week. Management teams respond this way because they are programmed to believe that the organization is most profitable when every operation is optimized for efficiency.
Even when management teams understand the error in this reasoning, they still make bad decisions instinctively because their organizations have what we call a cost-based operating system.
A Formula One team is a pretty good metaphor for a typical business. You have one critical, value-generating operation, and then you have a bunch of supporting operations.
Members of the pit crew spend most of their time idle. It should be evident that downsizing the pit crew until you have a single operator who is consistently busy is not sensible. No one in their right mind would do this to a Formula One team. But we do it to our own businesses every day in the name of efficiency.
Efficiency, in practice, is just another word for cost-cutting.
The critical, value-generating operation
The difference between Formula One and a typical business is that most managers have failed to identify the critical, value-generating operation.
Consequently, it isn’t possible to determine if a particular operation should be maximized (think of the race car) or if it should subordinate to that critical, value-generating operation (think of the pit crew).
Absent this understanding, the standard approach is to optimize everything, which, in practice, translates into trimming costs.
Now, costs should be controlled, obviously, but not trimmed. The relentless pursuit of lower costs leads to the erosion of protective capacity, which means we soon have a one-man pit crew and 20-minute pit stops!
What should we do?
If you recognize that your organization needs to transition from a cost- to a speed-based operating system, here’s a sensible 4-step process:
- Provide each department with a speed-based metric
- Organize the business into two discrete value chains (business as usual and growth)
- Identify your critical, value-generating operation and determine how all other operations should subordinate effectively
- Eliminate cost accounting and all local profit calculations (including branch-based P&Ls) and replace them with a global system of metrics
Speed-based metric
Your first step is to foster pit-stop behavior in each department. Rather than acting to keep team members consistently busy, management should have teams sprint to complete tasks when they appear and then relax. This requires that work be packetized.
Two discrete value chains
The BAU value chain stretches from the receipt of an inquiry (customer service) through delivery. One group within your organization (typically Operations) should be responsible for this entire value chain.
The Growth value chain includes whatever initiatives drive growth (typically, new customers, new products, new territories, and acquisitions). These initiatives should be structured as formal processes with their own resource pools.
If any resources have to be shared between the BAU and the Growth value chains, then these resources must have a lot of protective capacity, and their time must be formally scheduled.
Critical, value-generating operation
This is the resource that Eli Goldratt (The Goal) refers to as The Constraint. You need to identify a single resource or a set of resources that you will maximize. In the case of a printing business, this would be the press room. In the case of a smash-repair shop, this would probably be the paint booths. In the case of a consulting firm, this would be your bill-by-the-day consultants.
Avoid analysis paralysis. When in doubt, nominate a reasonable contender for this resource and determine how to maximize it. You can change your mind later!
Maximization requires determining how all other operations should subordinate effectively.
A global system of metrics
From day one, your management team should understand that profit is only an attribute of an organization—which is to say that there’s no such thing as a profitable transaction, a profitable customer, a profitable project, or even a profitable branch office.
In practice, exorcising the idea of local profitability (and its bedfellow, local efficiency) from your organization will take some time.
It isn’t enough to ban the use of these invalid concepts (although you should); you need to replace them with a new calculus for management decision-making and a global system of metrics.
Next steps
Ballistix helps organizations transition to the Speed-Based Operating System.
In addition to designing the global system of metrics referenced above, we chair and participate in a steering committee that helps organizations navigate the transition.
Reach out if you’d like a proposal!
