A new way to reduce complexity cost in your organization.

 

One of the questions we frequently receive from customers is if we can help with their complexity cost; complexity cost caused by the amount of suppliers, of products, of process variants, etc.

We absolutely can: with a radically new approach simulating complexity effect on free cash and profitability to derive decision criteria for taking action—supplier by supplier, product by product, process variant by process variant, etc.

Complexity costs grow quadratically with the amount of moving parts such as SKUs, process variants, payment terms and alike. An analysis by ATKearney found that “EBIT reserves of more than €30 billion are just waiting to be tapped,” and that “companies can increase their EBIT by 3 to 5 percentage points on average.”

Yet why do we have a difficult time unraveling complexity cost issues?

It begins with the term “complexity costs.” While the term is correct in describing the phenomenon that complexity drives costs, the term is misleading because it suggests that we have to analyze costs in order to be able to do something about it. This is wrong. Complexity is not a bad thing, per se. There’ s “good” as well as “bad” complexity. “Good” complexity is  value adding whereas “bad” complexity is value diminishing. Hence, the challenge is to differentiate between “good” and “bad” complexity.

Our approach starts by defining “value.” Though value targets vary per enterprise, they typically revolve around the capability to generate cash and profits and thus are composed out of cash (working capital) and profitability goals. That is the basis for our new idea. What if you could discern how your complexity affects free cash or profitability position? What if you could achieve this along all meaningful dimensions of your business like suppliers, products, customers, organization, geographies, and end-to-end processes?

To illustrate our new approach, we ran an analysis with one of our customers (who has near €3bn in revenue). We investigated how the absolute number of offered payment terms impacts profitability and cash (i.e. we studied the absolute amount of payment terms per customer, not the number of payment terms per invoice). The results were very insightful.

We started by reviewing gross margins; the chart below depicts the distribution of gross margins versus realized prices per absolute number of offered payment terms. At first glance, we see that a single payment term yields the highest profit.

The next chart depicts a simulation of the potential effect of offering more or less payment terms. We see that offering more payment terms yield a higher profitability but at a lower profit.

Then we studied the working capital impacts. The distribution chart suggests that offering only one payment term also yield the lowest DSO number.

A simulation confirmed that that lowering the number of absolute payment terms offered lowers the DSO.

By visualizing and quantifying financial impacts to complexity reduction, this customer is now in a position to take an educated trade-off decision between reaching his profitability and cash targets. Voilà.

How did our customers react to this? “Finally we can overcome our current stalemate situation.”, “We have new opportunities for action now.”, and “A refreshingly new way of attacking this long-standing problem.”