Conclusions Derived From History (Part 7)

Rate of Return

Decision-making based on financial targets was influential in the 1960s when there were still many opportunities as the market was not saturated yet. However, the second half of the 20th century did abound in competitions in all spheres because of globalization. Investing in promising short-term projects is not as effective as it used to be.

No other financial principle with which I am acquainted serves better than the rate of return as an objective aid to business judgment. . .

Alfred Sloan

ROI results were the basis for General Motors from which they derived conclusions to invest in a particular project or not. That same approach led GM to lose its market share in the 1980s, as they refused to focus on the emerging concept of small cars.

Big cars meant big profits, and small cars meant small profits.

David Halberstam

But:

In contrast, Toyota’s approach is about getting people to work systematically and creatively at the detail level to do what is necessary to achieve ambitious target conditions, which at first pass may not make it through a rate-of-return calculation.

Emphasizing departmental output maximization, rather than optimizing the overall flow for the customer, means that the departmental manager’s genuine interests may come into conflict with the company’s long-term survival interests.

Mike Rother

Furthermore, if we evaluate improvements cost-wise and accept without thinking about their benefit in a whole stream, it may result in sub-optimization. However, we need to understand the improvements from the long-term perspective.

Focusing on the Individual Processes

As mentioned, when individual processes are approached individually, it results in sub-optimization. In turn, each department will have its own goal and financial target. Ultimately, when each department tries to lower its costs and maximize efficiency as an island, that may create even more significant problems in others. That goes against the principles of systems.

Centralized Planning

So, now we have an organization that approaches processes from a financial perspective, with each department focusing on sub-optimization. The whole system is controlled from a central hub; every single significant decision is agreed upon with the administration first, then signed, looking through the prism of ROI. The result is, each department will be busy preparing reports on decisions. Then, that may end up with departments focusing too much on the reports about the profits they made, financial results they achieved because of the improvement, and so on. In the end, reports about results will get more important than the actual results.

That reminds of a notion from a world-renowned book “Zero to One”:

In the most dysfunctional organizations, signaling that work is being done becomes a better strategy for career advancement than actually doing work (if this describes your company, you should quit now).

Peter Thiel

The Gist

To achieve real improvement, managers must look beyond just quantitative metrics, but also they must focus on the underlying means that move an organization forward. However, nowadays, many companies emphasize the financial targets and useless reports about achieving them. In short, it is a Result Oriented approach, and it is inefficient and ineffective in today’s world.