What is Internal Entropy and How Business Engineering and USALI Can Combat It

What is Internal entropy

A very senior work mentor at The Tamara & a former Tata Group CEO once gave me a 30-second lesson while we were driving to Mysore to evaluate a hotel. His advice? Focus on two simple variables: revenues and costs. By drilling down from these, you can identify where profitability issues lie and develop strategies to fix them. It’s a lesson in combating internal entropy and aligning organizational focus with long-term profitability—a lesson that has never been more relevant.

This concept of balancing innovation with cost efficiency was echoed recently at the Intrapreneurship Conclave hosted by my wife, Puja Kohli. During the event, a participant asked Mr. Gopalkrishnan how organizations can encourage innovation while staying cost-conscious. His response? "Business Engineering." He explained that business model innovation significantly increases an organization's success with existing products and technologies. Crafting a compelling value proposition, for instance, can propel a new business model to scale up customers and create a lasting competitive advantage.

These insights underscore the importance of strategic focus and the need to avoid the pitfalls of internal entropy, where misplaced priorities can derail an organization's growth.

Case Study: Two Mid-Market Hotels in a Tier 2 City

To bring these concepts to life, let’s examine a case study of two mid-market hotels—Hotel A and Hotel B—both located in a tier 2 city. Despite their similarities, the financial performance and strategic positioning of these hotels vary significantly, largely due to how they manage their internal focus and resources..

The image shows that while both hotels have similar room counts and coffee shop areas, Hotel B has dedicated banquet venues and a smaller built-up area. This difference in facilities reflects their divergent strategies, which are further evident in their financial performance.

Organizational Entropy: Conscious and Availability Bias

Organizational entropy often arises from a combination of cultural and systemic issues. Leaders may face pressures to protect their teams, leading to what I term 'Conscious Bias'—the tendency to camouflage or distort information within the corporate environment. This bias is not just a byproduct of individual behavior but is deeply rooted in the organizational culture that prioritizes face-saving over transparency.

Compounding this issue is 'Availability Bias,' where management relies on the most readily available reports—often in the form of PowerPoint slides or Google Analytics summaries. These reports, while convenient, can lead to superficial decision-making. The danger here is that leaders make decisions based on outdated or incomplete information, rather than engaging with live data that can be dynamically filtered and analyzed to reveal the true state of affairs.

In the context of Hotel A and Hotel B, these biases manifest in their operational strategies. Hotel A, for instance, has heavily invested in banquet spaces, aiming to boost revenue through large functions. However, this approach, driven by the operator's focus on topline growth, overlooks the finer details of marginal profitability. The operator, who benefits from a 3.5% fee on the topline, has little incentive to scrutinize whether this strategy is truly profitable in the long run. This issue is exacerbated by the lack of comprehensive accounting practices like USALI, which would provide a more accurate breakdown of costs and profits.

This case highlights how both cultural tendencies to protect and distort information and the reliance on inadequate information systems can lead to misguided strategies that ultimately harm profitability.

Financial Performance: A Closer Look

The financial performance of both hotels further highlights the impact of their strategic choices. Here’s a detailed comparison:

Hotel A generates higher revenue due to its extensive banquet operations. However, this comes with significantly higher expenses, leading to a lower operating profit after operator charges compared to Hotel B. Hotel B, despite having fewer revenue streams, achieves higher profitability by maintaining lower operating costs and a more balanced incentive structure.

USALI: A Crucial Component in the Profitability Framework

For example, in the above case, Hotel A's failure to use USALI may lead to misaligned financial reporting, where revenue appears strong, but the associated costs—like staffing, utilities, and maintenance—are not accurately captured. USALI’s comprehensive categorization of revenues and expenses ensures that these critical cost factors are accounted for, providing a clearer picture of true profitability. This approach prompts an essential question: Are you sure your 50:50 rooms-to-F&B mix is profitable?

Corporate Anorexia and the Shift Towards Profitability

The term "corporate anorexia," coined by CK Prahlad and Gary Hamel in "Competing for the Future," describes a scenario where companies cut costs and employees to such an extent that growth becomes impossible. In many organizations, sales and marketing departments are often the first to suffer, as budget cuts are made to produce short-term profits.

However, the advent of RMS, (Revenue Management Systems) and tools like Hotstats that leverage / help you performance benchmark using USALI - has now shifted the focus from merely cutting costs to maximizing profit. This strategic shift, which began in the early 2010s, highlighted the importance of adopting a profit-centric approach rather than a cost-centric one.

Profitability & Business engineering:

My mentor's advice about focusing on revenues and costs is more relevant than ever. By drilling down from these variables, organizations can identify areas with profitability issues and develop strategies to address them.

Reflecting on this, I realize the profound impact of 'hanging out'. I look forward to these interactions just as much as I do our board meetings. It’s these 30-second lessons—these insights—that are the real gold nuggets.