As a result of continual pressure for growth, most companies have both expanded their product lines significantly and indulged in what appears to be ever promotional activity in an effort to stimulate customer interest and gain share. One of the consequences of all this activity has been an enormous increase in the complexity of their businesses which tends to increase the fixed costs of conducting their business. This complexity manifests itself in many forms affecting everything from the day-to-day operations of the business to senior management’s strategic plans. Economies of scale, scope and skills appear to be wiped out by ‘economies of complexity’.
Many companies have expressed serious concerns about their capability to successfully manage complexity and have striven to simplify their business, retrenching to a stable portfolio of core products and processes. Others have attempted to manage complexity through systems, structures, procedures, complex organization, and group decision making. Only a few have come to grips with the strategic challenge: they have learned to manage a complex business in simple ways improving both share of market, innovativeness and profitability in the process.
Over the next few pages, I will attempt to portray the increasingly complex environment which we face and argue that some approaches will allow solutions to the growing complications of dealing with the trade which will avoid the drastic ultimate solution once suggested at a Communist Party Conference by Vladimir Kabaidze, General Director of the Machine Building Workshop who has been reported as saying ‘I can’t stand this proliferation of paperwork. It’s useless to fight the forms. You’ve got to kill the people producing them.’
Nobody ever thought that running a huge global company was easy. According to The Economist, even Citibank’s managers were surprised, five years ago, when they looked into how complex its global banking operations had become. Around the world, for example, for reasons of local regulation, Citibank was offering not one demand-deposit account but numerous versions of it. Some accounts calculated interest daily, others monthly, some charged fees, others did not, and so on. To handle all this, Citibank’s back-office needed 28 different computer systems. Citibank has since launched a project to reduce its complexity by 75%, and to cut the number of computer systems to one or two. The hope is to save approximately $1 billion a year (...)
Complexity is a by-product of managers’ daily decisions - decisions which are influenced by many factors rooted in a company’s internal and external environment. For instance, companies have responded to competitive problems and opportunities by proliferating their product lines, promoting more frequently and aggressively, moving marketing euros and customizing their communication to meet local needs. Customers have been hit by an avalanche of new products as new product introductions have been growing at 10 to 20 percent per year. For the manufacturer this continuous new product extension has meant increasingly unwieldy product ranges. All of these moves increase the complexity of running a business, and, unless special care is taken, may eventually ratchet up costs.
Many large companies with broad product ranges are currently losing money while smaller competitors, specializing either in a few standardized products or in highly customized products, are profitable. Studies in such large companies have shown that poor management of complexity is one major cause. But although additional fixed costs - of which complexity costs are a part - may not matter during growth phases, they are unacceptable in the shrinking or slow growing markets of today. Fixed costs do not decline along with sales. And the share of costs concerned here is substantial: in the course of various studies, I have found that around 15 to 20 per cent of costs is complexity-driven, depending on the structure of the company and its industry. The multiple burdens of increased costs make excessive complexity a major competitive issue.
Managerial decisions generate complexity in terms of the number of ‘challenges’ that a company has to handle. Each of these can relate to either physical materials or bits of information. Now imagine the thousands of discrete challenges that a typical business must handle. All of these challenges are generated by the multitude of decisions managers make every day about the company’s activities. It is often difficult for (large) companies to make complexity cost/benefit trade-offs because their (decentralized) decision-making is split between (many) managers in different divisions or groups, business units, and departments. Each manager or group of managers does its best with the challenges it receives, and throws its own decisions ‘over the wall’ for the next manager or group of managers to cope with. In the end, decisions are made which add complexity without creating offsetting customer or competitive benefits. It is the exponentially expanding interaction of all these strategic and operational challenges and decisions that constitutes complexity and leads to severe reductions in competitiveness.
In the face of growing cost problems, more and more companies are now taking steps to identify and reduce complexity costs. The good news is that excessive complexity can be reversed and prevented.
First of all, to assess the extent and sources of excess complexity costs, transparency of cost information is required. This forms a sound basis for developing ways to influence complexity. All complexity-driven cost components have to be taken into consideration.
On the basis of transparent complexity costs, steps for minimizing the cost of product/part/process variety can be developed. Armed with a thorough understanding of complexity costs and with a knowledge of the critical benefits valued by customers, managers have to rethink decisions in all areas of a company’s business system.
There are basically two approaches to managing business complexity costs. We can attempt to simplify the business by, for instance, pruning the product line and cutting back on programs. Alternatively we can accept that some increasing complexity is inevitable in an era of disaggregation of needs and wants and we reconfigure the business system to better handle it.
Simplification may require drastically restructuring the business system to achieve substantial cost savings and seems only a partial or temporary solution. It’s a bit like standing in Trafalgar Square in London and clapping your hands. All the pigeons fly away, only three minutes later they are all back, only in new formations at different spots. However, in some situations seeing the Square without pigeons is clearly an essential first step to finding your way across it.
Complexity can be reduced by discontinuing products and/or processes whose complexity costs are higher than the profit contribution they generate, or operationally by increasing standardization (engineering, for instance, can be optimized to meet market requirements with a higher level of standardization or modularity of parts and products).
Box 1 Operational simplification strategies
Specific actions which simplify the operational business system are:
Shift customers to standardized products;
Select and concentrate on important customer segments;
Link product launch to discontinuation of old products;
Reconfigure the production process - eliminate stock pools and consolidate activities to achieve economies of scale and scope;
Limit design changes and introduction of new variants;
Automate business processes where economic;
Simplify and streamline administrative procedures, and
Improve commonality of parts/product modularity.
The first set of decisions which managers reassess when attempting to simplify their business system is the range of products or services and customers. Focus variety on a few features seems to be the name of the game at H&M. H&M, a global fashion retailer, successfully standardised most of its products (and distribution strategies), except for their color, which was added at the last minute in response to the latest tastes.
However, a reduction in the number of products and customers is not usually the most powerful driver of profit improvement. It represents one component of an integrated complexity reduction review. The reassessment process involves generating a true picture of variable profit margins, searching for profit improvement opportunities, and ultimately abandoning those unprofitable products, services and customers which are not required for financial or strategic reasons.
Product or service design simplification can not only reduce costs but also accelerate product or service development processes and improve customer satisfaction. Conventional trade-offs often do not apply. The secrets to success are to deeply understand customer needs, and segmentations, to have cross-functional teams evaluate costs of various design options for meeting these customer needs and to iterate toward solutions using frequent customer input.
Many complexity costs generated throughout the company are actually borne in secondary functions (e.g., administration, IT/IS, et cetera). Simplification of support functions can be realized through a disciplined analysis of the value of support activities. Typically, according to my studies about 20 percent of support costs can be saved by eliminating low-value activities.
Simplifying business system activities often simultaneously leads to the threefold benefits of lower cost, improved customer benefit, and faster response time. The key factor for success, however, is to ensure that new products/services (and business processes) are optimized before they are launched. Remember Sun Tzu’s adage: ‘Every war is won before it is ever fought’.
Reconfiguration on the other hand may provide a means to seize the opportunities of complexity - opportunity to deliver greater value to trade and consumer by finer, more targeted segmentation. To manage increased complexity through reconfiguration requires managing assets more flexibly, developing new information systems, building people with adaptable skills, and decentralizing decision-making. Approaches like these can substantially reduce the costs of complexity and make the revenue contributions for product and promotion variations more attractive to go for.
The chosen approach to complexity management will influence the company’s competitive and product strategy (and vice versa). The approach will also be influenced by industry specifics. For example, the types of complexity occurring in the process and assembly industries vary significantly:
In the process industries, complexity generally arises from proliferation of individual products (e.g., in paint production or packaged goods) or from ‘branching variety’. This means that the production flow branches over several production steps, with variations being introduced in each step (this is the case, e.g., in the steel industry or the chemical industry).
In assembly industries, with their vast numbers of input variables, complexity arises from ‘combination variety’, independent of the production steps (e.g., in the automotive industry and machinery industry).
Often, a business complexity reduction process is started by top management with the selection of a cross-functional team consisting of key managers from across the company, who are encouraged to break traditional territorial thinking to make integrated business decisions. The team analyzes the company and its environment to flush out the hidden linkages between costs, activities, and the decisions that generated them. Ideally, this analysis should be extended to include major suppliers and important customers. By involving these partners, the team will not only gain a better understanding of the total industry costs of complexity, but will also win the partners’ commitment to business complexity reduction.
Complexity is popping up on the radar screens of corporations all around the world: corporations need a clear (not complex) label if they want to please shareholders, investors, and other stakeholders.
Complexity is a hidden cost of doing business. Complexity has created a many-headed monster for management. Excessive complexity typically grows over many years and fossilizes into structures, cultures, systems, and personnel that are not easily altered. It impacts every aspect of the business and leads to suboptimal asset utilization. Most companies are well beyond the optimum degree of complexity. Most companies have slipped slowly into these practices not consciously planned them. But over time the impact on the way the company does its business can be profound.
Managing complexity to better serve the full range of customer needs and demands can provide a substantial competitive advantage. Reducing complexity can have a major impact on competitiveness by simultaneously lowering costs, improving customer benefits and cutting response times. Radical retrenchment (simplification or reconfiguration) to reduce complexity can allow significant advantages. Coping with and thriving in business complexity requires continuous efforts to identify and eliminate complications that add no value. Timely analysis can help companies master the increasing complexity of business. ‘Complexity value analysis’ has to be the name of the ‘complexity game’.
Pieter Klaas Jagersma is an entrepreneur, Professor of International Business at Nyenrode University and Professor of Strategy at the Free University (PDO-MC) of Amsterdam.