Experience shows: large automation projects are risky and are likely to be unprofitable. And yet, chasing white elephants is a dominant activity of large teams in sales departments of almost every logistics automation company.
Why Discussing the Risk of Large Projects?
Throughout my time in automation sales of a major warehouse automation company, I have rarely seen any large project delivering profits for us or for our competition. Some of them were beneficial for our customers (though certainly not all of them; in fact, most very large projects fail to deliver on customer expectations, too), yet you could safely assume that once a project exceeded an order volume of €50 M or so, it would take several small or medium-sized projects to make up for the loss incurred in a big project.
I made this point once in a seminar on project management which was attended by some people from the oil industry. To my surprise (because I had not formed a strong opinion about large projects back then) the oil people confirmed my notion that large projects tend not to make money; they told me that all their prestigious projects senior management allocated so much attention to ended up losing money.
On my way back from a client I got to know the gentleman who sat next to me in the plane. He was a commissioning engineer for a company selling large mixing machines for all kinds of industries. He has worked in some dozen countries with projects of all size. I asked him what the typical project sizes in his industry were, and what some of the biggest projects were he was involved in. Then I asked him if they made money on the large projects. He did not have to think for a second but replied immediately: “No, the big prestigious projects all ended with a loss”.
While this was certainly no exhaustive scientific investigation, it made me think: if people from entirely unrelated industries all report the same finding with great regularity, there may be some systematic problem with large projects. I believe it is fair to say that projects of different size – and due to their very size – have different risk profiles. And to me it looks like for some reasons risk increases with project size in a highly non-linear manner. So I sat down and looked at some of the reasons I experienced which led large projects to end with a loss, and I tried to categorize these reasons.
Reasons why Large Projects are Risky
Size Increases Complexity
Let us start with one of the most important drivers underlying risk – complexity. Complexity is quite an exhaustive topic and we could just talk about complexity all day. I attempt to keep this section concise.
First of all, what is complexity? A system is said to be complex if its behavior cannot be fully explained by reference to the functioning of its constituents. If you take it apart, a complex system ceases to exhibit the very phenomena that you want to explain. In this case, the system has emergent properties; properties which do not belong to any of the system’s constituents. And this is different from complicatedness which merely is a quantitative escalation, still obeying a “reductionist world view”.
Now, what drives complexity? The first driver is numerousness. When you increase the number of elements in a system, you also increase the number of possible combinations. This in itself could merely lead to complication instead of complexity. It leads to complexity, however, in combination with another driver – interdependency. Elements in a system mostly do not function independently of each other. That also means that if you change something in element A, element B or element C could be affected, and vice versa. For example, if you change the load carrier while engineering an automated warehouse, you would have to adapt the racking configuration, maybe the conveyors, maybe the palltizing robots or dolly stackers; maybe you would have allocated the SKUs differently to the various storage and picking areas in the system if you had known the new load carrier from the beginning. Chances are you will overlook something and you are best of starting over. Another example is your customer decides they want to increase the number of SKUs from 8.000 now to 20.000 in the future: possibly your entire logistics concept would look differently. Yet another example is that while you optimized the entire logistics concept for worker productivity, some senior manager comes around and tells you that the sytem needs to enable 1-hour delivery…
Importantly, the links of cause and effect are not always easily visible. They may be indirect – and, worse, there can be a time delay between cause and effect which significantly inhibits our learning capability. (Because of that time delay, by the way, managing a company by financial results is similar to steering a car through the back mirror. By the time you get the numbers, the cause of these numbers needs to be found long ago.)
Variability and variety are the next drivers. I make a distinction between variability and variety. Variability in my interpretation relates to the circumstances a system has to deal with as input, or which it creates as output, such as variability of customer demand and variability in quality of products leaving the assembly line. In manufacturing and logistics, variability is mostly something negative. Variety, on the other hand, often is a decision, something that is desired, and provides options to choose from. This has mostly positive connotations. Variety can lead to variability, however, which is why car companies work hard to reduce variety, for instance by bundling extra options into packages.
The impact of complexity on risk then is quite straightforward: complexity increases the likelihood of failure – and it also makes it more difficult to find and fix the root cause of problems. And because the size is bigger, the impact of the problems is likely to be much more significant, for instance when you have to pay penalties or liquidated damages as percentage of the total project volume in case of delays. So complexity impacts on both factors of risk, the chance of failure and the consequences of failure.
Size Makes Addictive
There is another thing to large projects: they make addictive and can send you up a spiral of ever-increasing project size that you are seeking.
Large projects make addictive for three reasons:
- Psychologically, they can become the “new normal” and people (especially management) do not want to settle for less. If you set a new benchmark by selling a project worth €100 M, going back to €5 M – €10 M projects will feel like you will stay below your potential. And this relates not only to your perception, but to other stakeholders’ (like management) perception, too.
- Economically, if something goes wrong and the big project turns out unprofitable, you will need the cash flow from other big projects (or from a lot of smaller ones) to pay for it
- Organizationally, because resources need to be built up for the big project and would otherwise remain unused subsequently
As with all things with addiction potential, you need to handle large projects with the due care, awareness and consciousness.
Size Creates Ripple Effects
Because of their risky nature, and because they are most helpful for managers’ egos, larger projects receive more management attention than smaller projects. Besides the fact that some people will get jealous as they feel their smaller projects do not receive the attention and recognition as they used to, which makes more people want to pursue bigger projects (which brings us back to the previous point about addiction), this also has a more serious implication: If something goes wrong, additional resources often will be allocated to the big project to fix the problem. And obviously these resources are not normally sitting idle somewhere, but they are working on something, normally on other projects.
So instead of one big project blowing up, you could have five or so projects blowing up which cannot be finished on time since key resources are retracted. Since resources don’t magically multiply and good resources in particular tend not to be idle, chances are you will create quite a ripple effect in the moment you are putting off fires in a big project, which, in the end, can lead to the situation that you are creating more problems than you solve.
I found this effect particularly powerful with IT problems in big projects. IT may be the one part of business which senior management understands least. And so senior management often believes that putting more resources on an IT problem will help solve it quicker when, in fact, the opposite might be the case. It will hurt all other projects, however, which will run the risk of being delayed.
Finally, there is a category of cost that you may not even see: opportunity cost. The cost of the best alternative that you did not choose. Instead of keeping 10 people busy with one project worth €100 M, these people could have worked on three projects, each worth €30 M, and chances are each of these projects would have made more money than the big one. And this is the true cost of such a project.
Escalating Project Size can Mark the End of a Boom Period
Here is one macro observation.
If it feels like it’s raining mega projects onto you, and projects by tendency become much larger than they used to be, this indicates people are losing their risk aversion. They feel too safe.
You normally begin to feel safe when things go well for a long period of time. In the economy, this is during the boom period. And if the boom period has been long, chances increase that it will be over soon.
This in and by itself does not have to be a problem – because maybe you have signed the contract for this large project already. But if not, it should give you reason to double-check your potential future customers’ financial strength and vulnerability before you commit to something. There are some industries which remain largely stable even throughout economic recessions, such as the food retail industry (everybody needs to eat); and there are others which are quite sensitive to economic fluctuations. But even if someone’s industry remains stable, there can still be changes, for instance with respect to terms and conditions to obtain a bank loan for a big project. Out of risk considerations, banks may straight out reject loan requests – as they did in 2008 in many cases – thereby sending the entire economy down a spiral, with many otherwise promising projects being left unfunded and stopped.
Consider that large projects have long project lead time, both in planning and in realization. So even if things still look good today when a potential customer approaches you with a project, by the time you want to sign the contract things may look differently, and even more so by the time the project is under construction.
(This article was published pre-CoVid-19. Let’s say the economic downturn in 2020 is a case in point for many industries, though certainly not for logistics automation).
Which leads me to my next point.
If Your Customer Has a Problem, You Will Have One, too
Now, if we indeed face the situation that the economy – or at least one specific industry – is going down the drain and cash becomes a rare resource, your customer’s problem can very easily reflect on you and become your problem.
In projects, the cash flow you receive from your customer is often – and should be – somewhat balanced with the expenses you are having. This is important as a hedge against the risk that you have significant expenses – and the cash flow coming from your customer suddenly dries out.
But even if this is the case: We said earlier that big projects make addictive. It can very well be that your organization really needs the cash flow from this project for other reasons, maybe to finance growth, or a new building, or to compensate for hick-ups in other projects. So if that cash flow from your customer dries out, it can easily happen that your organization is in big trouble. And obviously more so, the bigger the project is.
Don’t Risks and Benefits of Larger Projects Balance out?
Occasionally I have heard the argument that with larger project, it is of course not only the risks, but also the benefits, that are significantly higher. So shouldn’t larger projects be “neutral” from a risk perspective?
I believe this is not true for three reasons:
- While you can clearly have bigger benefits from a bigger project, the direct benefits are quite limited. It’s more money that you can make. And, maybe more importantly, you can prove to the world that you are capable of doing large projects and that you should get another one. But still – this is quite limited. On the other hand, when things go wrong, there is no limit to the downside. In the worst case, one huge project going wrong can wipe out your company. So upside is limited, downside is unlimited. And this imbalance between risk and rewards is important to consider as it tends to become larger as the projects become larger.
- The only way to have a larger project risk neutral is to grow your company at the same rate as the potential project risk. But that’s almost impossible and pure theory.
- The margin you could earn with a project grows with project size in a linear way. The risk of failure grows in a highly non-linear way. Thus, risks and benefits are only balanced in small projects; the bigger the project gets, the bigger the gap between risks and benefits grows.
Therefore, a larger project will always be more risky than it will be beneficial, all other things being equal.
So – large automation projects are risky and are likely to be unprofitable. With all that said, what should we do? Should we walk away from large projects and let competition try?
One of the most important things we can do to avoid a problem is to be aware that (a) there may be problem and (b) to understand why. So I hope above discussion provides a useful contribution to awareness and better understanding of the risk in large projects.
You can’t always choose which direction a project goes. But when you can, you should have serious discussions with your management, with your engineering team, and with your customer. My frank suggestion is to be clear about the risk involved for both, the customer and yourself, when project size escalates. My experience is that customers appreciate honesty.
Another thing to consider is that large is not the same for everyone. Witron has been hugely successful with a copy-paste approach. When their customers let them do what they think is right, even a large project is fairly low risk for them. Yet, when the customer has other ideas and attempts to dictate Witron how to do the project, even they will run into chaos, as it occasionally happens to them. So it is not “large” alone which works as predictor of unprofitable chaos, but rather the combination of “large” and “new concept” which turns out to be hazardous. Outside of Witron’s copy-paste world, most large warehouse automation projects are highly customized, however.
Also, better understanding of the risk of large projects should reflect on your project portfolio in the sales funnel. I may be totally acceptable to pursue on super-large project if your company is not dependent on its making profits. After all, these projects do challenge your organization and help you grow competencies and a reputation that you may otherwise never be able to obtain. But having too many large projects is likely to be unhealthy for your organization. As a rule of thumb (for the logistics automation industry), not more than one hot project in your sales funnel should exceed 50% of your target order income of a given year.
I’d be very curious to hear about your experience with large projects. If you want to share your experience, send me an email (email@example.com) or reach out to me on LinkedIn.
Some Additional Remarks
This Article is mostly about Suppliers – How About Customers?
Based on several discussions with experienced professionals from the logistics automation industry, as well as on own experience, it is fair to say that super large projects in the vast majority of cases not only make suppliers unhappy. They also fail to deliver on customer expectations. Way too often, they result in a lose-lose situation. Fascinating, is it not?
Large Centralized DCs versus Microfulfillment Centers
There is an interesting discussion currently going on in the field of online grocery services. While some eGrocery players bet on very large highly automated DCs, Microfullfilment has become a competing fashionable concept. Australien retailer Coles felt they had to defend their decision for a large centralized DC concept  after investment bank Jefferies called US retailer Kroger’s deal with Ocado a potential “multi-year mistake” . Nobody really knows which concept is going to yield most benefits since neither of them has been tested at large scale over a longer period of time. There is good reason to believe that unit economics are much better in large centralized DCs, but that statement is not limited to Ocado’s concept and technology.
 https://www.afr.com/companies/retail/coles-defends-150m-ocado-centralised-fulfilment-centre-deal-20191017-p531ir, last access on 2019-12-24
 https://www.cnbc.com/2019/10/10/this-fulfillment-method-could-a-multiyear-mistake-for-grocery-chains.html, last access on 2019-12-24 . It should be noted that the Jefferies report is based on a some wrong assumptions and there is good reason to believe that correcting these assumptions will lead to opposite conclusions. There does not seem to have been any debate regarding the validity of the report, which is concerning. The report shall be treated in a different article, however. Moreover, a different perspective on eGrocery solutions is provided in this article.