Complexity kills profits

CEOs need to simplify their businesses – not doing so is costing them as much as ten percent of their annual profits. Simon Collinson, Research Director at Simplicity, investigates

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Complexity in business is a fast growing problem. The Global Simplicity Index, which we have recently developed, has shown that the 200 biggest companies in the world are on average wasting 10.2 percent of their annual profits ($1.2bn) each year due to complexity.

This adds up to a loss of $237bn collectively. It’s a shocking statistic and despite complexity being widely acknowledged as one of the biggest barriers to business success, there are surprisingly few robust academic studies in this area. It is also apparent that leaders are not doing enough about this problem.

But what exactly is business complexity – and how does it erode profitability? Complexity is the result of adding new products, people, processes and strategic initiatives, either as a result of normal organic growth or through M&A. It takes the form of external pressures – from emerging markets, competitors, regulatory changes, red tape and the economic environment. But it can also brew within the business – as a result of complex processes, bloated product portfolios, increasing management layers, over-complex decision-making chains and other organisational processes.

Initially, complexity is no bad thing. As a business grows, it will naturally develop more formal methods for managing people, or adds specialist divisions, new processes and strategic initiatives in order to grow. But, left unchecked, these systems can proliferate and become unwieldy, over-complicated and a drag on efficiency. This is what we call the ‘Complexity Curve’ – an inverted U-shape graph that shows how complexity naturally reaches a tipping point, after which any benefits are outweighed by costs. We note two major effects on individual managers. They find it tougher to make key decisions because of the wide range of options and uncertainties they face; or they are distracted from their focus on making key decisions because of unnecessary demands on their time. Very often it is both.

So why aren’t more companies doing something about it? Identifying the sources of complexity within a business is not easy and knowing how to make necessary changes to eradicate complexity is even more difficult.

Our own survey of 500 middle and senior managers from companies across Europe with more than 10,000 employees looked to identify the most common causes of complexity and found over 100 common sources. They are grouped into the six overall categories: External drivers (regulation, competition, economic turbulence and other factors outside the business); People (the everyday behaviours of employees and managers); Process (the complexity of the business processes that are in use); Strategic (the goals and decisions the board makes in terms of where to focus and how to win in a particular market); Organisational (how the business is structured, talent management and decision-making) and Products and services (their number, design and the structure of your portfolio).
In the worst cases, external and internal pressures converge upon an organisation to create a ‘perfect storm’ of complexity – where industry rivals are more fleet of foot and internal processes only serve to slow you down and waste resources. In fact, four out of the five most complex companies in the Fortune 200 are seeing profits hit. Our study has also split companies into four main typologies depending on their levels of complexity and their performance. These are defined as: Performers; Complicators; Simplifiers; and Strugglers, which are failing to cope with complexity.

Organisations such as mobile phone-maker Nokia are highlighted as a ‘struggler’. Caught out by innovations in an industry it had dominated, it has compounded problems by making too many changes to senior management, to its brand strategy and its very business model – all identified as sources of harmful complexity. Even high performing yet complex businesses such as pharmaceuticals giant GlaxoSmithKline tread a fine line and must guard against the tendency to over- complicate organisational structures, particularly post-acquisition.

Companies that try to do too much, or spread themselves too thin across markets, also risk creating unnecessary complexity and alienating both customers and employees. Likewise, strategic moves such as mergers or acquisitions or restructuring may initially appear to add value, but often result in two complex companies further compounding each other’s processes and organisations.

So how do growing companies avoid bad complexity destroying their profits? Firstly leaders and managers need to identify and weed out the bad complexity, this requires a better understanding of the processes and practices which add value and those that do not. Next they need to change management behaviours. All complexity in business is created by people. So managers need to understand how their decisions can unwittingly create complexity and be trained on how to simplify their businesses. Thirdly, they should avoid further complexity by putting in place an evaluation process to test the impact of new products and services, new procedures or levels of management for example. Finally, they should identify and nurture the kinds of complexity that add value.

There is no quick fix solution but the process of identifying and rooting out bad complexity can be very cathartic for businesses. Ironically new regulation can be an excuse to open up the chest and operate on the procedures and processes that can often stifle profitability. Launching new products and services can also enable re-evaluation of complexity, avoiding unnecessary management layers and a tick-box culture for example. The aim is to help businesses grow without the shackles that complexity can impose. If European businesses are to realise their potential and the expected economic growth, then greater simplicity is essential.