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  • Gary Pine

Unpacking the investment chain

Updated: May 23, 2023

…a complete theory of how to invest to improve performance for people who need to design organisations strategically

Strategic design is really complex. Part of what makes it difficult is the few ways in which to frame an organisation’s problems that remains consistent across such a range of diverse concerns. These could be responding to customers, allocating capital, working out what technology to adopt, how to push sales, scoping projects, letting contracts…

One thing that can be counted on is time. Organisations process. Everything is a chain of events. These chains have different rhythms, intersecting and interacting in a complex, non-static pattern.

I wrote previously about there being a number of meaningful chains of events in an organisation, and that in general these fit into three categories:

  • the value chain — the core business of turning slightly less useful/valuable inputs into slightly more useful/valuable outputs

  • the decision chain — the observation of the core business, deciding whether and how to intervene, and then intervening.

  • the investment chain — deciding to spend time and money on things that will change how the previous two chains work.

Whilst the value chain and decision chain vary a lot from organisation to organisation and sector to sector (fundamentally they reflect the business purpose at hand), to my mind the investment chain is the most powerful for the purposes of strategic design because conceptually it is invariant — it stays the same across any and all organisations.

In this post I want to unpack the investment chain both as a framework for the analysis of strategic problems but also as a key tool for conducting strategic design.

Value chain squared

Before laying out a framework for understanding the investment chain, it is worth laying out really clearly what it does. For that we have to go back to the value chain.

The value chain has been a useful description of organisations since its formalisation by Michael Porter, although conceptually it has been around since at least Adam Smith’s pin factory. It shows the business as usual transformation of a variety of inputs into outputs that are saleable: that is products and services. In theory, the entire way in which an organisation thinks of its activities can be derived from its value chain through a hierarchy of ever more detailed tasks until one gets to each individual turn of the spanner turn and/or click of the mouse.

An obvious point: this transformation happens forwards in time — not in reverse. It flows from the past, to the present, to the future. Nuts, bolts and forgings turn into cars, not the other way around. If that value chain, that pattern of transformation, stays static — i.e the supply chain remains constant, the inputs (parts, labour, information) remain constant, the product mix remains constant, that customer preferences and behaviours remain constant — then it would be possible to manage an organisation simply by understanding the value chain process, its throughput volumes, the stocks at each point and its timings. And so even though the value chain may be static, the business is not. Changes to demand (outputs) and supply (inputs) are expected, as well as decisions on priority in times where these are mismatched (most of the time).

These are dealt with organisation’s decision chain — a transverse process to the value chain that transmits this information upward to management in order for decisive actions to cascade downward. It runs forward, not in reverse, so is performed essentially on a ‘past’ version of the value chain dependent on the latency of the decision making apparatus in the organisation. The decision chain makes interventions in the context of the same capacity, timing and configuration properties set out by the value chain. With a static value chain, there is only really one management imperative: to “control the bullwhip”. This frames the organisation as nothing more than one large production function to be optimised.

ASIDE: Note that the Executive still has leadership imperatives: to look after and support its people — this is not the same as management.

This set up however is fragile. The environment has a nasty habit of changing. So any organisation trying to manage business this way and wishing to operate in this universe will be killed off. The murderer will be technology, asset depreciation, regulation, customer preferences, or competitors whose value chains are just better. Anything that changes an input, assumption or constraint is potentially deadly.

The investment chain is second order to the value chain. It is parallel to the value chain, delivering important information and changes to the value chain in the form of:

  • creating it in the first place (a start up);

  • making it grow;

  • making it better (in terms of cost, quality or ability to control);

  • making it survive (e.g. competitors or market contraction); or

  • pivoting to/incorporating an entirely new chain or business model.

The investment chain governs the rate of change of the value chain. Assuming a business lasts more than a one off production run it cannot be avoided (and actually investment is a prerequisite for that one-off run as any founder will attest). So it is not a choice.

Framing the Investment Chain

The investment chain is the real-world way in which allocated capital earns an organic return in an organisation through changing how its value chain and decision chain works. Inorganic ways to allocate capital (buying companies, debt repayment, dividends, buybacks) just displace, postpone or pay back an action taken on an investment chain somewhere.

It represents the process of organisational transformation and can only flow forward — not in reverse. The chain is not quite comparable to the value chain in that the stages in Figure 2 represent a chain of logic, not a chain of activities. The green stages above relate to instances in time (i.e. they are capable of being time-stamped — this output delivered on this date), whilst the blue stages above have properties that vary with time (i.e. they are some function of time). Additionally, the stages in the value chain have the advantage of all being types of activity. In this representation, only the “investments” stage represent activity.

The chain is conceptually simple but analytically complex. I want to return to this important point later, but for now let’s unpack each stage and what each means.

#1: Investments — Targeting Change

Organisations continually make investments. Deployments of effort at the expense of the present for an improved future. Being completely dispassionate, the only purpose of this investment portfolio is to grant greater returns to an organisation or its wider context in the future. This is true in a shareholder, governmental or charitable setting. Note that “avoiding destruction” also counts as improved returns (particularly if the alternative to not investing is discontinued existence). Each investment usually requires an allocation of money, time, executive bandwidth, scarce delivery resources and appetite for the risk that the investment may fail even in spite of perfect execution. Examples are numerous, but I’ve listed below some of the key investments that are noteworthy:

  • Research and development (e.g. product development)

  • Technology implementation (both digital and platform)

  • Significant recruitment campaigns (or indeed redundancy rounds)

  • Training programmes

  • Complex data operations (e.g. cleansing, migrations, digitisation, indexing)

  • Complex, non-standard procurements (e.g. outsourcing contracts, construction, bespoke equipment acquisition or support)

  • Business transformation (e.g. operating model change, process optimisation, cost reduction, quality management)

  • Mergers, acquisitions, joint-ventures and divestitures

  • Regulatory compliance

  • Marketing, advertising and communications campaigns

  • Defensive measures (crisis PR, fighting lawsuits, patent enforcement etc.)

Do not read too much into the adjectives ‘complex’ or ‘significant’ describing some of the above. What will be complex for one organisation will be standard for another. The main criterion is whether or not the undertaking is sufficiently significant to be portfolio managed by the organisation as a whole rather than absorbed through normal business-as-usual spending.

It is right that the investment portfolio has a heavy financial emphasis. The investment portfolio represents the full extent of resources allocated in pursuit of the future — but that still means resources need to be spent in the present. Very few organisations have the luxury of being able to pursue every initiative. Available resources are limited and prioritisation is a thing. The most valuable resources are often not just financial capital.

#2: Outputs — Delivering meaningful things

Investments should beget outputs. If I fund a factory construction project, I should expect to see a working factory at some point. Broadly an output equates to an resource available to the business to use — either a completely new resource (e.g. a person being recruited) or the maintained availability of an extant resource (e.g. refitting an oil rig). Part built assets — like a half built factory — do not count, as they are not available for use, even though from a soulless accounting perspective the WIP asset contains some residual value. Common outputs are:

  • Buildings

  • Equipment (presses, transformers, planes, lasers…)

  • Staff into the organisation Uplifts in the qualifications/accredited training held by extant staff

  • Software

  • New or enriched information

  • Signed contracts

  • Compliance/standard adherence certificates

For each, a resource exists that allows the organisation to do more (or any) valuable work. Compliance certificates do not allow work; they prevent that work being written off as a result of sanctions on trading. Marketing/PR investments yield no outputs but prevent write off/reduce destruction of existing business resources.

It is strange to discuss outputs like this. They are surely so obvious that it feels as if they should go without saying. Surely these are the whole point of the investments in the first place? However it is both puzzling and at the same time depressingly common to spot portfolios with worrying ambiguity over what is being delivered. Many projects plain don’t know. This is often the first clue that an organisation’s investment chain is misfiring. An output should make resources available to a business. Or prevent ruin. Otherwise the investment is a white elephant.

#3: Capabilities — Achieving an effect

Capability is a problematic word. It has been interpreted differently by different organisations and different sectors. In areas like the military the word has a strict definition. In areas like policing, the word has a ‘sort of’ definition. Everywhere else there is little agreement on the definition. To compound the confusion, the word has been used (and occasionally abused) from a technical point of view in different ways by business architects, business analysts and people pretending to be business architects and business analysts. So it is worth definition.

…if I want to… then can I…?

A capability represents the complete amount of pre-requisite resources and their corresponding inter-arrangement so that a real world effect is achieved in a particular operating environment. It is the ability to perform a ‘verb’ if you like. Examples might ‘process an invoice’, ‘hire from the external labour market’, or ‘deliver wares to any global destination’. The test of a capability is the can I do it or not test. If a restaurant loses the ability to serve food, then it is not capable, regardless of whether it runs out of stock, runs out of tables, runs out of kitchen space, loses its chef or gets its hygiene licence revoked. The outcome to the binary question of can I serve my customers food is no. This is essence of capability: if I want to, then can I.

Actually this is half the story. Consider the capability to jump. Everyone is capable of jumping; the interesting question for the competitively minded is ‘how high?’. The capability to jump clear of half a metre is one thing — two metres is quite another. Equally, the corporate capability to deliver wares globally is one thing — to be able to do it within 24 hours, as a limited number of logistics firms can offer — is another. Capability has physical dimensions. How far? How wide? How much? How many? How fast? How well? How consistently? These can be applied to invoice processing, labour hiring and global logistics delivery right the way through to the highly complex technological or military concerns (e.g. could I launch a satellite, covertly, to any point in earth orbit).

The linkage to outputs: effectively absorbing the outputs of investments changes the physics of existing capabilities. Far becomes further, wide becomes wider, fast becomes faster. Or outputs can establish entirely new capabilities. Typically the former can be done with one investment. For example, invest in some technology — voila a faster invoice. The latter almost certainly requires a constellation of outputs, requiring a multiplicity of projects. The fact that a working capability does not arise without this coincidence of outputs is the raison d’être for the discipline we know as programme management.

The coincidence of outputs is a key feature of capability management as practised by Defence organisations. It is also often the primary feature of operating model design frameworks. Commonly, the acronym PPITF (standing for Processes, People, Information, Technology and Facilities) is given as shorthand for the different species of output that require this orchestration before any meaningful change of effect can be felt within the organisation. In general, to be capable, to create the effect, alignment is required across the following areas of output:

  • The right equipment and/or technology;

  • The right amount of people;

  • The right relationships between people (normally this requires hierarchies, contracts, effective division of labour, or healthy team dynamics);

  • The right training;

  • The right data;

  • The right facilities/infrastructure; and,

  • Actual knowledge about how to produce a meaningful transformation — i.e. how to combine the factors above to create the effect in question.

The key point here is the importance of the integration. The outputs from investment need to be combined skilfully for either the new capability to become self sustaining or for the previous capability to have its physics changed. The combination extends much more than ensuring the scheduled co-arrival of the outputs within a meaningful time window — the outputs also have to fit together and the actual desired effect needs to be demonstrably available.

Now for an annoying complexity. Capabilities result from the combination of outputs, but they can also result from the combination of other pre-existing capabilities. “Global delivery in 24 hours” is a good example. An organisation like that would no doubt need airlift, sealift and overland transport capabilities, but also access to tight consignment tracking (to confirm the order actually makes it to the destination on time) and 24 hour order placement and fulfilment (meaning a workforce working to shift patterns globally). Each of these elements is actually a capability in its own right, but the capability of interest is a resultant of the underlying capabilities working in a networked fashion.

ASIDE: This second source, from combinations of pre-existing capabilities is actually the norm. It is the essence of diverse specialised economy that the majority of the effects in an organisation get generated from other organisations. No organisation produces its own power, and creates its own food, and builds its own computers and sustains its own transport infrastructure, and grows its own humans… Generating capability is organisationally exhausting. This is because of the huge energy, information and focus required to “do” the integration step which requires coincidence of a number of outputs in the right place, at the right time in the right sequence and configuration.

This compounding of capabilities — effects from lower level capabilities combining to create entirely new effects — is a feature of almost all organisations. The capability to “retail food” emerges from the networked combination of lower capabilities (“source food”, “prepare food”, “accept financial transactions”, “advertise to customers”, “comply with food standards”). This in combination with a series of other capabilities might contribute to the larger capability of “host major sporting event”. Whilst tempting to align this hierarchy of lower and higher capabilities to frameworks that assign levels, and while this works as a rule of thumb for well understood business, in the end there are not any rules about how many capabilities can compound. This is a major source of complexity in large organisations, as line of sight as to which resources contribute to the availability and performance of capabilities can be easily lost unless rigorously maintained and can lead to management confusion about why an organisation behaves/performs as it does. In theory capabilities could compound, effects on top of effects, forever…

In real life this has a limit — it only applies inside the organisation in question. Capabilities can only be constructed out of the resources and relationships that an organisation can control — this represents a boundary. Note that relationships are explicitly included, meaning that contracts to other parties and their corresponding goods and services are within this organisational boundary, albeit that the capability that generates those goods and services are not (they belong to the supplier). The overall net effect of all the capabilities in an organisation gives the business its state.

#4: States — Aggregating effects

We are now at the point where we can ask what an organisation is capable of as a whole. Amazon is capable of global delivery. The United States of America is capable of near global projection of military force. SpaceX (might be) on the verge of re-usable space flight. All of the above are the emergent result of an advanced network of capabilities. These impressive effects are not the result of the direct addition of each capability one at time; network effects matter, its about the capabilities and the way they interconnect. Too often discussion on capability driven strategies focuses on the specific capabilities (core, supporting or otherwise) in isolation and not sufficiently on their interactions.

What an organisation is capable of is an emergent property of its underlying capability network.

This overall effect is described in a number of different ways: as capability systems, as coherence, or as a organisation’s production function. These are essentially equivalent. What an organisation is capable of is an emergent property of its underlying capability network.

The result is a change in the physics of the value chain as a whole, the adjustment of the value chain or a transformation of the value chain. This aggregate position is best described as an overall organisational state. Other emergent properties result from this state, including overall organisational productivity, regulatory compliance and product/service quality. These properties are emergent because they cannot accrue to individual capabilities in the organisation. They are only meaningful in the context of the whole. Profit and loss are not meaningfully attributable to individual business functions.

For complex organisations, the background flow of outputs (resulting from investments) mean that micro-variations in the aggregate state are happening all the time. Each state therefore can only represent a snapshot or slice of the organisation in time. So the properties of a complex organisation are always evolving; a function of the investments made, the outputs appearing, the capabilities working in concert. The state of business sets out the meaningful properties with which those looking from the outside would interact.

#5: Environment — Responses to scenarios

Managers can only control what is within the organisational boundary. Everything outside of that is part of the vast and ambiguous ‘environment’. This environment has the nasty habit of being more complex (by an infinite order of magnitude), being in a constant state of flux, and as result — being fundamentally unknowable, let alone predictable. Sometimes sales spike, and sometimes they flat-line. Sometimes competitors surge, sometimes they are quiet. Sometimes the environment feels like it can be forecast. Mostly that’s an illusion. If only things within the organisational boundary can be controlled then the key is to understand response.

Organisations nevertheless spend significant amounts of resources trying to predict to the environment. Everything from monitoring marketing fads, changes in customer demographics, competitor responses, regulatory changes to great macroeconomic fluctuations. Environmental changes in government are particularly complex — even random. Government organisations are exposed to everything from the amount and mix of crimes committed, the distribution of aptitude amongst schoolchildren, and in the case of A&E departments quite literally the number of people falling over. They attempt to predict correspondingly.

Sensing the environment — i.e. opening the eyes and ears of the organisation to data about outside conditions and the extent to which those conditions represent threat and opportunity is an indispensable capability. However, predicting the environment is a ultimately a fool’s errand, especially in this age of increasingly sexy analytics. We have the most exact physics known to humankind, with hundreds of thousands of data points across the world when it comes to predicting the weather — this we can only do with fidelity two to three weeks out. What is really needed is predictions about how our organisation will behave given fundamentally unpredictable and unknowable environmental dynamics. Especially the properties of the scenarios likely to kill the business.

This is a crucial distinction. Unfortunately, all organisations are at the mercy of the environment. There is a little point in attempting to crystal ball what it will do. Future predictive effort should be on how your organisation will respond, not on fortune telling. An internalised appreciation of this distinction is what enables capable managers to make genuinely strategic investments, which broadly fit into three categories:

building resilience to improve response to adverse conditions;

building a position of enduring strength to capitalise on advantageous conditions; and,

building the ability to learn from and improve under stressors (this is arguably the most powerful).

These investments made in respect of the environment are almost always counter to those required to optimise an unexposed value chain.

#6: Performance — the result that matters

We find ourselves at the end of the investment chain. A series of projects yielding meaningful deliverables that change how individual effects are generated inside a business that combine to produce aggregated organisation-wide behaviour that then interact with an unpredictable environment. The net effect — where state meets environment — is performance, which broadly has four facets.

The environment can always concoct circumstances that test the most established of organisations. So the first facet of performance is continued survival. This is not trivial. Taken over a long enough time period there are very few organisations that ever achieve it. Whilst this is (rightly) an existential daily reality for businesses and charities, government organisations can also fail. Entire countries are not exempt. It is sometimes seductive to conclude that this is indictment of the capability of the failed organisations and to attribute that failure to something being ‘wrong’ in the organisational management, strategy or leadership. This is to misunderstand the ferocity of the environment (…ask owners of new restaurants…). Survival trumps whatever mission an organisation might have; expiring prior to mission completion is de facto mission failure.

This leads to the second facet of performance — the effectiveness of mission accomplishment. Its measurement varies dramatically across types of organisation, some of which have implicit missions. Commercial missions demand the generation of profit. Charitable missions demand the generation of donations. Government organisations fundamentally need to fulfil policy outcomes. For each, this effectiveness of mission accomplishment is the extent to which the outcomes of the value chain meets the goals the organisation has set for itself (whilst surviving).

The third facet of performance is energy flow. For almost all organisations the unit of energy is money and therefore energy flow and cash flow are basically the same. Note that there are exceptions; an example is military campaigns, where energy flow is better represented by the flow of logistic materiel than money. Key accounting features give proxies for energy flow: the profit position (rate of energy surplus), balance sheet position (energy stock) and cash flow properties (true energy flow). Energy determines the ability of the organisation to act, acquire and allocate resources and (to the extent that the organisation can store energy/value) it represents a sense of the longevity of the organisation. This relationship underpins the aphorism ‘revenue is vanity, profit is sanity, cash is king’ as well as the seniority of the balance sheet to the P&L in shareholder analysis. These metrics and their governmental/charity equivalents represent the crucial measure of interaction between business state and environmental conditions.

The final facet is risk exposure. Risks are generally present against all the previous facets, and represent a lack of knowledge or that which is fundamentally unknowable about the environment or the future. For example in financial services, the level of market and credit risk borne by the organisation is a rich function of both the environment and decisions taken internally. As banks found out good ‘point in time’ survival, effectiveness and energy metrics make no difference if you’re overexposed to the wrong assets at the wrong time. Good measurement of risk should give leading indicators for the extent to which the organisation could be putting either its parochial survival in jeopardy or that of a wider system of interest (a parent company, a branch of government, a society).

These facets, lying at the end of the investment chain, should provide orientation for effective strategic design. Linking the start of the chain to the end, the key is to effective scope, select and track investments that make a well understood contribution to enduring survival, mission effectiveness, energy flow and risk exposure.

Analysing the Chain: Simple, but not easy

To recap, the investment chain is second order to the value chain, and describes its rate of change (see Figure 4). It is conceptually invariant. It’s the same for drug companies, police forces, investments banks, pet charities and sweet stores. Conceptually, this is straightforward enough to grasp. And this is sufficient to be able to do strategic design activities and/or understand the contribution of projects to meaningful outcomes through meaningful operational change.

This is not the case analytically. Even a medium-sized organisation (one that perhaps turns over between $100 million and $1 billion) typically have 100+ investments in-flight delivering outputs stretching from the immediate future through to 5–6 years in the future. Those same organisations may contain 50 or 60 discrete capabilities linked in a complex network and interrelated through multiple connections some of which represent reinforcing or balancing feedback loops. Predicting the emergent state properties are at best low — resolution and/or subjective. Understanding how this interplays with the environment is particularly difficult with a number of predictable, non-predictable and fully unknowable variables in constant flux amongst customers, competitors, suppliers and regulators. It is a classic big data problem; if only it weren’t so thorny a problem getting the data…

However, the tools to begin to do this are beginning to emerge, using the observation that time is the constant throughout this complex framework of analysis. The true strength of the investment chain is that despite the difficulty, it is analytically tractable. It means decisions are model-able. In the endgame it means that organisations are capable of being simulated…

Conceptual invariance. Analytical tractability. When testing alternative frameworks for understanding organisations for the purposes of strategic design, ask yourself whether it hits these two powerful standards.


Author: Dave Williams | Consulting | Deloitte MCS Ltd

Article reposted with permission from Dave Williams


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