Finding Scale, Profits, and Growth in an Age of Complexity

Wilson Perumal & Company, Inc.London CSO Conference

April 25, 2013

© W il so n P er uma l & C o mpa ny, Inc .© W il so n P er uma l & C o mpa ny, Inc .© Wilson Perumal & Company, Inc. 2

The world has changed!

Volume

Cost

Pre-Industrial Age

“Individual productivity”

Dominated by variable costs

Volume

Industrial Age

“Economies of Scale”

Dominated by fixed costs

Complexity

Post-Industrial Age

“Complexity”

Dominated by complexity costs


The rise of complexity (Tesco Stores)

Traditional UK Grocery Retail

NEW CHANNELS

NEW GEOGRAPHIES

NEW FORMATS

NEW RANGE

© W il so n P er uma l & C o mpa ny, Inc .© W il so n P er uma l & C o mpa ny, Inc .© Wilson Perumal & Company, Inc.

The magnitude of the issue

4

In many companies, 20-30% of products generate more than 300% of profits!

0% 25% 50% 75% 100%

100%

300%

0%

Products that create profit

Products that “lose” profit

% TotalProfits

% Total Products


And has implication

on your:(Examples)

Business Process Redesign

Supply Chain Strategy & Mgmt

Process PerformanceProduct

Portfolio Mgmt

Organisational Effectiveness

Operating Model Design

IT Strategy

Management Systems

Network Optimization

AssetUtilization

Risk Mgmt

Data Protection & Mgmt

Transaction Speed

Channel Strategy

Margin Improvement

Customer Experience

5

Has impacts across the businessCEO’s identified complexity as the primary challenge they face. Nearly 80% expect high levels of complexity over the next five years. Yet far fewer felt prepared.

Complexity affects your:

COMPLEXITYCost

StructureExecution& Growth

Business & Operational Risk

“Complexity dramatically increases cost and risk of failure. It is like a cancer that eats away

at efficiency and profitability.– Andy Beal

Chairman & CEO, Beal Bank


Motorola—Service is KingSelect Metrics Y1 Y2 Y3

Portfolio (#) 3500 2079 499

New products (#) 0 8 14

On-time delivery 70% 78% 90%

Cust. Satisfaction 27% 55% 90%

Mfg. productivity 1x 2.2x 3.1x

Operating Earnings -6% 3% 7%

Sales 1x 1.6x 3.4x

“Complexity kills innovation. Complexity can drive down quality, increase costs and lengthen lead times. If that’s the state you’re in, you have poor execution—and you can’t innovate your way

out of poor execution.” — Eamon Malone, VP, Motorola

• 86% reduction in portfolio!• 57% increase in cust. satisfaction!• 13% pt increase in op. earnings!• 3x growth in sales!


-8%

12%

8%

4%

0%Jul 11

-4%

-12%

-16%

Apr 10Jan 10Oct 09Jul 09Apr 09Jan 09Oct 08 Jul 10 Oct 10 Jan 11 Apr 11

+7%

+2%

Competitors’ salesMacy’s same-store sales

Same Store Sales(% change from 12 months prior)

Macy’s begins to

break away

7

Macy’s—localisation w/scale

“The retail landscape has deteriorated, not strengthened. But our outlook is going the other way.”

--Terry Lundgren, CEO, Macy’s

Impact of My Macy’s initiative:

http://terryjlundgrencenter.org/bio.html


• Smaller, coordinating role • National initiatives on

“opt-in” basis• Less ability to leverage

national scale

National level

• Less resources at local level• Not empowered to

respond to local tastes and preferences

Local level

• Buying, planning centralized at regional level (~100 stores)

• Command & control relationship over stores

• Operate largely independently from national level and other regions

Regional level

• Buying pulled up to national level, with aggregate local input

• Greater strength with suppliers, leading to greater ability to tailor offerings

National level

• Inventory planning pushed down to local level (~ 10 stores)

• More responsive/ customized stores with greater employee ownership

Local level

Previously regional functions

stretched up to national and

down to local level…

…requiring greater, richer and asymmetrical information flow between local and national levels

National

Local

Regional

National

Local

PREVIOUS REGIONAL STRUCTURE HYBRID LOCAL-NATIONAL STRUCTURE

Simple operating structure but less responsive to local preferences and

little national scale

Restructured operating model with richer information flow allows stronger national scale and greater responsiveness to local customers

8

Customer intimacy with scale


“The greatest challenge to any thinker is stating the problem in a way that

will allow a solution.”

— Bertrand Russell


VA

NVA

The COMPLEXITY CUBE framework

10

ProcessProduct

Organisation

• Complexity resides on the axis of the cube

• But complexity costs reside on the faces of and within the cube


“Complexity… is a ‘cube’ function. If I have 10 applications, I may be able to manage them all.

If I have 100 applications, managing them is not simply 10 times the complexity—it’s more

like 30 times the complexity.”

— Lee Coulter, former SVPKraft Global Shared Services Group


Geometric nature of COMPLEXITY

12

Geometric complexity costs

Traditional linear costs

Cumulative cost

00 Cost Driver


Geometric growth drives the shape of the WHALE CURVE

13

00

Total revenue

Total profit

Revenue-Profit Parity

Complexitycosts

Linear costs

• Complexity costs grow to the point that they overtake revenue growth and destroy profitability

• Complexity costs are often the single biggest determinant of cost competitiveness!


Blue Bell Ice Cream

“We can support only 25 to 30 flavors at a time.”--Paul Kruse, CEO, Blue Bell

• #3 ice cream company in the US nationally (after Dreyer’s and Breyers)

• #1 in the markets in which it competes

• Most profitable ice cream company


Principles for attacking complexity

15

1. Seek understanding over precision

2. Focus on the interactions

3. Take concurrent actions to unlock benefits

4. Avoid false choices (re-imagine the business to achieve the best of both worlds)


“By Volume” “By item”

Unit cost:

Vol.

Total cost:

Vol.

∝ 𝑣𝑜𝑙.

Vol.

Vol.

∝ 1𝑣𝑜𝑙.

“By SQRT vol.”

Vol.

Vol.

∝ 1ξ𝑣𝑜𝑙.

∝ ξ𝑣𝑜𝑙.

Example: SQUARE ROOT Costing

© Wilson Perumal & Company, Inc. 17

Product Unit sales Volume ratio

Inventory ratio

Inventory holding

cost

Inventory per unit

ratio

Unit holding

costProduct A 16,000 16x 4x $4000 1x $0.25

Product B 1,000 1x 1x $1000 4x $1.00

• Two products: A & B• 17K total units sold• $5000 inventory holding costs• Typical allocation:

$0.29/unit

Small-volume products are almost always under costed

𝐈𝐧𝐯𝐞𝐧𝐭𝐨𝐫𝐲𝐔𝐧𝐢𝐭 ∝ 𝟏ξ𝐯𝐨𝐥. All else being equal:𝐈𝐧𝐯𝐞𝐧𝐭𝐨𝐫𝐲 ∝ ξ𝐯𝐨𝐥.

Example:


Traditional fixed-variable cost paradigm is outmoded

Volume

Cost

Variable costs

Volume

Economies of Scale

Complexity

Complexity costs

• Under-costs small-volume items and over-costs large ones• Overestimates economies of scale (i.e., potential for fixed

cost leverage)

© Wilson Perumal & Company, Inc. 19

MillerCoors

“This was a quick and painless way to understand our true product profitability, and it challenges how we think about

our business. I am extremely pleased with the results.”—Fernando Palacios

EVP and Chief Integrated Supply Chain OfficerMillerCoors LLC

• 1700 products

• All nine breweries

• Down to operating profit

• In just Six Weeks!


Questions to Consider1. How is complexity impacting your business? How

are you currently approaching it?

2. What level of complexity can your current operating model support? Are you past that level?

3. How would knowing true costs and profitability impact your business decisions and performance?

4. Is your growth strategy creating scale or creating complexity?

5. How might you re-imagine your business?


“Anybody can make things bigger, more complex… it takes a touch of genius—and a lot of courage—to move in the

opposite direction.”

— Albert Einstein

Wilson Perumal & Company, Inc.

www.wilsonperumal.comRead our Blog: http://bit.ly/12sspPU

Discuss Complexity: http://linkd.in/181ahgG

Follow us on LinkedIn: http://linkd.in/10BnH1i

Follow us on Twitter: http://bit.ly/ZRqktE

http://bit.ly/12sspPU

http://bit.ly/12sspPU

http://linkd.in/181ahgG

http://linkd.in/181ahgG

http://linkd.in/10BnH1i

http://linkd.in/10BnH1i

http://bit.ly/ZRqktE

http://bit.ly/ZRqktE