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Why the 5 Focusing Steps are so Important

Most middle and senior managers do not understand or simply are not interested in how their business system works. They are content to focus on their local department and optimise that – rather than understanding the business as a whole to cause it to maximise results. Even top management (CEOs) often do not understand their business. They condone and even encourage their management teams to optimise their local departments – production, marketing sales, finance etc. Wherever local optimisation is the rule the business concerned will always harm the bottom line significantly. Local optimisation is a massive mistake!

The 5 Focusing Steps are guidelines that, properly used, will cause a management team to always reflect on their (local) decisions. Doe the action or decision taken locally help or damage the business as a whole? As we will see the 5 Focusing Steps are a guide, but they do not replace a deep understanding of the business system.

What follows is my third example of the impact of the exploit and subordinate steps on the bottom line. In this example I have chosen a situation in which management has split a very big business into many profit centres. Profit centres sell both to the outside World and to their internal customers along the value chain.
BTW. If you have any similar examples please share them with me. I will publish them (if there are not too many!) Send your stories to CSSTW@Bluewin.ch - I will credit you with the story.

4th Example of the 5 Focusing Steps in Action

Multiple profit centres within one product group (transfer pricing)

Many corporations divide their business into profit centres. The idea is not a bad one since smaller entities are easier to manage. Unfortunately these profit centres are usually  interdependent – they depend on each other. The targets profit centre managers are given can compound the problem and the damage to the corporation as a whole as managers will optimise locally - without regard for the system as a whole.
The graphic (a picture of interdependent multiple profit centres) below depicts a major business with 6 profit centres. All of the profit centres sell to customers in their particular  arkets. The 4 supplier profit centres sell both to external clients and transfer product to their internal client for further transformation. Since each of these entities is a profit centre they all have a profit and loss report and they have profit and return on investment targets. By these targets the corporation causes them to optimise locally by the way the profit centres must report and by the individual and local targets the corporation sets for them.
Internal transfer prices are usually set through negotiation, bearing in mind market prices. Common practice is to give internal customers some sort of benefit (discount) in order to fill capacities as much as possible (in order to prevent downstream businesses from buying from the outside). The consequence is that selling internally hurts the supplying entity. There will be a tendency to reserve more for clients and starve internal customers. The effect is aggravated by supplying profit centres having higher returns on investment than those at the end of the value chain - because why supply a lousy business - its got to be bad for our company as a whole.

In our theoretical example profit centre 1 is the constraint – it has insufficient capacity to supply all the demand placed on them. The profitability of the various profit centres is such that profit centre 6 has the lowest margins and ROI. In fact they operate at breakeven. However, the price of their product is 6 times that of profit centre 1 (on a per Kg (or other unit) basis).
Profit centre 1 sells as much as they can to clients to maximise their profit. 40% of their sales volume goes to the market causing profit centre 6 to be starved (profit centre 6 has plenty of spare capacity to produce more, and market demand also exists). Is profit centre 1’s tactic the correct tactic? After all, does it make sense to sell more in an operation (profit centre 6) that barely breaks even? (NB. Operating expenses in the system as a whole are constant since profit centre 1 produces the same quantity no matter what (they are sold out) and profit centre 6 has spare capacity.)
The answer is yes, it absolutely makes sense to NOT starve profit centre 6! The more sold through this profit centre the greater the profit for the sum of the 6 profit centres. The situation described is not unusual since the practice of having profit centres is quite common although the shape (interdependencies) are likely to be different . The correct tactic seems so obvious that one has to wonder the situation of starving profit centre 6 is allowed to exist! It exists because most corporations manage their businesses as profit centres and cause local optimisation. Whenever businesses are interdependent as in my example the corporation risks the mistake described. (Since operating expenses are constant and more revenue is realised with products from profit centre 6 it is obvious that maximising centre 6 sales will improve over all financial performance.
In the example the constraint (profit centre 1) is inappropriately managed because the constraint is not used to maximise profits and profitability for the corporation. If managers were taught the 5 focusing steps and if the managers of the 6 profit centres are collectively responsible for the bottom line, then they would probably discover the right tactic to maximise profits now and in the future - at the very least the chance for better decisions will be greater!