When we first meet most of the companies we work with, they are generally small to mid-sized business firms in the process of transitioning from entrepreneurial to enterprise.
By definition, entrepreneurial management is all about risk-taking.
The first great entrepreneurial leap—the first great risk—was found in making the decision to start the business at all. Next, most entrepreneurs take the lead in finding employees they trust and frequently give these first few employees significant latitude in making decisions and taking actions in the best interest of the business.
But, organizations become complex very fast.
If an organization has two people in it, there are only two potential paths for the flow of information or decision-making.
When the firm adds the third person, the number of potential paths for information flow and decision-making becomes six.
Add a fourth person and the number grows to 24 different unique paths by which information and processes may flow and for which decisions may need to be made.
With only five people in the organization, the number of distinct potential paths for information and process flows leaps to 120, and with six, the number grows to more than 700 (720, to be precise).
When a seventh person is added, the potential number of paths by which information may flow, business processes may be executed, and for which decisions may need to be made becomes 5,040.
Here is a chart for the rest of the numbers up to 15 employees:
Yes. That’s right. With just 15 people involved in your business, the number of potential lines of interaction for information, processes and decision-making grows to more than 1.3 trillion.
Reliable Entrepreneurial Intuition
When these small businesses were launched, chances are they were guided mostly by what we call the entrepreneurial “sixth sense”—a seemingly innate ability to draw conclusions based on simple calculations and a small number of factors like:
- “Throughput” (T) (~ gross profit) as being the difference between a potential change in revenue (from an opportunity) and the Truly Variable Costs (TVC) of obtaining that incremental revenue
- “Operating Expenses” (OE) sometimes referred to as “the nut” that has to be cracked every month, and
- “Investment” (I) being the amount of money that may need to be paid-out one time in order to take advantage of a perceived opportunity
Entrepreneurs generally can do (on a napkin, over lunch) this simple calculation in assessing any opportunity that lies before them:
Total Profit = Revenues – TVC – Operating Expenses
For any given opportunity, then, this becomes:
delta-Profit = (delta-Revenues – delta-TVC) – delta-Operating Expenses (OE)
[Note: the delta- expression means “change in”.]
If any one-time investment is required in order to leverage the opportunity, the entrepreneur quickly leaps in his or her mind to this calculation:
delta-Throughput (T) = delta-Revenue – delta-TVC
Therefore,…
ROI (return on investment) = (delta-T – delta-OE) / delta-I
In a very few moments, even if the numbers being used are not 100 percent accurate when rounded to the nearest penny, the entrepreneur has numbers that are close enough to be able to assess any business opportunity set forward. Frequently, he or she can usually do these calculations in their heads while carrying on an intelligent conversation at the same time.
Remember, in most cases for this kind of decision-making, being approximately right is far more important than being precisely wrong. The number are going to “wrong” in the final analysis—the question is only by how much they are wrong. At this point, these are forecasts and estimates in any event.
Connecting the Numbers to the Proper Actions
Notably, the entrepreneurs’ intuitive ability to manage their organizations and guide them towards success doesn’t end with doing these kinds of calculations. These managers intuitively understand the connections and interactions between specific execution and the financial result proceeding from the action.
The connections (shown in the accompanying figure) between actions taken to change Throughput, inventory (or investment) or operating expenses, and their corresponding effects on net profit, ROI and cash flow are held in them minds of most entrepreneurs with crystal clarity.
As a result, these leaders also know intuitively how to direct their organization toward achieving more of their goal. And, once again, their goal—especially in the early days of rapid growth—is also crystal clear to the entrepreneur.
Typically, the entrepreneur’s goal is to help his or her company make more money tomorrow than it is making today. It’s as simple as that.
Yes. These entrepreneurs might want to achieve their goal of making more money through intermediate objectives such as having the best customer service, or the finest products, or other means; but their goal is clear. As a result, their leadership is unmuddled, unadulterated, and they are able to offer clear directives to their staff as to how to leverage opportunities they may see before them.
Clarity Lost
So, what happens to the entrepreneur’s clarity on all of these matters as they organization grows in size and complexity?
Well, by the time the company has 15 people at work in it, one can hardly blame the entrepreneur or other executives in the business for not being able to necessarily understand which of the 1.3 trillion potential paths through the organization are actually being used for the movement of information, the execution of the customer-to-cash streams, and decision-making.
Frequently, the formally defined ones are not the paths actually affecting decision-making and outcomes.
The natural course for human beings faced with seemingly overwhelming complexity is to try to break down the complexity into smaller, simpler subsystems. In business, we call these “departments” and “functions.”
Peter Senge, writing in The Fifth Discipline stated the problem concisely:
“An acceptable way of tackling complex problems is to break them down into a series of simpler, more manageable problems. People pay an enormous price when they adopt this approach. We lose our… connection to the larger whole. When people try to see the big picture, they try to reassemble the fragments in their minds…. However,… the task is futile, similar to trying to reassemble the fragments of a broken mirror to see a true reflection. Thus, after a while, people give up trying to see the whole altogether.”
In attempting to make the leap from entrepreneurial to enterprise, the executive team works to break down the problems to make them “more manageable,” and in doing so, they lose their connection to “the whole.”
They can no longer, as the old saw goes, “see the [whole] forest, for the [individual] trees” get in the way.
This leads to stagnation. Changes intended to produce one result are found, instead, to produce a different result—or so many negative side-effects that the change must be abandoned or, at least, partially reversed. Then another method is tried, frequently, too, with poor results.
Managers soon feel “lucky” if one-in-three of their proposed “corrective” actions has any measurable positive impact on the company’s bottom-line.
Worse! “Luck” becomes, in fact, what is driving what success is achieved, because almost everything had become an “experiment,” even if this fact is not admitted openly amongst the management team.
There is a Way Back
We believe there is a way back. There is a way for a business attempting to leap this chasm from entrepreneurial to enterprise to once again see their business as a functional “whole.”
As believers in inherent simplicity, we are confident of tools and techniques that can help you and your management team regain a healthy and accurate view of how your enterprise actually works—end-to-end.
We have proven in working with our clients that it is possible for a team of executives and managers to quickly and simply begin to see once again which of the more than 1.3 trillion paths of interaction are actually being used in a business enterprise.
It is not untypical of our clients to say, after working with us with this method: “We have never seen our business so clearly as you have shown it to us.” And, they invariably say this with great gratitude.
And, once you learn to use these tools, you may do so on your own. Your business will continue to improve for as long as you choose to continue your POOGI—a process of ongoing improvement.
We are interested in your comments. Please leave them here, or feel free to contact us directly, if you choose.
Senge, Peter M. The Fifth Discipline - The Art & Practice of The Learning Organization. New York: Doubleday/Currency, 1990.
