Antidote for a downturn: Cut the complexity of business

The business news these days can be downright demoralizing. Housing is in the tank. The sub-prime mortgage debt crisis has made credit much tighter and more expensive. Oil costs are driving energy prices up. Fear of recession has shaken consumer confidence. What if you could capitalize on the current slowdown without tearing your company apart, and come out stronger than ever? You can. When this particular kind of toxic event occurs, here is a sure-fire “antidote.”

There is a way to reduce costs, improve business, and come out stronger. Drive out wasteful complexity. The least recognized source of waste is the hidden cost added by complexity. It’s hidden because no accounting systems identify its causes until too late. Complexity creeps into a company, created with the best of intentions — especially in good times — and infects every part of the business, consuming time, money and resources. Just as an antidote for a poison counteracts the ill effects, removing complexity draws out costs, reduces wasteful workload, and refocuses the entire organization on the important work.

The Search for Growth Leads to Proliferation

In the search for high growth in low-growth markets, you add new products. Unfortunately, the success rate is never very high. You enter “new” markets, which are new to you, but entrenched incumbents will defend their positions. You open new facilities, to service new customers, and you enter foreign markets. The weak dollar makes your products more cost competitive — for now — but foreign sales are complex too. You search out new, lower-cost suppliers. Asian sources promise lower costs, cheaper tooling and may offer a competitive edge — or may not. Here’s the rub. Your accounting systems are blind to most of the costs added, because they don’t appear in “standard costs” of products, but reside in ”catch-all” accounts. That’s where the costs of proliferation and complexity are hiding.

An Example: One White Coffee Mug

Your product is a white ceramic 11-ounce coffee mug. Landed cost: $1 each, individually packed. Sell them for $2 each and your (one) retailer sells them for $4. Everybody is happy, with 50 percent gross profit margins. Now you want to grow. Expand the mug selection to six colors; add four-packs and eight-packs to push higher ticket sales. Create a merchandiser with a color assortment, too. Sell to new customers. Exciting stuff, right? Purchasing, through good negotiations, proudly shows the mug cost as unchanged, despite the different colors and packaging.

Do you think the “cost” of your coffee mug is really unchanged? Now there are colors and packaging variations to forecast, inventory to manage, and whoops, two of the new colors are not selling. The retailer wants to return them. You’ll have to close them out, along with those in inventory. The eight-pack sales are slow. Repack them into singles and scrap the old packaging. The merchandiser has to be reworked to new colors, too. And the customer wants replacement colors “now” — via airfreight. The unexpected, unmeasured costs are piling up, but the product gross margin is still 50 percent. OK? NO!

On Cutting Complexity: The gross profit margin on cost reductions is 100%.

Here are some solutions:

1. Sort customers top down and cut bottom up.

Rank customers in descending annual sales and gross profit dollars. Show cumulative percentage columns, and analyze the top and the bottom of these two reports. The customers in the top 25 percent of both lists are your winners — serve them well and grow them. The ones in the bottom 25 percent are your losers. Most of them cause complexity that’s costing a fortune — expenses hidden in those “catch-all” accounts: variances, obsolescence, deductions, rework, closeouts, export sales, small order processing, high freight costs, etc.

At the bottom are mostly customers who cost way more to keep than you make in profit on them. Sort the few that have great potential, and go after more business there. The majority of the bottom-dwellers need to be moved out, or at least managed differently. To discourage small, unprofitable orders, set higher order minimums and change shipping policies. Switch small customers to distributors, who are set up to handle them. Or, just tell them you’re sorry, that you cannot afford to serve them any longer. A few will surprise you and ask what they need to do (buy more, pay more, etc.) to stick with you.

2. Do products this way, too.

Use the same ranking for products — create two reports — annual sales and gross profit dollars. The top 25 percent are the winners. Sell more of those. The bottom 25 percent are losers, costing you money to keep. Get rid of them — quickly. A common excuse for bottom-dwellers is, “we need it to fill out the line.” That means the product can’t make money on its own. Get rid of them, too (unless a “top” customer demands it.) Other bottom-dwellers are formerly “great ideas” that just didn’t make it, or “golden oldies” that are past their prime. Retire them. Save time, money and dramatically reduce your cost of managing complexity. Convert leftovers, losers and slow-movers into cash, even at closeout prices. They just cost you money sitting in your warehouse (space, interest, insurance, etc.), and during a downturn, “cash is king.”

3. “Mine” the middle — move them up, or down and out.

Dig for gold; there are some great prospects hidden in the middle 50 percent. Find the ones that share characteristics with the top 25 percent, and sell them more. Phase out the bottom-dwelling 25 percent except for the few high-potential ones just getting started. Clean out the losers, so your organization can devote its time and money to the current and potential winners.

4. Reduce the number of suppliers, too.

Sort suppliers’ annual purchases top down. As you shopped for lower prices, in more places, you added (new) suppliers. This led to more, smaller orders, less buying clout, more receiving activity, more invoices to pay, etc. Thus, more complexity — all of which cost time and money. Second and third sources also cause deterioration in quality due to variability on the “same” items. Cut complexity by concentrating on your best, most important and highest potential suppliers.

5. Have fewer faces in fewer places.

Next, analyze facilities, legal entities, locations and staffing, and cut non-essential ones. Complexity in these areas leads to more of everything: tax returns, audits, errors, duplication, phones/computers and especially people. Go on a “diet.” Cut unprofitable and non-strategic locations.

When you have removed the bottom-dwellers in products, customers, suppliers and locations/legal entities, remove the extra staff you added to manage them. The cost savings comes from taking out complexity in all areas, including overhead staff. This allows the remaining people to focus on the most important customers and products — and new ones.

6. Once complexity is gone, keep it out.

Set new rules, too. “To add one, drop one.” is a good product rule. Set minimum annual dollar levels for sales by SKU (stock-keeping unit), by customer, and for purchases by supplier. Monitor results — at least quarterly — so that complexity doesn’t return unnoticed. Keep it out!

When you’ve “taken the antidote” and removed wasteful complexity, you’ll find that the hidden costs drop away and the resulting clarity of focus energizes your entire organization. Instead of dying from overwork and complexity, it will be spending its time creating working on important customers and creating valuable new products for them, instead of wasting time and money on “losers.” You will come storming out of the downturn, stronger than ever.

About the author:

John L. Mariotti is president and chief executive officer of The Enterprise Group — a coalition of time-shared executive advisors. He is formerly president of Huffy Bicycles and of Rubbermaid’s Office Products Group. John serves as a director on several corporate boards including World Kitchen, HomeCare Industries, Henkel Consumer Adhesives and Petmate Inc. He is the author of eight business books and a novel, and his newest book, The Complexity Crisis, will be released early in 2008 by Adams Media’s Platinum Press. For more information on John’s books and consulting, contact www.thecomplexitycrisis.com.