I recently received a newsletter from Ian Dover, a colleague in Australia. Ian is head of the Simpler Business Institute. I’ve been writing a lot about the relationship between complexity and innovation, Ian’s latest communiqué got my attention. It opened with Ian quoting a couple of Bain Consulting positions on the topic:
“In 2005, Mark Gottfredson and Keith Aspinall asked in Harvard Business Review ‘What's the number of product or service offerings that would optimize both your revenues and your profits?’ They answered, ‘For most firms, it's considerably lower than the number they offer today.’ They go on to say ‘continual launches of new products and line extensions add complexity throughout a company's operations, and as the costs of managing that complexity multiply, margins shrink.’”
This was such an apt opening, I decided to “reuse it” in this piece about a new form of innovation.
For a long time, people have confused proliferation with innovation. Line extensions have been the quick fix, until they dilute or damage a brand beyond repair. Extending a line around a strong brand sounds so attractive and so easy.
Unfortunately, it usually just subdivides the sales volume among more choices, and adds relatively little new growth.
Of course, there are exceptions. The initial line extension of Coke to Diet Coke and Pepsi to Diet Pepsi likely did increase the sales of both Coke and Pepsi. But where did that volume come from?
Most likely, a large part of it cannibalized the original brand, when “diet conscious” people switched from the high calorie version to the diet version. The gain in sales was little or none—unless the people drank more of the diet version than of the original one.
However, now there are twice as many items to make, inventory, ship, display and sell. There sure weren’t twice as many sales. The cost of managing double the variety ate into profit. No other outcome is possible. Thus, the top line stays the same or goes up marginally and the bottom line goes down. That’s not what was intended.
Subsequent line extensions by each cola maker to flavors and other low calorie variations added even less incrementally to top line revenue and contributed far more complexity-related cost (and hence profit dilution).
Ian then related another useful story about workshops he held with a group of companies:
“One of the companies develops, sells and applies high-tech materials to dramatically improve wear and corrosion resistance. It has a lot of very smart people who love dealing with complex situations, both in their technology and their business processes. The end result of this is a lot of innovative projects designed to improve all parts of the business.
Management was pleased there was so much ‘innovation’ going on in the company, but it didn't hide the fact that overall business performance was not what it used to be. In fact, percentage profitability had been falling for a couple of years even though sales had been growing nicely. What was happening?
Unfortunately, this company was in the grip of a creeping complexity it didn't know it had—a complexity due to too much innovation! The more the company tried to do, the more its profitability continued to slide.”
This story was so close to home I couldn’t avoid citing it. Earlier in my career this same realization came to me twice in a few weeks. It resulted in my book The Complexity Crisis (Adams 2008).
The first occasion was a board meeting when the company was touting its nicely increased sales. Little was mentioned about the fact that profits were flat—until another board member raised the point.
It seems the sales increase was facilitated by a big increase in the number of SKUs (Stock Keeping Units) in the product line. They were selling more, but enjoying it less!
A few weeks later, I was moderating a large conference.
One of the speakers related the immense savings realized by a multi-billion global company as a result of a “War on Complexity.” My eyes were opened to what was causing this unusual inversion. When variety went up, sales might go up a bit, but profits went down. When variety went down, sales might go down a bit, but profits went way up. Aha!
Now, back to my friend Ian’s observations:
“In one case, for a large communications company, reducing the number of improvement projects to a few that people agreed were the real priorities delivered more benefit over six months than in the previous two years.
This issue of timeliness is particularly important for companies developing new products. Research from the electronics industry showed that getting to market late is much worse for return on investment than blowing your development budget to get to market on time.
So be prepared to stop some of your ‘innovation’ if you want to reduce these creeping complexity costs and increase your profitability. But also be prepared for resistance from those involved in the innovation.”
There you have it—the “new form of innovation” emerges. I call it “Selective Innovation.” Ian would call it “Simpler Innovation.” Together, we’d call if “Focused Innovation,” and we’d both be right.
The hardest job of any manager or executive is prioritization. There are only three kinds of resources they have to devote to every kind of work to be done: Time, Talent (people) and Money. The normal businesses devote far too much of these scarce resources to problem solving or to “incremental innovation,” which, if successful, adds only a small increment of revenue, and a larger dose of complexity.
The brilliant thinker Peter F. Drucker often observed that the primary job of management is to allocate scarce resources to the greatest opportunities, where the results of success would be a meaningful increase in profitable growth.
There’s the big “breakthrough.” Recognize the dangers of proliferation masquerading as innovation; of line extensions pretending to be new products and of incrementalism as a path to growth. All of these add far more in complexity and its hidden costs than they do in revenue. Profits will drop.
Focus on “Selective Innovation” and watch the reverse occur. Top line sales will rise and so will bottom line profits. Customers will appreciate not being burdened with just “more stuff” to sell. The smart customers will realize that Selective Innovation is good for them too. They will not only get productive new lines to sell, but they can also participate in the choice of which old, worn out “losers” should be dropped to make room for the new “winners.”
Doesn’t that sound like a lot better - and simpler - way to succeed? Thanks Ian, for bringing this concept to life.
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John L. Mariotti is President and CEO of The Enterprise Group. He was President of Huffy Bicycles, Group President of Rubbermaid Office Products Group, and now serves as a Director on several corporate boards. He has written eight business books. His electronic newsletter THE ENTERPRISE is published weekly. His website is Mariotti.net.