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Conquering Complexity in Your Business
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parts of the value chain it focused on, eliminating much of the complexity in its portfolio, and freeing up a lot of assets tied to unprofitable operations The review process has led to a substantial reorganization of the institution with an explicit emphasis on Economic Profit It has also marked the end of the Universal Banking concept We have set ourselves the objective of attaining a top 5 position in a peer group of 20 financial institutions within a four year period ABN-AMRO 2000 Annual Report
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Figure 44: ABN-AMRO Performance vs Citigroup, Wells Fargo, Barclays
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Citigroup (C) Wells Fargo & Co (WFC)
Barclays ABN-AMRO
ABN-AMRO remained true to much of its banking traditions throughout the 1990s, even as the global banking marketplace underwent huge transformation It had to redefine its set of competitors and adopt a value-view to regain competitive position
The nature and extent of proliferation itself has changed Product life cycles are getting shorter and shorter, the founders of Capital One wrote to shareholders in 1998 The intensification of competition and increased customer power has compressed life cycles, in turn spurring
4: How Conquering Complexity Drives Shareholder Value
companies to launch more and more new products/services and extensions For some, this has become a strategy: 3M dictates that 30% of its revenues will come from new products every year In 2000, 3M made 60,000 products Each new offering brings with it new levels of complexity, which must be compensated for by adequate margins However, the complexity costs of an SKU explosion (however that translates to your business) can overwhelm the additional value from more choice John Vegter, a vice president of logistics at SUPERVALUE, a Fortune 100 grocer and wholesaler, said that when one distribution center increased SKUs by 67%, sales rose only 102%11 The more capital tied up by slow moving products and offerings, the greater the risk that complexity will destroy value The faster the market, the higher the stakes for conquering complexity No market better encapsulates the fast market than the PC industry While it saw record growth through the 1990s, it was also prey to extremely compressed product life cycles Moore s Law12 that processing power would double every couple of years was less a law than a shot across the bows to Intel s lesser competitors warning that there would be the blistering pace of change in a punishing industry Figure 45 shows that despite economies of scale with gargantuan increases in unit sales, revenue per unit stays largely flat
Figure 45: Revenue Per Unit in PC Industry
PC Industry: Revenues per unit
1500 180
Total unit shipments (millions)
1994 1995 1996 1997 1998 1999 2000 2001
Revenue per unit has hardly changed at all in the PC industry despite a huge increase in overall volume This type of dynamic makes it imperative that players stay on top of market needs and provide only the kinds of complexity that customers are willing to pay for
Revenue per unit ($)
Revenue per unit
Total units shipped
The implication is that players in fast markets such as the PC
Conquering Complexity in Your Business
industry cannot afford high levels of non-value-add complexity because slow-moving products in fast markets never maximize ROIC Their shelf-life is limited: the company is left with obsolescence costs or the products Cost of Goods Sold is inflated The component cost of personal computers erodes in keeping with Moore s law of capacity expansion, hence, Dell s zealous focus on minimizing inventory levels
The Links between Complexity and Value
Look again at the two forms of the Economic Profit (EP):
EP = (ROIC% Cost of Capital%) * Invested capital EP% = ROIC% WACC%
The link between value creation and capital allocation (invested capital) becomes clearer Blind capital allocation processes that do not make a distinction between accounting profits and Economic Profits will end up investing capital in businesses that do not warrant it, while simultaneously underinvesting in value-creating businesses Strong capital allocation processes will do just the opposite: feed the strong and starve the weak Decisions about a firm s business portfolio directly affect its ability to create wealth for the shareholders The decision to broaden product/service lines and add new brands and offerings to increase complexity can drive revenues, build customer loyalty and steal market share But doing so also consumes capital and creates complexity costs In essence, businesses face twin pressures: (1) how to grow (exploiting the complexity that customers value), while methodically (2) pruning away dead branches (the value-destroyers and non-value-add complexity) What is clear: doing one and not the other is insufficient With broadening markets from globalization and deregulation, there is still a growth land-grab; and as we ve seen, the market rewards good growth Thus guarding EP margins is paramount Empirical evidence
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