The handoff itself does not create value, but it can destroy value, of course! Value is created by the overarching process.

The key to an effective handoff is a full kit.

The “kit” is a set of objective requirements, or prerequisites. A full kit exists when all requirements are present.

The two simple rules that govern handoffs are:

1. If requirements are missing, the intended recipient cannot accept the work packet.

2. If all requirements are in place, the intended recipient must accept the work packet (and, in so doing, they assume responsibility for the collection of any other requirements not specified in the “kit”)

These rules do not prohibit communication between the two parties on either side of the handoff, but they do define who owns the work packet at any point in time. So, for example, post handoff, an engineer might ask a salesperson for assistance discovering additional information, but it should be understood that this assistance is a favor, not an obligation.

The “kit” can only specify requirements that are objective in nature. However, this does not imply that ALL requirements are objective in nature. The kit is simply a mechanism for facilitating the change in ownership of the work packet.

Disclaimer: Full kitting is an established manufacturing concept. The adoption of the concept for all handoffs and the creation of the rules above is my own doing!

Your salespeople have finite capacity, and we should probably assume that they are consistently busy. This means that if we ask them to perform an activity, it will be performed in place of another activity.

If we consider the pool of possible transactions upstream from your organization, this pool can be divided into two categories: “yours to lose” and “yours to win”.

The first category contains those where inertia is acting in your favor. As long as you respond quickly and offer competitive prices, you will convert most of those potential transactions into revenue. Most inbound enquiries fall into this category, particularly if they are from existing customers.

The second category contains those possible transactions where inertia is acting against you (in a competitor’s favor). Unless you invest significant effort, you will not convert these transactions into revenue. You are not even aware of most of them! You know they exist because all your competitors can keep their lights on somehow, but you don’t have details. Obviously, this second category is by far the largest.

Now, your salespeople have two modalities. Diplomacy and Relentless Pursuit. Obviously, these modalities map to the two categories of possible transactions.

Per unit of effort, relentless pursuit has a much greater impact on revenue than diplomacy does.

Salespeople cannot switch back and forth effortlessly between these two modalities. Significant effort is required to switch to the relentless pursuit state. And it’s a fragile state, meaning that if flow is disrupted, they’ll quickly revert to diplomacy.

When we ask a salesperson (or anyone in our organization) to perform quote follow-up, we’re not expecting the relentless pursuit of that possible transaction; we’re simply asking someone to pick up the phone and confirm that the quote was received and that it is fit for purpose.

Diplomacy, in other words.

Diplomacy does not convince customers to purchase from you (except in a small number of edge cases). Customers are selfish creatures; they will purchase when you present a proposal that is in their economic interests and that is clearly superior to competitors’ proposals.

If you want your salespeople to drive revenue (and growth), you need to ensure that they are focused on the relentless pursuit of new business. They need to spend all day, every day, chasing “yours to win” transactions. You need to do everything you can to prevent them from switching to the diplomacy mode of operation.

If you direct them to follow up on all quotations, you will achieve the exact opposite.

So, what I’m saying here, as clearly as I can, is that not all quotes should be followed up.

You should design a process for inbound enquiries that captures customers’ requirements and proposes appropriate and competitively priced solutions with alacrity and without the involvement of salespeople.

Then, you should trust this process!

Now, it does make sense to monitor the flow of enquiries through this process and manually escalate some enquiries to salespeople (post-proposal) for relentless pursuit. But only some of them. Never all of them.

If you are doing a good job of maintaining your salespeople in that relentless pursuit modality, it should be evident that most enquiries should NOT be escalated to salespeople because most folks who already intend to purchase from you will not appreciate their breathless and unrelenting attention!

This claim is not wrong. But it’s not helpful either!

I’ve spent a week at the nation’s leading distributor conference, listening to executive after executive proclaiming the criticality of local customer relationships, maintained by branch salespeople.

Now, on the final day of the conference, McKinsey is presenting survey results, suggesting that customers value availability, price, and value-added services much more than they do relationships with salespeople.

Who is right here?

In my opinion, both parties are right, but the careless use of terminology is obscuring true insights.

Muddled thinking

It’s almost certainly true that customers value availability, price, and value-added services above all else.

But it’s also true that, in most cases, salespeople have a good deal of influence over price, availability, and value-added services.

Accordingly, there’s nothing technically wrong with the claim that branch salespeople’s customer relationships are the organization’s key value driver.

But this statement has limited utility because it’s based on an assumption begging to be questioned.

The pivotal assumption

If customers value availability, price, and value-added services above all else, and if salespeople have a good deal of influence over all three of these parameters, then the claim that salespeople’s relationships are a key value driver assumes that salespeople’s influence over these paramaters is either necessary, or beneficial, or both.

So let’s question that assumption.

To what degree should salespeople influence availability, pricing, and value-added services?

How we answer this question depends on the operational capabilities of the organization.

If the distributor has very limited operational capabilities, then it’s both necessary and beneficial for salespeople to involve themselves deeply in availability, pricing, and value-added services.

By present-day standards, distributors have evolved over many generations with limited operational capabilities, leading to the development of the current customer interface, featuring autonomous branches and commissioned branch salespeople.

However, recent advances in technology have collapsed the tyranny of distance as it applies to both material products and information.

Consequently, we’re starting to see examples of national organizations that can distribute at scale to small customers without a network of autonomous branches and commissioned salespeople.

The existence of these edge cases does not instantly invalidate the standard business model, but it should cause us to question the primacy of branch salespeople’s relationships.

I suspect that branch salespeople should probably maintain some influence over availability, pricing, and value-added services, but much less than they have today.

But the degree of salespeople’s involvement will not be seriously debated for as long as we continue to embrace the primacy of salesperson relationship assumption.

Update that mental model

So, I’m calling for an update to our mental model of the distributor organization and the marketplace in which it operates.

Let’s accept that customers value availability, price, and value-added services above all else. But let’s engage in a forensic analysis of the mechanisms via which these critical values are—and possibly can be—delivered.

This means—and folks will hate me for suggesting this—eradicating the word relationship from our mental model and from all serious conversations within our organizations.

The fact is, this word serves more to obfuscate than it does to inform.

Talking points

Eliminating the primacy of salesperson relationship assumption opens the door to conversations that aren’t otherwise possible and to approaches to organization design that would be otherwise unconscionable.

Here’s just one example.

Many distributors have embraced the idea of a hybrid sales environment. In practice, this means that different sets of customers are allocated to different channels.

But why is work divided according to customer type rather than activity type (which would be the case in any other environment)?

The answer, of course, is because of the the primacy of salesperson relationship assumption.

Because we assume that value is delivered to the customer via the salesperson rather than by the organization directly (with the salesperson’s involvement, when appropriate), we prohibit ourselves from even considering a more conventional division of responsibilities.

Here are some other talking points:

• Would you rather your salespeople were skilled at persuasion or at solving technical problems (and which of these skills does your organizational structure reward)?
• Branches should obviously have some autonomy (as should all parts of your organization that contain humans), but should branches really be encouraged to operate autonomously?
• Is it realistic to expect the growth of the organization to be driven by the same group of people who are responsible for business as usual?

justin.roffmarsh@ballistix.com

A healthy business

A healthy business has two value chains:

1. Business as usual (generates operating profit)
2. Growth (generates growth in operating profit)

It should not be controversial to suggest that both chains should be optimized for speed.

However, in most businesses, these two value chains do not exist in any meaningful sense. You have one big bucket of responsibilities rather than two discrete processes.

And, rather than speed, this bucket of responsibilities is optimized for cost (or efficiency).

A typical business

The result of pooling business-as-usual (BAU) and growth activities is that the former takes automatic primacy over the latter, meaning that the latter goes to zero.

In practice, this means that salespeople are busy managing customer transactions rather than hunting for new business. It also means that new product development, acquisitions, and other forms of expansion are neglected.

Optimizing for cost rather than speed results in the organization generating significantly less operating profit than it could.

This latter point warrants closer examination.

Why “efficient” means less profitable

Here’s what efficiency means in practice.

A critical machine is operating at 80% utilization. A consultant suggests that the provision of an assistant for the machine operator would enable utilization to go to 90%, generating an additional $30,000 a day in contribution margin.

The management team immediately responds that the assistant would spend 70% of their time idle, implying that their addition would be wasteful.

This is not a joke.

We (yep, we’re the consultants) have some variation of this conversation every day of the week. Management teams respond this way because they are programmed to believe that the organization is most profitable when every operation is optimized for efficiency.

Even when management teams understand the error in this reasoning, they still make bad decisions instinctively because their organizations have what we call a cost-based operating system.

A Formula One team is a pretty good metaphor for a typical business. You have one critical, value-generating operation, and then you have a bunch of supporting operations.

Members of the pit crew spend most of their time idle. It should be evident that downsizing the pit crew until you have a single operator who is consistently busy is not sensible. No one in their right mind would do this to a Formula One team. But we do it to our own businesses every day in the name of efficiency.

Efficiency, in practice, is just another word for cost-cutting.

The critical, value-generating operation

The difference between Formula One and a typical business is that most managers have failed to identify the critical, value-generating operation.

Consequently, it isn’t possible to determine if a particular operation should be maximized (think of the race car) or if it should subordinate to that critical, value-generating operation (think of the pit crew).

Absent this understanding, the standard approach is to optimize everything, which, in practice, translates into trimming costs.

Now, costs should be controlled, obviously, but not trimmed. The relentless pursuit of lower costs leads to the erosion of protective capacity, which means we soon have a one-man pit crew and 20-minute pit stops!

What should we do?

If you recognize that your organization needs to transition from a cost- to a speed-based operating system, here’s a sensible 4-step process:

1. Provide each department with a speed-based metric
2. Organize the business into two discrete value chains (business as usual and growth)
3. Identify your critical, value-generating operation and determine how all other operations should subordinate effectively
4. Eliminate cost accounting and all local profit calculations (including branch-based P&Ls) and replace them with a global system of metrics

Speed-based metric

Your first step is to foster pit-stop behavior in each department. Rather than acting to keep team members consistently busy, management should have teams sprint to complete tasks when they appear and then relax. This requires that work be packetized.

Two discrete value chains

The BAU value chain stretches from the receipt of an inquiry (customer service) through delivery. One group within your organization (typically Operations) should be responsible for this entire value chain.

The Growth value chain includes whatever initiatives drive growth (typically, new customers, new products, new territories, and acquisitions). These initiatives should be structured as formal processes with their own resource pools.

If any resources have to be shared between the BAU and the Growth value chains, then these resources must have a lot of protective capacity, and their time must be formally scheduled.

Critical, value-generating operation

This is the resource that Eli Goldratt (The Goal) refers to as The Constraint. You need to identify a single resource or a set of resources that you will maximize. In the case of a printing business, this would be the press room. In the case of a smash-repair shop, this would probably be the paint booths. In the case of a consulting firm, this would be your bill-by-the-day consultants.

Avoid analysis paralysis. When in doubt, nominate a reasonable contender for this resource and determine how to maximize it. You can change your mind later!

Maximization requires determining how all other operations should subordinate effectively.

A global system of metrics

From day one, your management team should understand that profit is only an attribute of an organization—which is to say that there’s no such thing as a profitable transaction, a profitable customer, a profitable project, or even a profitable branch office.

In practice, exorcising the idea of local profitability (and its bedfellow, local efficiency) from your organization will take some time.

It isn’t enough to ban the use of these invalid concepts (although you should); you need to replace them with a new calculus for management decision-making and a global system of metrics.

Next steps

Ballistix helps organizations transition to the Speed-Based Operating System.

In addition to designing the global system of metrics referenced above, we chair and participate in a steering committee that helps organizations navigate the transition.

Reach out if you’d like a proposal!

A viable alternative based on Goldratt’s Theory of Constraints

Imagine you were to take over the management of a Formula One team, and rather than focusing on the car’s speed, you focused on reducing fuel consumption.

That would be stupid, right? Idiotic, even!

But this is the orthodox approach to business management. Not surprisingly, the result is that almost every business is weaker, less profitable, and less competitive than it could be.

If yours happens to be one of these businesses, your only saving grace is that your competitors have likely adopted the same management approach.

It’s not that managers are unaware of the importance of speed. There are certainly speed-based metrics (on-time delivery performance, inventory turns, and debtors’ days, for example). The problem is that these are exceptions, not the rule. The default focus is cost.

This paper explains why a focus on cost minimization is harmful to both the profitability and the growth of businesses. It then describes how you can (and why you should) shift your focus to the maximization of speed.

Efficiency is another word for cost reduction

Now, you might object to my characterization of cost as the alternative to speed. You might argue that you pursue efficiency, an optimal mix of speed and cost.

In practice, efficiency-improvement initiatives are cost reduction by another name. Economists might measure efficiency at the level of the organization, but managers never do. In practice, efficiency improvement is performed at the level of departments, machines, or even individual contributors.

The goal of efficiency improvement is to ensure that the resource in question is fully activated (always busy). If the resource can’t be fully activated because it lacks work or because of a lack of demand for whatever it produces, then the only viable alternative is to downsize (or eliminate it).

The ideas presented here are derived from Eliyahu Goldratt’s Theory of Constraints. If you’ve ever read his best-selling book (The Goal), much of the reasoning here will be familiar.

An ode to speed

If I were asked to give a single piece of advice to the owner of an industrial business (or any business, for that matter), I would say to increase your organization’s clock speed.

By clock speed,I mean the default rate at which work gets done within your organization—not just some work, but all work.

If unnecessary work is being done in your organization, you should eliminate it; however, if it’s necessary, it should probably be done faster.

Modern businesses are incredibly complex systems, which is to say, massively interconnected. If a department anywhere within your organization performs important but non-urgent activities at a less-than-optimal rate, it’s almost certainly causing drag somewhere that really matters.

And if you have a department anywhere within your organization that is not marching to a time-based metric, that department is definitely operating at a less-than-optimal rate.

But, if your organization is typical, most departments march to cost- rather than time-based metrics, which brings us face to face with the villain in our little story.

Cost accounting

The villain, of course, is Cost Accounting.

It’s widely understood among experienced executives (and accountants) that cost accounting has problems. Most are aware of situations where the cost-based approach to management decision-making yields laughable results.

But the standard response to these problems is basically to shrug. “We need cost accounting. It’s better than the alternative. In most situations, it’s accurate enough.”

The first two of these responses are correct. The third is wrong. So, let’s take a look at each briefly. And then, let’s explore the core problem with cost accounting and an alternative approach to management decision-making.

“We need cost accounting”

It’s true that organizations need cost accounting. It’s critical for reporting the organization’s historical performance to external stakeholders (particularly shareholders and various statutory authorities).

So, where financial accounting is concerned, cost accounting is here to stay. And that’s fine because the problems inherent in cost accounting do not raise their ugly little heads in the generation of (historical) reports.

But we’re not here to talk about reporting. We’re here to talk about management decision-making. And that’s a forward-looking activity. No law dictates that cost accounting be used for management decision-making.

Organizations do this because they lack a practical alternative (and because everyone else does it!).

“It’s better than the alternative”

Remember when you were first exposed to business? Perhaps you were a new hire at a big, scary corporation. I guess there was a point where you suggested that the organization do something because it would make a bunch of money, and you were chided for not considering all the hidden costs associated with your proposition.

Maybe a customer asked to make a bulk purchase at a lower price, and you got excited about the juicy margin that would land in the corporate bank account. Then, a more seasoned executive pointed out that the “real” cost of filling that order was much more than you realized because you needed to allocate a portion of the organization’s operating expenses to calculate the “profit” in the deal.

This hypothetical highlights both the default alternative to cost accounting (which is to ignore operating costs altogether) as well as the solution provided by cost accounting (which is to allocate—via some method—some portion of operating costs) to every “profit” calculation.

Given those two alternatives, cost accounting is certainly the preferable one! But it’s a terrible mistake to assume that these are the only possible approaches to management decision-making.

“In most situations, it’s accurate enough”

It’s true that cost accounting can yield accurate results in some situations. And it’s also true that it can yield laughable results in others.

The distinguishing factor is the predictability of transactional volume.

This is why cost accounting works just fine when reporting on the past. Because the past has already occurred, you have perfect knowledge of the number of transactions in the period under consideration.

But, when considering the future, you’re unlikely to have that same level of confidence. Furthermore, many decisions involve proposals that are likely to cause a change in transaction volume.

So, where transaction volume is concerned, cost accounting works well when the organization is in stasis. It can furnish you with dependable answers if you’re attempting to make decisions that do not impact the rate at which your customers buy things.

However, if you’re contemplating a change that is likely to impact transaction volume, cost accounting is effectively useless as a decision-support system.

It’s worth pausing to consider the implications of this. Cost accounting (as it’s typically used) provides managers with dependable information only when they consider proposals that will result in them making minimal functional changes to their organizations.

But on the occasions when they are bold enough to propose something that might actually change the way their organizations function, their default decision-support tool punishes them with wildly unpredictable information!

The extent of the problem

In a moment, I’ll explain an obvious problem with the math underpinning cost accounting. And we need to acknowledge that problem before we contemplate a solution.

But it’s important to note that lousy math is not the extent of the problem.

The bigger issue is that managers build a mental model of their organizations, and cost accounting is an integral part of this model.

This means that cost-based reasoning is applied by default to day-to-day management decisions, even when no math is involved.

But it gets worse. Because there are frequent situations where cost-based reasoning furnishes managers with obviously false conclusions, managers suffer from regular cognitive dissonance. You might expect this cognitive dissonance would cause managers to challenge their mental model of the organization, but, for the most part, it doesn’t. The more common effect is that managers hunker down and become even more defensive of their belief system and even more insistent that others respect the answers furnished by their cost-based reasoning!

Taiichi Ohno, the father of the Toyota Production System, once said: “It was not enough to chase out the cost accountants from the plants. The problem was to chase cost accounting from my people’s minds”.

Cost accounting’s fatal flaw: bad math

It’s impossible to understand the bad math that underpins cost accounting without first understanding the concept of “profit”.

Profit is probably not what you think it is

If our goal is to have an intelligent conversation about business, it’s critical that we understand that profit is not what you get when you subtract raw material costs from revenue: that’s contribution margin.

Profit is the stuff that a business generates. Profit is an attribute of a business. It is NOT an attribute of a transaction, a customer, a branch office, or even a project. Only businesses generate profits. It makes absolutely no sense to talk about a profitable transaction, a profitable customer, a profitable project, or even a profitable division.

Okay, so what is profit?

In simple terms, profit is cash that is released by a business that can be used by the owners of that business for other things. It’s true that profit can be reinvested in the business, but rational owners only do that when they expect that the investment will cause the business to release even more cash in the future (which can then be used for other things).

Now, profit is not a quantity; it’s a rate. A rate is a relationship between two quantities. Profit is the cash that is released by a business in a given time period. Profit is denominated in units of time. If the period isn’t specified, it’s implied.

It’s helpful to compare the concept of profit with velocity. Velocity is also a rate: the relationship between distance and time. However, there’s a difference. We never use velocity as a synonym for distance. However, the word profit is frequently used to refer to a quantity (cash) as well as a rate (cash/time). This is unfortunate. The former usage leads to confusion and, frequently, poor decisions.

The next obvious question is, how do you calculate profit? Profit is NOT revenue minus cost. Profit is the difference between two rates:

1. The rate at which a business generates contribution margin
2. The rate at which that business accrues operating cost

The difference between these two is profit: the rate at which a business generates cash.

I’ll say it one more time for good measure: profit is not a quantity. It’s a rate. (Cash over time.)

The time dimension is critically important to business. The moment we forget about time is the moment our business begins to decay.

The forgetting of time, institutionalized

To use a fancy turn of phrase, cost accounting abstracts away the concept of time.

When a decision is made to allocate some portion of an operating cost to a transaction, a relationship between that cost and transaction volume is assumed and then forgotten!

From that point forward, whenever a manager makes a decision using a fully loaded cost, they inherit someone else’s assumption without question. And they are, in all likelihood, making a decision that will cause a change in transaction volume that renders the initial assumption invalid!

Now, you might wonder how a business benefits from removing time from consideration and focusing only on cost.

There are two benefits. The first is ease of use. The second is cost containment, a byproduct of ease of use.

Ease of use

It should be obvious that nothing good will come from ignoring operating costs when making day-to-day management decisions. So, cost allocation does at least ensure that operating costs are considered when managers make decisions at the transaction level.

And ease of use is a big deal.

Managers need some method to estimate the organization-wide profit implications of the decisions they are asked to make on a day-to-day basis.

It isn’t practical for them to use calculus to reconcile the two different rates that determine profitability. Nor is it practical for them to consult complex mathematical models of the entire organization.

It’s unfortunate that cost accounting has a tendency to generate wrong (often wildly wrong) answers, but ease of use is definitely a benefit!

If we are to provide managers with an alternative approach to management decision-making, ease of use is a critical attribute.

The direction of the solution

The following (fictitious) story illustrates the conflict between a manager whose intuition is furnishing her with a correct answer in conflict with a directive from the organization’s cost accountant.

It also points us toward an alternative approach to management decision-making.

A young manager operating an airline ticket counter is approached by an anxious traveler just as she is about to close the flight. The traveler offers to buy a ticket on that flight for $100 (one-third of the standard fare), if any seats are available.

The manager’s intuition tells her to take the money and let the traveler grab the one remaining seat on that flight. She knows that this is the last opportunity to sell that seat. She also knows that all meals have been loaded already, meaning there are no incremental costs associated with the sale of that seat.

But she denies the traveler the seat. She recalls a visit from a regional manager who talked about the airline’s operating costs. The regional manager explained that the airline’s operating expenses were equivalent to $250 per seat on every flight. This meant that around half the passengers on a typical flight were loss-making passengers.

Our young manager tells herself that she just saved the airline $150, even though this conclusion seems intuitively wrong.

There is no shortage of stories like this that highlight the laughably incorrect answers that can be furnished by cost-based reasoning.

But, rather than laughing at cost accountants, a better use of this story (and others like it) is to ask why the correct answer is so obvious. What is it, specifically, about this story that causes the manager’s intuition to be obviously more accurate than the cost accountant’s math?

And, if we can extract a lesson from this story, can we generalize it and package it so as to provide managers with a viable alternative to cost-based reasoning?

A Rosetta stone

In the story above, it’s easy to see that the last remaining seat on the outbound plane was a unit of capacity that was about to expire. The traveler’s offer would have generated contribution margin for the airline with no corresponding increase in operating cost.

The key insight is that the traveler’s proposal would have increased the yield on a capacity-constrained resource. Accordingly, all additional contribution margin would have dropped straight to the bottom line.

Here’s a general conclusion that we can draw from the story.

If we can identify the resource that limits the rate at which contribution margin is generated, then we can use the productivity of this resource as a proxy for the profitability of the organization.

It’s time now to introduce a couple of terms that will simplify this discussion.

Let’s use the word Throughput (capital “T”) in place of contribution margin. Throughput is revenue minus totally variable costs. (Totally variable costs exclude direct labor, which does not vary in direct proportion to transaction volume.) Additionally, Throughput can be used more generally to refer to a unit of value.

Let’s use the word Constraint (capital “C”) to refer to the resource that limits the rate at which Throughput is generated.

We can now introduce a formula that’s an alternative to the standard cost-accounting formula.

This formula tells us that a change in Throughput per Constraint Unit is equal to the change in the organization’s profitability.

A manager can use this formula to make a management decision so long as they are confident that the proposal will not cause the Constraint to move to another resource.

If we return to our airline counter manager and assume the plane has 175 seats, the traveler’s proposal (if accepted) would cause T/Cu to increase by $0.57. (This assumes that 174 seats each generate Throughput of $300, and one generates $100.) Consequently, the airline’s profitability would increase by $100 over the period under consideration.

The delta T/Cu formula is a Rosetta Stone that enables a manager to predict, with impressive accuracy, the impact that day-to-day decisions will have on profitability.

Is this insight useful?

I can anticipate your objection, but before I address it, let me point you to an organization that uses this method to make critical management decisions.

That organization is an airline!

If you have had any exposure to airlines (including as a customer), you already know that airlines do not use cost accounting to make decisions of the type described in the story above.

Airlines adopted dynamic pricing in the early 1980s and have been fine-tuning it ever since.

Dynamic pricing is based on exactly the logic described above. It recognizes that seats on aircraft (in conjunction with cargo hold space) are the resource that limits the rate at which the airline generates contribution margin. Pricing decisions are made explicitly so as to maximize that yield.

Increasingly, hotels are doing the same thing.

Now, your objection, I suspect, might be that the proposed approach to management decision-making will not work for many organizations because it’s impossible to identify the specific resource, at any point in time, that is limiting Throughput.

Now, this is true. But it doesn’t have to be.

The reason the Constraint location is unpredictable in most organizations is that organizations are managed with a view to minimizing cost rather than maximizing speed.

The relentless minimization of cost within an organization is beneficial up to a point, after which it causes the organization to become chaotic, meaning that it causes the Constraint to move unpredictably from resource to resource.

Once the organization becomes chaotic, whatever increases in profitability are generated by cost reduction are eliminated by a sudden decrease in the rate at which the organization generates Throughput.

And this is terrible news!

When the rate at which an organization generates Throughput slows, the rate at which the organization delivers value to its customers also slows.

Practically, this means that every customer interaction runs slower. It takes longer to get a quote. It takes longer to get an order filled. And it takes longer to get an issue resolved. This means that the organization has become less competitive.

If an organization is managed with a view to maximizing speed, it will never be allowed to become chaotic—meaning that the Constraint will not move unpredictably from resource to resource.

Speed as an antidote to chaos

There’s a very simple (and incredibly important) reason for this.

When it comes to generating Throughput, not all resources are equal. For each unit of available capacity, a few make a vastly greater contribution than others.

For example, if you own a printing business, you will be more profitable when your million-dollar printing press is fully activated and your design team is out to lunch than you will be when your design team is heavily loaded and the press is sitting idle.

If your goal is to maximize the rate at which your organization generates profit, it’s incumbent upon you to first identify your printing press: that resource that makes the most significant contribution to your organization’s profitability (per unit of capacity). You should then design your organization to ensure that this resource is:

1. Consistently fully activated
2. Loaded with the mix of work that generates the highest Throughput per Constraint unit

Once you have anchored your Constraint at its optimal location, the airline metaphor above suddenly becomes relevant. You can then use delta T/Cu to predict the profit implications of most day-to-day management decisions.

The solution: Throughput-based reasoning

Every meaningful management decision involves a prediction.

In a large, complex organization, effects are separated by both space and time from their causes.

When a manager considers a simple proposal (for example, should I offer a discount for a bulk purchase), their job is to try and predict the consequences of that proposal. And, ultimately, the consequence that really matters is the impact on the profitability of the organization.

So, cost-based reasoning is a means of making predictions. Throughput-based reasoning, proposed here, is an alternative.

The obvious questions, then, are which is the easiest to use and which has the greatest predictive power?

Two approaches to predictions

Cost-based reasoning excels when it comes to ease of use. You simply subtract the change in revenue from the change in fully loaded costs to arrive at the predicted change in profit.

Throughput-based reasoning requires that you calculate Throughput per Constraint unit for both the current and the proposed scenarios. The difference between the two is the predicted change in profit.

To determine if these additional steps are worthwhile, let’s consider the predictive power of both approaches.

Cost-based reasoning proceeds from the assumption that operating costs vary in direct proportion to transaction volume. If you sell one more unit, your operating costs increment accordingly.

We know this is wrong. The relationship between operating costs and volume is a step function. As you sell more units, operating costs remain unchanged until suddenly, they don’t!

This is consequential for two very important reasons. First, we cannot assume that the scale of an organization smoothes out this step function. Costs ratchet up periodically, but under normal circumstances, they don’t ratchet back down.

And, second, in a competitive market, profit is generated at the margins. What this means is that most of the Throughput generated by a large number of transactions pays down operating costs. The difference between being just profitable and very profitable comes down to just a few additional transactions. Cost-based reasoning actually obscures the outsized profit contribution made by those additional transactions.

The power of Throughput-based reasoning is that it recognizes the true nature of the relationship between Throughput and operating costs. It recognizes that these are not two independent variables (like a person running up a down elevator). It recognizes that, within a non-chaotic organization, there is a predictable relationship between a change in volume and a change in profitability.

The key to understanding this relationship is to recognize the reason why operating costs exist. Operating costs are the cost of our organization’s capacity: the capacity to do work and, consequently, to generate Throughput (either directly or indirectly).

Because we know that the profitability of an organization increases when Throughput increases relative to operating costs, then we can conclude that profitability is proportional to the yield on capacity.

In most organizations, this observation is correct but useless! Operating costs pay for all kinds of capacity (machines, real estate, insurance policies, HR departments, and so on). It’s simply impossible to reconcile the capacity of the organization with a unit of Throughput.

However, as discussed earlier, when an organization is managed for speed, management will act to ensure that the resource that makes the largest incremental profit contribution is fully loaded at all times.

When the organization is operating in this state it becomes easy to understand the relationship between Throughput and capacity. We can disregard all resources other than the Constraint, divide the capacity of the Constraint into units of useful work, and then simply estimate how many Constraint units will be consumed in order to fulfil each order.

Now that we understand the relationship between Throughput and capacity (and, accordingly, between Throughput and operating costs), we can quickly and accurately predict the (organization-wide) profit implication of most proposals.

A simple, bottom-up approach to management decisions

Throughput-based reasoning (unlike the alternative) empowers operators to make bold decisions: those critical decisions that have an outsized impact on the organization’s profitability.

If the location of the Constraint is obvious to operators, Throughput-based reasoning is intuitive. However, if the organization has been allowed to descend into a chaotic state, operators have no choice but to retreat to the relative safety of cost-based decision-making.

Accordingly, it is the responsibility of senior management to design the organization in such a way that the Constraint remains anchored at its optimal location by sufficient protective capacity at all other resources.

Senior management can also assist operators by identifying and visualizing metrics that reflect the contribution (positive or negative) that operators’ work is making to the productivity of the Constraint.

Upstream from the Constraint, metrics should be designed to ensure that the Constraint is never starved of work, and downstream, metrics should ensure that a unit of value generated at the Constraint is never wasted.

Obviously, operators should not be allowed to make decisions that will cause the Constraint to move. (We’ve all seen the catastrophic effect on airlines when a technology problem causes the Constraint to shift from their fleet of aircraft to the reservation system!)

However, in a healthy, well-designed organization, it should be very difficult to move the Constraint.

Containing costs

It should not be assumed that a shift in management focus from cost to speed is a license to spend indiscriminately. The overriding goal, obviously, is the generation of profit.

Raw-material costs are always considered in the calculation of contribution margin and any proposal to increase operating cost should be treated similar to an investment proposal.

The containment of costs is like wearing hearing protection on the plant floor. It’s not the goal, but it’s certainly a necessary condition.

The major difference in this new environment is a heightened awareness of the importance of protective capacity. An idle machine (or person) is adding value if they are preventing the Constraint from becoming idle. Think about it: you wouldn’t downsize your district’s fire brigade if you discovered that firefighters weren’t actually extinguishing fires 24 hours a day!

Two critical value chains

There’s another insidious way that cost accounting damages businesses. By abstracting away the concept of time, the cost-based approach to decision-making obscures the fact that businesses contain processes (or value chains) that must be decoupled.

By decoupled, I mean that they must operate with a high degree of independence.

Healthy businesses contain two such value chains. (I’m favoring the term value chain rather than process because these processes span multiple departments):

1. The first value chain generates Throughput.
2. The second value chain generates growth (a positive change in Throughput).

The Throughput value chain consists of the sequence of activities required to convert a customer’s order into money in the bank. (The various departments that perform these activities are typically members of the operations group.)

The growth value chain consists of the activities required to increase the rate at which customer orders are received. (The departments that contribute to growth include sales, new product development, quality, and acquisitions.)

If you consider the departments that contribute to growth, two things are clear. First, in most organizations, these departments are not managed as part of a distinct group. And, second, in most organizations, individuals within these departments are responsible for activities across both value chains.

For example, salespeople are frequently responsible for solving customer problems, and engineers are often responsible for both new product development and the processing of customers’ special orders.

The problem with sharing resources between these two value chains is that whenever there is resource contention between the two, the Throughput chain will win. Under these conditions, unless you have a lot of protective capacity (which is unlikely when cost-based decision-making is prevalent), what tends to happen is that the level of effort allocated to growth quickly goes to zero!

A better approach is to manage these two value chains as distinct groups. Each has its own goal. Each will have its own Constraint. And each will have its own set of metrics. If resources absolutely have to be shared between these two groups, those resources should have a lot of protective capacity and they should be formally scheduled to avoid contention.

Of course, these two groups are not fully independent—they are nested, like Russian dolls—but they should be managed independently. Money spent on growth should be treated like an investment, not a normal cost. This is because the output of this group (the addition of a new customer, the acquisition of a competitor’s business, or the commercialization of a new product line) is a new stream of Throughput that will persist for many normal reporting cycles.

An introduction to metrics

Eli Goldratt would often say, “Tell me how you’ll measure me, and I’ll tell you how I’ll behave.”

This idea should not be controversial, given that a metric is just a form of feedback. All but the most simple tasks require that the operator make regular adjustments to their work based on the evidence of their senses.

The purpose of a metric is to either augment or replace the operator’s senses (pilots, for example, learn to trust their instruments over their senses).

Metrics should be designed to synchronize the behavior of operators with the goal of the organization. A Kanban bin system is a perfect example of this in a production environment. If parts are present in a bin, the operator will process those parts, and when the bin is empty, they stop. The bin prevents overproduction and, more likely than not, results in the operator working faster when there’s actually work to be done.

Importantly, the Kanban system improves the profitability of the organization by causing the operator to be less efficient!

A system of metrics

It’s beneficial for the executive team to carefully design a system of metrics for the organization rather than inheriting traditional metrics or trusting that line management will select metrics that result in operators subordinating effectively to the goal of the organization.

Ideally, each department should have a single metric for value creation (or key performance indicator) and one or two necessary conditions that must be respected. The most effective key performance indicators (KPIs) are compound measurements that, under normal circumstances, make additional measurements redundant. (For example, if a production department is consistently averaging 95% on-time-delivery performance, we can assume that the assembly line is not suffering from unscheduled downtime.)

Your system of metrics should have a hierarchical structure.

At the top of the hierarchy, there’s a single metric that subsumes both the profitability and the growth of the business. That metric is enterprise value (or stock price, averaged over a sensible timeframe).

At the next level, we have the two value chains that drive profitability and growth.  The metrics for these will be Throughput per period and new-business value per period, respectively. In both cases, the period should be the shortest sensible timeframe. Ideally a day (not a quarter!). New-business value is the net present value of new business won (think of the lifetime value of a new account, for example).

Now, each of these value chains will contain a nominated Constraint. Accordingly, metrics for each department within these value chains should be set with respect to the Constraint. Generally speaking, activities upstream should replenish the Constraint as rapidly as possible (so it is never starved of work), and activities downstream should ensure that work done at the constraint is converted to value rapidly (so the Constraint’s capacity is not wasted).

So, as an example, if we consider the procurement department in an engineer-to-order production environment, we might conclude that the role of procurement is to ensure that all inputs for jobs are received prior to the scheduled release. However, we would also recognize that building parts inventories is undesirable. Consequently, we might measure the percentage of procured parts that arrive during a pre-release Goldilocks zone.

Such a metric would penalize both late deliveries and inventory building and would encourage the development of healthy supplier relationships and the micro-management of those suppliers with less-than-optimal historical performance.

If you’ve ever spent time in a procurement department in a cost-focused organization, you’ll appreciate that these are not common behaviors!

Retooling for speed

The move from cost- to Throughput-based reasoning does not start by teaching operators new operating procedures. It starts with:

1. A commitment to speed, rather than cost, as the basis for optimization
2. A redesign of the organization to anchor the Constraint locations

The former requires that you read (and maybe reread) this paper and, ideally, the additional resources referenced.

The latter is a more significant undertaking. First, you need to determine the resource (or set of resources) that should be the Constraint (for your Throughput value chain). If you’re not sure, your Constraint should probably be the resource that makes the biggest contribution to your competitive advantage (as well as to profitability) when it is fully activated.

You will then need to change the way that work is planned within your organization so as to force your nominated resource to become the Constraint. The transition from chaos to a single Constraint must happen quickly (definitely within 30 days).

And then, when the transition is made, you can turn your attention to your system of metrics and your plan to drive growth and, accordingly, the design of your growth value chain.

In a typical organization, these first two steps involve a significant amount of work. But, if you have a commitment to growth, you must compare the level of effort associated with this approach with the level of effort demanded by the cost-focused alternative.

An ode to speed: part 2

At the start of this paper, I stated that if I were to give a single piece of advice to the owner of an industrial business, it would be to increase your organization’s clock speed.

I truly mean that. A business that runs faster is a business that delivers more value to its customers and generates more profit for its owners. Furthermore, a business that runs faster also grows faster.

The widespread adoption of cost accounting has removed the time dimension from day-to-day decision-making and has contorted the mental model that informs most managers’ intuition.

If you want to outgrow your competitors, it’s critical that you reintroduce the time dimension to decision-making throughout your organization.

Coda: two examples of Throughput-based decision-making

How should a manufacturer of countertops price a new product

A manufacturer fabricates countertops from engineered stone for commercial projects. They have developed a range of sinks that can be fabricated from the same material as the countertop. They need to know how to price these sinks.

There are four critical pieces of information this manufacturer should collect to make this decision:

1. What is the price that the market is paying for comparable sinks?
2. What are the totally variable costs associated with the sink?
3. How many units of Constraint capacity will be consumed in order to fill an order for a sink?
4. What is the current yield (T/Cu) at the Constraint?

Let’s assume that the market is paying $1,000 for comparable sinks. Let’s also assume that the raw-material cost will be just $100 (we predict that 60% of the stone will be scrap from countertop production that would otherwise be discarded).

Let’s assume that this manufacturer’s Constraint is its installation crew. This would imply that the manufacturer programs the plant operation around the availability of the crew. With careful programming, we’ll assume that the crew can do two installations a day.

The current yield on the Constraint (T/CU) is the total Throughput for a standard period divided by the number of installations over that period. If we assume the crew averages nine installations a week (one half-day is lost to callbacks) and that the total Throughput generated over that period is $47,250, then an average Constraint unit is yielding $5,250.

If we assume that it takes the installation crew 60 minutes to install a sink, then this is a lot less than the half-day Constraint Unit. But, there’s a danger that, in some cases, the additional time required for sink installation will prevent the crew from doing a second installation that day. In these cases, the sink installation consumes an entire Constraint unit. If this occurs just twice a week, then the sale of each sink generates $900 in Throughput but decreases T/Cu by $467.

Under these circumstances, the manufacturer would need to charge at least $1,467 for the sink just to maintain current profitability, which makes these sinks a questionable proposition.

However, the manufacturer should consider some additional options:

1. They could take steps to reduce the sink installation time and eliminate the risk of the installation consuming an additional Constraint unit.
2. They could sell sinks direct-to-consumer, which would would place no load on their Constraint.
3. Additionally, the manufacturer might consider having a separate specialist perform callbacks. After all, it’s unlikely that callbacks require exactly the same set of skills as installations.

The profit implications of the four scenarios presented here are wildly divergent. However, the important point is that this analysis would not normally be performed in an environment where cost-based decision-making is prevalent.

The danger of the departmental profit and loss statement

A year ago, a large commercial plumbing firm acquired a small manufacturer of pre-fabricated plumbing racks.

These prefabricated racks dramatically reduce the time it takes for a plumber to install bathrooms and kitchens in large projects (like hotels).

The plumbing firm’s assumption was that the manufacturing business would increase the productivity of its commercial plumbers (a limited and expensive resource) and generate some additional profits by selling its products to other plumbing firms.

A recent review of the performance of the acquisition revealed that the expected productivity improvements had not been realized. The only good (but somewhat concerning) news was that the manufacturing division was selling more units to competitive plumbing firms than expected.

The problem was that the manufacturing division continued operating autonomously after the acquisition. Specifically, it generated its own profit and loss statement and sold its products to the larger plumbing firm at market value.

Because the manufacturing division was attempting to maximize its profitability, it kept costs low (which limited capacity) and sold its products to the highest bidder. Because supply was limited, project managers within the larger plumbing firm had concluded that the division was an unreliable supplier and were electing to have plumbers do their own fabrication on-site.

The root cause of this problem is a failure to properly integrate the manufacturer into the larger organization. It should not have been allowed to operate autonomously, and it should definitely not have been expected to generate its own profit and loss statement.

The larger plumbing firm should have held its new manufacturing division accountable to a metric that drove proper subordination. The identification of this metric requires an understanding of the Constraint within the larger enterprise.

If (as is likely the case) the Constraint is the plumbing firm’s pool of qualified plumbers, proper subordination would mean ensuring that prefabricated racks could be delivered to building sites whenever required (without the requirement for quotations or purchase orders!).

The metric for the manufacturing division would be on-time delivery performance, which means that the manufacturer would be forced to maintain protective capacity to accommodate variability in demand.

This protective capacity would inflate the manufacturing division’s costs relative to the autonomous mode of operation, but some of these costs could be offset by using downtime to manufacture units for sale in the open marketplace.

These changes would result in the enterprise Constraint becoming more productive, causing a direct increase in Throughput. The acquisition would perform as expected if the increase in Throughput is meaningfully larger than the manufacturing-related operating expenses.

Interestingly, it would make total sense for the plumbing firm’s finance department to use cost-accounting methods to analyze the commercial viability of the acquisition both before and after the fact.

But it makes no sense whatsoever to use cost-based logic to make day-to-day management decisions. In addition to generating incorrect results, the resulting cost-based mental model will create a gravitational pull toward the atomization of the organization (the presumption of profits at the level of divisions, product lines, and transactions).

Further reading

If this paper resonates, you really must read The Goal (Eliyahu Goldratt). This is one of the best-selling business books ever written, and it does a spectacular job of explaining the concept of the Constraint.

If you’re looking for an exhaustive exploration of cost-based reasoning, your next stop is Throughput Economics (Eli Schragenheim, Henry Fitzhugh Camp, and Rocco Surace).

And, if you’d like a break from reading, you might like to watch our video documentary (Double-Digit Growth) here: https://www.youtube.com/watch?v=1yoXmo_s_Bc

Assistance is available

Justin and the Ballistix team create and actively participate in Steering Committees for a small number of organizations. These Steering Committees are dedicated to transitioning those organizations to what we call a Speed-Based Operating System.

If you’d like an overview of this service offering, please send a request to mattie.hayden@ballistix.com

When we work with those manufacturers that sell via resellers of various types, we often encounter an instance of the Drunkard’s Search problem within the sales department.

This article describes the problem, as well as a solution we devised around 15 years ago—but abandoned because we believed it was too complex to be practical.

Our interest in the solution was reignited recently when we encountered two clients convinced it was a breakthrough! The first was the Australian organization for which we devised the solution 15 years ago. After our engagement ended they pressed our theoretical solution into service and have benefited from it ever since. The second was a South African organization that lept on this idea when we cautiously mentioned it to them because they concluded it was a perfect fit for their reseller network.

The drunkard’s search

The Drunkard’s Search is a parable that describes a drunk searching for his car keys under a streetlight (because that’s where the light is) rather than near his car, where he lost them! It points to a kind of observational bias where we assume something is meaningful just because it’s visible.

A manufacturer that distributes its products through a channel (a reseller network) is similar to all organizations in that it’s dependent upon revenue for its survival. But where this manufacturer differs from other organizations is that the revenue it banks doesn’t come directly from the end consumers of its products, it comes via one or more (somewhat disinterested) channel partners.

This revenue stream is similar to the ground being examined by the drunkard under the streetlight. It’s very visible but, where short-term decisions are concerned, it’s not particularly meaningful.

If you’re such a manufacturer and you have salespeople within a sales department who are held accountable for this revenue stream (perhaps even compensated based on it), this focus on the visible is likely resulting in some unintended negative consequences.

These negative consequences fall into two categories. There’s the damage done when salespeople stuff the channel with inventory. And then there’s the lost opportunity when salespeople fail to focus on the point in the channel where the ultimate sale (to the end consumer) is occurring.

Moving the streetlight

In theory, the solution to this problem is simple.

In organizations, there’s a strong tendency to measure what’s visible and then to optimize what’s measured. In short, this means that the behavior of employees is heavily influenced by what they can see.

Given this, you can often change behaviors by simply moving the streetlight.

In practice, this means making revenue less visible (by reporting aggregate numbers, or a rolling average calculated over a longer period, for example), and then highlighting a more meaningful metric.

Revenue: first- versus proximate-cause

Our quest for a more meaningful metric starts with revenue but it obviously doesn’t finish there.

Once a distribution channel has reached a steady state, the first cause of revenue is an end consumer making a purchase. The proximate cause is an upstream reseller placing a replenishment order with the manufacturer.

The manufacturer should be focusing most of their attention on the first cause of revenue (which is the final transaction in the chain). Yes, this is counterintuitive!

Now, there’s a natural limit to how much influence the manufacturer can wield over that final transaction. After all, the manufacturer has decided not to sell direct. The best it can do is influence the antecedents to that final transaction: the set of conditions that facilitated the final transaction.

We call that set of conditions the Ideal Condition Set. And, compliance with this Ideal Condition Set is our recommended metric for channel optimization.

The Ideal Condition Set (ICS)

We define the Ideal Condition Set (ICS) as the set of conditions that results in optimal sell-through at the final point of sale.

These conditions typically include things like the range of products stocked, the quality of merchandising, the competence of sales associates, and so on.

To be appropriate, these conditions must impact sell-through, obviously, but they must also be something that your “salespeople” can actually influence and something that can be measured.

If you’re wondering why the word salespeople appears in scare quotes above it’s because the folks who call on channel partners probably shouldn’t be called salespeople, they should be called channel managers.

And rather than selling, in a traditional sense, channel managers should use their persuasiveness to migrate channel partners toward full compliance with the ICS. This means that they should conduct themselves more like retail consultants than traditional salespeople.

As far as the metric is concerned, once you have a set of measurable conditions, all you need do is figure out how to score and weight each condition, and then you can reduce compliance for a channel partner (or a group of them) to a single number (72%, for example).

We argue that this is the number that your sales and marketing departments should be watching (and optimizing for).

If you mute the visibility of the revenue stream and, instead, shine a light on compliance with the ideal condition set, your channel managers will focus on driving sell-through at the final point of sale rather than attempting to convince the first reseller in your distribution chain to buy more inventory.

I think it’s reasonable to assume that this new focus will be good for revenue in the long run.

The mechanics

Finally, here are some pointers on how to turn this idea into a functional framework.

1. Segment channel partners into homogeneous groups (if you sell tools, for example, you might arrive at the following segments: big-box hardware stores, independent hardware stores, industrial supply houses, trade supply stores, and so on.
2. Within each segment, identify the best-performing channel partners. Visit them and try and determine the critical few factors that drive their success. Reduce this list to the factors your channel managers can reasonably influence. Devise a way to score and weight each of these factors. (KISS!)
3. Create a means to record these scores against the Account record in your CRM and a way to catalog evidence of these scores (e.g. a photograph of a point-of-sale display).
4. Create a process to update the status of existing accounts (please do not call this an audit!) and to onboard new accounts. 
5. Sell this new methodology to your team and allow them to contribute ideas and improvements. Deprioritize the existing revenue signal and find a way to prioritize your channel’s ICS compliance number over time (perhaps create a run chart that occupies an entire wall in your office!)
6. Monitor the relationship between ICS compliance and revenue (measure it over a sensible time horizon) and confirm that there is a positive correlation between the two numbers (adjust the ICS framework if not)

The following is precisely how most executives within industrial organizations conceptualize revenue.

Q. Where does revenue come from?

A. From salespeople.

Q. How do salespeople generate revenue?

A. Um. From relationships.

This conception of revenue is not even vaguely correct. And, unfortunately, this fundamental misunderstanding of the nature of revenue leads to a number of organizational design problems that, collectively, handicap growth.

Cause and effect

Given that revenue is the lifeblood of an organization, it’s probably worth investing a little effort to understand where it comes from.

The proximate cause of a unit of revenue is a transaction. A customer buys something. No surprises here!

Okay, so what causes that transaction?

It’s tempting to answer: a salesperson. But there’s a problem. We know that not all transactions are literally caused by a salesperson. For example, if your salesperson goes fishing for a week, you know that (fortunately) transactions continue in his absence.

Salespeople are happy to furnish a solution to this problem. They will advise us that this magical action at a distance occurs because of the relationships they have developed with their customers.

This explanation is not entirely fanciful (which explains why executives sanction it). I’m reasonably loyal to my hairdresser (hi Brittany!) which, I guess, is evidence of some kind of personal relationship. And I’m pretty sure that you are also somewhat loyal to your hairdresser, your dentist, your gardener, and your personal chef.

But, there’s a couple of problems with this explanation. First, in industrial organizations, most transactions are not accompanied by the delivery of personal services (as is the case with your dentist). Second, in most cases, when a salesperson leaves an industrial organization, their customers stay.

Industrial transactions are programmatic

Another reason why the salesperson’s explanation is somewhat believable is because it is half right.

Transactions do emerge from relationships. But the relationships from which they emerge are commercial relationships, not personal ones.

Unless your organization is operationally dysfunctional, most transactions are programmatic: which is to say that they occur without the provision of personal services. And to the extent that personal services are required, those services are delivered by members of your Operations group (customer service reps, engineers, project managers, etc).

Most transactions consist of existing customers purchasing one more unit of something they have purchased previously. Of course, this state of affairs is something to be celebrated. It’s exactly this phenomenon that drives down unit costs, drives up the profitability of organizations, and enables us all to live our rock-n-roll lifestyles!

Not surprisingly, salespeople are not enthusiastic about the distinction between commercial and personal relationships. It serves them to ignore the qualifier and encourage everyone around them to go on believing that all relationships are of the latter type.

A solution to this semantic problem is to stop using the word relationship altogether. Given that most transactions are programmatic, it’s useful to recognize programs as the source of transactions.

From whence do programs spring?

In industrial environments, programs—rather than discrete transactions—are the default. Imagine you need business cards and your previous provider has gone out of business. When you find a new provider, this print shop gets to print your business cards for you but they also become the default provider of other print services, moving forward. (This is inertia at work.)

If that print shop thinks they are selling you business cards, they are mistaken. They are selling you a program. In financial terms, that program is an annuity, meaning that its value is the net present value of future cashflow.

As is often the case, the value generated by printing a set of business cards is dwarfed by the value of the program, assuming the print shop does a decent job of pricing, printing, and delivering future jobs.

Okay, so where do programs come from? Well, hopefully, your salespeople sell them!

You’ll get some from word of mouth but if you want to grow your organization aggressively, you’ll need your sales team to sell a bunch of programs every month.

If salespeople sell programs, don’t they generate revenue?

If salespeople sell programs and programs generate revenue (via transactions) it would be tempting to conclude that salespeople generate revenue.

But this conclusion is dangerously wrong. It’s a gross oversimplification of the nature of commerce.

From the perspective of Sales, transactions occur on autopilot once a program is sold, assuming that Operations does a good job of onboarding the new customer, and assuming that Operations maintains competitive products, pricing, and delivery performance. 

Revenue is actually generated by Operations, not Sales.

Salespeople generate programs.  And a program is an annuity: a bundle of potential revenue.

These are NOT the same thing.

How to handicap your organization’s growth

If you fail to recognize this distinction between potential and actual revenue, what you will end up doing is giving your salespeople license to involve themselves in the onboarding and delivery of programs.

There are two obvious problems with this. First, your salespeople are (hopefully) not the best people in your organization to perform operational tasks—meaning your service quality will suffer.

Second, time spent performing customer-service, engineering, and project-management tasks is time that salespeople are not dedicating to the sale of programs.

And if your organization’s going to grow at a faster rate than your competitors, that growth is not going to come from transactions, it’s going to come from the sale of programs.

Justin Roff-Marsh is author of The Machine: A Radical Approach to the Design of the Sales Function. You can get the first four chapters of The Machine in print or audio version for free here.

Well, I’ve created a video demonstration of an eight-minute briefing—and you can watch it below.

Why an Eight-Minute Briefing?

First, I should stress that there’s nothing special about eight minutes. It could just as easily be six, or twelve.

The significance of the small number is that we want to highlight that this briefing has been deliberately constructed to be economical with the prospect’s time.

This makes it easy to sell and, more importantly, easy for a prospect to say “yes”.

An eight-minute briefing is not appropriate if you’re selling a commodity product (nuts and bolts) but it is appropriate if you’re selling new technology or a program of some kind (e.g. vendor-managed inventory of nuts and bolts.)

Conduct

The briefing should be pitched as a mini-event with stand-alone value.

For example, a salesperson might say:

Look, I don’t know if our Integrated Supply program will make economic sense in your environment. But our briefing will enable you to make a determination in just eight minutes. Best case, you save tens of thousands of dollars a month. Worst case, you squander eight minutes! Would early or later in the week suit you better?

The briefing is a video conference, conducted in Zoom (or similar). The salesperson will typically present the briefing along with a 3-slide presentation (so named because it contains no more than three slides—or 4 if you’re a risk taker).

They will deliver a concise, canned eight-minute presentation and then segue into a standard sales conversation (assuming that the prospect’s interest has been piqued by the presentation).

Don’t you sell by asking questions?

Salespeople are often uncomfortable commencing a conversation with a canned presentation. After all, most have been taught to sell by asking questions.

It’s important to remind salespeople that you can only ask questions once your prospect has granted you a mandate to do so. If you’re responding to an inbound inquiry, this mandate is implicit. However, if you’ve initiated a conversation with a stranger, you can’t lead with questions (unless you want to be shut down quickly); you need to stimulate interest.

The eight-minute briefing is a great way to do this. It’s a small ask that results in one of two things. Either the mandate that the salesperson is looking for, or an informed decision not to proceed. The salesperson benefits either way.

Note

The attached video is a dramatization of an eight-minute briefing, prepared for your benefit. We would never send the video to a prospective customer. The briefing will always be presented live.

In two short years, Emasal totally reengineered its entire front-of-house.

Two years ago they had 6 regional offices, each with its own sales and customer service representatives. And, two years ago, salespeople were commissioned, semi-autonomous operators, doing a mix of field and telephone work.

Today, Emasal has one central customer service team and one central internal sales team. They have a couple of technical field specialists in each region, but no salespeople. Oh, and salespeople today earn salaries only. No commissions!

Emasal made this transformation because, after 38 years, growth had slowed. They realized a new sales model was required. Achieving the transformation in two years required a herculean effort, obviously. It would be easy to imagine the executive team today, waiting with bated breath to see if this expensive and risky transformation will, in fact, generate the anticipated uptick in growth.

But there’s no bated breath. The results are already in. There were bumps in the road for sure, but Emasal was able to prove the efficacy of its new model in real-time, as the team was making the transition.

Here’s what the numbers say.

• In year one of the transformation, revenues rose by 19%
• In year two of the transformation, revenues rose by 17% (on top of the year-one increase)
• There was no increase in total operating expenses (including Ballistix fees), and no expenses relating to the transformation were capitalized
• The velocity of customer service transactions (quote generation, order processing, and issue resolution) increased significantly
• Only one senior person left the organization (but this departure had no adverse financial impact)

With this new model, Emasal’s requirement to open up a new region is a single, local, technical specialist. This is in contrast with the old model, where they needed an office, a general manager, and sales and customer service teams. This minimizes the risk associated with expansion and makes it possible to expand into regions that would otherwise have been too small to support their legacy model.

If all that wasn’t enough to make this story interesting, consider this.

Emasal is not based in the USA.  The company is headquartered in El Salvador. And their “regions” are not different cities, they are different countries! (El Salvador, Costa Rica, Nicaraguaua, Panama, Honduras, and Guatemala.)

If you think it’s hard to sell the idea of moving sales inside in the USA, imagine how hard it is to sell this concept in Central America. (Justin, you don’t understand, we have a Latin culture here!)

In case you’re wondering, Emasal sells packaging machinery and consumables to (primarily) food and beverage manufacturers.

Enjoy!

When young executives discover enterprise technology, their first instinct is to build a unified, organization-wide workflow. (Actually, this tendency also extends to the not-so-young!)

It seems perfectly sensible. The idea appeals to the innate desire we all have for elegance (and the love we have for new technology).

But in practice, more often than not, this is a mistake. What you end up with is the oversimplification of work, the destruction of information, and the generation of conflict between departments.

If your business is any more complex than a lemonade stand, it’s likely that you do not need (and should not have) a unified, organization-wide workflow. But what you should have are unified inboxes within each department.

And it turns out that our local restaurant—a business not much more complex than a lemonade stand—contains a perfect example. 

Two important definitions

For clarity, let me start by defining a couple of terms.

By inbox, I mean the portal via which work finds its way to a person or a department. I’m not referring specifically to the email inbox, although your email inbox may actually (for bettor or worse) fit this definition.

By unified workflow, I mean the idea that you can deconstruct your organization into a single network of work packets (tasks) that are routed dynamically from person to person.

The lure of the unified workflow

Years ago we worked with an organization that was transitioning to Netsuite. Netsuite promotes themselves (as ERP providers like to) as a unified operating system for the organization.

The chief executive of this organization was in the process of making Netsuite tasks the default organizational work packet. His idea was that all knowledge work, organization-wide, would be done within Netsuite and, if a unit of any work could not be done within a core Netsuite module, it should be represented as a Netsuite task.

The dream, obviously, was to capture the complexity of the organization entirely within the ERP where it could be tamed, managed, and scaled. This is an alluring idea. What it allows you to do is to simplify your organization into two components. There’s a set of resources that transforms stuff. And then there’s a routing system that shuttles work from resource to resource. It makes perfect sense that this routing system should be centralized and that it should live in a piece of software.

The problem with the dream is that it ignores the true nature of reality.

The problem with oversimplification

The folly of this line of reasoning first became visible within our friend’s technology department.

The technology team had traditionally used Jira to manage their work. Jira is the software that most engineering teams use to manage the software development process. As well as coordinating the development process (from user stories to lines of code), Jira has deep integrations with critical resources, like code repositories, chat, software lifecycle management, and dashboards.

Management recognized (correctly) that Jira was fundamentally a task-management system and replaced it with the Task module that comes standard with Netsuite. After all, why have two task-management systems when you can have one?

It took less than a week for the damage to become obvious.

Babushka dolls

It used to be that there were two conversations. There was the technology conversation that occurred outside the technology department and there was the technology conversation that occurred within the technology department. Now, because of the unification of tasks, these conversations had been collapsed into one. The result was the sudden emergence of conflict between technical folks and the rest of the organization, and a dramatic reduction in output.

The problem here is that these conversations are materially different from one another. And they MUST be, for the technology team to generate value for the organization. And this is true in all specialized domains. (Think of the conversations doctors have with one another versus the ones they have with patients; or air-traffic controllers, with one another, versus pilots.)

Another problem is that there is often not a one-to-one relationship between work packets as they are defined within, and outside of, specialized domains. What appears to be one task will often explode into multiple tasks (with different owners) or, conversely, what appear to be multiple tasks might coalesce into one.

Our friend’s mistake is that he had visualized his organization as one large conversation. But this is a bad model of his organization: a bad model of pretty much any organization.

It would be more correct to think of an organization as a collection of discrete conversations with very limited (but very important) connections between them.

Or, better still, rather than visualizing an organization as a two-dimensional workflow map (like the map of a subway system), it makes more sense to think of it as a three-dimensional set of those maps, with maps on the third dimension nested under the first two, like Russian dolls.

You should not be striving for a unified, organization-wide workflow because this is not reflective of the inherent nature of your organization.

The magic of loose coupling

It turns out that there’s a better use of technology if you want to dramatically improve information flows within your organization.

Rather than trying to unify workflows, globally; unify inboxes for each department. That is to say, ensure that each department has a single portal via which work is received. The benefit of that single portal is that it decouples the local (departmental) workflow from the global (organizational) one.

It allows the local conversation to be independent of—but loosely coupled to—the global one.

Now, these inboxes do not have to be of the same type (in most cases, they should not be). The type of inbox should be driven by the ease of unification, not by the careless pursuit of standardization.

Some general rules. If inbound tasks can be corralled into a single inbox, then they should be (think of a ticketing system for a technical helpdesk). If some inbound tasks must be received via an email inbox, then route all tasks to a central email inbox (think of a customer service team). If work cannot be processed according to a simple algorithm (e.g. first-in-first-out), then route all work to a human scheduler (think of a job-shop production environment)

The unified inbox, done right

Consider your favorite restaurant. Within this establishment, there are two critical conversations. The front-of-house conversation, involving guests and waiters. And the conversation that occurs in the kitchen. As you know from watching Gordon Ramsey, these are two quite different conversations. (No good would come of any attempt to unify them!)

What’s interesting here, is not the conversations, it’s the integration point. The integration point is the chef’s ticketing system. A rail containing tickets representing guests’ orders. 

This ticketing system is a perfect example of a unified inbox. All work that enters the kitchen enters by way of that ticketing system. If a staff member wants a meal, they create a ticket and add it to the rail. If a delivery order comes in from Uber Eats, someone converts it into a ticket and adds it to the rail.

Imagine if the kitchen didn’t operate that way. Imagine if requests emerged from multiple sources and were routed directly to different kitchen staff members? Obviously, if we owned that restaurant, we wouldn’t allow that to happen. That would be idiotic!

But, and I think you know where I’m going here, if you take a look around most organizations you’ll see that this is exactly what is happening, all day, every day; often with the explicit sanction of management.

What’s really concerning though, is that the negative effects of this poor organization design tend to be misdiagnosed as communication problems, and the default cure for these problems is—you guessed it—a unified, organization-wide workflow!

My advice to you is don’t focus on the conversations. Focus on the integration points between the conversations. An attempt to unify conversations by unifying workflows is a fool’s errand. But there’s massive potential to improve flow by focusing on the integration points and unifying inboxes.

By the way, once you’ve unified inboxes (within each department), you’ll come to recognize that the content of each inbox is probably your organization’s most valuable source of real-time information. But that’s a conversation for another day.

Photo by Ronan Kruithof on Unsplash