Information Strategist Paul Strassmann

 

INC.: Is there a headline for all this?

STRASSMANN: I think the underlying economic concept is that we are going from a period in which the focus for managing economic decisions will shift from overhead costs to direct costs. If you watch what percentage of the total revenue is in purchased services and materials, it is interesting. In the automobile industry, for example, it is a much higher percentage for both Ford and Chrysler than it is for General Motors, which is having its problems. The same is true if you compare Japanese electronic companies with American. Companies such as Toshiba would buy up to 80% from the outside, and thereby gain a much greater flexibility, as compared with their U.S. competitors, which frequently insist on doing most important things on their own.

INC.: Rather than look at this from the point of view of General Motors, let's look at it from the point of view of somebody running a small, growing company. He hears what you say about overhead, but it is not exactly clear what he's supposed to do about avoiding it.

STRASSMANN: The dangerous threshold is at about 100 employees. It is then that the CEO starts thinking about a finance department, an accounting department, purchasing, personnel, what have you. That's the beginning of the potential disintegration of the enterprise. That's when you start having functional views, when the power begins to pass to the specialists, and that's when you start adding overhead by increasing the cost of coordination and integration.

A good part of the problem, by the way, lies with the current accounting system, which sort of makes overhead disappear -- it simply gets added into the cost of a product, like a tax.

INC.: How would you change that?

STRASSMANN: I think we have to move away from a system that focuses on assets and return on assets to something I call return on management. Return on assets is a 1920s concept -- it is a ratio between profits and assets, which was an important measure back when assets and capital were the decisive resources. Today it is different. Assets and capital are commodities, just like labor, so the ratio between profits and assets doesn't tell you much. What's important now is how effectively you are leveraging your scarcest resource, which is your management. Good management creates value. Bad management diminishes value.

INC.: But how would you measure return on management?

STRASSMANN: You take revenue and subtract purchases, the cost of operations, the cost of capital -- and what's left is the value added of management.

INC.: Isn't that basically net profit?

STRASSMANN: No, there are differences -- in the way you treat depreciation, for example, which under the current system is a cop-out. Also in the way you allocate overhead, which under current accounting often gives management the wrong signals about what products are the most profitable.

Really, what I am suggesting is a different definition of profit. What you should be trying to do in a company is reduce the time that is not devoted to producing goods or services and thus directly serving the customers. Some people call this overhead; I call it the cost of management. And the question is: for the money that I am spending on this management, on this overhead, what am I getting for it? What do I get for having a three-person control department? Or a two-person personnel department? That is what the CEO ought to be worrying about, because by my definition, all overhead is the cost of generating and distributing information.

INC.: OK, so I'm a CEO and I'm worried. How do I do my job differently?

STRASSMANN: My view is that the principal job of the CEO is to be the information and communications architect of the firm. In the information age, all that matters is information and communication. Just remember this: organization means communication, communication means connectivity, connectivity means knowledge -- that's the mantra.

INC.: So I'm the chief information architect of my company, and that is my mantra. Now, what do I do on Monday morning?

STRASSMANN: First you have to analyze the business, to figure out where the value is being created and where your choke points are -- where you are building up overhead. Look carefully inside the organization, because its structure and the information flows dictate the way overhead is created. How you "wire" your operation becomes very important.

Then you have to put a philosophy in place, a notion of how you're going to distribute responsibility, how you are going to deal with the enclaves of functional specialization, where you are going to move cost data, how you are going to deal with incentives. Watch out especially for situations in which under the guise of efficiency you begin to remove knowledge from operating people and transfer it to overhead custodians. This can be the start of gradual knowledge impoverishment of your people and the creation of a class of overhead-supported high priests.

Only after you have begun to answer those questions can you get to the matter of the information system. The system, in effect, becomes the mechanism by which you redesign the organization, achieve the connectivity, and generate knowledge. In the end, it is the application of this knowledge to the customers' problems that you are after, because it is only through superior knowledge that a company can create real value.

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