29 December 2009

The New ERP – Part 33

One of the things I try to do in working with a new team of executives and managers is to get them to enlarge their view of their own organization – their own enterprise. I encourage them to think in terms of potential and not just the results they are beholding today.

Most managers and executives think in terms of "forecasts" versus "actuals." In their minds, they compare forecast sales with actual sales, and they compare forecast profits with actual profits. But what the enterprise is really giving up is not the difference between "forecast" and "actual." What the firm is actually giving up – what the enterprise is actually losing – is the difference between their actual profit and the full profit potential for the firm. These losses are irrecoverable – gone forever – as a lost opportunity.

Cost-world thinking

If you are like most folks in management, you've heard the oft-repeated mantra of the cost-world: "Every dollar of cost (or expense) that is cut falls directly to the bottom line." This makes sense because it is true.

Unfortunately, this concept is a very constrictive, and sometimes misleading, fact when taken by itself.

Three or four decades ago, it was possible for companies to actually "cut costs" in a way that made, in some cases, a real difference. New technologies – not necessarily computer-related – were making companies more efficient. Competition from abroad just beginning to emerge in a good many industries, and real waste had to be cut away to stay profitable as prices fell.

By the 1980s and into the 1990s, most U.S. companies had already completed (or were wrapping up) major cost-cutting efforts. By this time, executives and managers had trimmed a good deal of the true waste available in their systems. Attempts to reduce costs further frequently butt heads with the law of diminishing returns: the efforts to reduce costs further simply do not produce enough benefits on the bottom-line to make them economically sensible to undertake.

Cost-Cutting Period
Est. Cost to Implement
Change in Profit
Pre-1980 Cost-Cutting
1980 - 1999 Cost-Cutting
21st Century Cost-Cutting

Actually, the real picture gets worse than this simple chart of diminishing returns.

Understanding protective capacity

Every business entity or other functional organization has two types of capacities: First, there is the organizations core capacity. This is the capacity the organization calls upon day-in and day-out to meet its normal workload. However, surrounding your enterprise's core capacity is another layer of capacity that is automatically generated. No deliberate act of management created this layer of capacity and its appearance varies dramatically from firm to firm. We refer to this capacity as protective capacity, and it is this capacity that is called upon whenever "Murphy" attacks and disrupts the organization's ability to meet its normal day-to-day demands. When protective capacity engages, it causes resources in the organization to work harder, faster, longer, more efficiently or in other ways to meet short-term requirements. It causes the organization the "sprint" to catch up at a pace that is unsustainable in the long-run.

Note: Some organization's have a third type of capacity: namely, excess capacity. We will address that capacity in a few moments.

During cost-cutting cycles, many management teams fail to recognize the presence of and need for the organization's protective capacity. When this happens, such firms run the risk of cutting away, not "fat," but protective capacity that is necessary to the maintenance of the organization in the long-term.

If protective capacity is, in fact, trimmed away during cost-cutting actions, the natural reaction of the organization is to shrink core capacity in order to rebuild the layer of protective capacity and thus protect itself against "Murphy." The resulting reductions in core capacity will have several ill effects on the enterprise:

  • A reduced capacity to recover from business disruptions
  • A reduced capacity to meet periods of unusually high demand
  • A reduced capacity to emerge rapidly or successfully from economic recessions
  • A reduced capacity to take advantage of unanticipated opportunities

Understanding excess capacity

During cost-cutting cycles, what executives and managers are frequently looking to efface from the organization is what might be deemed "excess capacity." But, if management will stop to consider, what might be classified as "excess capacity," is really the capacity in your organization that is unconstrained and which your management team has not yet exploited in the production of Throughput and profit. It is precisely that capacity that your enterprise has been paying for all along but failing to reap the benefits of leveraging it toward reaching the firm's full potential.

Cutting is always easier than thinking, but thinking is generally the more profitable.

Consider how Federal Express got its name. As I understand it, Frederick Smith, founder of FedEx had developed the concepts behind such an overnight courier service in college. When he got ready to put his ideas into action, he bought or leased some airplanes and hired some pilots, on the one hand, while negotiating with the U.S. Federal Reserve system on a contract to courier money and documents between the banks of the Fed on an overnight basis. However, just he was about to put it all together, the Fed backed out of the deal. That left Smith a lot of excess capacity in the nature of airplanes and pilots. The name "FedEx" stuck, but Smith put the excess capacity to work in private commerce by developing offers that made economic sense to his customers while creating new Throughput.

Had Frederick Smith been a "cost-cutter" rather than a visionary and an entrepreneur, FedEx may have fallen by the wayside instead of becoming the firm it is today.

©2009 Richard D. Cushing

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