Primary navigation:

QFINANCE Quick Links
QFINANCE Topics
QFINANCE Reference
Add the QFINANCE search widget to your website

Home > Mergers and Acquisitions Best Practice > The Missing Metrics: Managing the Cost of Complexity

Mergers and Acquisitions Best Practice

The Missing Metrics: Managing the Cost of Complexity

by John L. Mariotti

Executive Summary

  • Despite the best efforts in many areas, the accounting and finance systems currently in use overlook the costs of complexity.

  • The costs are hidden in the operating statements of a company until the period-end results show the adverse effects.

  • It is time to recognize that these costs exist, identify them, and develop new metrics in the place of those that are missing.

Introduction

Accounting systems have come a long way in the past decades. Activity-based costing revealed where costs were being incurred and what was driving them. The blizzard of regulations following the debacles involving Enron, WorldCom, and others led to the passage of the Sarbanes–Oxley Act (in the United States) and many other new regulations. Although these are burdensome, they impose much-needed disciplines on finance and accounting.

In spite of this, one area remains unmeasured, untracked, and unmanaged: costs caused by complexity. I began studying this area in earnest shortly after the dot-com collapse. When an area comes under intense scrutiny, some details are discovered that have thus far gone unnoticed. This is the case with the costs of complexity.

As far back as 2001, Oracle CEO Larry Ellison described a “War on Complexity” in computer software. There were simply too many systems that were not integrated, and others that were very difficult to integrate. This fragmentation of systems caused huge complexity, duplication of effort, and waste (which Ellison’s Oracle Corporation hoped to solve).

Variety Can Add Value—If Managed Properly

On the other hand, there are instances when complexity—properly managed—can be a source of great competitive advantage. Structure, systems, and processes must be carefully designed to minimize transaction cost and complexity. One example of the productive use of complexity is the web retailer Amazon, whose breadth of offering is extensive, thus making it a “one-stop shopping” site for millions. While Amazon’s distribution system is always at risk of being overburdened by complexity, its front end handles the huge variety of goods seamlessly.

Similarly, US sandwich seller Subway assembles sandwiches to order from about thirty containers of meat, cheese, and vegetables, using just a half-dozen varieties of bread. It can make millions of sandwich (and salad) combinations, to customer preferences, with minimal waste. There are many other examples like these two. All depend on the right systemic design to keep complexity from growing out of control, causing waste and inefficiency.

Complexity Costs Are Hidden

When I first began to research why complexity costs remained unmeasured in nearly all companies, I discovered that it was because these costs are, by their nature, hidden in accounting systems. To bring this problem into perspective, let’s consider how complexity occurs and what kinds of waste it causes. It will become apparent why financial systems simply “overlook” complexity’s costs until the end-of-period reporting shows the detrimental effects.

There is no doubt that complexity’s effects are readily apparent in month-end, quarter-end, and year-end results, where they adversely affect both the income statement and the balance sheet. Unfortunately, the only place where they are visible is on the bottom line, or on a few lines of the balance sheet. Even then, there’s no indication of how these costs were incurred, or what might have been done to manage them.

Seeking High Growth in Low Growth Markets

Much of complexity that goes unmeasured and unmanaged is created with the best of intentions, in search of revenue growth. Many wealthy developed countries (the United States, most of Europe, Japan, etc.) are growing very slowly, both in population and in their economies. When companies seek growth in these mature markets, they usually resort to proliferation, which leads to complexity. The gain in revenue is redistributed across a broader range of products and services, with only modest increases in total. The many resulting new products, customers, markets, and suppliers add much more in complexity costs than in profit.

Mergers and acquisitions are another source of complexity. If either of the two combined companies is already burdened with complexity, this will transfer to the merger. If both are thus burdened, real trouble is likely. Simply combining the “DNA” of two companies is a daunting task, as illustrated by the troubled combination of Alcatel (France) and Lucent (United States). There are issues of product and customer overlap, duplications of organization and facility, systems redundancies, and large cultural conflicts that must be sorted out. This is perhaps one of the main reasons why mergers seldom lead to long-term growth in shareholder value.

Less developed countries are typically growing at much higher rates (China, India, Brazil, etc.). Emerging consumer societies and favorable balances of trade fuel their economic growth. There’s a different complexity problem here: most of these countries save more and spend less—both as consumers and as governments. Further, these countries are less familiar to sellers who operate in developed countries, and therefore marketing and operating mistakes are made. These mistakes also lead to proliferation, often due to errors in targeting or serving the desired markets and customers.

Back to Table of contents

Further reading

Books:

  • George, Michael L., and Stephen A. Wilson. Conquering Complexity in Your Business. New York: McGraw-Hill, 2004.
  • Mariotti, John. The Complexity Crisis: Why Too Many Products, Markets, and Customers Are Crippling Your Company—And What to Do About It. Avon, MA: Adams Media, 2008.

Articles:

Reports:

Website:

Back to top

Share this page

  • Facebook
  • Twitter
  • LinkedIn
  • Bookmark and Share