Monday, June 04, 2012

The interesting thing about cutting costs

I've been reading about RIM's strategy and the announcements by Chief executive Thorsten Heins that they plan to build new smart phone software in an industry being increasingly commoditised through Android. They also plan layoffs to make RIM more profitable. 

I'm not impressed. First some background, just in case you need it.

All business activities (what we do) evolve through a common pathway but this also leads to co-evolution of practice (how we do it). For example computer infrastructure has evolved from its modern day genesis with the Z3 to custom built systems, products with rental services and finally to more commodity with utility services. As the activity has evolved, so has architectural practices for scaling, system resilience and overall fault tolerance. In the product world, best architectural practice was scale-up with bigger machines, N+1 and disaster recovery tests. In the utility world, this is increasingly being replaced with the emerging practices of distributed system, design for failure and chaos engines. These emerging practices will ultimately become best practice for the utility world.

The evolution of activity and practice both follow a path from a chaotic phase (rare, constantly changing, unmeasurable, poorly understood) to a more linear phase (common, stable, measurable and well defined). In activities this is shown as genesis to custom to product to commodity. With practices you have novel to emerging to good to best practice.

One of the consequence of this process of change is that higher order systems built with best practice in one evolutionary phase (such as applications built on infrastructure with architectural practices of scale up and N+1) incur a transitional cost to the new phase (i.e. you cannot simply port applications based upon scaleable and highly resilient hardware to a utility world offering volume provision of good enough and more standardised machines).

This is one of many inertia barriers to change but despite their existence you have to transition for reasons of competition. I've covered this many many times before, so I'll simply say it's not a question of if but when.

Inertia is important in the cycle of change (the process of commoditisation actually enables genesis of new higher order systems which then commoditise themselves) because it acts as a gatekeeper between different economic states or eras of the cycle - peace, war and build.

The peace era is one of relative competition, where sustaining change exceeds disruptive change, where listening to customers, product improvement and a focus on profit / margin are critical.

The war era is one that is often initiated by a new entrant not encumbered by past business models and the inertia to change this creates. It's a time where disruptive change exceeds sustaining, where competition is a fight for survival, where customers have their own inertia and say they want things (e.g. better SLAs, better hardware) before abandoning this to adopt volumes of good enough. It is a time of commoditisation and the disruption of past industries, past skills and past roles.

Overlapping this is the build era, a time of wonder where capital quickly flows from past industries to new. In this time of creative destruction, new organisations appear exploiting the new co-evolved practice and we see explosions in the rate of creation of higher order systems. It's a time of increased experimentation and uncertainty where there are no customers to listen to and massive increases in unmodeled data with endless arguments over classification. Eventually we see the formation of bubbles and corrections and the new super giants which will settle down to dominate the new industries as they enter a peace era and wait for the next wave.

Now different parts of the economy and its value chains can be in different evolutionary phases at the same time, so whilst one industry is in a era of peace, another is in a era of war. Whilst this cycle can be local it can bubble up through combinations of activities that are evolving in close tine order to create macro economic waves which we call Kondratiev waves or Ages.

The underlying drivers of this (user and supply competition), the process of evolution, co-evolution of practices,  the cycle it creates, the new forms of organisation, the increases in data and the link to macro economic waves can be traced back over 200 years. In business, I've been actively using these models and making public presentations on them over the last 6 years. The entire system not only has cause and correlation (thousands of data points) but is most importantly predictive - something which I finally was able to test at the LEF last year.

So, to the title - the problem with cutting costs.

If your industry (i.e. the parts of value chain which you sell) are in a peace era then cutting costs through efficiency to increase profitability due to declining revenue can be a good play, assuming you don't reduce barriers to entry into the space. There are many reasons why you would do this and often you can clear out a lot of waste in the organisation.

However, if your industry has moved into the war then then cutting costs through staff to restore profitability due to declining revenue is often a terrible move. The problem is your revenue is eroding due to a change in the value chain and the commoditisation of the activity. You need to respond by adapting and possibly moving up the value chain. However, by layoffs you're likely to get rid of those people who were seen to be less successful in the previous era.  That doesn't sound too bad but the result is you end up with a higher density of people successful in the past models (which are now in decline due to evolution) and hence you'll tend to increase your cultural inertia to change. Revenue will continue to drop and you'll start a death spiral. 

What you of course should be doing is adapting and realising that the tactics you play in one era are not the same as another (peace vs war etc). Now any large organisations has multiple different values chains in different evolutionary phases and you have to see this and know how to switch context between them in order to choose the right tactics. Naturally, most people don't manage to achieve this which is why big companies often die but at least that keeps things interesting.

So back to RIM. Trying to produce a new software product in an increasingly commoditised industry seems to smack of inertia to change. Cutting staff through layoffs will almost certainly reinforce this. RIMs future in my view has become pretty bleak. So expect the usual patent spats of a wounded creature which is in a self inflicted death spiral. Also, expect the usual nonsense about how it wasn't the strategy but the culture, market and competitors that finished RIM. Alas, this is a classic case of a succession of CEOs out of their depth and driving a good company to the wall.
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