and selective strategy. It varies by industry.
The metrics that matter are going to be the ones that you can take action on. There are two important words implied in the word actionable: action and able. I don't think that any organization can take action on all the metrics simultaneously. We need to start with two or three metrics and move them together.
After being chosen, the metrics cannot align organizations, but they can misalign them. It is only the action by leaders that can drive alignment.
A classic discussion for me is cost versus value. I want to sell value, and I define value as benefit over cost. Cost is only one side of the equation of value. As a result, you cannot have the operations team aligned for cost and the go-to-market teams of sales and marketing driving value. This is nonsense. We have to do it together.
Marty Kisliuk, Director of Global Operations, FMC Agricultural Solutions
Conquering the Effective Frontier
Joe asked me to come back the following week and we continued our talk. The BHAG discussion was still uncomfortable. He had gotten some tough feedback from his team.
As I worked with him, it became clear to me that he, like other executives I work with, was battling a list of ever-changing goals for growth, profitability, and cycles in the face of rising complexity. When this happens, frustration reigns. Arguments abound and tensions are high. Leadership teams want to do the right thing, but it just isn't clear what to do to move forward. The obstacles are large, and the benefits are many. Each organization has a unique potential as defined by the Effective Frontier in Figure 1.2.
Figure 1.2 The Effective Frontier
As we sat in Joe's office the next week, I tried to explain the concept of the Effective Frontier. “In our last conversation, you asked me about balance. Today, I want to share with you some insights from our research. We find that each company has its own unique potential. The frontier is defined by the interrelationships of growth, profitability, cycles, and complexity. The potential of the company on the Effective Frontier is determined by products, processes, technologies, markets, and channels. Within a company, there are finite trade-offs between interconnected metrics. While there are many definitions and possibilities of metrics for each part of the model, the most commonly used are these four.”
I then turned and wrote the following definitions on the whiteboard in his office:
1. Growth: Year-over-year revenue improvements
2. Profitability: Operating margin (OM), cost of goods sold (COGS), and earnings before interest, taxes, depreciation and amortization (EBITDA)
3. Cycles: Cash-to-cash, inventory turns, and order cycle times, days of receivables, days of payables, and production cycle times
4. Complexity: Increase in products or channels
After replacing the eraser in its holder, and laughing with Joe about my poor handwriting on the board, I said, “Joe, companies want to power a profitable growth strategy, but often find themselves trapped at the intersection of operating margin and inventory turns. It is a battle of cost versus cash. Leaders like you must forge the operating strategy to help others understand the trade-offs.”
“As complexity rises, the potential of the organization decreases. To maintain the status quo, you must constantly redesign operations. As you know, there are many elements that affect operating complexity, like product proliferation, platform complexity, and changes in manufacturing operations.” I then paused and looked him in the eye. “As you know very well, these impacts on complexity usually have a negative effect on revenue per employee, return on assets (ROA), return on net assets (RONA), or return on invested capital (ROIC).”
Joe nodded in agreement and said, “This is our struggle. We are constantly being asked to reduce costs and improve working capital, and do more with less, while complexity escalates in the organization. We have no way to push back and manage the metrics that matter. We are not thinking about it holistically as a complex system.”
About the Effective Frontier
It is important to note that the name of this model is not the Efficient Frontier. Readers who have taken economics courses may have even read it as the Efficient Frontier when speed-reading the page. This mistake is common. Often when I share this model in a lecture, someone will come up and try to correct me.
It is deliberately not named the Efficient Frontier. Why? The efficient organization is not necessarily the most effective. This is an important principle that underlies the research of this book. A singular focus on productivity or cost management can throw an organization out of balance. (An efficient organization is usually defined as one with the highest productivity per employee or the lowest cost per case.)
I had hit a nerve. I started the conversation by passing a piece of research to Joe that is shown in Table 1.1, and saying, “Today, nine out of ten companies are stuck. As shown in the table, when we analyze corporate balance sheet data for companies sorted by Morningstar sector, we find that nine out of ten companies have been unable to move forward for more than three years of sequential improvements on these two metrics. They are not stuck in a good way like a label to a bottle; instead, they are stuck in a bad way like a car in a massive traffic jam going nowhere. They may have made progress on a project, or a focus on singular metrics, but not in the delivery of a balanced metrics portfolio.”
Table 1.1 Percentage of Companies Demonstrating Consecutive Improvement on Both Operating Margin and Inventory Turns for 2000–2012
Source: Supply Chain Insights LLC.
Joe flashed his contagious grin and said, “This is certainly the case in my organization.”
“Take a look at how industries have changed,” I said, shuffling a sheaf of papers and handing to Joe what is shown in Table 1.2. “Growth is slowing; and as growth slows, organizational tension for metrics improvements increases. Balance and resiliency on the Effective Frontier is tougher with slowing growth. This has been the struggle of many companies in the past three years.”
Table 1.2 Industry Growth Patterns
Industry Average comprised of public companies (automotive industry: NAICS 336112), (brand apparel industry: NAICS 31522 %, where % is any number from 0 to 9), (combined food & beverage industry: NAICS 3112 %, where % is any number from 0 to 9, 311320,311520,311821,311941 & 312111), (chemical: NAICS 325188 & 325998), (consumer packaged goods: NAICS 3256 %, where % is any number from 0 to 9), (grocery retail industry: NAICS 44511), (hospital industry: NAICS 62211), (mass retail industry: NAICS 452 %, where % is any number from 0 to 9), (medical device industry: NAICS 339112), (pharmaceutical industry: NAICS 325412), (retail apparel industry: NAICS 44812 %, where % is any number from 0 to 9) reporting in One Source with 2012 annual sales greater than $5 billion.
Source: Supply Chain Insights LLC, Corporate Annual Reports 2000-2012.
“Okay, I get it,” said Joe. “But what do I do? What is my call to action? My organization is clearly stuck, and I see that you are saying it's a mistake to focus on only a single metric like inventory. Help me with the next step. What do I do now?”
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