The Hidden Cost of Complexity—and How to Eliminate It

*This article by Stephen Wilson originally appeared on Forbes and is republished here with permission.*

 

Over the years, my colleagues and I have seen leaders wrestle with the hidden impact of complexity on their businesses. Complexity is the web of interconnections that builds up as a company adds products, customers, geographies, systems, and processes. Each new element interacts with everything that came before it—increasing costs, hindering execution, and eroding performance.

Leaders suspect it’s there, slowing everything down and piling on costs, but figuring out where it’s coming from and how much it’s costing you isn’t easy. A traditional view, through the lens of fixed and variable costs, doesn’t account for the way variety drives costs. Traditional costing methodologies don’t reveal the impact of complexity costs, but these costs are often the single biggest factor determining profitability. Once you understand this, they are impossible to ignore. 

 

What Are Complexity Costs?

Complexity costs grow with variety—products, services, customers, processes, or even IT systems. They don’t behave like fixed costs, which stay the same independent of volume, or variable costs, which scale with volume. Complexity costs grow with the increasing number of connections between all the “things” in a business—a network effect. Each connection adds work, all that work adds cost, and those costs grow geometrically. 

Here’s an example: you add a new color option for a t-shirt. To start, it’s a simple addition. But as you introduce additional color options, you suddenly need extra warehouse space for materials, more staff to handle inventory, and new systems to manage production. What begins as a small change quickly snowballs as costs expand into overhead or administrative expenses, where they are harder to see. 

 

Why Standard Costing Falls Short

Most costing systems were not designed to reflect the level of complexity in markets today and don’t quantify these additional expenses—they assume costs are either fixed or variable. If you treat complexity costs like fixed costs, you will likely overestimate your fixed cost leverage, leading to a proliferation of more complexity. If you mistake complexity costs for variable costs, you will overestimate the profitability of low volume products, with the same effect. Either way, you end up making misguided decisions without a true view of profitability. 

 

The Profit Concentration Effect

Profit concentration is one of the clearest signs of complexity costs. Across nearly every business I’ve worked with, there’s a similar dynamic: 20–30% of products, services, or customers generate most of the profits (often more than 300%!), while the rest erode value. 

We’ve also looked at S&P 500 companies and found that more than half became less profitable as they grew. So, contrary to what seems intuitive, growth isn’t always the solution. Sometimes it’s the problem. The pattern is consistent: companies seek scale and growth, and to do so, launch new products or go after new customers and markets, in the process, introducing more sources of complexity, such as new processes and more people, and adding cost.

For example, a tool manufacturer client tried to boost revenue during a downturn by adding new products. It moved into new categories and services. This overwhelmed its operations and undermined the key metric that underpinned its growth: on-time delivery. In pursuit of growth, it impeded its ability to grow—we call this the “Growth Paradox.”

Managing complexity isn’t about doing less. It’s about understanding where your core business lies, finding ways to simplify the rest and then learning how to grow with scale, not complexity. 

 

Steps to Manage Complexity

Tackling complexity takes new tools and an acknowledgment that this is a systemic issue. It’s not something you fix by tweaking a process or improving things incrementally. Here’s how we recommend approaching it: 

1. Quantify the Costs

The first step is understanding how much the complexity in your business is actually costing you. That means going beyond standard profitability metrics and adjusting for complexity. We use an approach called Square Root Costing, which allocates costs in a way that accounts for how complexity grows disproportionately with variety, not just volume. This helps companies understand and reallocate shared costs, like SG&A or manufacturing overhead, back to the products, services, or customers that create those costs.

Analyzing complexity costs reveals surprising patterns—a fresh view of winners and losers in the portfolio—and a set of possible improvement levers. One client found that the bottom 10% of customers were creating a $90M profit hole, which it quickly addressed through repricing and service level adjustments. 

2. Scope Broadly Enough to Address Root Causes 

Complexity often shows up as a downstream problem, but it usually starts further upstream. Take invoicing, for example. If a services company has a hundred different ways to invoice—an upstream decision relating to serving customers—it creates a lot of extra work and headcount in the finance department. But it’s not an issue that finance can solve by itself. Unfortunately, it’s common in large organizations to take a big issue like complexity and quickly scope it down to a number of small projects in siloed functions or specific business units. But the hard truth of complexity is that it can only be addressed by undertaking projects broad enough to encompass the source and impact.

3. Remove Complexity in Chunks 

Small adjustments won’t make a dent. Clients have come to me after spending years picking off low-volume SKUs, only to find that it didn’t move the needle. If you want real results, you need to take out big chunks of complexity. 

One client halved their product portfolio. This wasn’t just about saving on inventory or manufacturing costs. By removing unnecessary SKUs, it was able to exit facilities and reduce overhead, freeing up resources to focus on its best-performing products. These kinds of bold moves generate the real value. 

 

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Recommendations for Leaders

A CFO told me, “Once you see complexity costs, you can’t unsee them.” When you discover how complexity is impacting your business, you can’t help but factor that into how you run the business. A complexity view also points to what matters most: simplifying your operations, cutting out unnecessary layers, and redirecting resources to your most profitable areas to unlock real value. Complexity costs may currently be a hidden tax on your business, but the good news is that it’s not one you have to continue to pay. 

 

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About the Author

Stephen Wilson is a Managing Director at Innosight, based in Dallas. stwilson@innosight.com