Operations Investment: Paying For It In The Long Run

Operations Investment: Paying For It In The Long Run

by Mike Ricotta - August 17, 2016

One of the most difficult decisions for an organically grown, self-funded business to make, is choosing to forego immediate profitability, in exchange for long term operations investments.  If you can’t afford it now, give it some thought but don’t put yourself in a hole.  That goes two ways, because as the old adage states, fool me twice, shame on me.

If you truly can’t afford the risk, committing too quickly to a long term investment can be costly but putting it off has diminishing returns.  Your clients have demanding timelines and failing to hit those timelines can cost you sales, up-sells, and hinder the frequency of your returns and speed of your growth.  Allowing your operations to evolve ahead of new systems will also cost you twice the effort as each day passes, when factoring in the effort to adapt your operations down the road.  The sum of those costs might surprise you and may very well justify the cost of your investment as quickly as possible.  So, how do you weigh these opportunity costs, to make an informed decision?

Consider asking yourself a few questions:

  • Does this investment improve my operational efficiency?

Time is the one constant that diminishes instantaneously.  It is is the single most valuable asset that you have as an individual and as an organization.  As your time becomes occupied and passes by, opportunities pass you by, in turn, and your rate of return fails to improve.  Growing your wealth of time with new hires might be one way to increase that constant but hiring the wrong people or introducing people to an inefficient system has diminishing returns that might outweigh the cost to you.Consider that the Law of Diminishing Returns acknowledges an increased efficiency when adding an extra pair of hands, typically represented by 2 units on the LoDR curve.  Consider that this same law recognizes that not every unit of input will lead to a proportional increase of output.  At one point on this curve, your operations become more cumbersome and your ratio of input to output costs increases, resulting in diminishing returns until ultimately it results in negative returns.  Perhaps you’ve spread yourself too thin with a broad range of offerings that require a larger range of skillsets and thus, greater numbers of required contributors.  Perhaps your operations have grown too bureaucratic as a result of post-mortem over-analysis.  Whatever the cause, allowing your operations to remain the same or expand a diminishing model, is a failing formula if you intend to grow.  By definition of a basic economic principle, adding input (hires) to that path, has diminishing returns.

Efficiency is the single most critical factor in extending your curve to permit a greater number of total input units (hires).  In short, only improved efficiency can allow you to grow without losing money, plain and simple.  Ask yourself what this investment is intended to do and if it will save you time and increase your team’s efficiency.

  • What’s the ratio of cost to revenue and what’s your date of return?

More simply, what’s your ROI? Whether an entrepreneur or a banker involved in mergers and acquisitions, there’s typically a timeline where profitability is expected to be reached.  In many cases, this may be 3 years but in other cases, it may be a smaller investment, something that’s expected to turn around in a year or even several months.  Take your desired date of return and double it, because let’s be honest… unless your bank account says “Wall Street” to you, you’re going to have to be more patient.  With this new investment, ask yourself how much you can expect to grow, MoM or YoY as a result.  If the cost of that operations investment is covered by your expected growth by the time this return date is met, you’re in the clear.  That sounds like simple logic, so let’s get into some more abstract questions.

  • What’s the opportunity cost?

That money is going elsewhere, whether you like it or not.  Just like the LoDR impacts active operations, it does the same thing to the money sitting in your bank.  Let’s consider some opportunities:

  1. The opportunity cost of keeping that money in your bank is achieving milestones in your long term timeline.  Maybe you need to secure the money, to protect you from risk or maybe you just don’t like to spend!  If your investment aims to return in 1 year and your money is sitting in the bank for 2 months, guess what… you’re missing out on 2 months of progress and in so doing, exponentially diminishing the returns of your money in that 2 months (excepting interest).  That’s right, you may have thought you were storing that money for a rainy day but because your operations have diminishing returns, you’re actually spending it!
    1. The sooner your operations investment goes to work for you, the less you’ll be spending in inefficient operations, which have costed you a higher overhead and a slower rate of return.  This also means less that you’ll have to spend, down the road, to reverse course on all the operational band-aids you’ve implemented.
  2. The opportunity cost of spending that money on other tools or rather, spending the money on your investment instead of other tools/investments. comes down to a comparison between each ROI.  Remember that efficiency is critical, so help weigh that cost by analyzing how this improves your operations.
  3. The opportunity cost of investing that money in a market is subject to many more factors like sector or market volatility and the simple fact that you’re no longer investing in yourself.  The best bet is the one you can control, so bet on yourself but don’t take it from me, I don’t want to hold you back from being the next Warren Buffet!
  • Is this operations investment contributing to the direction I want to go in?

Efficiency is critical and hopefully your investment is contributing to that efficiency but just because it’s a good investment for your current model doesn’t mean it’s the right move.  Sometimes the most efficient move is to eliminate inefficient branches.  Consider the direction you would like your business to go in.  Let’s say you have a services division with an inconsistent pipeline and a 10% margin.  As a service branch, it requires bodies to fulfill an unpredictable demand.  Let’s also say that you have a product division which is much smaller in size but with a predictable, albeit fluctuating, pipeline and a 30% margin.  Your company, as a whole, has a 15% margin.  Improving the efficiency of your services division through investment could be one solution to increasing this margin, given its larger impact but if you don’t expect to meet or exceed your 30% product margin, what’s keeping services around?It may very well be that you don’t need any services division at all.  A 30% company-wide margin sounds pretty nice to me.  Perhaps your services division is paired with your products division and makes for a good selling point to your existing clients.  If that’s the case, consider if not having that services division would cost you enough of your product division to bring your total margin down to 20% or lower.  In the end, investing in your services division could be a great move or perhaps not the right direction at all.  It doesn’t hurt you to save your money while also improving your overall operational efficiency.

  • What are other possible effects of this operations investment? Is it possible there might be diminishing returns?

Do your due diligence, consider that your investment has more than just an operational impact.  The greater efficiency of an automated phone system, for instance, may have a negative impact upon client relationships.  You may increase profitability per incident but your overall revenue stream might decline, leaving you stagnant or worse yet, declining.

When it comes to operations, technology can help improve efficiency or it can hinder progress.  A good tech consultant should be able to identify technical and operational inefficiencies, to recommend solutions and implement them, hands-on.  Whether automating processes, improving performance of equipment, or normalizing poor data practices, your consultant should be able to identify use cases in organization and performance faults of your human systems just as well as a written program.  When your consultant makes a recommendation, remember to consider the impact it has upon your organization.

Does it make you more efficient?  Might there be diminishing returns on sales?  Is this operations investment contributing to a channel you’d like to continue? What and when is your ROI?  and what is your opportunity cost?  If you can answer positively that your ROI can beat your deadline and makes you more efficient, does not negatively impact your revenue, contributes to the direction your company should go in, and is not drawing away from better opportunities, you should act now.  We’d love to be the ones to help you make your business more efficient because as you grow, we grow.