CHAPTER 1

The Imperative for Waging This War(And the Need forBetter Battle Strategies)

We're surrounded. That simplifies the problem.

—General Lewis B. "Chesty" Puller,U.S. Marine Corps

A few years ago, Procter & Gamble reduced product cost by more than $2/case overa three-year period as a result of a program of simplification andstandardization, accounting for nearly $3 billion in savings. An additional $1billion was generated through the closure of 10 plants as a result of thesimplification. Its margins over that period increased from 6.4% to 9.5%.

Similarly, Motorola generated savings of $2.6 billion in operating and materialcosts in two years of a "War on Complexity," at the same time reducing inventoryby $1.4 billion and capacity by 40% as fewer factories and distribution centerswere needed.

These cost reductions were all made before the current economic downturn savagedrevenues. The implication is even in boom times there was opportunity. But nowthat "the list of bad news is almost endless" (as The EconomistIntelligence Unit put it), the opportunity, and challenge, has beenmagnified manyfold.

Early in 2009, The Economist forecasted the worst global GDP performancesince the end of the Second World War. Global in nature, pan-industry, and toall indications sustained, this contraction is not only putting immediate costpressures on companies, but also threatening to reshape the economic landscapein ways that may last a decade or more. To what exactly, no one knows. But asthe landscape changes, so too must companies.

The contraction marks a sharp divide between the last decade and the next.Companies over the past decade were part of a rising tide that floated allboats, growing and expanding in sync with the consumer. They rushed to marketwith new products and line extensions, expanded into adjacent markets andservices, and grew rapidly into new geographies driven by steadily growingconsumer demand.

Consider, for example, the trajectory of many food retailers in the past decadeand the demands of growth, as they ...

• Expanded into new formats, from the traditional grocery store format tovariants including city center stores and the out-of-town megastores

• Stretched their processes and supply chain to handle an explosion in newranges, both inside existing grocery categories and beyond—into hardware,clothing, and electronics (in fact, many stores now carry more than 100,000 SKUsin diverse categories)

• Grew their organizations to expand into new geographies, from home basecountries to high-growth markets in China, India, and elsewhere

The consumer packaged goods companies, as suppliers to these retailers, havekept apace, launching a volley of new products: new versions of Oreo cookies, anaisle of potato chips, hundreds of types of toothpaste. The retailers, theconsumer goods companies, and their suppliers have all rightly rushed tomeet consumer demand, but not without considerable adjustment.

Think about the impact of all that change on the supply chain that "grew up"over many years getting cans of soups from the supplier to the shelf edge. Thatsame supply chain now has to also support flat-screen TVs ... now extend acrossmultiple countries ... now support different format stores, and on and on.

You may not be in the business of retailing soup or flat-screen TVs, but chancesare your business has gone through similar changes. You have seen your range ofproducts and services expand to meet the growing diversity of customer demands.Your internal processes, organizational structures, and technology have likewisegrown in complexity. Your business has stretched and rapidly grown to meet adecade of growth but has left in its wake an enormous burden of complexitycosts.

An Island of Profit in a Sea of Cost

As the P&G and Motorola stories illustrate, the prize for cutting complexitycosts can be substantial. At a general level, we've found that it's possiblefor companies to reduce costs by 15% to 30% in significant portions of theirbusiness by waging war on complexity costs.

How is this possible? Consider how profit is usually concentrated within acompany. A so-called Whale Curve (Figure 1) demonstrates this effect,plotting a company's cumulative profit as a function of products ranked by theirprofitability. (There are a variety of Whale Curves, each showing cumulativeprofits against various drivers, such as products, customers, and revenue.)

What does the Whale Curve tell us? Often the most profitable 20% to 30% ofproducts generate more than 300% of the profits in a company. Becauseactual profits can't exceed 100% of the total, the remaining 70% to 80%lose 200% of the profits: they are tied to assets, processes,products, and customer groups that are disproportionate drivers of cost in yourorganization.

The Whale Curve is a provocative representation of profit concentration, and itprovides a tantalizing reflection of the possibilities. What would yourorganization look like if you could somehow shed the 80% of products that weresapping profit? (We will later discuss how process and organizational complexityaffect the Whale Curve.) A prerequisite to shed that excess baggage is tounderstand how your product line creates or "loses" profits by undertaking aprofitability study. However, the results often jar with commonly heldassumptions. In his book The 80/20 Principle, Richard Koch reports,"Routinely, executives who commission product-line profitability exercisesoften do refuse to believe the results when first presented with them." Andeven if they believe that 80% of their products are "profit losers," they oftenshy away from dealing with that portion of the product line. The executives'rationale, Koch maintains, is that it is impossible to remove the 80% ofcorresponding overhead in any sensible time frame. Therefore, only the mosthorribly unprofitable business is removed. Koch further says,

Yet all this is a dreadful compromise.... The truth is that the unprofitablebusiness is so unprofitable because it requires the overheads and because havingso many different chunks of business makes the organization horrendouslycomplicated. It is equally true that the very profitable business does notrequire the overheads, or only a very small portion of them.

It is difficult for many—despite the data—to accept the impact ofcomplexity on the overall health of the organization, particularly given thefact that complexity does not announce itself with fanfare. Rather, it creeps indecision by decision, each choice adding costs that are hidden from traditionalaccounting methods. Worse still, its effects are geometric: a small expansion ina product or service line affects not just the offering of the delivery processbut also everything else that goes into creating and supporting thatprocess—inventory, instructions, overhead, and more.

Consider a familiar business strategy of the past decade: consumer goodscompanies proliferating line extensions as a way to secure customer nichesegments, steal share, or in response to customer requests. What has been theimpact on revenue and costs? The first thing to understand with line extensionsis that they rarely increase demand. As a study pointed out, "People do not eator drink more, wash their hair more, or brush their teeth more frequently simplybecause they have more products from which to choose." What happens frequentlyis a cannibalization of one product by another.

On the cost side, the news is rarely better: Line extensions require increasesin marketing expenditure, product development, production, and packaging as newmanufacturing lines are required. New warehouses and sometimes new factories areneeded. Transportation costs increase, not only with increased volumes going tostores but also with fewer and fewer full pallets being loaded onto trucks.Administration and overhead costs increase as new product managers are broughtin to manage the expanding portfolio. The result as cited in the above study:the unit costs for multi-item lines can be 25% to 45% higher than thetheoretical cost of producing only the most popular item in the line. (Wewill reveal the math behind the proliferation costs in Part II.)

Decomplexity Case Study

Let's consider a concrete example of complexity creep and what one company didto address it. Toblerone is the iconic candy bar with the distinctive triangularshape (meant to echo the Matterhorn in the Swiss Alps). As often happens,complexity within the brand line occurred as the result of many incrementaldecisions, all made with the best of intentions. Since its creation 100 yearsago, the Toblerone bar has grown in popularity and availability. Slightlydifferent versions were launched in neighboring geographies, requiring thesupport of additional processes and organizations.

In short, the growth created a web of complexity. To turn this around, Kraft(which now owns the brand) launched a "decomplexity" effort, which promotedthree strategic goals for the company: help drive growth, improve consumersatisfaction, and drive out costs and assets. The Toblerone effort is summarizedin Table A.

Kraft saw benefits in two types of cost:

1) Reduced material costs, from savings in raw materials, ingredients,packaging, formats, and SKUs

2) Reduced process costs, including savings in R&D, procurement,conversion, logistics, marketing, sales, and administration.

Kraft estimated that the result was an ongoing pre-tax cost benefit of $400million per year. With a focus on sustainable productivity improvements, Kraftused decomplexity as an enabler to efficiently attain global scale and developfunctional excellence. The company understood that a focus on eliminating thebad complexity costs was good for the shareholder and good for the customer.

Why Companies Lose the War or Avoid It Altogether

We've now seen three examples—P&G, Motorola, and Kraft—of companiesthat have made significant progress in cutting costs via complexity reduction.And we're now in a climate that demands meaningful action on costs. So thequestion arises as to why more companies have not taken action.

Clearly companies everywhere are looking at costs. But traditional corporateapproaches inspire little confidence. A recent study reported that fewer thanhalf of all the companies launching cost-reduction programs actually realizedbenefits, and even then the benefits were short lived. Only 10% of the companieswere able to sustain the cost reductions through year 3. Executives have theirown opinions as to why things go awry; we have heard the following:

"The cost program focused on the wrong areas.""It sacrificed long-term value for short-term benefits.""It didn't go beyond the low-hanging fruit."

Part of the trouble is that companies are not in business to cut costs, norshould they be. For the consumer products company, the source of competitivestrength lies in getting compelling new products to market fast; for theretailer, it is keeping shelves stocked with customers' favorites; for theindustrial goods manufacturer, it is keeping quality high and lead times short.In short, cost-reduction efforts for most companies are not a core competence.Such tactics are one-time events, forced by external circumstances, focused onshort-term results. This may be why so few cost-reduction initiatives deliverwhat's required of them or help truly transform the cost position of thecompany. (See "Deep Dive #2: Assessing Your Company's Cost-Cutting IQ" forfurther discussion of this topic.)

But all that said, our takeaway is the following: Cost-reduction approachesthat didn't work before won't work any better now just because the need isgreater.

It is our assertion that the best path to restructuring your costs is byattacking product, process, and organizational complexity. But although theissue of complexity costs is increasingly transparent, many shy away fromattacking the issue as a more strategic and effective path to cost reduction.Why does such a large and attainable prize go unclaimed?

1) No one has quantified the size of the prize—so attacking complexityas a root cause has not been made a priority. Financial systems andprocesses are ill equipped to quantify, or even flag, the costs of complexity,which is why many of these costs stay hidden from executive line of sight. Buteven when leadership recognizes the symptoms, they have difficulty placing adollar value on what it's worth to address complexity. This is a major hurdlewhen it comes to deploying real resources and investment to wage the war oncomplexity costs. Thus, such initiatives often fail to get traction,overshadowed by alternative initiatives that are less profitable but more easilyquantified. (The ineffectiveness of GAAP in capturing complexity costs has beenwidely explored elsewhere; we won't belabor the point here.)

2) Companies are put off by the scale and nature of the problem itself.Even for those executives who recognize the issue and the opportunity, it canseem at the outset an intimidating mountain to climb. There are manyinteractions between products, processes, and organizational structures thatextend beyond the normal functional structures in corporations for "gettingthings done." Cross-functional efforts, by definition, require coordinationacross functions to work. Given the nature of complexity, it is not surprisingthat many efforts that start out with ambitious goals are reduced to piecemealsolutions.

3) Companies need better battle strategies. Even companies thatunderstand the financial prize on the table, and are looking to take this on,need battle plans that account for the nature of complexity, which can extractmeaningful benefits quickly without quagmiring them in endless analyses andfrustrating sets of interdependencies. (In Parts II and III, we will explain thenature of unlocking complexity costs and provide specific battle strategies youcan use.)

To close these gaps, we are writing this book. We will explain how to size theprize, scope your efforts, and extract the benefits to successfully take costout of your organization.

The Art of Complexity Warfare

We recently met with the CEO of a Midwest industrial equipment manufacturer. Thecompany had correctly diagnosed complexity as an issue and formed an internalteam to reduce product variations by 40%. The team had worked diligently towardthis goal and eventually achieved this reduction. But the CEO was puzzled:Despite the efforts and investment in the team, there was no improvement in thebottom line. How could they cut the product offerings like this without seeing areduction in costs?

Unfortunately, this scenario is not uncommon. For while few companies can stickwith the "do nothing" strategy, the "just do something" strategy can be just asineffective, absent an understanding of what it takes to extract the fullbenefits of complexity reduction.

To meet the task before us, then, we need a different approach—different,and better, battle strategies that can help companies like this manufacturerbetter quantify, locate, and purge complexity costs. We need to thinkdifferently about how we approach the challenge.

There are six key principles that inform the art of complexity warfare:

• Principle 1: There is good complexity and bad complexity (reduce thebad and make the good less expensive to deliver)

• Principle 2: Complexity is a multi-dimensional issue (and must beviewed as such to be understood in its fullness)

• Principle 3: Piecemeal approaches will not move the needle on costreduction (don't nibble at the edges of the issue)

• Principle 4: Unlocking the benefits requires "concurrent actions"

• Principle 5: Complexity costs "creep in" incrementally, but you needto remove them in chunks

• Principle 6: This need not be a long, academic exercise

(Continues...)