Levers and Pulleys

I’m writing this based on my insights as a management consultant. Apologies in advance if I end up on a global or gyaan-spouting trip

One of the most common ways of ending up in corporate paralysis is to split up a particular target into constituent “levers” and hand over the management of each of these “levers” to a different manager. You construct an elaborate funnel based on several filters, and put a manager in charge of maximizing the efficiency of each of these filters. In the course of time, this manager’s performance will start getting measured on the effectiveness of the filter alone. The filter will get refined, and soon you will have the most perfect filters. And then you find that there is no way forward.

Beyond a point, any filter will stop working. This is because it hits what can be described as its “natural efficiency”. After this point, the only way you will be able to increase the output beyond this particular filter will be to increase the overall input to the filter. However, increasing the overall input will mean that this input will be of a lower quality than the input based on which the filter was perfected. Which means there will be a (at least temporary) loss of performance in this particular filter. Which means that the manager in charge of this filter will see a temporary dip in his own performance, based on the metrics he is currently measured on. It is now easy to see why it is in his interest to block any move to increase the volume of input! Apply this process at all points of the “funnel” and you see that the entire system is at a standstill.

The problem lies in the part of the process where an artificially defined construct, such as a particular efficiency ratio becomes sacrosanct and gets institutionalized as someone’s performance metric. Let me illustrate this with an example.

Business school graduates and followers of corporate brothels will be familiar with the concept of the DuPont analysis. It is basically a combination of three ratios – leverage, asset turnover and profit margin, all of which together gives you to the return on invested capital, which according to the authors of the model, is the holy grail of evaluating a company.

Suppose you believe in this analysis and so put one senior manager in charge of each component of the DuPont analysis. So your finance manager is in charge of leverage, ops manager for asset turnover and one other guy for profit margin. The firm has gone ahead in such a way that each of these managers are now evaluated according to these ratios. All of them are doing great jobs and have optimized their respective silos. Now, you decide that the firm needs to expand further. How do you go about it?

You need to invest in some capital goods. So how do you pay for it? If you take a loan, interest payments will affect your profit margin and the manager in charge of that will object. The other option would be to raise equity capital, but now the leverage is lost and the finance manager is not happy. Let’s say you work out some way to finance the deal. Now in the time it takes for this asset to start “producing”, the asset turnover is going to be depressed so the ops manager is unhappy. So as long as you measure your managers on these “intermediate goals”, the larger objective of business expansion will get compromised.

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