Friday, March 25, 2011

Strategic Planning Analogy #384: Salty Popcorn

Back when I was a young boy, I was part of the Cub Scouts, the younger version of the Boy Scouts. One time, the leaders took a group of us young Cub Scouts to a scout campground to spend the weekend camping in tents.

One night during that weekend, a few of us boys got hungry for some popcorn, so we quietly left our tent and sneaked over to the rustic kitchen. Without any adults to supervise us, we made a big batch of popcorn. This was in the days before microwaves. I’m surprised we didn’t burn the place down.

One of the boys wanted to be in charge of salting the popcorn. He put practically an entire box of salt on the popcorn. This made the popcorn so salty that it was inedible. So we got the bright idea that if we made a second batch of popcorn and mixed it with the first, the whole thing would taste good. So we made a second batch and mixed the two. It was still too salty to eat.

So we decided to mix in a third large batch of popcorn. The end result was still extremely salty, but almost tolerable, if you only ate one handful and had a lot of water to wash down the salt.

Of course, by now we had a huge supply of popcorn—more than we could possibly eat. So we went outside and yelled that we had free popcorn for anyone who wanted it. Suddenly, all these other Cub Scouts showed up to get some popcorn. They each took only one handful, because it was too salty. But eventually that got rid of most of the popcorn.

Unfortunately, our yelling also woke up the leaders who were supposed to be supervising us. They weren’t very happy when they found out what we did.

At the campground, we had something bad—over-salted popcorn. We thought we could make it good by adding something good to the mix—unsalted popcorn. However, we kept adding more and more good and the end result was still bad. In the end, all we had was a bigger pile of bad. We would have been much better off just throwing away the first batch and starting over.

It seems like a lot of businesses act like I did at that campout. They have a bad situation on their hands—not enough growth, not enough profits, etc. And just as I tried to fix my bad popcorn by adding new popcorn to the mix, these businesses try to fix their bad business situation by adding new businesses to the mix. It could be line extensions, diversifications, or other types of new product introductions. Whatever the means, the focus is on growing the top line with new lines of business. Unfortunately, the net results are usually still below expectations. They probably would have been better off if they had focused on tossing out the bad businesses rather than adding the new businesses to the already toxic business situation.

The principle here is that our strategic goal should not be to become bigger, but to become more profitable. And many times, the most effective way to increase profits is by shrinking the scope of our business. Tossing away the elements which destroy huge amounts profitability can often provide a greater improvement than layering on more elements which are only marginally profitable.

Just as it takes a huge amount of new popcorn to overcome a small salty batch, it can take a huge amount of new business to overcome a dysfunctional business base—probably more than you can afford to undertake (either in money or manpower). Rather than adding, it may be more desirable to subtract.

Proctor & Gamble Example
Think about Procter & Gamble. Back at the beginning of the 1990s, they had 31 varieties of Head & Shoulders shampoo and 52 versions of Crest dental products. All of those were a lot of additional versions which drove up the costs of manufacturing, distribution, inventory management, marketing, management and so on. So P&G decided to cut its variety.

By the end of that decade, P&G had cut the number of its products by one-third. In hair care alone, the variety was cut in half. So how did all that cutting impact sales? Well, the market share in hair care went up nearly five points and overall P&G sales grew by one-third during the mid 1990s.

And while sales were rising, costs were dropping, because a lot of costs can be eliminated when you eliminate all of the inefficiencies from excessive variety.

And it didn’t stop there. Back in December of 2010, P&G leaders talked to analysts about the benefits from even further simplifying their business. In 2008, P&G had 500 manufacturing platforms. By 2014, they plan on having only 150. That is expected to produce savings of about a half a billion dollars.

They are also going to simplify the processes used to run the business. By moving to fewer, but stronger regional centers over the next three years, they expect annual savings of $160 million. By replacing bad inefficiencies with new technology, they anticipate annual savings of about $50 million per year, not to mention other ways to cut which will add even more.

When you add it all up, we’re talking about an annual increase to the bottom line for P&G of hundreds of millions of dollars. Just imagine how many new businesses P&G would have to add to their mix to get the same amount of net impact on the bottom line. Keep in mind that a lot of that new innovation would probably cannibalize other P&G businesses and add to the complexity costs of the company. So these new businesses would have to create even more profits than this to make up for that cannibalization and added complexity costs.

It’s like that popcorn. Rather than trying to add on layer upon layer of new business (unsalted popcorn) to the mix, P&G threw out the salt that was causing the problems in the first place (too much variety, too much overhead, too many platforms, etc.). Getting rid of the salt (bad costs of excessive complexity) got to a good flavor much faster than heaping a lot more popcorn (marginal business) on top of the bloated cost structure. Tossing away can be far more profitable than adding on.

Wilson and Perumal, in their book “Waging War on Complexity Costs” claim that a focus on cutting out complexity can reduce a typical business’ cost structure by 15 to 35%. Can you imagine how much new business innovation would have to occur to create a similar improvement to your profitability?

Pressure to Innovate
Yet the current pressure in the business world is to increase innovation and pump even more new businesses into the company’s bloated product pipeline. Everywhere you look in the business press, one sees the thrust to innovate more and create more lines of business.

Remember, innovation can be very expensive, and about 80% of new business ventures fail. And, as P&G and others have found out, added variety doesn’t necessarily lead to additional net sales. It may just spread the same sales volume across more product lines (causing less volume per line—fewer economies of scale).

Worse yet, new ventures often lead to added overall business complexity, which increases the costs for every product you sell, even the old established ones. So you may be hurting the profitability of the status quo product mix almost as fast as you are adding marginal profits from the incremental variety. In other words, your business mix will still be too salty even though you add a lot of new popcorn to the mix.

Therefore, when you are having your strategy sessions, don’t just focus on ways to grow the top line. Don’t let the current wave of innovation pressure you into seeing additional new product lines as your only strategic option.

Instead, consider spending time strategizing around the benefits of cutting out complexity and redundancy. Look for ways to simplify your processes through standardization. Consider places to eliminate the variety and scope of what you offer. In other words, look for ways to get rid of your excess saltiness.

Yes, this approach can potentially hurt top line growth rates. But, it can make your bottom line skyrocket. And, at the end of the day, if profits are growing wildly, the market will reward you very well.

When seeking to improve your business performance, don’t just look at strategic options which attempt to increase sales through new product innovation. Instead, consider ways to eliminate marginal businesses and all the needless complexities they bring. Shrinking the business and tossing away the bad can be a quicker and more powerful way to improve profits.

With all the emphasis on the word “innovation”, I figure we need another word to counteract it in the discussion. Innovation comes from the Latin—“in” for “in” and “nova” for “new”. In other words innovation is about bringing something new into the business. But what about the idea of taking something old out of the business? I fiddled around on the internet and invented my own Latin-like word: “eximotraditionalis.” This word means to remove some the stuff you traditionally have been doing. Hopefully, “eximotraditionalis” will become as popular in the business press as “innovation” (but somehow I doubt it).

1 comment:

  1. Gerald Nanninga,

    I keep saying that I shouldn't comment on almost all your posts, but the trigger I get from reading them pushes me to comment.

    In agriculture, it is advisable to remove weeds and parasitic plants before growing a plant. Your popcorn metaphor is in line with this thinking. Weeds grow fast and deprive the plant from the required nutrition. By the same token, weed businesses consume time, energy, resources and efforts only to weaken the profitable products.

    In a second thought, I like the selectivity of your approach: eliminate before you grow. In many businesses one way of differentiation is eliminating features of some products to lower the cost of their production. True, it is more important sometimes to know what not to do before knowing what to do
    I hope there are not many weeds in this comment