4th Sigma: A Tale of Efficiency… Why Bigger Is Better!

This Blog is another chapter in our ongoing collection of tips, tools and observations to drive simple process improvement…The 4th Sigma. Today, we’re going to talk about growth. A healthy firm is always trying to grow. Growth may be needed to overtake a competitor, or to open up new markets. Growth may be demanded by investors, or it may simply be needed to stay in business.  Whatever the reason for growth, there is an underlying assumption that as your firm scales up in size it will become more efficient. Bigger is supposed to be Better! The largest firms pay more, or offer better benefits, or have nicer offices for their workers. The largest firms can afford the best proprietary software, the best support services, the best of everything. But where does the advantage of scale come from? How big do you need to be to gain these advantages? Exactly how much of an advantage does size provide?  Surprisingly, a physicist has finally answered these questions!

A great source of information on leading-edge thinking is: TED Talks. TED (Technology, Entertainment and Design) brings together some of the most intelligent people on the planet, who make short video presentations on important subjects. In one of these videos Geoffrey West, a theoretical physicist, presents data on how the metabolic rate of an animal increases with size. Bigger animals require more energy than smaller animals, but per gram they consume less. Obviously, a single lion eats more than a single mouse, but the equivalent weight in mice will eat more than a lion. The really interesting thing is that it doesn’t matter what the specific animal is, the ratio of energy consumption to size is incredibly steady: double the size of an animal (grow by 100%) and you add 75% more energy. That may not sound like the most important thing you’ve heard today, but keep reading… it gets more interesting.

West’s research doesn’t apply to just animals. Forests follow exactly the same growth curve. Cities grow according to the same curve. The final test was to apply this to corporations… which follows exactly the same curve. For the average corporation, we can say with 90% confidence that doubling its size should only add 75% to cost. If a company, division, location, department, etc. that used to cost $100 million doubles in size (organic growth, merger, acquisition) should now cost $175 million to operate. That means that the new entity is 15% more efficient ($25 million savings divided by $175 million operating cost). Each additional doubling generates an additional 15% efficiency.

We can now measure the efficiency we can gain, but do we know how this happens? As a matter of fact, we do! Dr. West explains that growth efficiency comes from NETWORKS. If you look at the development of internal organs as animals grow in size, you will see that they get more sophisticated, through networking processes. For example, lungs and circulatory systems (both examples of networks) gain complexity with size. In corporations we grow management groups, upgrade our email and phone systems, create negotiation groups (Procurement) to obtain goods, and so forth. When animals evolve to a larger size without these improvements, they tend to die off. Companies that grow without gaining efficiency can be smothered by their own growth.

West’s statistics are only for the survivors. Except for a few outliers, firms that fail to develop efficiencies die off due to excessive costs. It really is a case of expand (and improve) or die. However, specific efficiencies can be much greater. When positions are collapsed, they cost less. Consider a $10 million firm, with a CFO that is paid “X”. When you grow to $100 million, the CFO will have a higher compensation (2x, 3x, more?) but not 10X. Some of the remaining savings may go towards people and projects, but the overall savings will follow the normal curve.

When you develop your business plans, or plan a merger, or expand a business group, what are your cost assumptions? Was the plan driven by linear assumptions (100% growth means 100% higher cost) or was a realistic sub-linear budget (100% growth for 75% higher cost) used? Should the performance of a group, the return on projects, and other growth-oriented planning be “discounted” for the 15% so you can measure any “real” performance improvement? Should growing departments that are not delivering, at least a 15% improvement be put on your “endangered species” list?

Only you can decide what’s the best for your operations, but you now have a tool to quantify the benefits of growth, adjust a budget to see “true” efficiencies in a growth plan, and be able to set expectations for growth and mergers (minimum of 15%). Add this process to your 4th Sigma knowledge-base, and remember the “15% rule” when planning or building a budget. And that’s my Niccolls worth for today!

This entry was posted in 4th Sigma, Best Practices, Decision Making, Delivering Services, Unique Ideas and tagged , , , . Bookmark the permalink.

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