In the first article of this series, Extension Mergers: Why Roll-ups Succeed or Fail, I discussed the ups and downs of these types of mergers. I also introduced the Value Creation Matrix (below), a useful tool in identifying opportunities for value creation.
Industries on the right side of the Matrix are among the earliest industry roll-ups and have considerable national economies of scale. These economies of scale make value creation straightforward: Merge companies into national platforms and realize huge cost efficiencies from higher volume. Since many of these types of roll-ups have been completed, investors turned their attention to industries on the left side of the Matrix in search of new opportunities.
Industries on the left side of the Matrix have few sources of national scale. Local operations drive most of the cost structure. This is, even more, the case for local commodity industries in the lower-left quadrant of the Matrix. In industries like couriers, janitorial services, and security services competition can be fierce. Hustle and street smarts–combined with local scale–separate the winners and losers. This article focuses on the billion-dollar question that is the core issue for extension mergers in the lower-left quadrant:
How can a company transform a group of aggregated local companies into one national or regional enterprise with competitive differentiation and advantage?
This is a hard, multi-dimensional problem; a tangled web of micro-economics, people, culture, processes, systems, and local market dynamics.
One popular approach is to identify best practices à la In Search of Excellence or Good to Great, and then try to standardize other operations to these best practices.
While this method seems scientific, it is flawed: The first problem is statistical. Separating the impact of best practices from random luck is difficult. Flip a coin enough times, and you will find long streaks of heads. Similarly, in any collection of local companies, you will find high performers who used best practices and others who were simply lucky.
A second, more troubling problem is survivor bias. We do the analysis and find best practices that seem to explain winning performance. However, it is impossible to know how many others tried those same practices and failed.
Another common approach is to centralize work into lower-cost environments. Centralization can appear to yield major cost savings on part of the cost structure due to lower labor costs and economies of scale. However, it does not always lead to better results.
For example, centralizing phone calls has been tried in health care, telecommunications, cable, home repair, and numerous other industries. As anyone who has waited all day for a repair person only to find out they are not coming can attest, disconnecting the work from the local operations can cause unexpected customer service problems and increased costs. While local monopolies like phone and cable companies may be able to get away with terrible service, local commodities like doctors, vets, plumbers, and other local service providers cannot.
So, how do we untangle this web of issues to unlock value?
The secret lies in understanding there are two levers for improving local operational performance. The first is local scale and the second is local operating competence.
Take a large sample of car dealers and plot their operating costs per unit vs. sales and you will see a pattern. Operating costs per unit drop by 5-10% with every doubling of sales. That’s economy of scale at work.
You would also see a huge amount of variance from the pattern. Swings of plus or minus 15-20% would not be surprising. That’s the impact of local factors like operational competency and location.
1. Driving local scale.
A larger scale operation allows for better staff utilization, more specialized skills, and increased amortization of overhead costs. The downside to greater scale can be increased distance from the customer and risks to customer intimacy. Finding the right balance is critical.
The first way to drive local scale is to identify overlaps and adjacencies in service territories. Some opportunities for consolidation will be obvious and should be pursued. Other opportunities will require judgment calls as to whether the economic benefits of consolidation are greater than the potential increase in management complexity or disruption to customer intimacy.
The second way to drive scale is by focusing and prioritizing business development activities within existing service territories. A client within the service territory that increases scale and density is much more valuable than a client outside the service territory that dilutes scale. Some of this increased value should be channeled into sales incentives to focus the business development team on these higher value accounts. Pricing and service level tactics should also be pursued to help drive conversion and retention for these higher value accounts.
2. Improving local operating competency
Every local operation will have its own operating constraint that limits its performance. It might be a market constraint such as limited demand; a resource constraint like recruiting or retaining skilled employees; or a process constraint as in a decision-making bottleneck. And while that constraint may not be unique, it will be different from many other local entities.
A further complication is that the local operating constraint is likely to move around over time. As an example, at some point in time sales levels may be lower than expected and you have staff surplus. At other times, the business might be booming and create a shortage of staff.
When we aggregate lots of location operations, it creates a portfolio of operating constraints that limit the performance of the whole. The variety and movement of these constraints make it very difficult for any centralized process improvement effort to gain traction and show progress.
The person in the best position to address these local constraints is the local operations manager. However, this person is frequently too busy and may not have the requisite skills to address operating constraints systematically. Urgent problems consume their time, and they get hired because they are good at fighting fires, not because they are wizards of continuous improvement.
One way to tackle this is to treat local managers as the universal resource constraint that’s limiting overall performance. We organize the business to make these local managers as effective as possible with a goal of shifting most of their efforts from working “in” the business to working “on” the business.
Focusing on making these front-line managers more operationally competent can be a game changer. In one example from the banking industry, front-line managers were able to increase the amount of time they spent analyzing the business, coaching, and giving feedback from about 15% of the daily work to 69% of their daily work, yielding improvements in throughput, cost, and quality.
To help a local manager make this shift, a skilled business coach can walk them through a standard process to become more effective. The four major process steps, as shown in the graphic below, are:
- Document and Prioritize
- Standardize, Stabilize, and Simplify
- Systematize and Centralize
2.1 Document and Prioritize
Before deciding on the methods to get local managers working on the right things, we need to help them take an inventory of the “as-is” operations and performance versus the desired outcomes. This “as-is” documentation includes:
- Quantification of how local managers spend their time
- Staff assessment of frequently occurring problem areas
- Assessment of staff training, skill sets, and areas for improvement
- Current target outcomes and performance measures in use (Note: These may differ from the outcomes and measures they should be using.)
- Comparison of currently used outcome and performance measures vs. recommended outcome and performance measures
- Quantification of performance vs. targets
Once the manager has documented the “as is,” it will likely be clear where they spend most of their time: fighting fires. These are the areas that need to be prioritized for further investigation to identify root cause problems that impact the constraint. The business coach can help managers and local staff use analytic methods, such as asking why something happens and then repeating it until you identify root causes of problems (often referred to as the “5 Whys”).
The priority is the root cause issue whose solution is most likely to improve the productivity of the constraint on business performance, i.e., have the biggest impact on freeing the local manager from low value-added work to give them time to focus on being more effective. That single improvement opportunity becomes the focus of the next phase of work. The other root cause issues should be placed in a parking lot for the future. Once the priority has been addressed, repeat the process to identify the next area of focus.
Before focusing on making things better, take steps to organize the work environment for maximum focus and productivity. The goal is twofold: First, reduce the amount of time and energy that goes into maintaining order in the work environment; second, lay the foundation for continuous improvement.
Start by organizing the work environment to make it conducive to productive work. Get rid of paper and other clutter that clogs up the work environment.
Purge or archive documents no longer in use. Remove unnecessary equipment. Clean and organize everything, both in physical space and on computers used by staff. Classify all working papers and tools by their frequency. Define and label a home location, organized by frequency of use, for everything you keep.
Define a clear process for where new work will enter and completed work will exit. Also, assign a staff member to audit the work environment every week and initiate corrective action to ensure it stays organized.
The second step in getting organized is to create visual controls. We want to make it easy to see performance versus plan and corrective action underway. Ideally, these visual controls will be readable at ten feet away. Be patient and don’t overwhelm managers with too many visual controls, starting with a minimum core set they will find immediately useful then add more visual controls over time.
In service environments, work quality, safety performance, a work schedule/attendance plan and performance vs. plan, and the current priority and action steps associated with it will often form the centerpiece to visual controls. Other visual controls may include plans for new or changing customer requirements, an hour-by-hour choreography of what staff should be working on, the parking lot of future issues to work on, and other key activities you want staff focused on.
2.3 Standardize, Stabilize, and Simplify
This is the heart of the continuous improvement process. Given the prioritized area of focus, we want to standardize, stabilize, and simplify to bring order to the work and make it repeatable and effective.
The business coach, the local manager, and other key staff take time out from regular work and engage in a continuous improvement event. These are often called “Kaizen” (a Japanese word meaning ‘change for the better’) events. The focus of the event is on mapping, measuring, and identifying actionable improvements to the process.
Finding early wins that free up the local manager’s time is essential. One way to do this is to develop standard work for the process. Standard work is a document that breaks the process down into repeatable work steps, work roles, and sequence. We can then examine the manager’s role within the standard work to eliminate, delegate, or simplify to free up management attention.
Once we have freed up some of the manager’s time, we can then redirect that time into repeating the process with a focus on the next constraint.
2.4 Systematize and Centralize
Once we have standardized and simplified the work, workflow automation and centralized support organizations start to become much more useful. The focus is on improving local outcomes by making work in the local operation flow faster and with less variance. These changes, done well, will support much more advanced process improvement techniques, such as process mining and data analytics. These tools will allow the organization to take performance up to an entirely new level of operational excellence by constantly monitoring performance, process variability, performance problems, and time traps.
The front-line managers will be the heroes of this journey. When effective, their mindset will go from a focus on fighting fires to one of building the business. Some will find this the most exciting work they have ever done, while others will not be able to make the transition. To be successful, they will need significant coaching, help, and support.
The success of this group and how they are treated will determine whether other staff see your company as a great place to work. Regardless if a manager can make the transition or not, treat them well.
Patience, persistence, and repetition are the recipe for success. The goal is continuous improvement that compounds over time and not one-time performance improvements. This aspect can be difficult for many leadership teams to accept and embrace. Leadership teams are often impatient for change and like to see home runs, i.e., big changes that have big results.
This is not a game of swinging for the fences; it’s a game of continuous singles and doubles where the goal is to win every day. Those who win every day will build a different kind of company with a durable competitive advantage.
More on Mergers
You can read Part 1 of this article here: Extension Mergers: Why Roll-ups Succeed or Fail. You can also read more about successful mergers in Alex’s white paper, Why Do Intentions Matter in Making Mergers Work?
Alex Nesbitt is a Senior Advisor at HighPoint Associates, a strategy consulting firm headquartered in El Segundo, CA. Alex has 30+ years of management consulting experience and a strong track record of partnering with CEOs to tackle issues related to strategy, organization, senior team management, operational effectiveness, and performance improvement.