THE COMPLEXITY TAX: QUAD 4 AND THE DIRTY DOZEN | EP5

1,000 days. That's enough time to transform a company, but not enough time to waste. Welcome to The 1,000 Day CEO, the podcast about decisive leadership, sustainable growth, and building a business that thrives beyond any one leader. Your host is Bill Canady. Let's make every day count.

It's day 1 of the new phase. Now, not day 1 of the hold, day 1 of the simplification. We spent 11 weeks building the segmentation profit and loss statement. We had the quads, we had the kill list. And on a Sunday night, I sent the note to the leadership team that said, starting tomorrow, here's what we're going to stop doing. Monday morning, 7:40, an email lands from one of our largest distributors. They wanted a program renewal. That was nothing unusual in that. And of course, they asked for expanded terms, expanded stocking commitment. A price hold for 18 months. The product line in that program was a Quad 4 product. The customer mix underneath it was a B only, the bottom of our customer base buying the bottom of our product line. Holy cow. It's exactly what you'd expect to happen, and you definitely don't want it to happen. It was almost line for line the exact set of accounts my team had been told the previous evening We were exiting that week. And here we got a big order on our hands. What are we going to do? 12 hours. I want to tell you I had a plan for this. I did not. What I had was a room full of people watching to see whether the thing I sent Sunday night was a strategy or just a move. Did the boss just say we're going to do something and keep doing what we had been doing? Well, that's the lesson, isn't it? It's why I opened with it. The test always comes immediately. When you need it the most and want it the least. Not eventually, immediately. Usually from your biggest account. Usually before your own team has finished reading the memo. Your customers know which of your products they're getting away with buying. And they'll move to protect that before your people have updated the item master. They're going to get ahead of it. They don't have anywhere else to go to get this stuff. You're the one they want. It's hard to say no. So you got to plan for it. You gotta plan for this test. It's coming on Monday. Here's the proof. PowerBand Parts, $310 million industrial business. When I took it, 32% gross margins, not terrible. 8% EBITDA, kind of where you'd expect it to be in that low to mid single digits. This was in the upper piece of that. So not horrible, but lots of upside. It's respectable, unremarkable. And stalling. When we ran the simplification, this is 4 moves, which I'll walk through in detail. Order count came down to 38%. Average gross margins per order went from 19% to 31%. We like that. EBITDA rose 1.9 percentage points in the first quarter after implementation. And we closed an outsourced call center because the calls they'd been justifying it had stopped happening.

That's right.

Good things happening when you start simplifying. 38% fewer orders, 12 more points of margin on every order left. That's not a cost program. Nobody got laid off to produce those numbers. We just stopped doing things that didn't make any sense to us. So here's my promise. By the end of the next half hour, you'll be able to name the 12 places unprofitable complexity hides in the middle market company. Size the top 3 of them in dollars rather than in opinions. And answer out loud in a room without flinching the one sentence that kills more simplification programs than every other competitor you've ever met combined. And here's the plan. It's 3 moves. Audit the 12 and size the top in $3. Pick one reversible move and run it for 30 days. And write the pushback script and rehearse it with your commercial team before you need it. Remember, it's coming on Monday morning before you even got a chance to get the stuff in. So you're going to need it. It's 7:40. Prepare yourself. This is the 1,000 Day CEO, and I'm Bill Canady. Let's get into it. Starting first with, here's the problem. Let's define Quad 4 precisely because it gets used loosely and loose definitions produce loose, loose decisions. Segment your customers into A and B. A is the vital few at the very top. They're the ones we want to keep. B is everything else. You don't need C and D. It's either the ones you want The ones you don't want. Segment your products the same way. Now you got 4 boxes. Quad 1 is A customers buying A products. That's your business. Protect it with everything you have. That's the fort. You wanna treat it as such. Quad 2 and 3 are the mixed boxes. Good customers buying tail products, small customers buying core products. These are opportunities and they're in a different episode. It's coming up. So keep listening. You'll get there.

Mm-hmm.

Quad 4 is B, customers buying, T, products. The bottom of your customer base buying the bottom of your product line. That's what Quad 4 is. We've talked a lot about that in previous episodes. Quad 4 is where profit goes to die. And here's the number that makes people sit up. In most middle market industrials, Quad 4 is around 4% of revenue. 4%. That's right. Which sounds like a rounding error. And that's exactly the trap. It may be 4% of revenue, but it's somewhere between 20 and 40% of capacity.

Hmm.

4% coming in, soaking up something less than just half of your business. That's not good. 20 to 40 order lines, service minutes, expedites, credit memos, engineering changes, SKU helds, quote revisions, collection calls. Every one is a unit of capacity, and Quad 4 consumes them at 5 to 10 times its share of revenue. It's easy. They're small customers buying products you don't really want to sell, They don't have the systems to handle it. They're gonna depend on you to handle it, and you're not making any money doing it. Now, here comes the moment. You will build this analysis, you'll put it on a screen, and somebody in that room, usually somebody senior, usually somebody good, usually somebody whose compensation is attached to revenue, think salesperson, will say this sentence. But that's $4 million of revenue. I want you to be ready for that sentence because how you answer it in the next 30 seconds determines whether the Next 6 months are real, or are they just decorative? Are you just doing kabuki-style theater here? Are you getting something done? Here's the answer to it. It's 3 parts. Part 1, ask what the margin is on it. Not the gross margin off the ERP, the contribution after the cost to serve. Order handling, service minutes, freights, returns, working capital, you know, all that stuff. Make somebody go get it while the room watches. It's almost always somewhere between zero and negative. That's right. Worse than zero. It's a taker. Part 2, ask what it consumes. Put the capacity number next to the revenue number. 4% of revenue, 30% of order lines. Say both out loud in the same sentence and let the room sit with that in the gap. Gonna let that just settle there. Part 3, and this is the one that actually changes minds. Reframe the question. The question is not, Do we want $4 million of revenue? Of course we want $4 million of revenue. We're not crazy. We're in this thing to make money. But the real question is, what would we do with 30% of our capacity if we got it back? And is that worth more than the $4 million at zero margin? My sense is yes. It's always been yes for me. Can't imagine it's not gonna be yes for you. And the answer is yes by a factor of 3 or 4. Essentially every time. As I said earlier, it's always been a yes for me, which brings me to the line I want you to carry out of this episode. The 4% is not the cost. The 4% is the bait. Say that again. It's not the cost. It's the bait. It's how they lure you in, get you on that line, hook it deep. It's the thing that looks like revenue and functions as a trap, and it keeps you from doing the profitable thing because you can't bring yourself to walk away from a number with a dollar sign in front of it. Look, it's hard. You're sitting there, you're trying to make your number, make your budget, and now you're going to take some away? Well, that's exactly what we're going to do. Now, why does none of this show up until somebody goes looking for it? Complexity is the silent killer of profit, and it's silent for a structural reason, not a psychological one. There's no expense category called too much stuff. Well, you might see it in your E&O, but typically it's not too much stuff and it gets hidden pretty easily. There's no line on your profit and loss statement labeled complexity. There's no actual accrual for it. No owner, no monthly variance report. So at high, it's where you can't book it in capacity, in cycle time, in the 14% discount somebody granted in 2019 that nobody has revisited in the next 3 extra days it's going to take to close the month because of the exceptional of the approvals that you needed. Your finance team cannot show it to you because your finance team can only show you things that have a line item. There is no line item here. Okay, here's the part that keeps CEOs from being angry about it, which is important because anger makes you stupid in this particular meeting. Every one of these started as a good idea. We don't say, I got this really dumb idea, gonna cost us a whole bunch of money. No, these are good ideas. Let's go serve our customer. Every one of them. The custom configuration was to win a real customer, not someone with a made-up idea. The extra channel was to reach a real market that you weren't getting after. The pricing exception saves a real order in a quarter when you really needed it. Boy, we've all been there. The extra report answered a fair question nobody ever asked again. The extra layer was a good manager who needed a promotion and there was nowhere else to put them. We gotta look after our people, right? Nobody in your building woke up and decided to make a company complicated. They made it 100 reasonable decisions over 10 years, and the aggregate is a business that's carrying 30% of its capacity on 4% of its revenue. I was just in a meeting this weekend and it's exactly this. Like, how did we get so much taking care of so little? So the instruction isn't to stop being stupid, even though you might think it. The instruction is concentrate, don't spread. That's the whole discipline in 3 words. Your resources, your attention, your capacity, your best people concentrate on the vital few, not spread evenly across everything you happen to currently do. It's hard to do. People come up and got 25 ideas. We talked about it in the episode before. Get 2 or 3 things. Get one. Fewer's better. Better to win something than advance 100 things. Okay. Here's the framework I like using. I call it the Dirty Dozen. It's 12 sources of unprofitable complexity. These are the 12 I look at for in every business in this order. Get yourself a pen. All right. First one, SKU sprawl. The item master, nobody has pruned. Run it by a trailing 12 months volume and look at the bottom quartile. Second one, customer customization, special packaging, special labeling, special pa— palletizing, special anything. Each one was a yes that became permanent. I know we said we're gonna do it a short period of time. But somehow it stays there forever and that adds cost. Number 3, channel expansions. Direct distribution, dealers, marketplace, national accounts, a specialty rep group. Every channel needs its own pricing terms and conflict management. It's a lot. Number 4, pricing exceptions. The one-off deal price that never expires. Count how many active pricing exists in your top 10 SKUs. The number will surprise you. It always surprises me, but it will not surprise your CFO or your controller. It'll be like, I've been telling you folks this for a long time. It seems like you're starting to listen. 5, custom contracts, bespoke terms, bespoke SLAs or service level agreements, bespoke rebate structures. Every one is a document someone has to read before answering a simple question. Takes time, adds complexity, adds cost. 6, low volume products. Oof, we see those all the time. Distinct from SKU sprawl, these are real products with real part numbers that move 11 units a year and occupy a production changeover, supplier relationship, and the shelf. You don't want it. You're not making any money there. Number 7, niche services. The thing you do for 3 customers because you did it once. Field calibration, custom kitting, installation in one region only. You know what they are. Time to go get rid of those. Get to auger those out. 8, redundant systems. 2 ERPs from an acquisition you never integrated. Boy, if you only got 2, you might be lucky. Sometimes you get 10 or 15. Some of them are just Excel, right? And they're closing them from there. 3 CRMs, a pricing tool, and a spreadsheet that disagree. We've got them all. Go in there, get rid of them. 9, organizational layers. Count the layers between you and the person who touches the product. If it's more than 5 in a $200 million company, You're paying for translation. I was talking to a fellow earlier and they've got 11. Good reasons how they all get there, but there's no good reason to keep them. They're not adding value. They're slowing it down. They're making you less nimble and you're paying for the privilege of it. 10, meeting overload. Pull the calendars. Recurring meetings, headcount hours per month, times loaded rate. It's usually a bigger number than the last cost initiative you ran. It's one of the hardest things to get rid of. People hate meetings. They complain about them, as they should, but they never want to miss them. So get rid of the meetings. 11, report proliferation. Every report that gets produced and not read. There's always someone who reads it and they think, well, this is important. They don't want to get rid of it. Cancel them all. See who complains. See if you care. Put back the ones you need. It's a simple way to find out. Same way with software. The tell, cancel it for more than 1 month here and count the complaints. Zero complaints. I mean, that was free money. So cancel them all. All right. 12, process variation. 4 plants doing the same job 4 ways. 3 branches quoting the same product 3 ways, probably competing against each other. You're paying for the variation and getting nothing back. That's 12. SKU sprawl. Customer customization. Channel proliferation. Pricing exception. Custom contracts. Low volume products. Niche services. Redundant system. Organizational layers. Meeting overload. And finally, report proliferation. Plus, process variation. That's 12. There's a lot. These are things that just are low-hanging fruit, but someone's got to go do it. It's worth your time. Put someone on it. How to get rid of them? 4 steps. And step 2 is the one that most people get wrong. Step 1, audit all 12. All of them. Not the 3 you already have opinions about. You assign an owner per category. You give them 2 weeks, no more. In fact, less is better because Because they'll expand to do the time and they'll wait for the last couple days anyway to before they start pulling it. And you ask for a count and a dollar figure, not a narrative. You just need a couple of numbers. Step 2, pick the top 3 by dollars, not by drama. Now I need to sit on this one. In every room I've ever been in, the loudest item is not the biggest item. The loudest item is the one with the best story attached. The customer who yells, the product line somebody's proud of. The process fight 2 VPs have been having for 3 years. Drama is a terrible ranking criteria. It selects for the item with the most emotional energy around it. That's not always the one you care about. People just get, you know, fired up about things. And when it's usually the item with the sunk cost is highest and the payback is worse. So rank it by dollars, contribution recovered plus capacity recovered priced at your loaded rate. 2 or the top 3. That's your program. Everything else wastes. Go get those. They're big. It'll move the needle. Step 3, build an elimination plan with named owners and dates. A name, a date, a definition of done, not reduce SKU complexity. Boy, I see that all the time. Instead, 947 SKUs deactivated in the item master by March 31st, and the owner is Karen. We love Karen. Go get 'em. If you can't write it that way, you haven't decided anything. You've got a wish. Step 4, right? The final one. Communicate loudly what you're going to stop doing. Let people know. Make it loud. This is the opposite of what your instinct says. Your instinct is to do this quietly so no one panics. Quiet simplification does not survive contact with the first pushback. Because when a customer calls and yells, the person who takes the call does not know whether the policy is real, so they make an exception. And 40 exceptions later, there's no policy. Announce it internally in a room, externally in writing with dates and names, and make it expensive to reverse. That's not bravado. That's engineering. You're removing the option of quietly not doing it. You're locking it in. You're burning the boats. You're gonna get people on board. Now let me show you what this actually looks like. $310 million, 32% gross margins, 8% EBITDA. Okay. Not great. The first move that we did was we froze the discount. We isolated Quad 4 only book, right? Accounts that bought nothing but the tel product. That book carried average field discounts of 14%. 14 on price we didn't wanna make with people who didn't buy very much. 14. Granted over the years by good salespeople, one reasonable emergency at a time, and never revisited because nobody's job was to revisit them. We froze them. No new discount authority on that book. Existing discounts expire at the next order. That's right. That's, that's cold-hearted stuff right there, but it doesn't make a difference. We budgeted to lose roughly a third of the volume. I wanna be honest about that number. That was the plan. We told the board that was the plan, and we'd run the play if we'd have lost the whole third. The result, the EBITDA rose 1.9 percentage points in the first quarter after implementation. And the second result I did not forecast and now look for every time. Finance recovered 90 days of capacity. 90 days. Their year had been full of exceptional approvals, credit memos processing, and pricing reconciliation on the book. And when the exceptions stopped, a quarter of the finance department's year came back. I had no line item for that. Nobody does. That's the point. That's why you want to do it. All right. The second move, the commission ledger. At the start of Q2, the Quad 4 only book came off the commission ledger. If you sold it, you no longer got paid for it. 3 sellers chose to leave. Let that sit there for a second. I want to talk about that honestly, because this is where CEOs lose their nerve and it deserves better than a slogan. Those were not 3 bad people. They were not cheating. They had been building a living on a book of business that was destroying value, and they built it because we paid them. We designed the compensation plan. They optimized against it exactly as designed. We got what we were paying for. When we changed what we paid for, the economics of their job changed and 3 of them left. It changed enough because they left. Now that is the trade and it's a good trade. You lose 3 sellers and you get a sales force pointed at Quad 1. But run it like an adult. Do it at quarter boundary, not mid-quarter. Make sure that people know this is coming. Tell them a full quarter ahead. Don't pretend it isn't a pay cut for some of them. They can do arithmetic. They're smart people. And the moment you insult their intelligence, you lose the ones you wanted to keep. Okay. The 3rd move, payment terms. One of my favorite. 187 Quad 4 only accounts moved to a credit card on order over a single weekend with 60 days of advance written notice. And we charged a fee for credit cards, for God's sakes, because we had to pay it. 22 accounts declined. Fine by us. 22 out of 187 is about 12%. And I'll tell you what those 22 had in common. They were disproportionately the accounts our collection people could have named from memory. They self-selected out. We didn't have to fire anyone. We didn't have to argue. We changed the terms on the accounts that were structurally unprofitable and they removed themselves. Thank the Lord. 60 days of written notices isn't politeness. It's what makes 22 a clean exit instead of a dispute. All right. Move number 4, MOV and MOQ. Minimum order value, for those of you, of $500. Minimum order quantity at the SKU level. Order count dropped 38%. 38%. That's a big deal. Average gross margin per order rose from 19% to 31%. I like that. 12 points. The orders that disappeared were the $22 ones that cost $40 to process. You know what I'm talking about. And the customers who still wanted the product consolidated. They stopped ordering 4 times a month and started ordering once. It's good for them, good for us. Then the downstream effect, which is the one I pointed the board to. Customer service calls fell by enough that we closed an outsourced call center. We didn't need those. That center existed to handle order status, expedite short order shipments called on high frequency, the small orders. Take away the small orders and the calls stop. A whole vendor contract just ended. And that's music to your ears. Nobody got laid off to produce that. We stopped doing the work. One structural point, and that one determines whether any of this survives. Do not let the people compensated on the revenue decide which revenue to cut. That's right. Don't let the salespeople decide what's going. There's a misalignment in incentives. It's not a comment on anyone's integrity. It's a comment on incentives and incentives always wins. How you pay them. If your VP of sales owned Quad 4 exit list, that list will be short and it will contain accounts he already didn't like. He already thought they were leaving, and it will be revised upward twice before it's implemented. So build the decision differently. Finance owns the analysis. Operators own the capacity numbers. The decision sits with a small group chaired by somebody with no commission exposure. Don't ask them to take and eliminate themselves. Do it with people who. Or not judged by it. With you breaking the ties, you wanna own the piece here. If it can't get decided, you decide. Commercial gets a full voice and commercial owns the execution and the customer conversations because they're the only ones who can. That's their job. Commercial does not own the list. All right. The plan. 3 moves. Move number 1, audit the 12 and size the top 3 in dollars. Take the list, 12 categories, assign an owner to each. 4 people with 3 categories each is fine. Take 2 weeks, 1 page per category with 2 things on it, a count and a dollar figure. A count means how many, how many SKUs in the bottom quartile, how many active price exceptions, how many recurring meetings over an hour with more than 6 attendees, how many reports produced monthly. A dollar figure means contribution recovered plus capacity recovered at the loaded rate. Make them show the arithmetic. Then rank by dollars and take the top 3 by dollars. Not drama. Simple. Doesn't matter what people are passionate about. Do it on what's gonna be impactful. Write the other 9 on a separate page and put it in a drawer. You'll come back to them soon enough. Having them visibly parked stops people relitigating the issue. They know what's coming. They know where they're focused now. Second move, predict one reversible move and run it in 30 days. That's right. Reversible move. Might get it wrong. It's one, it's reversible. You're gonna try in 30 days. Reversible really matters. Your organization's probably never watched you actually stop doing something. The first one needs to teach them that you will follow through. Not that you'll bet the company though. Don't bet the farm here. We don't wanna put it all on one roll of the dice. Pick something you could unwind, unwind in a week. 3 good candidates and any one of them work. Minimum order value, set it, publish it, watch the order count, margin per month. For a month. Discount freeze on one defined book, one area, pick something, not the whole company. It's one book defined by segment with existing discounts expiring at next order. Or payment terms on one order account tier with 60 days of written notice. Pick whichever one your data supports is the best and your team will be least afraid of. You're not trying to win the war in one month. You're trying to get momentum, get people excited. You're trying to prove that a policy in this company is a policy. Measure 2 things at day 30: the margin effect and the capacity effect. The capacity effect is the one nobody logs, and it's the one that compounds over time. Once your equipment producing things, you make money and a lot of it. Move 3: write the pushback script and rehearse it before you need it. You are going to get pushback. Know what you're going to say before you have to say it. This is the move no one does, and it's why programs die. Customers are going to push back. Distributors will push back. Your own salespeople will push back. On behalf of customers who have not pushed back yet. Let them. Pushback is not evidence you've made a mistake. Pushback is evidence the policy has reached somebody, which is the entire point of having a policy. So write the script on a page and sit down with your commercial team and rehearse it with them out loud together with somebody playing the angry customer. That's right. Make it real. It feels ridiculous. I know, but do it anyway. You'll be surprised the impact. The alternative is a 26-year-old inside salesperson improvising your pricing strategy at 4:15 on a Friday. Good luck with that. And here's the principle the script has to encode. 4 things. You do not apologize for the strategy. You do not negotiate the principle in the moment. You do not promise to escalate. You do not invoke the supervisor as a possible source of relief. Let me take those one at a time because each one is a specific failure. I have watched happen. You do not apologize for the strategy because an apology is an admission that the policy is a mistake and the customer will correctly hear it as an invitation to keep pushing. Be warm. Be sorry the change is inconvenient. Don't be sorry about the decision. All right, you're trying to save the company. You do not negotiate the principle in the moment because whoever is on the phone doesn't have the information to trade correctly, and a concession made under pressure Becomes precedent inside of a week. Transition terms are negotiable. Timing is negotiable. The principle is not. You do not promise to escalate because let me take this up the chain tells the customer the real answer lies somewhere else, and now they'll wait for it. The person on the call is the company. That's it. That's who they are. Make sure they understand it. You do not invoke the supervisor as a possible source of relief. No, I'd love to help you, but they won't let me. That's the most human sentence in the world, and it is fatal. You've given away all your power because it tells the customer there's a they and they can be worked on. The script itself is short. The change effective on this date. Here's what it means for your account. Here are your 2 options. I can help you with transition, and I'd like to. If the customer keeps pushing, repeat the 2 options. Same words, warm, unhurried, identical. Repetition is the technique, not volume, not cleverness. The same 2 options delivered in the same way the 4th time, as calmly as the first. All right. What does it look like when it's working and when it's theater? Working is quiet and countable. SKU count is down, and you can say by how many. Order count is down and margin per order is up. A vendor contract got canceled. Someone's calendar has 4 fewer recurring meetings on it. And when a customer calls to complain, 3 different people give them the identical answer. That's key. Identical answer without checking with each other. Theater is complexity reduction initiative with a name and a logo, and it looks pretty. Theater's a rationalization committee that meets monthly and produces a list of candidates. Theater is a quad 4 exit list that's been revised upward 3 times and hasn't lost a single account yet. The test is simple and it's a count. How many things have you actually stopped? If the answer is zero, You're running theater, no matter how good the analysis is. And the analysis is usually excellent. And that's what makes it convincing. All right. 3 things worth keeping. Number 1, Quad 4 is a B customer buying B products, buying the tail products. And it's where profit goes to die. It may be 4% of revenue, but it's somewhere between 20% and 4% of capacity. When someone says, but there's still $4 million more of revenue, you answer with the margin after cost to serve. The capacity number next to the revenue number and the reframe. What would we do with a third of our capacity back? And what is it worth? Is it more than the $4 million at zero margin? The 4% is not a cost. The 4% is the bait. 2, the dirty dozen. The SKU sprawl, customer customization, channel proliferation, pricing exceptions, customer contracts, custom contracts, low volume products, niche services, redundant systems, or Organizational layers, meeting overload, report proliferation, process validation, process variation. Audit all 12. Pick the top 3 by dollars, not drama. Named owners, real dates. This is important. And announce loudly what you're going to do to stop doing these things. Every one of these started as a good idea. They were, but now it's over, which is why you can't be angry about it and you can't leave it alone. 3, the line gets tested immediately. So write the script first. You do not apologize for the strategy. You do not negotiate the principle in the moment. You do not promise to escalate. Very simple. Those 3 things will help you a lot. You do not invoke the supervisor as a possible source of relief and keep the decision away from the people paid on revenue. Discounts are frozen. That book off the commission ledger. 187 accounts to credit card on order. A $500 minimum order value. Orders down 38%. Margins per order from $19 to $31. EBITDA up 1.9 points in a quarter. Ooh, I like that. 90 days of finance capacity back. One call center closed. This business is ready to leap off the page and run. It's gonna grow. It's gonna grow profitably. Nobody was laid off to produce that. We just stopped doing things. So concentrate, don't spread. Oh, and the distributor who emailed at 7:40 on that Monday, we said no on the price hold, no on the expanded terms, and offered them the Quad 1 program instead at list. 6 weeks later, they took it. They're still a customer at roughly 2/3 of the volume and about triple the contribution. Triple. That was the trade we were willing to make. I'm Bill Canady. Now go do the work.

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