How to Root Out Knowledge Workers’ Waste

While waste on the manufacturing floor is routinely identified and excised, the same can't be said about white-collar waste in creating intangible ...
William HeitmanMay 20, 2015
How to Root Out Knowledge Workers’ Waste

Aficionados of gangster films know that the “Vig” is the percentage that bookmakers, casinos, and loan sharks take off the top of all money that changes hands. If the Vig — short for vigorish, the Russian word for winnings — is pointed out to gamblers, they shrug it off as an unavoidable expense and continue their game.

William Heitman, managing director, The Lab Consulting

William Heitman, managing director, The Lab Consulting

Outside of Wall Street, few would conceive of any parallels between gambling and the operations of the Fortune 500. However, our 22 years of project experience and analysis of more than 250,000 job positions suggest that those large companies give up a sizable share of their earnings — an average of around 12% — to the wasteful activities of their knowledge workers, the employees we once labeled “white-collar” or office workers. If this waste is pointed out, executives shrug it off as an unavoidable expense and continue the game.

This could be called the “Earnings Vig.” In this case, it’s the knowledge workers that are skimming off the top. It’s not intentional, but their one-off, undocumented work methods can increase the overall workload by 20% to 40%. This translates to permanent overstaffing. A lack of documentation creates experts in tribal knowledge, who become indispensable and very costly.

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This Vig is a big number, because knowledge work is almost always the largest share of a company’s intangible assets. In turn, intangible assets generally represent the largest share of business value — about two-thirds, which merely reflects the price-to-book ratio. And as the knowledge-worker population continues to grow, so does the Vig, enticing activist investors and takeover specialists.

Fortunately, companies already possess the expertise to reclaim the Earnings Vig. They also have an executive who is uniquely positioned to lead the reclamation: the CFO. What’s needed is a new perspective to uncover the Vig as it hides comfortably and confidently in plain sight.

How to See the Opportunity

The best way to recognize the Earnings Vig is through comparison.

In contrast to factory workers, knowledge workers are autonomous. They can define their own operating practices, set their own parameters for success, and measure their own performance. This subjective approach allows wasteful activities to hide alongside essential tasks.

Wasted effort in a conventional factory produces scrap material, downtime, or returned defective goods. This waste is tangible and obvious. Accounting rules mandate that it be added to the cost of finished goods, which are assets. Assets attract investment to improve productivity. Managers, industrial engineers, and factory workers invest obsessively to discover and eliminate wasted labor. They track progress in objective, quantitative terms: ratios, unit rates, or parts-per-million.

These investments have worked magnificently in the classic plant — call it the “downstairs factory.” Over the last century, manufacturing labor productivity has increased by at least tenfold.

The Wasteful Upstairs Factory

Think of knowledge work as an “upstairs factory.” It has many similarities with its downstairs counterpart. However, upstairs hardly anyone has the objectivity to recognize what is valuable and what is waste. The upstairs factory produces products and delivers services, but these are for internal consumption: finance produces management reports, marketing produces campaigns and collateral, IT produces data. These processes can be streamlined and improved. As in a conventional plant, the workers generate waste that could be reclaimed to increase margins and deliver competitive cost advantage.

The difference between these two factories lies in what might be termed the “value recognition process.” The contrast is stunning. Although 60% of most knowledge work is repetitious, industrial engineers are not assigned to scrutinize it for standardization opportunities. Consequently, knowledge workers design their own methods, which are inconsistent and largely undocumented, often existing only as tribal knowledge. The result is costly variation in even the simplest tasks.

Our research shows that 20% to 40% of knowledge work is devoted to error correction, manual workarounds, and customer over-service. Knowledge workers view these activities as unavoidable and frequently blame them on inadequate technology or actions outside of their group. Often they are right, but the job needs to get done somehow.

They earnestly explain that their actions preserve revenue, serve customers, and support the salespeople. Again, they are often right; they are prisoners of dysfunctional business processes. Because they see themselves doing good, we can call this “virtuous waste.” It’s the Vig hiding in plain sight.

Hide and Seek

Because these wasteful activities are individually small and dispersed throughout the day, managers cannot catch them through casual observation, despite high occurrence rates. But if you map the workflows and analyze the time spent, you will discover that virtuous waste consumes 30% to 40% of organizational capacity. This is the classic “long tail” phenomenon applied to improvement: many small gains can deliver massive total benefits.

The sum of these little things would certainly get noticed. In 2013, the Fortune 500 reported earnings of $1.23 trillion. According to our analysis of more than 200 of these companies, approximately $150 billion was spent on virtuously wasteful activities. This could have dropped straight to the earnings line. Capitalize this at an average price-to-earnings ratio of 20, and it represents $3 trillion in untapped market value.

Accounting rules also help hide the Vig. Knowledge work is part of a company’s intangible assets, together with what we usually think of as intellectual capital: patents, copyrights, trademarks, and trade secrets. Accounting rules allow intellectual capital to be booked as assets. However, 75% of intangible assets are what economists refer to as “competencies,” like databases, work methods, research, and know-how, the costs of which are booked on the income statement. And because assets attract productivity engineers while expenses typically do not, these particular intangible assets, hiding as expenses, are second-class citizens in terms of value recognition.

This is what we end up with: intangible assets constitute two-thirds of the value of the business, but only 25% of that value is carried on the balance sheet as assets. The remaining 75% derives from competencies, which appear on the income statement as expenses. That means roughly half of the value of the business resides in hard-to-describe, hard-to-perceive, intangible assets that are booked as expenses.

For building business value, expenses are the road less traveled. Executives prefer to focus on revenue and conventional assets, and thus a company might never notice that 12% of its earnings are disappearing.

At one of the world’s largest publishers, industrial engineers examine every expense in creating a magazine, from production labor to binding staples. They arduously control the expenses that get converted into assets—the unit cost of magazines, the finished goods. The value of such scrutiny is obvious. It helps lower the cost of the asset, a magazine, to improve gross margins.

However, they lavish no such attention on the expenses — the competencies — required to market and distribute these finished-goods assets. For example, extensive market research is routinely produced, but because of lax procedures almost half of the company’s marketing campaigns ignore it. No “industrial engineering” ensures that marketing managers even understand the research.

Distribution operations aren’t monitored with the same engineering discipline as the printing presses, creating costly errors that persist indefinitely. One newsstand received the wrong language edition for more than five years before the publisher’s finance department noticed. It was easier for the newsstand to return the unsold copies than report the mistake. The publisher’s expense for processing the returns was perceived as “unavoidable” customer service — an example of virtuous waste.

This is how the Vig lazily nibbles away at earnings. A company’s office furniture is typically managed more rigorously than the competencies that contribute half of the company’s market value.

Sniffing Out the Vig

To reclaim these losses, executives must perceive knowledge workers, their tasks, and their autonomy with a “factory eye.”

The root causes of waste on the assembly line and in the office are the same: excessive variation in output, needless customization, ambiguous decision rights, and inadequately documented processes. Although knowledge workers rarely recognize it, both types of work have repeatable patterns.

As the authority on value assessment, the CFO has the responsibility and resources to highlight waste, whether it’s tangible or intangible. And as the liaison between the CEO, the board, and the business units, the CFO is ideally positioned to lead the charge.

The first step is to reimagine the role of the finance group. Employees who perform internal reporting can be transformed into an industrial engineering (IE) group for intangible assets, just as a conventional IE organization is accountable for getting the most from the tangible assets.

Their first project would be to upgrade internal management reports. Finance should work with the business lines to create reports that expose virtuous waste. That’s not the way it works today. Business lines ask for reports; finance delivers whatever is requested. That often creates a plethora of conflicting reports that obscure how the business generates and loses margin.

As an example, tellers in a major bank receive incentives to send customers to lending officers, regardless of whether those customers are bankrupt or prosperous. These “prospects” are virtuously seen as “potential revenue.” A simple report would show how many unqualified prospects are shuffled through the lobby in this game.

After the unqualified person arrives at the officer’s desk, another game ensues. Up to 60% of the officer’s skills are wasted on mundane administrative activities, such as obtaining signatures, generating presentations, and retrieving loan files. Standardization would eliminate more than half of these tasks, but no one is assigned to look for standardization opportunities.

Let the production of the reports themselves be the first improvement target. The process needs to be “industrialized.” That means adapting the techniques used on a plant floor to create a disciplined “reporting factory.” For example, finance should create an inventory of existing reports and standardize and document the basics: report names, users, distribution lists. That kind of standardization is gospel on a factory floor.

Next, do the reports actually work? Are they accurate? Are their components interchangeable? In other words, are definitions and data standardized? Can the users in the business understand the reports? Do these reports have to be modified for the user’s purposes? Do they expose redundant and one-off activities? Do they miss some activities or processes?

When success is achieved in one area of management reporting, replicating it in other areas is a relatively simple task. Begin with one business area, and then extend and connect to its related sales and marketing groups. This will enable valuable connective reporting. For example, have marketing plans been reviewed with the contact center operations executives to anticipate volumes of calls from new customers or promotions?

The ultimate value of the Vig lies in the eye of the beholder. Knowledge workers see the waste in their methods and shrug it off as a negligible, unavoidable expense. Plant workers see their waste as a clue to hidden value — gamblers would call this waste a “tell”— and stop the assembly line to fix it.

Which way will you choose to see it?

William Heitman is managing director at The Lab Consulting, which advises companies on non-technology business-improvement efforts.