Far too many times, organizations behave like dysfunctional systems with their different arms working at cross-purpose to each other. I once had an opportunity to engage with a company producing and selling custom-built equipment for banks. The objective of the engagement was to identify ways and means of reducing their SG&A expenses, preferably through an IT software implementation, which would streamline their office processes (order entry, pre-sales support etc., cut the “flab” and steer the company towards improved profitability. But what unfolded, during my discovery of company’s practices was an object lesson for me on:
- How organizations sometimes turn a blind eye to the real issues at hand and indulge in “piecemeal” thinking
- How formulation of wrong organizational policies can take them away from their real goal, which is to make money now and in future, by creating a vicious cycle of spiraling costs and reducing profits
As mentioned, the company produces large custom-built equipment, which it sells to banks and direct marketing companies, each fetching a price of about a million dollars or more. The equipment themselves are fairly customized, so much so that every sales cycle begins with an elaborate requirements gathering exercise, where specs are gathered and the product designed to arrive at a configuration that customer desires. At the end of this exercise, the customer may take a decision to buy, to postpone or to not go ahead with the purchase at all, if the pricing negotiations fail. The requirements gathering was done by experienced engineers, who, in addition to assisting the sales personnel in the sales cycle, were also involved in resolving issues cropping up during equipment production.
In this company, there were a grand total of 10 such engineers assisting 70 sales personnel, each of which had 15-20 deals open at any given point of time. Therefore, each engineer was working on 105-140 sales opportunities at any given point of time. A large number of deals involved straight forward designs and required minimal intervention from the engineers. However, about 30-40% of the deals (about 35-40 deals on an average) were complex in nature and the engineers had to get involved intensively during the sales cycle. Conflicting priorities among sales people managing the deals meant that these engineers kept moving from one deal to another – doing a bit here and a bit there and working on all of them at the same time. As a result of this multi-tasking, the sales cycle was extremely stretched and lasted for months together, before a sale could be closed. So far so good (or bad?)
Let me put in some more complications. This company was publicly traded and was “answerable” to its shareholders- some said, every quarter. As a result, there were quarterly reports to be made and quarterly targets to be achieved. However, the time taken to close a typical sale (either as a win or a loss) was much more than a quarter. Now some of you may ask- what is the link between the two? Let’s explain the linkage by considering a very simple scenario. The scenario is simplistic and cannot be replicated in real-life, but would suffice to explain the subject at hand:
Let’s consider a company A, having a Lead conversion rate of 10% (i.e. 10 out of every 100 leads get closed as a win) and a Quarter end target of, say 10 wins required (let’s assume that each deal value is of same value).
Question 1: What should be the no. Of open opportunities that the sales people should be pursuing, at any point of time, to ensure that they are able to achieve the quarter-end target of 10 won deals?
Answer 1: 100, since 10% of 100 are 10- Right? Well not exactly! The answer is – “We do not have enough information here!” The logical question to ask is, what is the average time taken to close a sale?
Let’s assume that for company A the time taken to close a sale (which is the sales cycle) is exactly 1 quarter or 3 months. Now, the answer of 100 makes sense!
Question 2: What if the time taken to close a typical sale increases from 3 months to 6 months?
Answer 2: In such a case, we would realize that at steady state, the target number of deals that the sales needs to keep open and pursue, given a conversion rate of 10%, would double from 100 to 200 if one were to end with 10 wins every quarter. The 200 deals will be at different stages of sales cycle at any point of time. But this is still not the complete answer- what will happen to the lead conversion rate itself? With the sales and support functions having to pursue larger no. Of deals simultaneously there would be 2 unavoidable consequences:
- The amount of attention given to individual deals will reduce if the total no. Of open deals in the pipeline increase. Since most sales are done in a competitive scenario and have to be closed in a certain span of time (else they would go to the competition), this has a direct impact on the conversion rate itself. Therefore, the probability of closing a sales deal as a “win” is bound to reduce in such cases, everything else remaining the same. Therefore, one can safely assume that beyond a certain point, the lead conversion ratio is inversely proportional to no. Of open sales deals in the pipeline, assuming that the sales and support capacity does not change. This implies that to achieve a target of 10 deals in a quarter, if the sales cycle increases from 3 months to 6 months, the no. Of open deals in the pipeline may actually have to increase much beyond 200, which in turn reduces lead conversion rate further!
- Similar to above, higher no. Of open deals in sales pipeline result in sales and the supporting organization (the engineers in this case) focusing on too many deals at the same time. Conflicting priorities ensure that the sales and the engineers keep moving from one deal to another and the average time taken to close a deal increases further, which in turn, increases the need to have more open deals to achieve the target.
The moral of the story is, as the lead time to close sales increases, the amount of deals required to be pursued to meet quarterly targets increase non-linearly, which in turn increases the sales cycle time further. This is a vicious cycle from which there is no getting out unless one takes certain conscious steps to break it.
The Tree above tries to depict the vicious cycle which feeds on itself to spiral out of control.
The tree depicts an unstable system, which can quickly go out of hand if proper steps are not taken to either:
- Reduce sales cycle time from first principles OR
- Strike a balance between the pipeline size and the capacity of sales and support pro-actively to manage the pipeline
Well, this company had been experiencing ever-reducing lead conversion rates and ever increasing sales cycle, which were impacting its profitability. But the supposed solution that this company formulated to get out of this cycle led to additional problems, as will be depicted later in this post.
The sales personnel and the top management of this company did not take any of the two courses mentioned above. Instead, they realized that there was an easy and obvious way to get out of this predicament. This was by offering incentives to their customers to buy from them in the form of discounts, particularly at quarter end when the pressure to meet targets was high and there were large no. Of open deals in the pipeline.
The effect of discounts to customers for a limited period at quarter end would be to:
- Forcefully curtail the sales cycle as ‘won’ before its predicted average closing time. This would have the effect of reducing the no.Of open deals in the pipeline, which has been mentioned as one of the Undesirable Effects (UDE) in the tree depicted in the previous section.
- Increase the conversion rate by appealing to customers’ greed of getting a discount, another UDE mentioned in the tree.
This was expected to move the company out of the vicious cycle described in the previous section. However, with time, customers had turned wiser and waited for quarter end to come so that they could get better deals out of the company. As a result, this practice of offering discounts to customers became a quarter-end ritual. The sales head was once heard telling others- ‘Our business is different and it cannot sustain without the quarter end discounts’.
But by taking the above steps, was the cycle really broken?Unfortunately, it was found, that even after offering quarter-end discounts, the company was experiencing poor profitability and the sales growth was negative to meager. The policy of quarter-end discounts wasn’t working. But why?
The production connection
Enter the production people, the ‘poor’ victims, who were suffering because of the ‘inefficiencies’ in the sales organization. As already mentioned, in this company, the sale cycle was long. In comparison, the time taken to actually assemble the custom-built equipment designed during the cycle was much lesser. On an average, production had the capacity to quickly assemble the order once the deal was signed. But they were still facing a problem.
The practice of giving quarter end discounts was resulting in huge spike in order quantities towards the end of the quarter when the deals were getting closed. Most of these orders, being custom built in nature, could not be assembled in advance. Production had to wait for orders to be confirmed before commencing the assembly process. As a result, there was a huge load on production towards the end of the quarter, while they were sitting idle at other times.
Although the production had excess capacity on an average, it was struggling to cope with the quarter end spikes in orders.
Production tried to address the situation by hiring excess labor, just to deal with the additional load towards the quarter end. Unfortunately, the nature of the product was such that the labor had to be trained and it was not possible to get rid of them after the quarter ended- most labor tended to be permanent. The problem was accentuated further by the typical factory obsession with efficiencies- it was found that plant efficiencies were reducing, particularly during the months which were not quarter-end months and “something had to be done” to address the situation. The production, along with Finance and HR started putting enormous pressure on sales to give them orders in the middle of the quarter. In response, sales came up with an innovative solution- they began selecting open sales deals which were “done deals” that were “most likely” to be closed by the quarter end and started “pushing” these orders into manufacturing in advance. Off-course, this process was institutionalized through proper approvals and these orders were known bya different name (such speculative orders are not uncommon in organizations- they are also called ‘briefcase orders’ and exist in different forms in different industries.)
Impact of ‘pushed’ orders on sales
Since the production got these ‘special’ orders in advance, they used to produce them and keep them in FG stock. There were times when these “special” orders were already assembled and waiting in the plant and the deal had not even been signed. As a result, the FG inventory piled up and there was pressure towards the end of the quarter to dispatch them to customers (Yes. They not only want the sales to go up but also the FG inventory to be reduced by quarter-end!) In fact, the author once intruded into a situation where the sales director was frantically pleading with the customer to sign the deal since the equipment was already on its way to the customer site! The customer was trying to extract his extra pound of flesh on seeing the situation that the poor sales director was in. By the way, we are talking about a highly customized piece of equipment, which cannot be readily sold to other customers, but has to be broken down and reworked on, if the sale does not go through. The pressure on the salesperson to accept the terms as dictated by the customer cannot even be imagined!
Wondering what would be going on in the minds of a salesperson while he negotiated with a customer to close a “done deal” that he had already pushed through to production? The following thoughts would be playing on his mind:
Problem 1: It’s quarter end …. And I have to meet my targets
Problem 2: The equipment is waiting in the warehouse ready to be shipped
Problem 3: But this ***** customer is absolutely refusing to take the price offered!
Problem 4: What would happen if he refuses? -The production would be on my back- why did I confirm this order to them?
Solution: Let me give him the additional 2% he’s asking for and close this deal! I would achieve my target anyway and get out of this sticky situation. All would be well!
Additionally, there were times when the specifications actually changed by the end of the negotiations while the equipment with the initial specs, was waiting in the warehouse to be shipped! This resulted in huge reworks that affected the profitability of the sale.
No wonder the company’s margins were spiraling downwards while the FG inventory was going through the roof! The organization was sitting on a powder keg of assumptions and faulty policies ready to explode at any time.
Retracing the chain of events
Retracing the chain of events in the story, one can perceive each function as playing the ‘aggressor’ and the ‘victim’ at different times:
- By blindly insisting on quarterly targets, the company owners (top management and the shareholders) played the aggressors.
- The immediate victims, the sales people, responded by formulating policies around quarter-end discounts, which were supposed to resolve their sales woes.
- By propounding the discounting policies which resulted in quarter-end spikes, the sales personnel played aggressors on the production
- The victims, the production responded by formulating their own policies on ‘special orders’ which greatly reduced the negotiating powers of sales, resulted in reworks and increased overall FG inventory
- The final result- the entire organization became a victim of its own policies created by its entities, each behaving in a disparate manner to achieve its respective local optima.
This story is not meant to end with a solution. It’s supposed to end with a realization that somewhere, we are all connected, and the decisions we make for ourselves, quite clearly, impact others- in organizations as they do in personal life. This realization is facilitated by Theory of Constraints, which then proceeds to help us resolve these conflicts and blaze a path to greater Harmony.