Cutting through complexity - Audio slideshow with text transcript

Hello, this is Mark Gottfredson. I would like to spend a few minutes sharing with you some of our thoughts about complexity and how you can find the right balance to optimize the revenues and costs in your company.

When most people think of complexity, they tend to go after it on the cost side. The reason that innovation-which is normally a good thing-becomes a problem is that our traditional accounting mechanisms don't consider the full costs of adding additional products, SKUs and options. And because we don't have the right economic information, we tend to make wrong decisions. That leads to a lot of missed sales in the marketplace.

Now, while we believe that most companies are too complex, we don't believe that taking every bit of complexity out is the right answer, either. It is possible to be too simple. And if you become too simple, then you'll lose sales as well.

We've developed a proprietary approach we call the "Model T" approach, which leads to very dramatic changes in the way a company might do business and, in general, has led to revenue uplifts between 5% and 40% and reductions in costs of 10% to 35%.

The traditional wisdom is that if you offer more products, people will buy more products. But in company after company, we have found that frequently the simplest and most focused ones are growing the fastest and have the most profitability.

The traditional view is to give the customers anything they want; then they'll become satisfied. And if they're satisfied, we'll gain share and be profitable. But too often, it's very difficult to identify the fast sellers. For example, let's say you have 17,000 SKUs in your catalog, but your average retailer is carrying only 17 on its shelves. What's the probability that the right 17 will be there?

It also turns out that when you have high complexity, you have quality problems and cost problems. You end up with the wrong products and services available for your customers and at a poor quality and cost position. As a result, you have dissatisfied customers, and you lose market share-which is exactly the opposite of what you want.

This is an example from a packaging company. You can see that, regardless of the volume produced, their standard costs were fairly similar across the different products. When adjusted for complexity, we found that many of the low runners had costs that nearly doubled the standard costs, whereas the high-volume products had costs of as much as 25% lower than the standard costs. Now, there are a number of obvious reasons for this: For example, with shorter runs, you have to change the equipment more frequently, and you have more inventory hanging around. You also have quality problems developing, and you have more re-work to be done on them. All this actually understates the full costs because it doesn't capture a more expensive scheduling system. A lot of infrastructure gets built up that you don't even realize as a variable cost, and you start to consider those things as fixed costs of doing business.

On the revenue side, you'll tend to have the wrong products on the shelves. They will either clog up the shelf or you'll experience stockouts. One consumer electronics company we worked with had 7 to 10 slots with the average retailer. We asked Wal-Mart if it would allow us to identify the right SKUs on its shelves. We actually saw about a 30% uplift in sales, so having the right product actually allowed Wal-Mart to sell much more.

Henry Ford wanted the middle class to be able to afford cars, so he was very diligent in bringing costs down. He understood intuitively that adding too many product varieties would raise those costs. GM, on the other hand, added colors; from 1921 to 1929 GM gained market share dramatically. In fact, at one point it held almost 75% of the US market. Ford has never been able to regain that leadership position that it had. So clearly, you've got to be able to find that right balance.

This is a grocery store that worked very effectively on its complexity. It had many SKUs going through the retail store. It cut things that were duplicates or near duplicates and ended up reallocating the space to the faster-moving items. It took out about 20% of its SKUs in the store, and several months later, when we did a survey of the stores, about 80% of the customers perceived that there was no difference in the number of SKUs.

Most companies have not found their innovation fulcrum. That's the point where the products or services fully meet customer needs with the lowest possible complexity costs. They companies are getting the revenues because they're focused on the key needs; they have better availability, superior service and less discounting; and they have lower costs because they have more predictable demand, higher quality, simpler logistics and more marketing impact. The basic idea is that you get your revenue up and your complexity-related costs down.

Our approach to this is the "Model T." We start at the left side, zero-basing the costs of complexity by choosing one average product for your company and asking, "What could your costs be if you only made one of these?" That allows you to begin to think about all of the systems costs that are built in and how you might streamline them. It also opens people's minds to the way they can change things.

Of course, you're not going to have just one product, so you've got to go through a careful customer research process that allows you to understand what kinds of complexity customers really value. Then you add those things back one at a time. Basically, you add them back as long as the customer is willing to pay what it costs you to add them back. We typically find that when you reach a certain point, costs begin to spiral out of control-you need to add a different kind of scheduling system, and so on. Once you have reached the right balance point, you can institutionalize keeping the balance in and the complexity out.

We've done this many times across a lot of industries, and the full database suggests that revenues will go up for most companies where this is an issue-somewhere between 5% and 40%-and costs can be reduced by anywhere from 10% to 30%.