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Chapter 1

Responsiveness Trumps Efficiency

by Michael Hugos

(Excerpted from, Sustainable Prosperity: Generating Sustainable Growth through Enterprise
Agility, John Wiley & Sons publisher, available February 2009)


The global economy squeezes profit margins more efficiently than ever before.
Electronically connected global markets are doing what markets do so well; the
commodities traders and stock brokers call it "efficient price discovery". That means
global markets are constantly finding the lowest price for all basic commodities and
services based on current supply and demand; everything from blue jeans to fuel oil, and
hotel rooms to accounting services; and constantly re-setting those prices as conditions
change.

This tends to relentlessly reduce profits and it drives the prices people can charge for
products and services closer and closer to their cost of production (sometimes even below
their cost of production). Companies are always moving their production to low cost
labor markets, and outsourcing activities in a scramble to lower their cost of production
so that they can still make a profit at price points set by the market.

Because of this, the best profits for most companies no longer come from standard or
commodity products; the best profits are now to be found in new and creative products
and services. Because if they catch on, for a while, they have no competition and there is
lots of demand so prices stay high. But products and services are new and innovative for
only a short time. Then they become commodities because they get copied and offered at
lower prices. And profit margins drop again when that happens.

So most profitable opportunities in the global economy are, by definition, short-term
opportunities. Companies need to respond and act quickly in order to capitalize on
opportunities that arise. This has always been true, but now it is critical if a company is
going to maintain its long term profitability.


THE WORLD BEHAVES LIKE A STOCK MARKET

The Internet and the search engines, and the trading and procurement systems that make
global markets possible also do something else. They provide massive and continuous
flows of data the likes of which we used to see only in connection withRESPONSIVENESS TRUMPS EFFICIENCY 2
financial markets such as stock and futures markets; now our economy everywhere is
generating similar flows of data. Companies generate data flows from their internal
systems; e-commerce and supply chain networks generate more data flows that go
between companies; and the Internet moves all this data from anywhere to anywhere 24
hours a day, seven days a week

These real-time data flows cause the whole world to behave like a giant stock market
with all the volatility and uncertainty that goes along with such markets. And because
real-time data is available, we are all doing business in real-time now whether we know it
or not. Just as stock brokers use real-time stock market data to constantly monitor and
react to their markets, so too can people in business use available real-time data to
monitor their own markets and react quickly as situations change.

The very fact that more and more companies are connecting up with e-commerce and
electronic trading networks means that the markets they work in are becoming more
volatile. Because information is available in real-time, people are learning to react more
quickly. Change ripples through markets much faster than ever was possible in the
industrial economy. Supply and demand data for products and services are communicated
quickly so the prices of those products change quickly (just like stock prices). Gone are
the days when people could confidently predict the price of any commodity for more than
a month or two.

Companies that succeed are learning to make continuous small adjustments in their
operations to remain efficient as conditions change and they are learning to continuously
enhance their products and services with new features as their customers desires evolve.
They learn to make money from many small adjustments and from some occasional big
wins - just as stock traders do.

Companies must attain and maintain a level of "good enough" efficiency, but unless a
company is the low cost leader in its market, it cannot use efficiency alone to generate
profits. For the most part, it is now customer responsiveness that generates profits in the
form of customers paying slightly higher prices for products and services that they find
more responsive to their needs. Since these products deliver more value, people are
willing to pay more.

Opportunities to make money by being responsive have exploded. There are far more
ways to use responsiveness to attract customers than there are to use efficiency and low
prices. This is because there are so many different kinds of customers and they each are
looking for slightly different mixes of products and services. Constantly changing
environments and customer needs enable responsive companies to offer continuously
evolving mixes of new products and services.

Companies respond to evolving needs and desires of specific groups of customers by
wrapping their products and services in tailored blankets of value-added services. And
occasionally they find opportunities to introduce whole new products and services. AsRESPONSIVENESS TRUMPS EFFICIENCY 3
profits on old products decline, profits are always to be found by creating new products
that respond to new needs.

Responsiveness enables a company to consistently earn an additional gross margin of two
to four percent (and sometimes more) than what they would otherwise earn for their
commodity product or service alone. This responsive focus on customer and market
specialization is now the most promising and the most sustainable source of profits in our
fluid, real-time economy. These ideas are summarized in Figure 1.1.

In this high change, global economy, responsiveness trumps efficiency.

Figure 1.1
Companies Exist on a Continuum between Two Needs
Efficiency Responsiveness
Responsive Organization
Assembly Line

- Long production runs - Short production runs
- Standard products - Customized Products
- Linear process - Circular feedback loops
- Rigid central control - Decentralized coordination

Efficiency requires predictability and low change.
Responsiveness to continuous change now creates more value.



EFFICIENCY IS ONLY HALF OF THE EQUATION

For the last few hundred years the most important consideration in business was
efficiency–producing products at the lowest possible cost. But now we are all part of a
global labor force and there are countries in Europe and North America that can no
longer compete on efficiency alone because their labor costs (also known as peoples'
salaries) are so high compared to labor costs in countries in Asia, Africa, and South
America.

What is to be done? Will the economic boom for some countries be economic doom for
others? That might be the case if the only economic force we considered is efficiency.
But we are missing something important when we do this; in addition to efficiency there
is another economic force called responsiveness. Efficiency provides us with basic
products and services at the lowest price. Responsiveness wraps those products and
services in a blanket of value-added services that customize them to our particular needs
and, in doing so, makes them more valuable to each of us.RESPONSIVENESS TRUMPS EFFICIENCY 4
Everybody has needs that go beyond efficiency. As soon as people are able to acquire the
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basics they want something more (see Figure 1.2, Maslow's Hierarchy of Needs ). A
basic pair of sneakers costs about $20, but there are a whole lot of people willing to pay
$100 or more for sneakers that respond to their other needs. A basic new car costs about
$18,000 (or even less), but there are many millions of people willing to pay much more to
get cars that respond to their other needs.

People want what they want. They want a good price, but that doesn't mean they want the
lowest price. People usually also want a tailored bundle of additional services and
features wrapped around the basic product. They will pay extra for these other features as
long as they meet expectations. Maslow's hierarchy of needs shows that once a lower
level and more basic need is filled, people then aspire to fulfilling higher level needs.

Figure 1.2
Maslow's Hierarchy of Needs
SELF-
ACTUALIZATION
ESTEEM
BELONGING

SAFETY
PHYSIOLOGICAL


Even the most basic commodity product can be wrapped in a blanket of value added
services that increases its value to particular customers because those value added
services provide features the customer wants. For instance, we have all seen how a
commodity product like the coffee bean can be wrapped with a blanket of value added
services and so give rise to a whole industry. People will pay more for a good cup of
coffee made just so and served in a cozy setting. Yet if the quality of the coffee and the
coziness of the setting start to decline at one company, customers simply go elsewhere;
customers do not pay extra if they are not getting what they want.

Good customers (and most customers are good customers when you figure out what they
really want) will pay a few percentage points more in order to get a carefully tailored
bundle of goods and services from you that either solves an important problem of theirs
or enables them to enjoy a major benefit. Who are the good customers in your business?
How will you get more of them? What are the tailored solutions you offer them? How
will you evolve these solutions over time to keep up with good customers' changing
needs?RESPONSIVENESS TRUMPS EFFICIENCY 5
And here is another thing to think about; if you don't have many good customers then
how will you keep your bad customers from destroying your profits and your business? Is
efficiency alone a sufficient answer to this question?


TRADITIONAL BUSINESS MODELS ARE COMING UP SHORT

Many large, established companies are demonstrating that their traditional focus on
efficiency no longer shields them from market fluctuations, nor does it deliver the profits
it once did. Their business models need to be redesigned. They follow business strategies
based on 20th Century industrial concepts of efficiency such as spreading fixed costs
across huge numbers of units sold, scheduling long production runs, and assuming there
is a steady, predictable demand for their products.

In reality, things such as stability and predictability are conspicuously absent from our
global economy. Yet companies continue their old industrial strategies, and continue to
struggle with rigid multi-year plans and projects as they drift farther and farther away
from alignment with constantly changing market conditions.

Then, when the alignment between company operations and actual customer demand
becomes seriously out of balance, when finances drift deep into the red zone, they have
no other options for responding except to make sudden and drastic cuts in their operating
expenses. They sell off businesses, and close down factories, and disband whole groups.
They lay off thousands of employees at a time.

These bouts of corporate cutting and restructuring happen with regularity now; they
happen in good economies and bad economies. And individual companies go through
these restructurings not just once but repeatedly. Why is this necessary? It would seem
that something about the business models they follow, something about the way they are
managed, must be seriously out of line with current realities.

The relentless focus on efficiency is the legacy of a frame of mind inherent in the culture
of the industrial economy and its great invention - the assembly line. That mindset
attempts to organize every activity down to the lowest levels of detail. It makes rules and
regulations for everything and then tries to run each activity over and over, faster and
faster without changing anything. This is how you get economies of scale - greater and
greater productivity at lower and lower costs. This is what we call efficiency. But this
model is breaking down.

The assembly line requires things to stay the same long enough to churn out large
quantities of predefined products and services. It is the best way to deliver masses of
standard products and services at the lowest cost. But what happens when people no
longer want standard products and services? What happens when product life cycles are
measured in months instead of years? That lack of predictability throws a major wrench
into the gears of the industrial efficiency model.RESPONSIVENESS TRUMPS EFFICIENCY 6
Business strategies that emphasize efficiency and economies of scale no longer yield the
profits we seek because they are so vulnerable to unexpected and sudden changes. The
efficiency model does not allow for much responsiveness since it concentrates on
removing all extra capacity and reducing operating expenses to the absolute minimum.


EFFICIENCY WITHOUT RESPONSIVENESS WILL KILL
YOUR COMPANY

Responsiveness calls for flexibility, and flexibility calls for maintaining some extra
capacity and for budgeting additional money to be available when needs and
opportunities arise. A single-minded focus on efficiency views this extra capacity and
funding as wasteful and strives to remove it. So in the name of efficiency, companies
give up the flexibility and responsiveness they need to handle unexpected situations.

The fast pace of events now overwhelms the assembly line operating model and the
efficiency mindset that goes along with it. Companies spend years organizing work,
writing out rules and procedures and putting systems and facilities in place. Then the
world changes in unpredictable and uncontrollable ways and their plans don't work out
because they become so quickly irrelevant.

I once worked for a CEO who was forever attempting to screw down operations as tight
as a drum - cut staff and squeeze out the last ounce of cost in the name of ultimate
efficiency. He would look at me with a maniacal gleam in his eyes and laugh as he
chopped away at headcounts and budgets. His plan was always the same; in every
situation it was to cut costs and run operations hard and fast, day and night, and thus reap
the profits of ultimate efficiency. That is the assembly line mindset.

The problem was that in spite of his best laid plans, the world would change in
unforeseen ways and then he had no reserve and no flex in his operations with which to
respond. So instead, he would pound the boardroom table at our monthly management
meetings and insist there was no change; and if there was, well then everyone should just
work harder (but we were already working at full capacity - he had seen to that).

The more he cut budgets and focused on efficiency, the less able we were to respond to
customers' changing needs. We missed profitable opportunities to grow the business and
some of our biggest customers came to believe we were no longer capable of keeping up
with their evolving business needs. They became dissatisfied with our service and they
began looking elsewhere for more responsiveness business partners.


Customer Relationships are the Most Valuable Asset

That CEO forgot that the customer is the ultimate asset these days, not buildings or
equipment or products. Those things can readily be acquired from many different
sources; but by far the hardest thing to acquire is customers. The opportunity in businessRESPONSIVENESS TRUMPS EFFICIENCY 7
now is to apply what you know about your customers and what you know about your
products to create a tailored bundle of products and value-added services that constantly
evolves to best fit their needs.

As you combine your knowledge of your customers and your knowledge of the products
you sell, you become in effect, your customers' purchasing agent. You're someone
constantly seeking the best mix of your products and services to fit your customers'
changing situations. You are no longer just a clever gadfly trying to sell them something
they don't really need. Your fate is now much more tied up with that of your customers.
If they don't grow and prosper, you won't either.

Think of your customers as your capital and think of responsiveness as the way to earn
interest on that capital. The bigger your base of customers, the more the opportunities
there are to be responsive to their changing needs (and earn a higher rate of interest).
Opportunities these days quickly evolve into other opportunities; one opportunity usually
leads to another; learn to ride the waves of change. Develop a reputation for
responsiveness; your customers will seek you out for this very reason.


THE VALUE ADDED PAPER CUP

Let me provide an example of tailoring products and services to respond to customer
needs. For six years I was the chief information officer of a national distributor of food-
service disposables and janitorial supplies for restaurant chains, property management
companies and grocery stores. We're talking paper cups, plastic forks, paper towels and
floor wax. These are humble products, and a paper cup is a commodity product if there
ever was one. What do you suppose is the profit margin on a paper cup? The answer is
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"not much", and it gets lower all the time.

So our challenge was to wrap a blanket of value added services around those paper cups
to make them more valuable. We put together a project team from the company's sales,
customer service, information technology and finance organizations, and we devised a
menu of about 50 different value-added services that salespeople could then mix and
match to meet specific customer needs.

We made it very easy and convenient for customers to find and order our cups by
providing an online product catalogue that let them search on many different product
parameters (like size, strength, color, materials used, etc). We also set up the product
catalogue to remind them to order other items that normally go along with cups, like lids
and sleeves.

We let customers place and track their orders online so they could know when their
supplies would be delivered. We also created customized labels and packing boxes so
that when cups were delivered, customers could quickly receive, store and retrieve them.

We enhanced our billing system to streamline the processing of invoices by customers
and reduce their costs of doing business with us. We sent invoices in whatever formatRESPONSIVENESS TRUMPS EFFICIENCY 8
customers wanted so they could automatically import them into their accounts payable
systems. We even pre-processed invoices, inserting customers' general ledger codes into
every line item on invoices so those costs could be automatically disbursed to their
general ledger systems.

Finally, we provided customers with easy-to-use Web-based reporting that let them see
how many cups they ordered at each of their ordering locations over any period of time
from one day to two years. They could monitor their spending and get detailed data for
planning and budgeting, along with real-time insight into usage patterns and purchasing
trends. This is illustrated in Figure 1.3 below.

Figure 1.3
THE VALUE ADDED PAPER CUP
Ordering Budgeting
Labeling Receiving Usage
Reporting
Delivering Invoicing
Surround commodity items with tailored blanket of value added services


We negotiated a set of service level agreements (SLAs) with customers and then used a
business performance management system and some web-based dashboards to track our
actual performance against customer SLAs. The business performance management
system compared customer purchase orders with our advance ship notices and invoices to
automatically calculate the performance statistics displayed on the dashboards (things
like order fill rates, on-time delivery rate, and perfect order rates). These dashboards were
updated every 24 hours and could be accessed on our website by customers as well as our
own people.

We also experimented with customer contracts where, if we met or exceeded our SLA
targets in one quarter, we had the right to raise our prices by a fraction of a percent in the
following quarter. This was a way for the customer to share a bit of the extra value we
delivered to them by our high service levels.

In short, we turned our products into tailored solutions that solved important problems for
our customers. And therefore, we could sell our paper cups for a few percentage points
more than our competitors. We did so by making strategic investments in informationRESPONSIVENESS TRUMPS EFFICIENCY 9
technology (IT). This is a clear example of employing IT as a profit center instead of as a
cost center. This is what the future looks like.

Every company has its equivalent of the paper cup. Figure out how your company can
take its otherwise commodity products and tailor them to respond to your customers'
changing needs. Once you start this process it can take on a life of its own; your company
can find itself engaged in a process of continuous response to change and that process can
transform your business.


A MOST AMAZING INNOVATION

The most profound innovation since the assembly line is staring us right in the face. But
we don't see it because we are so busy looking for something else. For most of us the
word "innovation" still conjures up images of new gadgets such as technology to turn
water into gasoline, black boxes to project moving 3D holograms from our TV sets, and
biotech breakthroughs that reverse the aging process.

Of course, some of these things will come to pass. But in our fixation on individual
gadgets we are missing an innovation that is based more on process than it is on
technology. Consider this: a hundred years ago there was a process-based innovation in
business so profound it became the basis for the economy of the industrial age. That
process was the assembly line. The assembly line delivered a new level of efficiency that
became the basis for prosperity in the industrial economy.

Another process-based innovation is once again sprouting in our midst. It is a business
operating model coming to be known variously as the "agile enterprise" or "real-time
enterprise" or "responsive organization". Companies using this operating model are
delivering customer value and operating profits that will become the basis for prosperity
in the real-time global economy. The responsive organization is a human driven
organization whose primary assets are the relationships that exist between its employees
and its customers and suppliers. It is capable of endless adaptations and reconfigurations;
it evolves as its customers evolve. It is enabled by the technology it uses, but is not
controlled or dominated by its technology.

With markets constantly moving and product life cycles often measured in months,
companies can no longer hope to fine-tune their operations to fit some existing set of
conditions and then expect to simply run those operations unchanged for years and years.
That was the old industrial model; we need something more responsive now - something
that constantly adjusts to changes and opportunities.

A responsive organization constantly makes many small adjustments to better respond to
its changing environment and in doing so it reduces costs and increases revenues every
day. No one adjustment by itself may be all that significant, but the cumulative effect of
all of them over time is enormous - just like the effect of compound interest over time.RESPONSIVENESS TRUMPS EFFICIENCY 10
Traditional organizations are now caught in an inexorable squeeze as profit margins on
their commodity products and services are relentlessly ratcheted down by the global
economy. The agile enterprise is an enterprise that has learned how to make profit by
many small adjustments and some occasional big wins. Soon enough those companies
that cannot earn profits from constant small adjustments (and a few big wins) will hardly
be profitable at all.

Just as we recognize the efficiency of the assembly line as the great wealth producer of
the industrial economy, we will see the responsiveness of the real-time enterprise as the
great wealth producer of the information economy.


USING INFORMATION TECHNOLOGY TO MAKE MONEY

We need to change our thinking about what information technology (IT) contributes to an
organization. In the industrial economy of the last century we were used to viewing
computing as a back-office function - a cost center. The reality now is that IT is part of
the production capacity of a company; if used well, it is a profit center. We need to ask
ourselves what we can do with IT that our customers will pay us for; what value added
services can we provide them and how can we use IT to deliver those services.

Most responsiveness comes from customizing existing products and services with a mix
of value added services, and most value added services are information based. That's
because they must be customized to meet particular needs of particular customers. What
is valuable to one customer in one situation is not valuable to another customer in a
different situation.

Opportunities to make money by being responsive have exploded. Constantly changing
environments and customer needs enable responsive companies to offer continuously
evolving mixes of new products and services. As profits on old products decline, profits
are always to be found by creating new products that respond to new needs.

Get to know your company's customers; go on sales calls; take note of how your
customers talk about your products and the questions they ask. Concentrate on what
customers like and don't like about your products.

Find out what your competitors are doing. How do their products features and prices
compare with yours? Think about what will make the products your company sells more
attractive. How can IT improve the things customers like and reduce those that they don't
like?


All Products and Services Have Two Components

As you ponder these questions, remember that all products have two components. This is
illustrated in Figure 1.4. The first component is the basic product or service itself; the
price for that is set by the market, no longer by individual companies. And productsRESPONSIVENESS TRUMPS EFFICIENCY 11
quickly become commodities because your competitors have or soon develop similar
products, so the prices you can charge get ratcheted down.

The second component is made up of the information about your product and the value
added services that surround your product. This is what enables customers to find and
evaluate your product, to understand how to use it, and to get the results and benefits they
want from it.

Figure 1.4
TWO COMPONENTS MAKE UP EVERY PRODUCT
Actual Item or Service - by itself is often just
a commodity; easily copied and offered by
others; very low profit margins
Information Component - guides customer in
selection and use of product; tailored to each
customer so they achieve their desired results
and benefits; generates best profit margins



This second component is where above market prices and profits are to be found.
Through creative use of the information component, you can wrap any commodity
product with a mix of value-added services that make it more useful, and for which
customers will pay a little extra. Information technology lowers the cost and expands
capacity to deliver the information component. This is where skillful use of information
technology enables a company to earn higher profits.

Figure out how to leverage information about the products your company sells and
information about who it sells these products to. Figure out how to use IT to deliver a mix
of value-added services tailored to your customers' needs so that you deliver more value
to customers, and you will see your IT organization become a profit center.

And your company can take that straight to the bottom line.TABLE OF CONTENTS 12
Sustainable Prosperity
Table of Contents

Chapter 1: Responsiveness Trumps Efficiency
The world Behaves Like a Stock Market
Efficiency is Only Half of the Equation
Traditional Business Model are Coming up Short
Efficiency Without Responsiveness will Kill Your Company
The Value-Added Paper Cup
A Most Amazing Innovation
Using Information Technology to Make Money

Chapter 2: Generating Alpha
Valued-Added Services and Entrepreneurial Employees Generate Alpha
Escape from the Trap of Commoditized Jobs
Welcomes to the First World - Now Your Labor Rates are Too High
New Opportunities to Create Value
Fix the Opportunity Gap
Profit Potential of the Self-Adjusting Feedback Loop
Toward a Responsive Business Operating Strategy

Chapter 3: Principles of the Responsive Organization
More Coordination, Less Control
A Case Study in What Works and What Does Not
End of Control as We Know It - The Dynamics of Swarming
Leadership for the Responsive Organization
Dynamics of the Responsive Organization
Structure of the Responsive OrganizationTABLE OF CONTENTS 13

Chapter 4: Speed, Simplicity and Boldness
Five Themes From the Art of War
Insights From People Who Have Been There
Observe - Orient - Decide - Act
Maneuver Warfare
Modern Warfighting
Case Study: The Tao of Supply Chains

Chapter 5: Strategically Focused, Tactically Responsive
Awareness Drives Effective Strategy (Loop 1)
Balancing Means Continuous Improvement (Loop 2)
Agility Means Move It or Lose (Loop 3)
Pulling It All Together
A Formula to Measure Business Responsiveness
Serious Games

Chapter 6: Thriving in a Competitive, Fast-Paced World
Leadership in the Old World and the New
Case Study: A Business Application of Visibility and Game Theory
Three Application Technologies with Great Potential
A Supply Chain Game
Agile Systems for Responsive Operations
IT Agility Enables Business Innovation
Case Study: Selling "Designer Chocolates"TABLE OF CONTENTS 14
Chapter 7: Ya Gotta Wanna
We are Capable of Great Things
Executive Behavior Defines the Workplace
Thoughts on the Practice of Agility
The 30-Day Blitz, IT Agility in Action
Agility Means Simple Things Done Well, Not Complex Things Done Fast
Agility Ebbs and Flows

Chapter 8: The Essence of Innovation
How to Get Inspired
Art, Sports and Business All Blend Together
Innovation is a Constant Mixing of Ideas
Picture of a Responsive Company
Five Key Characteristics of the Responsive Organization
Sustainable Prosperity

Appendices
Appendix A: Executive Checklist for Monitoring Development Projects
Appendix B: Seven Strategic Guidelines for Designing Systems



1 Proposed by Abraham Maslow in his paper titled "A Theory of Human Motivation",
Psychological Review ,1943: pg. 370-96.
2 This section was first published by the author in CIO Magazine as an article titled "Show Them
the Money". Framingham, MA: CXO Media Inc., 15 August 2006


Michael Hugos can be contacted via his website: www.MichaelHugos.com

Place advance orders for this book via email sent to: mhugos@yahoo.com
We will notify you when the book is available for purchase in February 2009

© Copyright 2008, John Wiley & Sons, Inc.