Businesses constantly struggle with capacity issues. Manufacturers seek access to the ideal manufacturing capacity, and service providers look to employ the optimum number of employees.  Both understand their labor spend is a key component of a company’s profit formula. So how is the entrepreneur to scale in an uncertain economy?

Those who had not experienced rapid market erosion previous to the liquidity crisis learned an important lesson; high fixed costs can be truly catastrophic when demand contracts quickly. Employers must marry labor costs with demand. There are several steps one can take to mitigate labor capacity risk:

Optimize Labor Efficiently- Most entrepreneurs intuitively understand that they should push low value activities down through (or out) of the organization.  Senior managers should aim for “zero administration”, where virtually all of their time is spent improving service or profitability, and not loading paper in the copier.  A good administrative assistant is worth their weight in gold. Similar thinking should apply to all; all work should be allocated to the appropriate staff based on their skill level, experience and cost.

Outsource Low Value Activities Based on Demand- The zeal for outsourcing is far from over. Organizations are not only seeking lower costs, they are looking to move resources outside their organization so that they can scale  their bandwidth quickly. Look for outsourcing partners who have infrastructure that can move, (in real time) with your business. Such organizations typically have an existing core competency in the services provided, including technology and human capital geared towards executing such work.

Increase Weighting of Incentives to Total Cash Compensation-Those who only provide subjective bonuses are actually doing themselves a disservice. Practically the entire Fortune 500 have moved to some type of performance based pay. Part of the rationale is to only pay out incentives when an organization reaches certain performance thresholds.  Failure to have a significant portion of cash compensation in incentives (20% or more) creates fixed costs and puts stress on a business and on employees. Fluctuations in demand require drastic action such as lay offs or furloughs.

Measure Labor Meticulously- Labor KPI’s are amongst the easiest predictive indicators to measure, and directly affect the bottom line. Examples include overtime, labor dollars per unit, direct labor, indirect labor and labor as a percentage of revenue.

Beware of External Demand Indicators- Within virtually every business segment there are external measures that provide context on future demand.  Add external indicators to your scorecard/dashboarding system so that you can stay in tune to the market place. Government websites, trade associations, and private research organizations offer a litany of statistics.  Plot such data  against company revenue to find which numbers correlate with business growth.

In Outliers, Malcolm Gladwell asserts that one needs to invest 10,000 hours in an activity in order to become an expert. I take solace in knowing that I am evidently both an expert in Strategic Planning, and overcoming the drama induced by teenage daughters.

The rapid escalation of global competition has brought about a new round of hyper-specialization.  The concept of specialization is nothing new; the division of labor has been a key tenant of economics since the birth of capitalism. Yet sites such as Guru or eLance, have propelled specialization to a new art form, where one can access dozens of specialists from around the world in any conceivable competency in a matter of minutes.

Specialties that do not require any special education (other than what is readily available on the internet) such as graphic arts have quickly commoditized. You can hire a graphic artist online for $15 an hour.  In cases where greater technical aptitude is required, specialists still out-earn generalists. The median Internist in the U.S. earns $176K per year, while Cardiologists earn a median of $403K (some make $800K or more). [i] If you had a heart attack, which would you see?

Perhaps the most common strategic blunder I observe within entrepreneurial companies is a penchant for addressing overly broad targets. Marketers, seeking the largest audience cast too wide a net. In their need to satisfy the largest number of prospects, they become de facto generalists. That is, instead of addressing a niche market with specific solutions, they try to satisfy a larger audience with a multitude of products and services. At some point, the value they can provide suffers from diminishing returns.

The more crowded a space, the more difficult it is to differentiate, and the greater the need for expertise. Before its bankruptcy filing, GM attempted to sell within every segment, from sub-compact to Hummer. GM experienced what is often referred to as the peanut butter effect; the wider you spread something, the thinner it gets. GM’s branding was diluted and ability to control quality constrained.

Many small businesses may employ generalists because of their lack of talent depth. To have one IT professional manage a network, build the company website, select an ERP package and fix all the desktops is an archaic paradigm worthy of recalculation.

The reason that specialists are worth more than generalists is that they have a deeper subject matter expertise that drives:[ii]

Quality-Processes replicated over time promote less deviation, less defects and fewer errors.  The specialist thinks deeply about an area of expertise in which they have experience and are less likely to make mistakes.

Speed- Specialists do not need to reinvent things. Cycle times on proposals and product delivery is faster. If a company offers 50 stock products instead of 500, they can manage less inventory and ship items quicker. For every new project outside the boundaries of a company’s expertise there is resource draining learning curve that costs time and money.

Relationships-As the specialist is highly respected, their opinions are sought after by the media and people who want to know them, hire them and refer them to others.

The realities of outsourcing and off-shoring are driven by these phenomena. It is inherently inefficient to participate in activities that are not within a firm’s core competency and do not directly contribute to the bottom line. Thus, the migration of labor (outsourcing) will rise at a fervent rate.

In fact, the entire concept of the corporation, with its multiple functional departments (such as accounting, sales and marketing, design, operations, engineering, manufacturing, etc.) is under some attack. Social norms around what constitutes a working environment are shifting quickly and enabling greater specialization. Collaboration tools make the world of work far more virtual, which will continue to feed the frenzy.

Think about how to specialize as to optimize your revenue, margin and profit.

Being Opportunistic in a Volatile World

Last week my post drew considerable attention, perhaps because of its shock value at a time when the news was truly shocking. While the tsunami was a natural disaster, the response on the part of the Tokyo Electric Company was a human calamity. Lack of preparation will invariably lead to unintended consequences, if you are managing a nuclear power plant or any other business.

The reverse is also true. The entrepreneur capable of understanding seemingly unrelated external forces, and weaving them into a thoughtful strategy, will clearly realize strategic advantage. How might the strategist consider social, technological, economic, ecological and political factors to gain insight on how to take advantage of ever changing market conditions?

Scenario planning is a methodology whereby the entrepreneur considers converging factors that (in combination) creates a tipping point. Consider some of the following predictions, based on facts already in evidence today.

In the next decade, we are likely to see:

Predicative Modeling-Cloud computing enables the migration and cross-referencing of large institutional databases.  For example, actuaries, using sophisticated algorithms are able to model ailments based on lifestyle choices monitored in real time. They are able to calculate your risk of a heart attack based on which smoothie you tend to order at Jamba Juice, your frequency of exercise, prescriptions you use, etc. Offered as a benefit of a health care plan, the member is offered incentives to opt-in and receive preferential rates. Such tools slow down rampant health care inflation.

A Cashless Society-The majority of transactions amongst big banks are managed by exchanges where no money actually changes hands. Coins of small denomination are nearing extinction. Today, you can download an iPhone app that serves as a debit card, and can be swiped within Starbucks locations.  For most transactions, cash is already irrelevant.

Smart Infrastructure- Automobiles come preinstalled with all of the features of an iPad (the 2011 Hyundai Equus will come with one) and all the benefits of the internet. Smart grids control the flow of traffic, directing drivers to particular lanes at a given speed to optimize drive time and reduce accidents. Traffic signals are regulated based on traffic volume. Sensors predict bridge and rail failures.

Of course, rapid change will occur in every industry, and the strategist must weigh various opportunities based on an organization’s ability to take advantage of them. As a general rule, organizations should seek to achieve scale and reach within its core (at least 30% market share) before expanding into new endeavors. As Jim Collins points out in his sequel to Good to Great (How the Mighty Fall), many companies fail because of an “Undisciplined Pursuit of More”.  In their zeal for diversification they often leap too far from their core competency.

Each opportunity must be assessed within the context of the organization’s resources, bandwidth, and human capital.  For every opportunity there is a cost, and an opportunity cost. To pursue any new opportunity an organization must leverage resources which dilutes focus on the core business.  Choose your opportunities carefully.