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An article entitled “It’s Complicated” appeared recently in The Economist magazine and, of course, caught my eye. What especially captured my attention was the concluding paragraph that included this profound statement:

“The biggest threat to business almost always comes from too much complexity rather than too much simplicity.”* [Emphasis added.]







On 14-15 November 2013, hundreds of management enthusiasts of all kinds met in Vienna, Austria, to discuss the complexity of today’s business environment and what managers and executives can do to survive and thrive it the midst of it.


There is no doubt that managers and executives are being confronted with increasing complexity. The article says:

“Businesspeople are confronted by more of everything than ever before: this year’s Global Electronics Forum in Shanghai featured 22,000 new products. They have to make decisions at a faster pace: roughly 60% of Apple’s revenues are generated by products that are less than four years old. Therefore, they have a more uncertain future: Harvard Business School’s William Sahlman warns young entrepreneurs about ‘the big eraser in the sky’ that can come down at any moment and ‘wipe out all their cleverness and effort.’”*

Simplicity out of complexity


Interestingly, in the midst of all of this, an apparent dichotomy has emerged.

“Organisations built for this new world may look complex and unwieldy but they have an inner logic and powers of self-organisation. Global networks such as Kiva, a crowdfunding website, and CrisisCommons, which musters tech volunteers in disasters like the Philippines typhoon, can mobilise thousands of people with little top-down direction. Accelerate, a call-centre company, employs 20,000 people but has no call centres: they work from home.”


How is it possible for complex, loosely-knit organizations such as Kiva, CrisisCommons and Accelerate to function efficiently and effectively in meeting the needs of their clients and customers?


The answer appears to be found in recognizing that the old “command-and-control” mechanisms of a fast-passing age can no longer be applied.


The failure of command-and-control


The genius of Taiichi Ohno at Toyota Motor Company was that of involving people in building the processes by which they conducted business and interacted. By inviting them to participate in building something—rather than attempting to exercise “command-and-control”—he was able to take that which is complex and manage it successfully based on inherent simplicity.


The concept of “inherent simplicity” simply assumes that the complex a system (or situation, or problem) appears, the simpler the answer must be to be effective.


Look closely at how relatively self-organizing networks like KIva, CrisisCommons, Accelerate or even (to a great degree) companies like Google or Toyota work and you will discover, I think, that they have avoided “being blinded by complexity” by concentrating “on the few simple things that can give their business focus and their workers direction,”* just as the article’s author suggests.


Concentrating on the few simple things…focus


More and more, as we work with small to mid-sized business enterprises, we are discovering that they are being overwhelmed by the complexities of their own organizations and the increasing complexities they perceive in their supply chains.


As a result, it is increasingly necessary for us to help them apply tools that bring them back to a focus on the very few simple things that will provide trustworthy direction and will guide their actions toward that which will be effective in bringing immediate return on investment (ROI).


Focus becomes everything.


Our guidance in the application of focusing steps has helped our clients increase Throughput while holding the line on operating expenses. This means improvements in cash flow and better profits.

In many cases, no new technologies are involved in making these gains.


Our experience concurs with the findings of the article in The Economist:


The biggest threat to businesses and their supply chains almost always comes from too much complexity rather than from too much simplicity.


We would like to hear your comments on this topic. Please leave them here, or feel free to contact us directly, if you prefer.


* "It's Complicated." The Economist 9 Nov. 2013: 68. Print.

Recently, I read a brief article by Lisa Anderson entitled “Business Process ROI.” I could not help but chuckle at my broad agreement with Anderson when she said that, while she endorsed the concept of “business process improvement,” she was “not a fan of what many term ‘business process improvement’ which turns into a wasted exercise of creating volumes of 1-inch thick binders of best practice processes that sit on the shelf and collect dust.” [1]


Bravo! for that.


First on the list of Anderson’s tips was “Involve employees” and this immediately reminded me of the Toyota Way and what has come to be known as the Toyota Production System “House” diagram.


Sadly, a great many executives and managers today believe that their ERP (enterprise resource planning) system is the “heart of their enterprise.” People, to these misled managers, are secondary and replaceable components.


Between 1950 and the mid-2000’s, Toyota Motor Company managed to build a worldwide business enterprise which, by 2004, was making more profit than General Motors, Ford and Daimler-Chrysler combined. And its management did, for the most part, without either the computers or the capital available to the Big Three American auto manufacturers.


Involving people


Toyota accomplished this by relying upon people—upon their intuition and upon their innate desire to do a good job.


To this day, Toyota’s manufacturing floor remains, essentially, “a black box” to finance and accounting. Accounting knows the inputs to and outputs from manufacturing operations, but it does not concern itself with measuring “efficiencies” or “utilization.”


The finance department reaps the rewards—the profits—and measures the ROI (return on investment) of a system built on “involving people” in process improvement.


Beginning with the end in view


At Toyota, they begin every thought of “improvement” with the end in view. Their measure of quality is “the entire customer experience” in buying and owning a Toyota product. Therefore, even the profits reaped by Toyota and its supply chain participants do not come from focusing on short-term profits.


Instead, Toyota’s profits are a side-effect, in its view, of creating “fast, flexible processes that give customers what they want, when they want it, at the highest quality and affordable” prices. [2]


Driven by people with a long-term view—and a very successful one at that—Toyota works its supply chain in ways that sometimes seem counter-intuitive ways to those caught up in cost-world thinking.

  • Often the best thing you can do is to idle a machine and stop producing parts
  • Often the best thing you can do is to level-out production rather than attempt to manage according to constantly fluctuating periodic demand
  • Often it is best to selectively add and substitute overhead for direct labor, because when you see the real value of value-added workers, you want to support them like you would a surgeon performing a critical operation
  • It is not always a top priority to keep your workers busy making parts as fast as possible
  • It is best to selectively use information technology and often better to use manual processes, even when automation is available and would seem to justify its cost—because people are more flexible than technology in most cases

The right process will produce the right results


Not long ago, I was helping a client with some production issues that were, believe it or not, being made more complicated and more difficult to manage as a result of the ERP systems the company had in place.


The CEO of the company asked me, “How can we keep our people from taking shortcuts that mess up the data in the [ERP] system?”


I replied, “I believe that your people want to do the right thing. In fact, I think when they take the ‘shortcut’ you describe, that they believe they are doing the right thing. They are serving your customers. They are trying to get the product completed and out the door in order to keep the promises you have made to your customers.


“For these workers, the data in the ERP system is secondary to serving your customers and keeping your promises. And, frankly, when it comes right down to it, I think you believe the same thing.”

The CEO, of course, agreed with me.


What needed to be changed was the process by which the ERP system got its information. Ultimately, it was dramatic simplification of the process that actually improved the flow of production and required no additional personnel.


People want to do the right thing


When it comes to creating a process of on-going improvement—a POOGI—I tell the companies I work with to begin by listening to what your people are saying.


Toyota has built a worldwide, highly profitable enterprise by listening to its employees. They believe that no one knows more about running the machine—or the process—than the people who actually run it. Managers don’t. Executives don’t.


Start by involving your people. Start by really listening to them.


The same thing goes for listening with an open mind to all of the participants in your supply chain. Toyota does that, too.


It’s a practice worth emulating.



We would be delighted to hear your comments on this or any related topic. Leave your comments below, or feel free to contact us directly, if you prefer.


[1] Anderson, Lisa. "Business Process ROI." Recent Posts. Kinaxis, 21 Nov. 2013. Web. 22 Nov. 2013.

[2] Liker, Jeffrey K. The Toyota Way: 14 Management Principles from the World's Greatest Manufacturer. (p.8) New York: McGraw-Hill, 2004. Print.

In a discussion I had not long ago with supply chain leaders from several Fortune 500 firms, I was surprised to find them embracing a dichotomy. On the one hand, they acknowledged that complexity in their supply chains tended to make firms less profitable, not more profitable. On the other hand, they actively embraced “supply chain complexity” as a “competitive advantage.”


“How could this be?” I thought to myself.


Inescapable complexity


As I listened to these supply chain executives describe what they meant, I came to understand that the “competitive advantage” of which they were speaking stemmed from the complexity of the supply chain itself. And, that they measured the complexity of the supply chain mostly around the number of nodes in the supply chain—how many trading partners were involved in delivering the final product to the consumer.


I was somewhat inclined to agree with them.


However, why was this so-called “competitive advantage” working against them when it came to creating long-term improvements in the overall performance of the companies themselves?


Many of the facts and figures presented at the 2013 Supply Chain Insights Summit (held in Phoenix, AZ) regarding Fortune 500 companies indicated stagnation—little or no significant improvement over the last decade or longer for many of these firms. Lora Cecere’s comments at the Summit affirmed that a great many of these companies “are stuck,” unable to find a path to ongoing improvement.


I have come to believe that many supply chain managers and executives fail to distinguish between what I will call “necessary complexity”—even, advantageous complexity—and “self-imposed complexity.”


Complexity as an advantage


When products (or services—I will use “products” inclusively) are created that inescapably demand many nodes in the supply chain to reach the consumer, then the firm that masters this complexity is likely to have a competitive advantage for some period of time.


It is likely, however, that the ability to successfully manage this complexity is not a durable competitive advantage.


Before long, others will learn to manage the complexity successfully, as well. Or, others will innovate a way to meet the consumers’ demand with less complexity, higher quality, or achieve some other competitive advantage.


Self-imposed complexity


Self-imposed complexity, however, is never a competitive advantage.


Consider the case of Toyota.

In the 1930s, the leaders of Toyota Motor Corporation, a small Japanese company that made simple trucks—and made them poorly—visited Ford and General Motors to learn more about assembly lines. They were shocked by what they saw. By controlling the whole value chain, Ford's River Rouge complex was able to shrink the lead time from melting iron to making cars. Assembly lines dedicated to the same types of cars allowed for standardization that improved productivity and quality, so much so that Ford was ten times more productive than Toyota, with quality that was thirty times better. To complicate matters, Toyota didn't serve a large market and couldn't dictate what consumers would buy, which made mass production problematic, and it had nowhere near Ford's financial resources.


World War II made things worse, destroying industries—including Toyota's suppliers—and leaving Japanese consumers with little money to spend. Once again, Toyota's leaders decided to learn from their American counterparts, devoting twelve weeks to studying U.S. production processes. The year was 1950, the year Taylor's scientific management system may have peaked and its successor was born. [1]


In 1950, Ford Motor Company and the U.S. automakers (in general) “held all the cards,” and had all the advantages over Japanese firms.

By 1980, Toyota had overtaken [Ford Motor Company].


In the early '80s, Toyota decided to open its first overseas manufacturing plant in the United States. It approached Ford, the company it admired and had learned so much from, and offered 25 percent of Toyota for $2 billion. Ford declined. Toyota then partnered with General Motors, taking over a plant in Fremont, California, that had been closed in 1982 when it claimed the worst quality and productivity of any GM plant, absenteeism above 20 percent, and a contentious local union. Toyota reopened the Fremont line in 1984 as New United Motor Manufacturing Inc. (NUMMI). Against GM's advice, it brought back the same union and the same workers.


Two years later, NUMMI had higher quality and productivity than any GM plant, absenteeism had dropped to 3 percent, and worker satisfaction was best-in-class. Toyota continued to improve. By the 1990s, its quality and productivity were each at least 50 percent better than Ford's. In 2004, more than half of the top ten selling cars in the U.S were made by Toyota, and its operating profit was greater than that of Ford, GM, and DaimlerChrysler combined. Today, it is the world's most respected automotive company, according to Fortune, and one of the top ten companies of any kind worldwide. [2]


Here were two different firms manufacturing the same product (motor vehicles) who must be faced with very similar external supply chain complexities. They consume the same kinds of raw materials. They use many of the same components from an essentials point of view—wiring harnesses, brake pads, body parts, ad nauseum.


Yet, Toyota set about systematically slashing away relentlessly at self-imposed, non-essential complexity.


What was Toyota’s reward for doing so?


“In 2004, …its operating profit was greater than that of Ford, GM, and DaimlerChrysler combined.”


That’s a nice reward.


Inherent simplicity


We are firm believers in inherent simplicity. We find that most U.S. companies have self-imposed complexity and that a great deal of that self-imposed complexity today stems from their belief that ERP (enterprise resource planning) should be the center of their enterprise.


Some are even under the errant impression that more data will help them manage better—and that if they could just get all the data, that they could manage flawlessly. This is the siren call of poorly considered technology investments and the drive toward ever-increasing self-imposed complexity.


Many of these firms have come to rely upon “invisible management” systems—things that happen “in a black box” that many in management do not even fully comprehend and could not describe properly if called upon to do so.


Toyota took the opposite path: Toyota has relied upon simple “visible management” systems—systems developed by the workers themselves; systems that are clearly understood; and systems that are inherently trusted by those who must rely upon them for day-to-day productivity.


Today, even though the firm I work for sells ERP systems, we are helping more and more companies take steps toward inherent simplicity—and helping them increase profitability and smooth the flow of goods in their supply chains, at the same time.



We would like to hear your comments on this topic. Please leave them here, or feel free to contact us directly, if you prefer.


[1] Koenemann, Ken (2013-01-15). Think Sync: The Competitive Advantage of a Lean Value Chain (Kindle Locations 193-201). TBM Consulting Group. Kindle Edition.

[2] Ibid. Kindle Locations 230-240


When Jeffrey K. Liker published The Toyota Way* in 2004, he said, “I have visited hundreds of organizations that claim to be advanced practitioners of lean methods. They proudly show off their pet lean project. And they have done good work, no doubt.”


But, “[t]he problem is,” Liker goes on to say, “that companies have mistaken a particular set of lean tools for deep ‘lean thinking.’”



“U.S. companies have embraced lean tools but do not understand what makes them work together in a system…. [t]hey do not understand the power behind true TPS [Toyota Production System]: the continuous improvement culture needed to sustain the principles….,” opines Liker.


What Liker expressed in 2004 about individual firms is equally true about most so-called “lean supply chains” today.


Most “lean” companies (in 2004) were stuck on the “Process” level in the 4-P model of the Toyota Way shown here. Today, for those companies working on implementing “lean supply chains,” they, too, are stuck on “Process.” And a great many of them are still stuck primarily on internal processes.





For all the talk about “collaborative supply chains,” there has been very little real movement toward “Respect and Teamwork”—the “People and Partners” level in the Toyota Way.


Most supply chain relationships amongst small to mid-sized business business enterprises today are still arms’-length agreements between two parties that know little about one another’s operations and, sadly, they are happy to have it that way.


We call it a “supply chain” for a reason


Apparently, for a great many executives and managers, the term “supply chain” has not really sunk in, yet. They think of the SUPPLY side of the transaction without considering the CHAIN side.


Anyone who has ever worked with a chain knows that, if a chain is going to fail to fulfill what is being asked of it, it’s going to fail—by definition—at its weakest link.


It is the weakest link that defines the very limit to which a chain will be reliable. Yet, a great many executives and managers involved in supply chain management do not know where the weakest link in their supply chain is—literally.


They don’t know the geographical locations involved in the flow of materials from raw materials (e.g., mined, harvested, reclaimed) to their receiving dock. Most can only guess whether a disruption in the shipping lanes in some part of the world might have an effect on supply of a product to their firm. And, if they do know, it is probably because they have already experienced a disruption in their supply chain and were forced to discover the cause.


Everybody’s Throughput is limited by the weakest link


Because every participant’s Throughput is limited by the ability of the weakest link in the supply chain, it is in every manager and executive who is involved in supply chain management to know and understand these factors:

  1. Where is the weakest link in my supply chain? Where is it geographically?
  2. What company in my supply chain is responsible for the weakest link?
  3. Who is responsible for the weakest link? Meet the managers and executives in the firm involved. Get to know them so that you can have an open dialog with them about how you can help them strengthen this weakest link.
  4. When is the weakest link the most vulnerable to failure? How can managing the supply chain on your end help minimize negative impacts on the weakest link?
  5. Why is this the weakest link? What are the weaknesses? How can the limited Throughput of the weakest link be improved?

As long supply chain managers and executives busy themselves around “processes” with an internal focus, supply chains in most small to midsized companies will remain vulnerable to the weakest link in their supply chains.


Real improvement to supply chains comes from getting outside the four walls of your enterprise and working with supply chain partners—especially the present “weakest link”—respectfully challenging them and helping them grow.


Such an approach will strengthen the weakest link and increase Throughput and profitability for all of the participants in the supply chain. This is a real win-win!



We would be delighted to hear from you on this topic. We are being called upon more and more to help companies improve the approach to supply chain management. Leave your comments here, or feel free to contact us directly.



* Liker, Jeffrey K. The Toyota Way: 14 Management Principles from the World's Greatest Manufacturer. New York: McGraw-Hill, 2004. Print.


When we first meet most of the companies with which we work, they are generally small to mid-sized business firms in the process of transitioning from entrepreneurial to enterprise.


By definition, entrepreneurial management is all about risk-taking.


The first great entrepreneurial leap—the first great risk—was found in making the decision to start the business at all. Next, most entrepreneurs take the lead in finding employees they trust and frequently give these first few employees significant latitude in making decisions and taking actions in the best interest of the business.


But, organizations become complex very fast.


If an organization has two people in it, there are only two potential paths for the flow of information or decision-making.


When the firm adds the third person, the number of potential paths for information flow and decision-making becomes six.


Add a fourth person and the number grows to 24 different unique paths by which information and processes may flow and for which decisions may need to be made.


With only five people in the organization, the number of distinct potential paths for information and process flows leaps to 120, and with six, the number grows to more than 700 (720, to be precise).


When a seventh person is added, the potential number of paths by which information may flow, business processes may be executed, and for which decisions may need to be made becomes 5,040.


Here is a chart for the rest of the numbers up to 15 employees:


Yes. That’s right. With just 15 people involved in your business, the number of potential lines of interaction for information, processes and decision-making grows to more than 1.3 trillion.


Reliable entrepreneurial intuition


When these small businesses were launched, chances are they were guided mostly by what we call the entrepreneurial “sixth sense”—a seemingly innate ability to draw conclusions based on simple calculations and a small number of factors like:


  1. Throughput” (T) (~ gross profit) as being the difference between a potential change in revenue (from an opportunity) and the Truly Variable Costs (TVC) of obtaining that incremental revenue
  2. Operating Expenses” (OE) sometimes referred to as “the nut” that has to be cracked every month, and
  3. Investment” (I) being the amount of money that may need to be paid-out one time in order to take advantage of a perceived opportunity

Entrepreneurs generally can do (on a napkin, over lunch) this simple calculation in assessing any opportunity that lies before them:


Total Profit = Revenues – TVC – Operating Expenses


For any given opportunity, then, this becomes:


delta-Profit = (delta-Revenues – delta-TVC) – delta-Operating Expenses (OE)


[Note: the delta- expression means “change in”.]


If any one-time investment is required in order to leverage the opportunity, the entrepreneur quickly leaps in his or her mind to this calculation:


delta-Throughput (T) = delta-Revenue – delta-TVC


ROI (return on investment) = (delta-T – delta-OE) / delta-I


In a very few moments, even if the numbers being used are not 100 percent accurate when rounded to the nearest penny, the entrepreneur has numbers that close enough to be able to assess any business opportunity set forward. Frequently, he or she can usually do these calculations in their heads while carrying on an intelligent conversation at the same time.


Remember, in most cases for this kind of decision-making, being approximately right is far more important than being precisely wrong. The number are going to “wrong” in the final analysis—the question is only by how much they are wrong. At this point, these are forecasts and estimates in any event.


Connecting the numbers to the proper actions


Notably, the entrepreneurs’ intuitive ability to manage their organizations and guide them towards success doesn’t end with doing these kinds of calculations. These managers intuitively understand the connections and interactions between specific execution and the financial result proceeding from the action.



The connections (shown in the accompanying figure) between actions taken to change Throughput, inventory (or investment) or operating expenses, and their corresponding effects on net profit, ROI and cash flow are held in them minds of most entrepreneurs with crystal clarity.


As a result, these leaders also know intuitively how to direct their organization toward achieving more of their goal. And, once again, their goal—especially in the early days of rapid growth—is also crystal clear to the entrepreneur.

Typically, the entrepreneur’s goal is to help his or her company make more money tomorrow than it is making today. It’s as simple as that.


Yes. These entrepreneurs might want to achieve their goal of making more money through intermediate objectives such as having the best customer service, or the finest products, or other means; but their goal is clear. As a result, their leadership is unmuddled, unadulterated, and they are able to offer clear directives to their staff as to how to leverage opportunities they may see before them.


Clarity lost


So, what happens to the entrepreneur’s clarity on all of these matters as they organization grows in size and complexity?


Well, by the time the company has 15 people at work in it, one can hardly blame the entrepreneur or other executives in the business for not being able to necessarily understand which of the 1.3 trillion potential paths through the organization are actually being used for the movement of information, the execution of the customer-to-cash streams, and decision-making.

Frequently, the formally defined ones are not the paths actually affecting decision-making and outcomes.


The natural course for human beings faced with seemingly overwhelming complexity is to try to break down the complexity into smaller, simpler subsystems. In business, we call these “departments” and “functions.”


Peter Senge, writing in The Fifth Discipline stated the problem concisely:

“An acceptable way of tackling complex problems is to break them down into a series of simpler, more manageable problems. People pay an enormous price when they adopt this approach. We lose our… connection to the larger whole. When people try to see the big picture, they try to reassemble the fragments in their minds…. However,… the task is futile, similar to trying to reassemble the fragments of a broken mirror to see a true reflection. Thus, after a while, people give up trying to see the whole altogether.”


In attempting to make the leap from entrepreneurial to enterprise, the executiveteam works to break down the problems to make them “more manageable,” and in doing so, they lose their connection to “the whole.”


They can no longer, as the old saw goes, “see the [whole] forest, for the [individual] trees” get in the way.


This leads to stagnation. Changes intended to produce one result are found, instead, to produce a different result—or so many negative side-effects that the change must be abandoned or, at least, partially reversed. Then another method is tried, frequently, too, with poor results.


Managers soon feel “lucky” if one-in-three of their proposed “corrective” actions has any measurable positive impact on the company’s bottom-line.


Worse! “Luck” becomes, in fact, what is driving what success is achieved, because almost everything had become an “experiment,” even if this fact is not admitted openly amongst the management team.


There is a way back


We believe there is a way back. There is a way for a business attempting to leap this chasm from entrepreneurial to enterprise to once again see their business as a function “whole.”


As believers in inherent simplicity, we are confident of tools and techniques that can help you and your management team regain a healthy and accurate view of how your enterprise actually works—end-to-end.


We have proven in working with our clients that it is possible for a team of executives and managers to quickly and simply begin to see once again which of the more than 1.3 trillion paths of interaction are actually being used in a business enterprise.


It is not untypical of our clients to say, after working with us with this method: “We have never seen our business so clearly as you have shown it to us.” And, they invariably say this with great gratitude.


And, once you learn to use these tools, you may do so on your own. Your business will continue to improve for as long as you choose to continue your POOGI—a process of ongoing improvement.



We are interested in your comments. Please leave them here, or feel free to contact us directly, if you choose.


Senge, Peter M. The Fifth Discipline - The Art & Practice of The Learning Organization. New York: Doubleday/Currency, 1990.


So, you and your company’s executive and management team are considering investments in new or upgraded technologies in order to get to all those improvements promised by the software or hardware salespeople. Of course, all of the sales folks’ claims are firmed backed up by their “Needs Analysis” and the assertions of the “Sales Consultants” and other techies they brought along with them.


Each vendor, in turn, will tell you just how critical it is to your business’s success to find “the right technology” in order to make the “gains in productivity” promised.


These folks are helpful!


Not only are they willing to help you answer the questions. They will even tell you what questions to ask.


This, of course, is to keep you from asking the wrong questions—questions they do not want to answer.


So, we are going to help you hear by juxtaposing the kinds of questions commonly asked alongside the right question to ask in its place. We will also provide some helpful commentary to explain our rationale.


Business Opportunity Questions

Commonly asked: What is our greatest opportunity to improve efficiency and how will this new technology help us do so?


The so-called “efficiencies” promised by technology vendors through investments in new or upgraded technologies tend to evaporate. This is because the improvements are not focused on the few functions that will really make a difference.


Think of your business as a chain—a chain of dependent events that lead from customer acquisition through to sales and profits on the bottom-line.


In order to strengthen (read: improve) a chain, one must strengthen the weakest link!


Strengthening (or, improving) accounts payable, for example, makes little (or, no) difference to the bottom-line unless accounts payable is truly the weakest link in the chain of events leading to more profit.


If it is not the weakest link, then making it “more efficient” adds not a single penny to your firm’s bottom line.

CORRECT QUESTION: What is our greatest opportunity to increase Throughput, and how will this new technology help us do so?


Here we define Throughput (T) very narrowly:

T = R – TVC
P = T - OE

T = Throughput,
R = Revenue,
TVC = Truly Variable Costs,
P = Profit, and
OE = Operating Expenses


We further note that TVCs are narrowly defined to include only those costs that are truly and directly (not indirectly) variable with incremental changes in revenues.


Put simply—and liberated from any complex allocations of overhead and so forth—this simple formula boils down to this:


Throughput can be increased by increasing revenues or decreasing TVCs, and as long as OE remains unchanged, any increase in T falls directly to the bottom-line of your company.


Going back to our example, using these formulas, we should be able to estimate the impact of improvements in “efficiencies” on the accounts payable link in our “chain.”

CASE 1: Typical


In most cases, so-called “efficiency” improvements in the accounts payable department will have the following effects:


R = No change
TVC = No change
OE = No change (because no one gets laid-off when the efficiencies are introduced)


Therefore, the the values of T and P are not increased and the company derives no financial benefit from the “investment.”

CASE 2: Rarely


In some rare cases, one might find that things are so bad in accounts payable that one FTE (full-time equivalent) can be reduced in the department. In such a case, we can apply the formulas along these lines:


R = No change
TVC = No change
OE = Savings of 1 FTE * $70,000/year (labor and burden)


This results in the following calculation:

delta-P = delta-T – delta-OE



(delta stands for "the change in...," so delta-P would be "the change in Profit)



delta-P = 0 – (-$70,000), therefore…


delta-P = $70,000 (first year)


WARNING: If you are going to use this calculation to justify your firm’s “investment” in technology, however, be absolutely certain that you are willing to cut the $70,000 from your Operating Expenses. If you are not willing to take that step, then your “improvement” will be no investment, at all. It will just an increase in your operating expenses.



Commonly asked: How will the new technology help us generate more revenue?


This is actually a pretty good question, but for the reasons above, a better way of stating the question is like this:

IMPROVED QUESTION: How will your technology help up increase our Throughput while reducing or holding the line on our Operating Expenses?


In subsequent articles, we will take up other questions that should be asked any time a technology vendor throws out rules of thumb about “improvements in efficiencies” and “payback periods.”


You and your management team deserve better information upon which to base any proposed “investment” decision.



Leave your comments here, please, or feel free to contact us directly, if you prefer.


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