Companies have two ways of exploring trade-offs, inside-out techniques, which I'll talk about in this video, and in a later video, I'll talk about what I call outside-in techniques. Inside-out techniques means really understanding how the business model works. In all my years consulting with companies, I was surprised to find how little the executives I work with knew about the specific mechanics that produce their returns. How does the company make money really? I will start by breaking down the components that contribute to a company's profit margin. The goal is to break it down far enough that you understand what the operational drivers of value are. Margin comes from revenues minus costs. For revenues, it might be what the mix of customers is, how productive the sales force is, how much each customer spends per order or visit, what competitive product offerings are, and so on. For costs, it might be how much workers are paid, capacity utilization, shipping costs, costs of inputs and so on. But the process extends beyond these inputs, and then considering how each of these specific levers involves the various stakeholders. Salesforce productivity obviously involves a salesforce workers themselves, but it might also involve customers who might be pushed into buying something they don't actually understand or can't actually afford. Think of subprime mortgages in the United States as an example. Capacity utilization might affect the environment if the push to use equipment keeps operators from conducting maintenance and repairs that can prevent leaks or explosions. Think of the Bhopal disaster in India. This is the first conversation a company might have. Most companies have the tools to do this kind of analysis, but haven't pushed it far enough to see what it looks like from the perspective of different stakeholders. The broad movement towards producing sustainability or corporate social responsibility reports done well, can be a crucial component of mode 1 action to understand trade-offs. Even if these reports start out mainly as a PR exercise, they can force companies to come up with measurements for what they are doing, and how they're making progress. Measurements matter a lot, because as the old adage goes, "What gets measured gets done." That's why putting the caveat about reports being done well, figuring out what to measure and how to measure it isn't always obvious. There is a plethora of emerging accounting systems that are not yet fully aligned with each other. I'm thinking, for example, of the Sustainability Accounting Standards Board, also known as SASB, or the Global Reporting Initiative, known as GRI, or the Task Force on Climate-related Disclosures, or TCFD, or the Sustainable Development Goals, or SDGs to name a few. There are some advantages of adopting one or more of these standards, because it will help you compare your progress over time, and with competitors, and industry benchmarks. The key is to remember that as with any system of quantification, what you choose to measure will depend on who you count as a stakeholder, it is important to at least take a stab at what would matter. Once you know the carbon footprint of every shoe you make, for example, you can set a target for reducing the impact. Once you know how much water goes into making a cotton t-shirt, you can look towards creative solutions to reducing water use, such as closed-loop water recycling or using recycled cotton. Once you know how many safety violations exist in your factories, you can make upgrades or several relationships with certain vendors. More and more, companies are doing sustainability and social responsibility reporting voluntarily. We can also expect more and more regulators and legislators to begin requiring these reports. The key is not to treat this simply as a compliance exercise. It shouldn't be a public relations activity. The greatest value of this kind of reporting is in the process of understanding your company's social and environmental performance and the trade-offs the business is implicitly making. The insights that come from this exercise can be hugely beneficial for operational improvements and for inspiring innovation. The best companies will treat this reporting exercise as a strategic rather than as a bureaucratic one. I particularly appreciate the transparency that came from Nike CEO Mark Parker in their 2017 sustainability report. He wrote, throughout the process of pulling this report together, I've been thinking a great deal about what it means to lead in a time of such dramatic change. It's moments like these that offer the opportunity to hit the pause button and ask the big question. Is it possible to grow the Nike brand into new markets while leaving a smaller footprint? As we transform our business model to move faster and to be more consumer-centric, how does that affect a sophisticated value chain that employs over a million workers and delivers over a billion units a year? How can we challenge ourselves to cultivate a company culture that is more inclusive and empowering. What policies and practices will accelerate the pace of change within our own teams? This report covers many of these complex challenges. It reveals our flaws and shines a light on our victories. Most importantly, it tells us where we need to work harder. It's great to see the admission that the process is complex, and that there's value in, as Mark Parker said, revealing their flaws. These ideas should help you with inside-out techniques for understanding trade-offs. In the next video, I'll tell you more about outside-in techniques.