was an enabler. For many, it was a disruptor. It permitted and empowered companies to increase potential and move to new levels of the Effective Frontier. Today, the belief that the efficient organization is the most effective defies conventional wisdom. The historic focus was to improve efficiency. The belief was that increasing efficiency would lower costs and improve performance.” The reduction in labor did not translate to an improvement in operating margin. As I showed him the chart, I said, “However, as shown here, this singular focus had an adverse effect on operating margin and inventory cycles in 7 of the 11 industry sectors.” Joe's eyes sparkled. He loved data, and motioned for me to continue.
“In some industries, costs were shifted. Three out of the 11 industries grew sales and general administration (SG&A) expenses. In an effort to spur growth, there was a shift in spending from the back office (manufacturing, distribution, procurement and logistics) to the front office (sales and marketing). There was a belief that we could save money in the back office, and move the money to the front office to fuel growth; however, this level of thinking was flawed. It was not that easy. Teams need to align to win together. Functions need to build potential on the Effective Frontier jointly as a strategy.”
Joe asked, “So, since most companies went for improving employee productivity, why didn't margins improve at the same time?” As I stirred my black coffee, I saw that it was as opaque as the answer to his question. “I like this line of questioning. This is something that I am doing more research on, but right now, I believe that it was a misaligned emphasis on the input metric (revenue per employee), not a focus on the output metric (operating margin). Most companies can put data into systems, but they cannot get data out to measure progress. As a result, the focus is misaligned to concentrate on input, not output. That's why metrics matter so much! Would you agree?”
The Need to Focus on the Right Metrics as a Complex System
On the walk up the stairs back to his office, Joe stated, “I get it. Companies want to increase, or accelerate, inventory turns and reduce cash-to-cash cycles. Improving inventory turns and decreasing cash cycles improves working capital; but, an increase in complexity will decrease margin and reduce inventory turns. They are connected and interrelated. Working these metrics as a complex system while on the effective frontier enables companies to build a road map to drive business strategy. The freeing of capital enables investment. Right?”
I nodded while laughing. Joe walked up the stairs two at a time leaving me out of breath as I struggled to keep up with him while continuing the dialogue. “In the past decade, the use of technology improved the results of large companies greater than $5 billion in revenue. While companies thought that the overall results would be greater, they improved efficiency, not the overall results that they hoped. As we discussed at lunch, it did improve revenue per employee. The adoption of processes and technologies has been slower in mid-market companies with less than $1 billion in revenue. Whew…” I said, as I leaned my hand against the wall at the top of the stairs to get my breath.
Joe laughed and said, “Sorry, I get carried away. I am so used to the stairs and taking them two at a time that I didn't mean to make you winded. I guess it's just easier for a tall guy to take these stairs fast. Let's take a moment to catch our breath. I appreciate you explaining this to me.” We stood on the stair landing for a couple of minutes and talked about his challenges.
Moving Forward, Not Backward
As we walked down the hall, we continued the dialogue. Joe's questions were getting more intense. As he peppered me with them, I stated, “Today, there are more challenges to managing metrics trade-offs while on a frontier than earlier in my career. The pace of change is rapid. Think about it. Today, businesses are larger and more global. Organizations are not aligned. As a result, there is a greater need for focus and conscious choice.”
Joe agreed. “I cannot speak for everyone, but I know for us the past decade was turbulent. Demand and supply volatility increased. Markets became more competitive. Merger and acquisition (M&A) activity was rampant. To meet the expectations of financial markets, we pushed costs and elongated the cycles of suppliers. This improved our cash-to-cash cycle by lengthening payables, but is starting to impact margin.
“It is easier to shift costs than improve internal operations,” Joe continued. “Over the past year, I had a lot of pressure from my finance team to lengthen payables. However, I keep telling them that it is a penny-wise and pound-foolish strategy, but this is hard for them to see. Pushing costs and waste backward to suppliers and lengthening payables will give short-term benefit; but, I am now seeing that it can cause longer-term issues.” The conversation had been as fast as our walk, and we were now back in Joe's office.
Moving to the Next Level on the Effective Frontier
“While this makes sense to me conceptually, it is difficult to orchestrate. As a leadership team, here, we are focused on functional metrics. The concept of the Effective Frontier is a new concept. How would you suggest that we go about adopting the methodology?” asked Joe.
I thought hard and leaned back in my chair. I paused for a moment, and said, “Each organization that I work with has its own unique potential, and is operating on its own frontier. Within each organization, the functional areas also have their own unique potential. The goal is to first recognize it on a corporate level, and then on a functional level, and then define the frontier that best realizes corporate objectives at all levels. The second goal is to know when to move to the next level. This takes training.”
“I think that I am getting it. I am trying to absorb the concepts, but it is like drinking from a fire hose,” Joe said.
“I know. It's for this reason that most organizations are treading water. It's hard to get the attention of the leadership team. With the rise of complexity in the last decade, most organizations have made unconscious trade-offs,” I stated.
“What do you mean?” asked Joe. “Tell me more about unconscious trade-offs.”
“Sure, let me explain,” I continued. “As complexity increased – products proliferating and service expectations rising – the impact on the metrics portfolio and the potential of the organization is not known. While it can be modeled today using new technologies, most companies do not. It is not a conscious choice. The increase in complexity makes it harder to achieve the same level of operating margin and inventory turns,” I said while looking at my watch.
“Why do companies not model it and drive the outcome to maximize potential?” asked Joe.
I shrugged my shoulders and shook my head. “Isn't it ironic that companies design factories, and work for years on the development of those factories, but do not model corporate performance systems? I think that it is because it is a new way of thinking,” I stated and stood up and started to gather my papers and pack my briefcase.
“In the face of this challenge, there is a need to drive conscious choice on metrics trade-offs. I can work with you and your team to help you understand how industry leaders that did not modify business processes and assets to drive strength and year-over-year improvement in performance have struggled to deliver a balanced portfolio with resiliency. Joe, do you think that this would be possible?” Joe nodded his head yes, and motioned for me to continue as he said, “I know that you only promised to stay an hour, but I would like you to continue. I am finding this discussion to be very helpful.”
“Okay,” I said. “Let me make a phone call. Let's take a quick break, and we can work together for a couple of hours.”
Getting Off the Plateau
“Thanks for staying,” said Joe. “It's just that I don't get a lot of time
