Wednesday, 17 July 2013

Are Complex Businesses More Fragile?



Just before the Global Financial Crisis hit, there was a number of high profile businesses that were making very high profits. Then, seemingly in the blink of an eye, these businesses had failed – for some reason their wheels had fallen off.

How could companies that were making so much money one minute be ruined in the next? Clearly they were very fragile in some way.

If you remember the stories in the press, it seems that many of these companies were either selling complex products or they had complex structures, or both.

So, does complexity in business contribute to fragility in the face of surprising and extreme events such as economic changes and natural disasters?

Could it be that there is a necessary level of robustness or resilience in a business that gives it a good chance of overcoming the fallout from these sorts of events? If so, how would you measure the level of robustness or fragility of your business?

A fairly simple way is to ask your people how robust or fragile things are in the way they deal with your customers every day? They’ll be getting the feedback from your customers about any problems or opportunities to improve. They’ll also be hearing the comments from your staff about their reactions to the customer feedback. This is a structured, qualitative approach, but we’ve found it to be very useful over 15 years in finding how well your systems hang together when they come under stress.

Another way is to calculate (or estimate) the net profit that comes from each customer over a period of time, say three months or even a year. Analysis of most businesses reveal that the top 20-30% of their customers deliver 120-150% of the profits while the bottom 20-30% of customers actually take away all this extra profit. We’ve noticed over the years that the causes of this severe loss of profits by the bottom range of customers lie mainly in the complications of dealing with difficult customers, the product range being too broad and therefore costly to manage, or the fact that the internal systems are too complex for people to do good work easily. So analyzing which customers (or customer groups) are being serviced at a loss will help you locate where your business is fragile.

There’s a simple way to check if complexity is making it hard for people in a business to do good work – this is to track the trends in the ratio of Total Revenue / Total Wages paid. If everything is working well and employees are getting better at what they do through better training, systems, amenities and marketing, then as each year goes by, the total sales output per unit of wages paid should increase slightly. If this ratio is flat or decreasing, it means that something is getting in the way of good work. This something is generally unnecessary complexity within the business.

A fourth way is to calculate the Complexity Factor developed by John Mariotti and described in his book The Complexity Crisis (Adams Media 2008). This factor comprises input such as the number of products, customers, market segments, suppliers and staff, the different legal entities and main sites of the business. It calculates a factor that describes the level of complexity and hence the level of danger to the business. Mariotti’s formula reflects the added risk, complexity and fragility caused by a proliferation of legal entities (doing business in many countries) and entering many different market segments in the search for revenue growth.

Finally, the European company Ontonix Complexity Management has developed an elegant way to compare the relationships between different financial, production and economic variables that describe the performance of a business.

The input to this analysis is a spreadsheet of the value of variables such as sales, profits, product numbers, customer numbers, various costs, assets and liabilities, stock levels, employee numbers etc. They don’t have to be the same variables for each business, nor in any particular order – they just have to be complete and placed into rows of a spreadsheet that represent different historical times such as days, weeks, months, quarters or years.

This Ontonix Self-Rating analysis allows you to calculate the level of complexity in your business based on the data you have input. Naturally, the more data you put in to the spreadsheet (eg the longer the history of the variables), the more accurate your complexity measurement becomes.

The complexity level is then translated to a Robustness Rating for the business. This is done via a Star Rating – 5 Stars is very robust while 1 Star means it’s very fragile and may react badly to an external or internal change event or crisis.

Finally, the service delivers you a report that shows how much each of your business variables contributes to the overall complexity of your organization. Some complexity is necessary in any business, but too much complexity is a bad omen.

The diagram below comes from a report for a public financial institution. You’ll see that the majority of the complexity of this business resides in a number of variables at the top of the diagram.

 


This is a huge benefit because it guides you to where to start to change your business to make it more robust, profitable and sustainable. And this is where the Simpler Business Institute comes in – we have more than 20 years experience in removing unnecessary complexity and simplifying business to increase performance, profits and sustainability.

The Simpler Business Institute has worked with both Ontonix and John Mariotti to offer a world-first service of measuring, diagnosing and treating costly complexity in business. Ontonix provides the ability to measure the complexity of any system (eg a business). John Mariotti can interpret the impact on a business of complexity as defined by his Complexity Factor. The Simpler Business Institute gives guidance on how to treat the profit-sucking complexity.

The small relative cost of the Ontonix self-rating diagnosis offers huge value in understanding your business in a way you’ve never known before.

To access the Self-Rating service, go to www.simplerbusiness.com and click on the Rate-a-Business logo on the top right. You’ll then access the service, download a free white paper and example reports and be on the way to knowing how robust or fragile your business really is in the face of the types of change we are seeing in business these days.

Applying the Ontonix techniques to businesses in the same sector, we start to see benchmark data supporting the argument that the higher the complexity, the lower the profitability. We’ve thought this for years and now we’re getting the proof.

Complexity analysis is part of the business education and coaching services offered by the Simpler Business Institute, so take the opportunity soon to attend one of our seminars or request some help by contacting us directly at info@simplerbusiness.com

Simply does it!
Posted by Ian Dover - Simpler Business Institute.