You can't beat the man if you are the man

In essence, profitability is a function of two dominant factors: strategy and execution. Without both happening in perfect synergy, profitability will never achieve its full potential. It could be argued that for any given organization, when considering their core operations, mission, and existing infrastructure, there exists an equilibrium level of profitability. It can be exceeded by beating the system, and it can fall short by losing while attempting to beat the system.

Within strategic operations, there exists vision and analysis. One must first set goals for their organization, align this with the overall intent, and then quantify its value before implementation. Once approved, it is simply (well, not always) a matter of execution. Execution is taking the goal, examining its structure, designing the processes, and implementing controls. Once this is accomplished, operations are ideally like clockwork. Continuous improvement necessitates better and more targeted controls to identify systems out of control. The definition of ‘out of control’ is that the execution is not falling with an upper and a lower bound – this bound is ultimately cost (costly). The most direct and functional tool with a great scope is Zero-Based Budgeting. Simply, if the company ceased to have expenses, the budget would be zero – but this is clearly not the case, so each expense is quantified, justified, and approved, marginally increasing the budget. When this process is complete, a budget is born. This is the internal control of an organization to manage all directives and functions.

Ultimately, for costs to be cut, incentives need to be put in place. If the almighty dollar is the measure of strategy, then it also must be the measure of improved execution. These incentives vary, but are generally the same – esoteric motivation. Whether these be in-kind or in-cash, variable or absolute, they are carrots. Economics rests on the notion of human reaction and behaviour to incentives – without this basic principle, economics is but a fallacy. Through measurable targets, variable compensation can be determined for the individual employee, and through profitability, the overall compensation for the group as a whole is found.

When these two tools are used in unison, theoretically you obtain a balanced attack at profitability. The incentives dangled over the individuals are to encourage new ideas and directives to cut out the fat (costs) within every process and method. If you consider that individual functions’ budgets will each be zero-based, then you have a playing field for charge backs. Each function can charge services, or even divert, costs to another function. It is both in the department’s interest and the individuals (so long as their variable compensation is tied solely to its ‘profitability’) to minimize their own costs, irrespective to overall costs. It is as simple as thinking of a bucket filled with water, when you insert a divider (assume it has zero volume), the volume of the segments is less than before (as there used to be one), but the overall volume has not changed. If you were to move the divider away from the middle, again, the overall volume does not change – only the relative proportions.

The results are divided. Although the implementation of individual incentives and company targets would theoretically create a machine for cost-savings, this is not necessarily the case. There is one sore assumption, and that is that the controls can be put in place to mold human behaviour (employee performance). The question becomes, can controls be put in place in alignment with a corporate policy such as ZBB to create equilibrium? I guess no.

The perception is that these tools together will drive improvement, although does it necessarily every get off the ground? I conjecture that they can create mixed results. It is quite possible for it to drive costs down, but one can’t rule out the fact that they are combatants to one another. The individuals will fight over their respective budgets, disregarding the net impact on the overall budget. Each owner would need to be as prude as the other in order for this cost-cutting equilibrium to be found. If this is not the case, the situation will arise where one owner acts in a way to reduce his costs, diverting added costs to another function, and it actually increasing overall costs. Under no circumstances can relatively higher costs over a fixed revenue increase operating profit.

To be successful in an organization structured like this, one must be prudent and greedy. One must be seeking not the best interests of the company, but himself. The strategy is based on the assumption that the individual’s interests can be aligned to that of the company through controls. Instinctively, man survives not through subsistence, but through accrual.

Organizations attempting this form of management system but be wary – for they must be more prudent and greedy than the individuals that work for them. But if the only ones who succeed in this organization are those that are the most prudent, is this not a paradox? It looms on disaster…

You can't beat the man if you are the man.

Jeremy Boorman

Copyright 2007