Managing in an age of modularity

Modularity is a familiar principle in the computer industry. Different companies can independently design and produce components, suck as disk drives or operating software, and those modules will fit together into a complex and smoothly functioning product because the module makers obey a given set of design rules. Modularity in manufacturing is already common in many companies. But now a number of them are beginning to extend the approach into the design of their products and services. Modularity in design should tremendously boost the rate of innovation in many industries as it did in the computer industry. As businesses as diverse as auto manufacturing and financial services move toward modular designs, the authors say, competitive dynamics will change enormously. No longer will assemblers control the final product: suppliers of key modules will gain leverage and even take on responsibility for design rules. Companies will compete either by specifying the dominant design rules (as Microsoft does) or by producing excellent modules (as disk drive maker Quantum does). Leaders in a modular industry will control less, so they will have to watch the competitive environment closely for opportunities to link up with other module makers. They will also need to know more: engineering details that seemed trivial at the corporate level may now play a large part in strategic decisions. Leaders will also become knowledge managers internally because they will need to coordinate the efforts of development groups in order to keep them focused on the modular strategies the company is pursuing.     

Vital truths about managing your costs

Four truths apply to every business situation: 1. It is essential to be a lower cost supplier. 2. To stay competitive, inflation-adjusted costs of producing and supplying products and services must trend downward. 3. The true cost and profit pictures for each product/market segment must always be known, and traditional accounting practices must not obscure them. 4. A business must concentrate as much on cash flow and balance-sheet strengths as it does on profits. In order to ascertain exactly what your costs are, you must carefully isolate and assign various costs to specific products, accounts, or markets. Managers often do this badly, working on the basis of "average" costs. This ignores important differences among products and the fact that different products, different markets, and different customers incur different overhead costs. Most manufacturing companies' most important expense categories are R&D, sales, and general and administrative costs, but surprisingly, they generally don't get the attention they should. Neither do two crucial ratios-gross margin and the percent of assets employed per dollar of sales. Gross margins should usually not be less than 40%, and for most manufacturing companies, assets should not be over 60% of annual sales. Wrong deviation from these ratios will undermine profit targets. Once your costs are known and clearly assigned to product lines, markets, and key customers, they should be widely shared in the organization so that everyone will feel committed to cost management and know when deviations occur.     

Six Sigma pricing

Many companies are now good at managing costs and wringing out manufacturing efficiencies. The TQM movement and the disciplines of Six Sigma have seen to that. But the discipline so often brought to the cost side of the business equation is found far less commonly on the revenue side. The authors describe how a global manufacturer of industrial equipment, which they call Acme Incorporated, recently applied Six Sigma to one major revenue related activity--the price-setting process. It seemed to Acme's executives that pricing closely resembled many manufacturing processes. So, with the help of a Six Sigma black belt from manufacturing, a manager from Acme's pricing division recruited a team to carry out the five Six Sigma steps: Define what constitutes a defect. At Acme, a defect was an item sold at an unauthorized price. Gather data and prepare it for analysis. That involved mapping out the existing pricing-agreement process. Analyze the data. The team identified the ways in which people failed to carry out or assert effective control at each stage. Recommend modifications to the existing process. The team sought to decrease the number of unapproved prices without creating an onerous approval apparatus. Create controls. This step enabled Acme to sustain and extend the improvements in its pricing procedures. As a result of the changes, Acme earned dollar 6 million in additional revenue on one product line alone in the six months following implementation--money that went straight to the bottom line. At the same time, the company removed much of the organizational friction that had long bedeviled its pricing process. Other companies can benefit from Acme's experience as they look for ways to exercise price control without alienating customers.     

Firm size and cost system sophistication: The role of firm age

The costing literature has failed to conclusively explain why some companies implement sophisticated costing systems while others do not. Although some contingency variables were proposed, inconclusive results were reported which raised concerns about their underlying theory. Focusing on firm size, as the most examined and confusing variable in this contingency literature, we develop and test more complex relations than in prior studies to provide more insights into its role. More specifically, we test potential indirect positive relations between firm size and cost system sophistication (through product diversity and cost structure) and bring to light the role of firm age largely neglected in the cost accounting literature. Using two different statistical analyses (i.e. SEM and PLS) and data from manufacturing firms, our findings suggest, in contrast to the majority of prior studies, that not all larger firms should be expected to have sophisticated costing systems. The impact of firm size on cost system sophistication depends on firm age and is mediated by product diversity but not cost structure. We conclude by emphasizing the need for more complex models to further advance the theory on costing systems. Such models should go beyond explaining the potential impact of each contextual variable in isolation.     

Lean consumption

During the past 20 years, the real price of most consumer goods has fallen worldwide, the variety of goods and the range of sales channels offering them have continued to grow, and product quality has steadily improved. So why is consumption often so frustrating? It doesn't have to be--and shouldn't be--the authors say. They argue that it's time to apply lean thinking to the processes of consumption--to give consumers the full value they want from goods and services with the greatest efficiency and the least pain. Companies may think they save time and money by off-loading work to the consumer but, in fact, the opposite is true. By streamlining their systems for providing goods and services, and by making it easier for customers to buy and use those products and services, a growing number of companies are actually lowering costs while saving everyone time. In the process, these businesses are learning more about their customers, strengthening consumer loyalty, and attracting new customers who are defecting from less user-friendly competitors. The challenge lies with the retailers, service providers, manufacturers, and suppliers that are not used to looking at total cost from the standpoint of the consumer and even less accustomed to working with customers to optimize the consumption process. Lean consumption requires a fundamental shift in the way companies think about the relationship between provision and consumption, and the role their customers play in these processes. It also requires consumers to change the nature of their relationships with the companies they patronize. Lean production has clearly triumphed over similar obstacles in recent years to become the dominant global manufacturing model. Lean consumption, its logical companion, can't be far behind.     

The superefficient company

Most companies do a great job promoting efficiency within their own walls, streamlining internal processes wherever possible. But they have less success coordinating cross-company business interactions. When data pass between companies, inconsistencies, errors, and misunderstandings routinely arise, leading to wasted work--for instance, the same sales, order entry, and customer data may be entered repeatedly into different systems. Typically, scores of employees at each company manage these cumbersome interactions. The costs of such inefficiencies are very real and very large. In this article, Michael Hammer outlines the activities and goals used in streamlining cross-company processes. He breaks down the approach into four stages: scoping--identifying the business process for redesign and selecting a partner; organizing--establishing a joint committee to oversee the redesign and convening a design team to implement it; redesigning--taking apart and reassembling the process, with performance goals in mind; and implementing--rolling out the new process and communicating it across the collaborating companies. The author describes how several companies have streamlined their supply-chain and product development processes. Plastics compounder Geon integrated its forecasting and fulfillment processes with those of its main supplier after watching inventories, working capital, and shipping times creep up. General Mills coordinated the delivery of its yogurt with Land O'Lakes; butter and yogurt travel cost effectively in the same trucks to the same stores. Hammer says this new kind of collaboration promises to change the traditional vocabulary of corporate relationships. What if you and I sell different products to the same customer? We're not competitors, but what are we? In the past, we didn't care. Now, we should, the author says.     

Beyond offshoring: assess your company's global potential

In the past few years, companies have become aware that they can slash costs by offshoring: moving jobs to lower-wage locations. But this practice is just the tip of the iceberg in terms of how globalization can transform industries, according to research by the McKinsey Global Institute (MGI). The institute's yearlong study suggests that by streamlining their production processes and supply chains globally, rather than just nationally or regionally, companies can lower their costs-as we've seen in the consumer-electronics and PC industries. Companies can save as much as 70% of their total costs through globalization--50% from offshoring, 5% from training and business-task redesign, and 15% from process improvements. But they don't have to stop there. The cost reductions make it possible to lower prices and expand into new markets, attracting whole new classes of customers. To date, however, few businesses have recognized the full scope of performance improvements that globalization makes possible, much less developed sound strategies for capturing those opportunities. In this article, Diana Farrell, director of MGI, offers a step-by-step approach to doing both things. Among her suggestions: Assess where your industry falls along the globalization spectrum, because not all sectors of the economy face the same challenges and opportunities at the same time. Also, pay attention to production, regulatory, and organizational barriers to globalization. If any of these can be changed, size up the cost-saving (and revenue-generating) opportunities that will emerge for your company as a result of those changes. Farrell also defines the five stages of globalization-market entry, product specialization, value chain disaggregation, value chain reengineering, and the creation of new markets-and notes the different levers for cutting costs and creating value that companies can use in each phase.     

The sales learning curve

When a company launches a new product into a new market, the temptation is to immediately ramp up sales force capacity to gain customers as quickly as possible. But hiring a full sales force too early just causes the firm to burn through cash and fail to meet revenue expectations. Before it can sell an innovative product efficiently, the entire organization needs to learn how customers will acquire and use it, a process the authors call the sales learning curve. The concept of a learning curve is well understood in manufacturing. Employees transfer knowledge and experience back and forth between the production line and purchasing, manufacturing, engineering, planning, and operations. The sales learning curve unfolds similarly through the give-and-take between the company--marketing, sales, product support, and product development--and its customers. As customers adopt the product, the firm modifies both the offering and the processes associated with making and selling it. Progress along the manufacturing curve is measured by tracking cost per unit: The more a firm learns about the manufacturing process, the more efficient it becomes, and the lower the unit cost goes. Progress along the sales learning curve is measured in an analogous way: The more a company learns about the sales process, the more efficient it becomes at selling, and the higher the sales yield. As the sales yield increases, the sales learning process unfolds in three distinct phases--initiation, transition, and execution. Each phase requires a different size--and kind--of sales force and represents a different stage in a company's production, marketing, and sales strategies. Adjusting those strategies as the firm progresses along the sales learning curve allows managers to plan resource allocation more accurately, set appropriate expectations, avoid disastrous cash shortfalls, and reduce both the time and money required to turn a profit.     

Eager sellers and stony buyers: understanding the psychology of new-product adoption

Companies that introduce new innovations are the most likely to flourish, so they spend billions of dollars making better products. But studies show that new innovations fail at a staggering rate. While many blame these misses on lackluster products, the reality isn't so simple. The goods that consumers dismiss often do offer improvements over existing ones. So why don't people purchase them? And why do companies keep peddling products that buyers are likely to reject? The answer, says the author, can be found in the brain. New products force consumers to change their behavior, and that has a psychological cost. Many products fail because people irrationally over-value the benefits of the goods they own over those they don't possess. Executives, meanwhile, overvalue their own innovations. This leads to a serious clash. Studies show, in fact, that there is a mismatch of nine to one, or 9x, between what innovators think consumers want and what consumers truly desire. Fortunately, companies can overcome this disconnect. To start, they can determine where their products fall in a matrix with four categories: easy sells, sure failures, long hauls, and smash hits. Each has a different ratio of product improvement to change required from the consumer. Once businesses know where their products fit into this grid, they can manage the resistance to change. For some innovations, major behavior change is a given. In those cases, companies can either wait for consumers to warm to the product, make the improvement so great that buyers get past their apprehension, or try to eliminate the incumbent product. Firms can also try to minimize buyer resistance by making products that are compatible with incumbent goods, seeking out those who are not yet users of the existing product, or finding true believers.     

Why change programs don't produce change

Faced with changing markets and tougher competition, more and more companies realize that to compete effectively they must transform how they function. But while senior managers understand the necessity of change, they often misunderstand what it takes to bring it about. They assume that corporate renewal is the product of company-wide change programs and that in order to transform employee behavior, they must alter a company's formal structure and systems. Both these assumptions are wrong, say these authors. Using examples drawn from their four-year study of organizational change at six large corporations, they argue that change programs are, in fact, the greatest obstacle to successful revitalization and that formal structures and systems are the last thing a company should change, not the first. The most successful change efforts begin at the periphery of a corporation, in a single plant or division. Such efforts are led by general managers, not the CEO or corporate staff people. And these general managers concentrate not on changing formal structures and systems but on creating ad hoc organizational arrangements to solve concrete business problems. This focuses energy for change on the work itself, not on abstractions such as "participation" or "culture." Once general managers understand the importance of this grass-roots approach to change, they don't have to wait for senior management to start a process of corporate renewal. The authors describe a six-step change process they call the "critical path."     

The relationship between cost system complexity,purposes of use,and cost system effectiveness

This paper uses survey data from 133 Dutch, medium-sized manufacturing firms to examine the associations between cost system complexity (in terms of the applied overhead absorption procedures), purposes of use, and cost system effectiveness. First, factor analysis identifies two underlying dimensions of cost system purposes of use, which refers to the range (scope) of purposes for which the cost system is used, among nine widely used purposes: cost system usage for product planning and cost management purposes. Next, the joint effect of cost system complexity and usage for product planning and cost management purposes on cost system effectiveness, as proxied by the intensity of use of and level of satisfaction with the cost system, is examined. The results robustly indicate that at higher (lower) levels of usage for product planning purposes, cost system complexity negatively (positively) affects cost system intensity of use, while at higher (lower) levels of usage for cost management purposes, cost system complexity positively (negatively) affects cost system intensity of use and satisfaction. This implies that when cost system design (i.e., its level of complexity) and its purposes of use are better aligned, the cost system is more effective.     

Competitive Pricing in Markets with Different Overhead Costs: Concealment or Leakage of Cost Information?

This paper experimentally investigates how leaders and followers in a duopoly set prices for two product markets that have different overhead costs. In a fully crossed two-by-two design, we manipulate the participants' private cost report quality as either low or high, representing the extent to which these reports reveal that product markets have different overhead costs. We show that when only the leader is given a high-quality cost report, private cost information of higher quality is better incorporated into market prices (that are observable to participants). Both the leader and follower improve in profits and their prices better reflect the differences in overhead costs because the follower infers information from the leader's prices (information leakage). In contrast, when only the follower receives a high-quality cost report, the leader's profits and prices do not improve. This occurs because the follower conceals cost information when the leader has a low-quality cost report.     

Will disruptive innovations cure health care?

It's no secret that health care delivery is convoluted, expensive, and often deeply dissatisfying to consumers. But what is less obvious is that a way out of this crisis exists. Simpler alternatives to expensive care are already here--everything from $5 eyeglasses that people can use to correct their own vision to angioplasty instead of open-heart surgery. Just as the PC replaced the mainframe and the telephone replaced the telegraph operator, disruptive innovations are changing the landscape of health care. Nurse practitioners, general practitioners, and even patients can do things in less-expensive, decentralized settings that could once be performed only by expensive specialists in centralized, inconvenient locations. But established institutions--teaching hospitals, medical schools, insurance companies, and managed care facilities--are fighting these innovations tooth and nail. Instead of embracing change, they're turning the thumbscrews on their old processes--laying off workers, delaying payments, merging, and adding layers of overhead workers. Not only is this at the root of consumer dissatisfaction with the present system, it sows the seeds of its own destruction. The history of disruptive innovations tells us that incumbent institutions will be replaced with ones whose business models are appropriate to the new technologies and markets. Instead of working to preserve the existing systems, regulators, physicians, and pharmaceutical companies need to ask how they can enable more disruptive innovations to emerge. If the natural process of disruption is allowed to proceed, the result will be higher quality, lower cost, more convenient health care for everyone.     

Pricing and the psychology of consumption

Most executives know how pricing influences the demand for a product, but few of them realize how it affects the consumption of a product. In fact, most companies don't even believe they can have an effect on whether customers use products they have already paid for. In this article, the authors argue that the relationship between pricing and consumption lies at the core of customer strategy. The extent to which a customer uses a product during a certain time period often determines whether he or she will buy the product again. So pricing tactics that encourage people to use the products they've paid for help companies build long-term relationships with customers. The link between pricing and consumption is clear: People are more likely to consume a product when they are aware of its cost. But for many executives, the idea that they should draw consumers' attention to the price that was paid for a product or service is counterintuitive. Companies have long sought to mask the costs of their goods and services in order to boost sales. And rightly so--if a company fails to make the initial sale, it won't have to worry about consumption. So to promote sales, health club managers encourage members to get the payment out of the way early; HMOs encourage automatic payroll deductions; and cruise lines bundle small, specific costs into a single, all-inclusive fee. The problem is, by masking how much a buyer has spent on a given product, these pricing tactics decrease the likelihood that the buyer will actually use it. This article offers some new approaches to pricing--how and when to charge for goods and services--that may boost consumption.     

The value of distorting overhead cost allocations in an agency setting

This paper shows a strict demand for suitably chosen inaccurate overhead cost allocations in an agency model in which a profit centre manager is in charge of production cost containment and pricing decisions. Given exogenous restrictions on the compensation scheme, the use of distorted overhead costs by transforming the performance measure into an ‘accounting profit’, helps calibrate incentives for the manager. The paper derives conditions for under- or overallocation of overhead costs to products. Generally, underallocation is preferable if the riskiness of quantity is strongly positively related with price and unit cost of a product, or if the product is relatively more price-sensitive.     

劳动力成本与利润差异对制造业升级的影响研究

引入单位劳动力成本和人均利润,考量劳动力成本与利润影响制造业升级的效应。结果表明：样本期间内虽然劳动力成本快速上涨,但劳动生产率增速更快,制造业整体单位劳动力成本没有上升,且有小幅下降,劳动密集型制造业仍有一定综合成本优势,但其人均利润低于制造业整体水平,比重总体下降,发展后劲不足,须转型升级;资本密集型虽然利润率相对较低,但人均利润为最高,比重不断上升,仍应是当前发展的重点;技术密集型比较优势不明显,急需突破核心技术,提高综合国际竞争力。     

Uncovering your hidden occupancy costs

Senior managers at large companies may not believe that they can have much impact on the "bricks and mortar" of their cost structure. They may even think that occupancy costs are too insignificant to worry about, too technical to analyze, and too fixed to control. But as real estate consultant Mahlon Apgar argues, occupancy costs can hurt a company's earnings, share value, and overall performance. On the other hand, every dollar saved drops straight to the bottom line. Shearson Lehman Brothers, for example, has found that it can save as much as $20 million annually by reducing occupancy costs in its branch offices and headquarters. Managing occupancy costs isn't easy. But it is timely. As companies strive to improve productivity by consolidating functions and downsizing staff, they are saddled with excess office space. Expansions abroad present completely different market conditions that put a premium on reducing occupancy costs. At the same time, the changing nature of work is challenging deeply held beliefs about the workplace, and, consequently, traditional expectations of office space are giving way to innovations that are less costly and more productive. To manage occupancy costs, managers must be able to identify their components, measure their impact, understand what drives them, and develop options to change them. Four basic tools help diagnose problems: a cost history, a loss analysis, a component analysis, and a lease aging profile. Understanding cost drivers like leasing, location, and layout can give executives the insights they need to reduce occupancy costs while improving the effectiveness of facilities to support day-to-day operations.     

UNIVERSITY OF GEORGIA ROUNDTABLE ON: Enterprise‐Wide Risk Management

For many years, MBA students were taught that there was no good reason for companies that hedge large currency or commodity price exposures to have lower costs of capital, or trade at higher P/E multiples, than comparable companies that choose not to hedge such financial price risks. Corporate stockholders, just by holding well‐diversified portfolios, were said to neutralize any effects of currency and commodity price risks on corporate values. And corporate efforts to manage such risks were accordingly viewed as redundant, a waste of corporate resources on a function already performed by investors at far lower cost. But as this discussion makes clear, both the theory and the corporate practice of risk management have moved well beyond this perfect markets framework. The academics and practitioners in this roundtable begin by suggesting that the most important reason to hedge financial risks—and risk management's largest potential contribution to firm value—is to ensure a company's ability to carry out its strategic plan and investment policy. As one widely cited example, Merck's use of FX options to hedge the currency risk associated with its overseas revenues is viewed as limiting management's temptation to cut R&D in response to large currency‐related shortfalls in reported earnings. Nevertheless, one of the clear messages of the roundtable is that effective risk management has little to do with earnings management per se, and that companies that view risk management as primarily a tool for smoothing reported earnings have lost sight of its real economic function: maintaining access to low‐cost capital to fund long‐run investment. And a number of the panelists pointed out that a well‐executed risk management policy can be used to increase corporate debt capacity and, in so doing, reduce the cost of capital. Moreover, in making decisions whether to retain or transfer risks, companies should generally be guided by the principle of comparative advantage. If an outside firm or investor is willing to bear a particular risk at a lower price than the cost to the firm of managing that risk internally, then it makes sense to lay off that risk. Along with the greater efficiency and return on capital promised by such an approach, several panelists also pointed to one less tangible benefit of an enterprise‐wide risk management program—a significant improvement in the internal corporate dialogue, leading to a better understanding of all the company's risks and how they are affected by the interactions among its business units.     

Don't homogenize, synchronize.

To be more responsive to customers, companies often break down organizational walls between their units--setting up all manner of cross-business and cross-functional task forces and working groups and promoting a "one-company" culture. But such attempts can backfire terribly by distracting business and functional units and by contaminating their strategies and processes. Fortunately, there's a better way, says the author. Rather than tear down organizational walls, a company can make them permeable to information. It can synchronize all its data on products, filtering the information through linked databases and applications and delivering it in a coordinated, meaningful form to customers. As a result, the organization can present a single, unified face to the customer--one that can change as market conditions warrant--without imposing homogeneity on its people. Such synchronization can lead not just to stronger customer relationships and more sales but also to greater operational efficiency. It allows a company, for example, to avoid the high costs of maintaining many different information systems with redundant data. The decoupling of product control from customer control in a synchronized company reflects a fundamental fact about business: While companies have to focus on creating great products, customers think in terms of the activities they perform and the benefits they seek. For companies, products are ends, but for customers, products are means. The disconnect between how customers think and how companies organize themselves is what leads to inefficiencies and missed opportunities, and that's exactly the problem that synchronization solves. Synchronized companies can get closer to customers, sustain product innovation, and improve operational efficiency--goals that have traditionally been very difficult to achieve simultaneously.