Avoid getting a complex

In 2004, long before the financial crisis, ‘Fred the Shred’ delivered a Royal Bank of Scotland (RBS) report to analysts entitled ‘Managing Complexity’. The 40-page plus presentation concluded that the RBS model works; has helped to reduce complexity; remains relevant and viable. Four years later – it turned cap in hand to the UK government on the brink of one of the highest profile banking failures in corporate history.

So was complexity actually a major contributor to RBS’ downfall, and after beating its chest about managing complexity, has anything changed?

The Global Simplicity Index (GSI), a new study conducted jointly by Warwick Business School and consulting firm Simplicity, suggests that complexity was a major factor in the downfall of RBS, but also concludes that the majority of big banks are losing profit because they are more complex than they need to be.

But what exactly is business complexity – and how does it erode profitability? Complexity is the result of adding new products, people, processes and strategic initiatives, either as a result of normal organic growth or through M&A. It takes the form of external pressures – from emerging markets, competitors, regulatory changes, red tape and the economic environment. But it can also brew within the business – as a result of complex processes, bloated product portfolios, increasing management layers, over-complex decision-making chains and other organisational processes.

Initially, complexity is no bad thing. As a business grows, it will naturally develop more formal methods for managing people, or add specialist divisions, new processes and strategic initiatives in order to grow. But, left unchecked, these systems can proliferate and become unwieldy, over-complicated and a drag on efficiency. This is what we call the ‘Complexity Curve’ – an inverted U-shape graph that shows how complexity naturally reaches a tipping point, after which any benefits are outweighed by costs. This has two major effects on managers. They find it tougher to make key decisions because of the wide range of options and uncertainties they face; or they are distracted from their focus on making key decisions because of unnecessary demands on their time.

Very often it is both.

From an organisational perspective the cost of complexity is huge. Our study found that on average the 200 biggest companies in the world are wasting 10.2% of their annual profits (EBITDA) each year owing to complexity.

Looking more closely at banking, our study split the banks into four main typologies depending on their levels of complexity and their performance. These are defined as: Performers; Complicators; Simplifiers; and Strugglers – which are failing to cope with complexity. Alongside RBS as Strugglers are HSBC, Zurich and ING. In contrast, Barclays is a Complicator with above-average performance levels combined with above-average complexity levels. In comparison with many of its rivals, Barclays has developed better mechanisms for coping with high levels of complexity, however even Barclays is losing profit owing to unnecessarily high levels of complexity.

As well as having a major impact on profits, highly complex companies, such as RBS, find it much harder to react quickly and decisively in the case of financial crises. This is because their elongated internal organisations and processes make decision processing and remedial action far too slow.

So why is RBS suffering?
After being lauded for its successful acquisition and integration of NatWest, calamitous takeovers such as Charter One and ABN Amro tipped RBS over the edge. Our study found that it had over-stretched its global structure, with a large number of subsidiaries and divisional offices across a wide range of overseas locations. This adds coordination costs as well as the complexities of operating in many different institutional environments and across a variety of business cultures. RBS also manages a large portfolio of products and services relative to other banks, making its external strategic positioning, including the challenges of market segmentation vis-à-vis competitors, complicated. This has a direct effect on its internal organisation structure, with multiple business units and sub-divisions struggling to clearly prioritise the allocation of resources and effort to add value for clients.

These findings are supported by The UK Government’s Independent Commission on Banking (ICB). Last year it produced a report on recommendations made, and steps already taken, to reduce the scope of RBS’ operations. Since December 2008 it reported that RBS sold 31 businesses and ‘exited or substantially reduced its presence in 35 countries’. This disposal programme has already improved performance with £1.13bn losses for 2010 a considerable improvement on the previous two years.

So how can the banking sector avoid bad complexity destroying profits? First, leaders and managers need to identify and weed out the bad complexity. This requires a better understanding of the processes and practices that add value and those that do not.

Next they need to change management behaviours. All complexity in business is created by people, so managers need to understand how their decisions can unwittingly create complexity and be trained on how to simplify their businesses. Thirdly, they should avoid further complexity by putting in place an evaluation process to test the impact of new products and services, new procedures or levels of management. Finally, they should identify and nurture the kinds of complexity that add value.

There is no quick-fix solution, but the process of identifying and rooting out bad complexity can be very rewarding, making your business more profitable and a more productive place to work.

Complexity is clearly still a problem that needs to be dealt with by the UK banks. Just last month, the outgoing Lloyds chief executive Eric Daniels, when appearing in front of the Commons Public Accounts Committee, and questioned on whether the banks were too big to fail, said: “I don’t think it’s a big-ness issue; it’s a complexity issue.”