Sleepwalking into structural decline

Gemini AI’s rendition of what could have been before the decline.

Change is rarely linear. Small changes can add up to massive achievements or strategic risk and structural decline. All leaders need to take a longer term view. Here’s how.

The long term impact of annual budgets

It’s budget season here, and I’ve been thinking about the compounding impacts of small changes over time.

I like CPI as a starting point.

A well respected Chair once said “Any company should be able to achieve CPI profit growth without doing anything interesting. At a minimum, a well run company should be able to achieve CPI + 3%. Anything less than that and the team is underperforming.”

Put another way, not achieving this is falling behind while others grow.

And anything less than flatlining is possibly structural decline or hollowing out – particularly if this happens multiple years in a row.

This is a great rule of thumb for whether a company is performing well, or whether a department or service is hollowing out.

In the case of a cost centre or government agency, my starting point is CPI less 0.5% while maintaining the same level of service. Sometimes I’ll substitute wage growth or specialised inflation indices as a base instead of CPI. But the principle is the same – improvement in real terms (after inflation is taken out).

Then the goal is 3% better delivery and outcomes for the same inflation-adjusted cost base – a similar standard as the one at the start of this article and what we should all expect from a listed company.

This is outcomes across all domains (social, environmental, future capability) and not just financial – although financial is always the budget anchor. (Here’s a quick refresher on six capitals, the SDGs and Donut Economics to get your thinking going – in many ways. the inverse of the WEF Global Risk Report).

This is the minimum starting point. Anything less could be driving a wedge that becomes a chasm.

More on that later.

The wedge and the chasm

If a business grew by 3% a year, how long would it take to grow by 20%?

And if a business or department shrunk by 3% a year, how long would it take lose 20%?

The answer is just over 6 years for growth, and a few months longer for shrinking.

Grab a calculator and enter 1.03. Then hit the times (x) button and then hit the equals sign 6 times. And then a few times more and watch the numbers go. Exiting right?

Then do the same thing but enter 0.97 (3% reduction). That’s what atrophy and structural decline looks like.

3% might be revenue. Or cost base. Or talent. But it could be IP. Or market share. Or customers served. Or customer value. Presence? Relevance? Any of your top line measures.

The 20% rule

20% has always been a rule of thumb for me for any change being significant enough to engage with as a management consultant, advisor or sponsor.

Anything less has often failed to capture my interest.

20% is a significant change to what you did previously. It opens up new frontiers and possibilities.

Anything less is still worthwhile and necessary as part of normal Kaizen and doing worthwhile work, but it’s not game changing in a single cycle.

That’s not to say you need to do it fast or all in one go.

Slowly and smoothly is great. Kaizen and all the quality science will get you there. Think Atomic Habits, and you’re on the right track. 3% improvement will get you there in 6 cycles. 1% will get you there in 18.

But sometimes you’ll want to go faster. Or need to. This is step change and requires a different approach.

To get there in a single cycle, you’ll want dedicated effort, possibly new skills, capabilities, thinking and extra bandwidth. Some thinking on change management that goes beyond sending people to a training program is necessary. And the bigger the change, the more this is necessary. This is step change / discontinuous change.

The trick is to do both – to walk and chew gum at the same time. Chase a few big goals that are in step with the today’s challenges, opportunities and people’s capabilities that keeps them in the challenge/skill sweet spot.

Optimise for this when you can.

Sleepwalking into structural decline

So that’s the growth side of the equation. That’s fun and exciting. Let’s talk about decline.

Let’s grab that calculator again and see what happens over a decade.

Grab it, and put in 0.97 and hit the times (x) and then the equals sign 10 times. You should get 0.71 – or just under a 30% reduction in 10 cycles.

Then let’s see how long it would take you to get back to where you started. Multiply 0.71 by 1.03 again and see how long it takes to get back to where you started.

That’s 12 years (not 10). This is asymmetrical risk in action.

So it’s a long way back to where you would have been. Which is fine, if everyone else was standing still.

They weren’t.

If everyone else has grown 3% during that 10 years… they’re 50% ahead of your baseline and about 80% away from where you are now. This is what I and the team from Resilient Futures call – “the chasm” or “a bridge too far”.

Put another way, even if you doubled your normal improvement, (6% instead of 3%) it would take you 13 years to close the gap.

By then the world has moved on, and there isn’t enough capital or capability for find your way back.

This is where structural decline and hollowing out come from. It’s particularly relevant for government and cost centre budgets.

This is what we need to watch for, when approving those 3% cuts to anything that impedes capability or growth for more than 1 year in a row.

Death by 1000 Accountants

Think about any product or service that is not great any more, or hollowed out, or doesn’t exist any more. Probably it followed this sort of pattern.

This is the difference between Leaders and Administrator Managers.

Leaders leave the place better than they found it. They help the organisation punch above its weight. This is not growth for growth’s sake (although it can be), but usually is about outcomes (benefits for multiple parts of the value chain – customers, staff, suppliers etc), and impact (legacy and a better life for everyone in it).

Administrator Managers can shrink a department or organisation’s muscle by 10% in 3 cycles, to the point where it is no longer in the same weight class. And capabilities hollowed out – possibly generationally with no road back.

It keeps the accountants happy, but no one else. This is hardly a source of joy.

Breaking the pattern

There’s a lot in this, but at the simplest level there’s three things in your planning cycle you can do:

  1. Budgets and goal setting:

    When setting or approving an annual budget or goals, pay attention to the multi-year trend (last 2-3 + next 2-5) and not just this year.

    Are you approving accelerating capability and building muscle? Or endorsing and going along with loss of muscle and structural decline.

  2. Risk assessment:

    Most risk assessment is necessary anchored in the near term (within the next 12 months) and the known knowns. This is convergent thinking and deliberately blinkered. It is focused on execution and BAU.

    Strategic and structural risk requires a different lens and thought process.

    At least once a year take a broader view that looks 5-10 years forward and looks back over the last 5, with a particular view on your organisation’s capability and positioning and long term trends.

  3. Strategic Risk:

    Undertake a dedicated exercise on your strategic risks before you start your strategic planning cycle.

    Do this for every planning cycle.

    Get fresh thinking involved from outside your usual cohort to unlock your thinking and reveal blindspots. This will help you know where you’re at, whether your strategy is off course and where the possibilities are.

    While risk is the focus, this timing then gets everyone into the art of the possible (rather than the art of the now) and sets everyone up to get the strategy right with bigger thinking that’s in tune with exponential change.

    This is our speciality. If you’d like to know how to do this, or would like to freshen your thinking please get in touch.

For more like this, you folllow Todd on LinkedIn, or subscribe to the Davies Report.

Resources and other reading