Friday, March 22, 2013

"Let's Get a Team on This Right Away..."

How would you respond to this chart? Let's say it's a chart of your gross margin. Don't worry about the relative strength of it. Look at the variation.
 The books would say, "Form a team to do some analysis on the product mix. Determine a strategic response. Pull your sales team together and talk about this; see if prices can be raised. Find out if the competition is undercutting you. Have the operations cut expenses immediately. Get concessions from the suppliers."
 When I add some (simplified) statistical control limits, based on past performance, a different picture is created. Knowing the past variability, we would expect to see low results approaching 8% or so occasionally (and high results nearing 50% occasionally); there were some past results as low as 7-8%. Therefore, at this time we wouldn't need to do anything special. This is a normal, expected result. We can call off the task forces, cancel the sales meeting, discontinue the recycling paper towel program.

If the low result repeats sometime in the next two months, then we might have a downward shift caused by a significant change in our operations or the marketplace. If it bounces up the next two months, then this is just a low margin month. "Wish it were different, but it's not unusual" would be your response.

In fact, when you look at the continuation of the chart, the margins did return to 'normal' without any special intervention. If we had overreacted, we might have created higher margins, but we might also have created chaos that jeopardized the normal level of profit. We would have expended effort to find a problem that doesn't exist, and correct a cause that isn't there.

Hopefully, your board understands statistics and doesn't force you to react to non-events, just to 'do something'. Chaos can be powerful. However, it is always disruptive and changes the expectations.

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