Thursday, September 08, 2005

Companies Increase Financial Returns by 40%

A few weeks ago we wrote about the range of bottom-line performances that a company can produce - for the same strategies, tactics, operations, processes and people - changing only its operating dynamic. This was written from our experience as turnaround and performance improvement practitioners, not as a result of a scientific study. We said that a 20% improvement in the operating dynamic of a company would systemically generate at a 10% increase in profits.

Since then, more than twenty people have asked us if we have PROOF for what we claimed; some antagonistic, some skeptical, some challenging. And some hopeful.

Thanks to Jim Nelson who gave us the lead on our new Blog (comment to the post, Rebirth of a Board), we can now say, Yes We Have! And the sources are impeccable : The London School of Economics and McKinsey & Co.

This is what they said* about their joint study of 100 Companies chosen at random and focusing on just three elements of their operating dynamics:

"A 20% improvement was correlated with a 25% increase in a company's Total Factor Productivity (TFP**). To put this into perspective, such an improvement is . . .
  • comparable to increasing the workforce by 25 percent
  • comparable to going from 10 manufacturing plants to 17
  • correlated with an increase in financial returns of 42%
  • comparable to that of raising capital investment by 70%
  • correlated with a 5% increase in return on capital employed
  • . . .
  • high performing companies get the same benefits from these efforts"
It seems we had underestimated the benefits.

This is heartening news for any ambitious managing officer, or any director who wonders where the company is heading. Because the improvement (or dis-improvement) in operating dynamic will result in a performance shift.

What is even more encouraging is the fact that improvements to the operating dynamic, if done properly, cost a lot less than strategic, tactical, operational, procedural, or system changes. And bring results faster and surer. (As a general rule, if a project to change the operating dynamic costs a lot, or takes a lot of time, or generates an ROI of less than 10:1 the first year, it was badly done.)

Of course, what the LSE/McKinsey paper did not explain was HOW a managing officer could:
  • Measure where his/her company is in respect to these three elements and their components
  • Identify and quantify the other affecting elements (possibly ~90)
  • Trigger the changes needed to generate the 42% improvement in financial returns.
That is our work. And we have been doing it since 1976. We know how to identify and measure the drivers that underlie the elements*** identified in the study. We know how to measure the generators and blockers of those elements. We also have identified elements that are even more fundamental to improvements than those identified in the study. Most importantly we know how a CEO can trigger the changes that will generate the results. Quickly, clearly, and very affordably.

We describe these in other blog posts (below) and articles on our web - http://www.managementconsultants.com/.

* Full McKinsey Article: http://www.mckinseyquarterly.com/article_abstract.aspx?ar=1477&L2=13&L3=11&srid=63&gp=0 (may require registration)

** TFP Includes both labor and capital productivity
*** Talent Management, Performance Management, Lean Operations

9 Comments:

At 11:43 AM, Anonymous Anonymous said...

The McKinsey article URL no longer works. They have removed the article from free access to subscription only mode. They do that with their more important and heavily trafficked papers.

But this is so seminal an article on so important a subject that every CEO, MO or CFO should be aware of it.

Anyway the subscription is not a lot.

Jim Morgan

 
At 3:36 PM, Anonymous Anonymous said...

The financial returns we got over a period of two years was definitely better than 40%. However we changed more than the three of the drivers mentioned in the McKinsey article.

We moved a lot of the increased "surplus" into new product development and at least one new market, so the two year improvement only showed at about 35%. We would never have been able to take the leap we did over then next five without the changes.

Jim Newton

 
At 10:13 PM, Anonymous Tom Horne said...

I have just been to the McKinsey site and article and was able to access it just by registering for free to the McKinsey site...also signed up for their newsletter. The article was stimulating and really shows the amazing leverage a company gets by transforming management systems (people)...this ought to be a lifetime commitment of management/boards to the companies of which they are stewards.

Candyman
tom@todaysleadership.com

 
At 10:46 PM, Anonymous Anonymous said...

Sorry...I just went back to McKinsey site and found I could no longer the article for free...must be after the first free one, all becomes premium. I agree however that executives would find it valuable to be on premium.

Candyman

 
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