NICK KATKO, RICCARDO PAVANATO, GIANANDREA CAPO
This free article appeared in the Harvard Business Review – Italy as part of a free series of articles published to help companies deal with the consequences of the COVID-19 pandemic.
Companies go bankrupt. This is the naked truth that even Jeff Bezos pointed out stating that every single company is intended to fail sooner or later. In fact, if we look at the numbers, the average life of Italian companies is just 12 year[GC1] s. The goal of people working in the organizations and of those who manage them is to postpone that moment as much as possible. This can happen if a company is dedicated to continuously improve its processes, defining and deploying efficiently its strategies, focusing on constantly reviewing customers’ needs and designing value streams that can fulfill those needs.
But organizations are social entities that are goal-directed, are designed as deliberately structured and coordinated activity systems, and are linked to their external environment (R. L. Daft 2017). To survive, a company must not only interact with external environment, it also has to manage and organize its internal relations, thus including all the people that cooperate and are connected with external environment. One of the most common ways to manage organization is to create compartments of people that share similar tasks, centralizing decisions and promoting the establishing of hierarchical control. Without a doubt this kind of functional organization has the merit of facilitating vertical coordination and relations between people that works in the same process steps, improving their efficiency.
Evidence is clear that in the last few years markets shows more and more volatility, and customers’ needs are in fast and continuous evolution, but never as drastic as it happened with the actual pandemic, where some companies abruptly had no more market and other, on the contrary, had to face high demand peaks.
In the first quarter 2020 the balance in startup and closed companies is -30.000; to find such a negative trend we need to look at 2013 crisis (Unioncamere Movimprese 17/04/2020). A Cerved Rating Agency study shows that, in case the pandemic would have ended by June 2020, the number of companies with a very low rating (high risk of default) in Italy would have increased of 8 percentage points. If the pandemic would continue till the end of the year, this number could increase to 26 percentage points because of the shocks created on Italian market.[GC2]
Being able to create compartments in a company in this context could become particularly useful, as it could be necessary to close a portion of the organization due to deep markets changes or because of some infection cases. For a functional organization structure it could be easy to create as well physical compartments as often such organization correspond to a similar structure of offices and space; this could offer the company a chance to close only a portion of the business, maintaining a partial functionality.
Is this organizational model useful to reduce the risks and to face the actual situation? Only partially. In fact, a company that had to face a market fall in a particular product line won’t be able to just “turn off” one of these compartments, as well as it won’t be able to close the purchase office for a reduction in the supply chain workload, or to close the order entry office because there has been an infection case. Doing so would result in the paralysis of the entire organization also affecting the part of the business that is still working. How is it possible to face these extreme events reducing the risk of being wiped out?
An organization based on value streams
The best way is to change the organizational model is to switch to a value stream organization. Sometimes big companies adopt a divisional organization, which is similar, because it divides the company by business units, which can make it easier to close or convert those business units that are not profitable anymore or are not useful to satisfy a specific customer’s need. This is something that can be adopted also in smaller environment, creating compartments that don’t put together people that do the same job but, on the contrary, put together all the people that work in the same value stream.
Once you identify your value streams, you can create a team of people that work in different offices or departments, from the order receipt to the production, order fulfillment and shipping. This team won’t report to a functional manager but to a value stream manager, someone who will be accountable for the performance of the entire process. The basic principle is to organize and manage the company as if it were made of many micro-companies, each of them is responsible for everything needed to satisfy a customer. This way the organization is more agile, quicker to react to change because closing or converting a value stream has little impact on the rest of the company.
To adopt such a model efficiently you need to adopt a different managerial style, where value stream managers have an entrepreneurial role as they are accountable for the profit of the entire value stream. Like entrepreneurs who manage and control a company through a set of KPI and financial reports, a value stream manager is in need of a set of tools that can lead to better decision making to manage and improve the value stream and is also aligned with the strategies defined by the company.
At the same time, these tools are needed to align people that do totally different jobs in the same value stream and that usually, in a traditional organizations, report to different offices or departments. These functional areas have often different KPIs, different objectives and often they are even in contrast among each other. Having a common set of KPI and report is useful to create a common view over the ultimate goals and therefore, using techniques such as lean accounting is mandatory to create these tools.
The relevance of indicators of performance
The first consideration is that the main generators of profit in a company are, as a matter of fact, the value streams. Hence, management accounting and every internal report must be focused on measuring and monitoring such objects.
Defining and implementing a set of operational KPIs is the first step to create alignment among the people working in a specific value stream towards a common objective. These KPIs must measure the relevant performance dimension for a process, that are: velocity, delivery, quality, productivity, flow, and continuous improvement culture. The value stream manager must learn to understand the relationship between the operational measures and the financial performance generated, so that the best possible decisions can be taken to continuously improve the process.
Management accounting has the important role to build a reporting tool that can show the resources that are used by the process (materials, men, machines, etc.) and the output value generated (product or services delivered to the customer) so that it is possible to link a financial impact with the decision that generated it.
Implementing the value stream management, supporting it with a management accounting system based on lean principles, is a key element to build a lean organization, efficient and responsive to the abrupt market changes we have recently seen that could undermine the company stability and in some cases even endanger its survivability.
Nick Katko , President of BMA, organization worldwide for the lean accounting and author of “The Lean CFO”, (ed. Guerini Next).
Riccardo Pavanato , CEO auxiell.
Gianandrea Capo , Value Delivery Manager auxiell.
[GC1]Italian data, we should present it as it is or find same information regarding US companies?
[GC2]Italian data on companies, we should present it as it is or find similar data on US companies?