Executive Summary
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Despite the best efforts in many areas, the accounting and finance systems currently in use overlook the costs of complexity.
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The costs are hidden in the operating statements of a company until the period-end results show the adverse effects.
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It is time to recognize that these costs exist, identify them, and develop new metrics in the place of those that are missing.
Introduction
Accounting systems have come a long way in the past decades. Activity-based costing revealed where costs were being incurred and what was driving them. The blizzard of regulations following the debacles involving Enron, WorldCom, and others led to the passage of the Sarbanes–Oxley Act (in the United States) and many other new regulations. Although these are burdensome, they impose much-needed disciplines on finance and accounting.
In spite of this, one area remains unmeasured, untracked, and unmanaged: costs caused by complexity. I began studying this area in earnest shortly after the dot-com collapse. When an area comes under intense scrutiny, some details are discovered that have thus far gone unnoticed. This is the case with the costs of complexity.
As far back as 2001, Oracle CEO Larry Ellison described a “War on Complexity” in computer software. There were simply too many systems that were not integrated, and others that were very difficult to integrate. This fragmentation of systems caused huge complexity, duplication of effort, and waste (which Ellison’s Oracle Corporation hoped to solve).
Variety Can Add Value—If Managed Properly
On the other hand, there are instances when complexity—properly managed—can be a source of great competitive advantage. Structure, systems, and processes must be carefully designed to minimize transaction cost and complexity. One example of the productive use of complexity is the web retailer Amazon, whose breadth of offering is extensive, thus making it a “one-stop shopping” site for millions. While Amazon’s distribution system is always at risk of being overburdened by complexity, its front end handles the huge variety of goods seamlessly.
Similarly, US sandwich seller Subway assembles sandwiches to order from about thirty containers of meat, cheese, and vegetables, using just a half-dozen varieties of bread. It can make millions of sandwich (and salad) combinations, to customer preferences, with minimal waste. There are many other examples like these two. All depend on the right systemic design to keep complexity from growing out of control, causing waste and inefficiency.
Complexity Costs Are Hidden
When I first began to research why complexity costs remained unmeasured in nearly all companies, I discovered that it was because these costs are, by their nature, hidden in accounting systems. To bring this problem into perspective, let’s consider how complexity occurs and what kinds of waste it causes. It will become apparent why financial systems simply “overlook” complexity’s costs until the end-of-period reporting shows the detrimental effects.
There is no doubt that complexity’s effects are readily apparent in month-end, quarter-end, and year-end results, where they adversely affect both the income statement and the balance sheet. Unfortunately, the only place where they are visible is on the bottom line, or on a few lines of the balance sheet. Even then, there’s no indication of how these costs were incurred, or what might have been done to manage them.
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