February 8, 2018

When to leverage variability

Variability in business processes tends to have a bad name because it is related to uncertainty and inefficiency. I argue that labeling variably as strictly negative is unfair, because it interacts differently with each of the drivers underpinning shareholder value creation. 

Such value drivers are:

1.     Efficiency: productivity improvements resulting in improved operating margins

2.     Risk reduction: removing uncertainty, resulting in a lower cost of capital

3.     Growth: growing existing, and/or developing new propositions to increase revenues

 

First, let’s investigate why labeling variability as a threat to creating shareholder value makes sense. 

The first two drivers, efficiency and risk reduction, are interrelated and benefit from low variability in processes to deliver shareholder value. A car manufacturer with a below average and stable number of defect products will do better than its competitors, all other aspects considered equal. The below average number of defects obviously creates an efficiency advantage, but it is the stability (read: low variability) over time of that number of defects which makes the advantage sustainable. Measuring efficiency is a snap shot of cost and benefit balance, whereas risk reduction is the stabilization of variability in a time series of efficiency snap shots.  

 

The third value driver, growth, has a different relationship to variability. The growth of existing business may benefit from stability, but product innovation definitely benefits from variability.

 

It benefits from variability in two interacting ways:

·      Intrinsic: Product innovation is primarily managed in the form of a funnel that has a large pool of abstract but distinct product market combinations that go through stages of concretization, ending in a small pool of viable products. The more diversity (read variability) on the idea level at the start of the process, the greater the pool of viable products. The external environment considered stable, that is.

Alessi, a manufacturer of household goods is known for leveraging the intrinsic view of variability in the product innovation process by keeping an eye on the number of failed product launches. While most companies would like to reduce those failures, Alessi considers a diminishing number of failures a lagging indicator of too little variability at the start of the innovation funnel, and therefore underutilisation of the market's potential.  

·      Extrinsic: The external environment is the space in which market product combinations are to be discovered. If it were totally stable, all possibilities would be discovered at some point, thereby halting growth. It is the variability of the external environment that drives the discovery of product market combinations. Ideally, the external environments are dynamic enough to allow for discovery of opportunities and stable enough to exploit them.

·      Interaction between the intrinsic and the extrinsic. Markets are level II chaotic systems, which means that making predictions about product market combinations will change the reaction of the market to the product. That partly explains the secrecy that surrounds product innovation departments. But more importantly, it allows for opportunities to be created (suggesting variability to the market), rather than just to be discovered. 

A great example remains of a "suggestion" to the market is the launch of of the Apple iPad. It was not a product market combination waiting to be discovered. Consumers did not identify the need for the product, and they certainly didn't express their need in market research. Yet, apple successfully exploited the market's responsiveness to new information.  

In summary. Welcoming variability, and managing it away, can both be successful strategies for creating shareholder value. They can even be implemented at the same time when the processes they span are clearly defined.