Business Performance Excellence 9781472920430, 9781849300438

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Introduction: The Origins and Structure of the Original Model for Business Performance Excellence (BPE) Part 1: The Origin of the BPE Model Jeffrey T. Luftig Lockheed Martin Professor of Management, Lockheed Martin Engineering Management Program, College of Engineering and Applied Science, University of Colorado, Boulder, USA Shortly after the seminal NBC White Paper episode “If Japan can, why can’t we?” was televised in June 1980, Don Petersen, who later retired from the Ford Motor Company as its chairman and CEO, hired W. Edwards Deming to assist in the turnaround of the company. Starting with a series of management seminars, Dr Deming quickly evolved into a high-level consultant and guru who would be instrumental in establishing a comprehensive and firm commitment to the quality sciences at Ford. Deming became a close adviser to Mr Petersen and his management team, and was instrumental in significantly increasing the profitability of the firm. To accomplish this task, Dr Deming strongly suggested (i.e. required, actually) a number of actions be taken in the early days of this effort. A statistical methods office in Dearborn, staffed at the time by Peter Jessup, Bill Scherkenbach, and Ed Baker, became instrumental in directing the quality initiative. Ancillary to this effort was the directive that each operating division of Ford had to engage their own statistical/quality consultant, who would report on a solid-line basis to the president of that division, and on a dotted-line basis to the statistical methods office and to Dr Deming himself. At this time, I was a professor at Eastern Michigan University (EMU), teaching statistical methods courses for the Electrical-Electronics Division (EED) of Ford (EED was later spun off by Ford as Visteon). EED management funded an endowed chair for research and training in statistical methods in the College of Technology at EMU, and after interviews with the statistical methods office personnel and ultimately Dr Deming himself, I became the approved external consultant for the EED, reporting to Fred Herr, the division president, and Frank Macher, the division vice-president. My primary role at this time was to facilitate the implementation of the Deming philosophy in the EED. The three primary sets of tools/guidelines brought to Ford by Dr Deming were: 1. the Fourteen Points; 2. the Seven Deadly Diseases; 3. the widespread use of statistical process control (SPC) and its associated tools to bring processes and products into stability so that serious improvements in quality could be achieved. Many individuals today, unfamiliar with the efforts that were actually conducted inside of Ford at that time, largely view the Fourteen Points as philosophical exhortations that were static through time. The fact is they were neither static nor philosophical. The

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Fourteen Points when Dr Deming was working with Ford were in many cases stated very differently to how they were presented in later years at firms working with Dr Deming. The point that comes to mind as critical to what we were attempting to accomplish inside Ford was to “Reduce the supplier base” (which changed in later years to “Stop awarding business based on price alone”). This was far from a philosophical treatise at the time. The implementation of this point as a management directive eventually led to the development of a Supplier Quality Assurance Group within the procurement department of the EED, and the creation of the Q1 program. The supplier base was reduced from more than 2,000 to less than 1,000 in a three-year period. Many of the suppliers who were de-sourced never shipped Ford-EED a defective part—they simply resisted the idea that they implement statistical process control methods so that EED would receive a stable and predictable supply of incoming material and supplies. In support of this drive to reduce the supplier base was a directive from Dr Deming that it was management’s responsibility to provide their Tier 1 suppliers with an opportunity to understand where Ford was headed in terms of quality, and to join them as partners, rather than adversaries. To implement this directive, two seats in every statistical methods class I taught at the EED during this period were made available to each of the Tier 1 suppliers, free of charge. Many of these suppliers adopted the quality model they learned at Ford (e.g. Molex and Alcoa), and in turn drove those same principles and requirements down through their own supplier base. In this way, it might be argued that it was the NBC White Paper episode that was the fuse that set off the most dramatic change in American quality systems ever seen; at least in my lifetime. The gains executed and leveraged by Ford, their suppliers, and other OEMs in the automotive industry quickly spread to other sectors and industries, and quality improvements were soon realized across the country. What became immediately obvious after a decade or so, however, was that the initial focus on product quality, once effectively implemented, was starting to deliver diminishing returns. Some of this was a function of having picked all of the “low hanging fruit”; but slowly, as SPC morphed into statistical quality assurance and incorporated a much more extensive set of tools, methods, and strategies, practitioners started to understand that focusing on products (or services) alone was not enough. To a certain extent, it took the understanding of one of Dr Deming’s principles as to what the next step might be: “Every activity is a process, to be standardized, controlled, and improved on a neverending basis.” This realization, that the improvement effort had to be approached in totality, was the basis for the development of the total quality control (TQC)/total quality management (TQM) movement. The TQM movement lasted, depending on the authority you cite, about a decade. The reasons for interest in this model falling off is and has been debated ad infinitum (many would assert it was the failure of some “TQM consultants” to focus on business in favor of repackaged attempts to improve product quality under a different name); but what is less debatable is what replaced it—Six Sigma. Initiated by Motorola and Allied-Signal, with Mikel Harry arguably the best recognized designer of the system, Six Sigma took off as a program across the United States when Jack Welch, chairman of General Electric (GE), made a serious commitment to the program and widely advertised the beneficial results of the effort at GE.

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Six Sigma programs enjoyed a great deal of popularity for another decade or so, but quality practitioners and business professionals started to note that the effectiveness of these Six Sigma efforts, which often focused on projects to reduce cost with an assumption that this would subsequently lead to improvements in profitability, were mixed in their results. This was even the case when the same firm or consultants provided the training in two different firms which subsequently experienced widely varying benefits. By this point in time (the 1990s), I had left the Ford-EED chair and created a consulting firm which was serving many Fortune 100 firms among the approximately 65 clients we served from 1994 through 1998. This exposure to multiple management teams, across multiple business sectors, allowed for the illumination of many of the problems that firms had experienced, or were experiencing, in implementing management initiatives such as TQM/TQC, Six Sigma, lean engineering, or virtually any other systemic effort requiring that they overcome the natural resistance to change exhibited by the business organism (as so well described by Professor Joseph Juran many years ago). A more than cursory review of our clients revealed that some were successfully progressing from “good to great,” while others were languishing in “good to good”; while still others were progressing from “good to gone.” Over time, common symptoms of organizational deficiencies became evident. Less effective firms and management teams exhibited most of these symptoms:

8 A vision and mission which serve mostly as the basis for supposedly inspirational posters, slogans, wallet cards, pocket protectors, and “thought of the day” quizzes; all of which constitute non-value-added expenditures and activities. 8 Little or no integration between the organization’s vision and mission statements, its strategic and business plans, and the critical performance measures (CPMs) measured on a daily basis. 8 The organization annually generates hundreds of “number one priorities” (goals/objectives), while everyone recognizes it doesn’t actually have the resources to achieve half that many. 8 The organization’s strategic and business plans are last viewed each year by managers when they place the four-inch-wide three-ring binders containing those plans on their shelves. 8 The divisions or departments within the organization can all successfully “hit their numbers,” while the organization as a whole fails to make an acceptable profit. 8 Projects are selected for their interest level and/or cannot be killed off. 8 Individuals’ responsibilities are often only related to the vision and mission statements and the strategic plan of the organization by happenstance. 8 The organization operates with a “feed the beast” mentality, assuming that any business is superior to no business (i.e. revenue is king). 8 The organization employs standard or average cost accounting procedures to ensure that no one understands what business is truly profitable. 8 Incentive systems are employed that encourage the sale/production of “any” units, versus the optimization of the “richness of product mix” sold/produced. 8 Using x% headcount reductions across the board (in the name of fairness) to reduce costs.

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8 Using headcount reductions and capital equipment investments as a first rather than last choice to improve profitability.

8 Working on process improvement projects which ultimately reduce profit (asset) dollars generated.

What became clear over time was that what differentiated the companies in their ability to be successful was not the quality or enthusiasm of the management team and/or workforce, or the quality of their strategy, but the ability to deploy that strategy in a data-based, disciplined way, to every member of the organization, and remain focused on those (per Juran) “critical few” broad objectives. The missing link, if you will, was the gap between the strategy at the management team level, and what an individual 15 levels down in the business worked on and measured an on day-today basis. At this same time (the 1990s), Dr Deming began discussing his “theory of profound knowledge.” Encompassing much more than his observation that a group of people in a pit cannot get out of that pit by digging harder, or more efficiently (the pit only gets deeper), this theory revealed that in order to effect systemic change, one had to have a working understanding of:

8 cognitive psychology; 8 organizational behavior; 8 statistical and scientific theory; 8 systems theory. And that was best delivered by individuals with “profound knowledge”—an outside view. This theory of profound knowledge was utilized to develop a comprehensive system by which the primary gap previously noted could be closed—a policy deployment model (hoshin planning in Japan) that would bridge the gap between strategy and actual activity cascaded through the entire organization. This model became phase I of the BPE model. Phases II and III of the model were developed to deliver the “voice of the customer” with the implementation of a customer quality assurance (CQA) model, and a highly unique total asset utilization/customer product rationalization (TAU/CPR) model, which provided the “voice of the business.” Phase III of the model incorporated a daily management model, which integrated all of the “old” tools associated with supplier quality assurance systems, statistical quality assurance systems, and team management, as well as employee involvement initiatives. Management models such as allocated cost accounting and appropriate reengineering approaches were also included at appropriate places within the model. As a result, the BPE model became a repository for strategies, methods, and tools utilized to achieve both strategic breakthroughs and tactical improvements in key financial and nonfinancial performance indicators (KPIs and NFIs). Because the model was developed based upon viewing an organization as a process, to be controlled and standardized, it has been successfully deployed in for- and not-for-profit companies, across virtually every business sector imaginable.

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Part 2: The Structure of the BPE Model Steven M. Ouellette Instructor, Lockheed Martin Engineering Management Program, College of Engineering and Applied Science, University of Colorado, Boulder, USA I first encountered Dr Luftig’s approach to business performance improvement while working for Alcoa in 1992 as a metallurgical engineer. I must confess that I went into that training session fairly hostile to the idea that I, an engineer, would need to know anything about “that business stuff.” Give me a product and a process, and I would make them better—leave me out of all that folderol. By the end of the training, I had come to the painful realization that every process and product decision I made as an engineer was, at its core, a business decision. From that point on, I learned as much as I could from Dr Luftig’s consultants about how to employ not only product and process quality improvement technology, but also the tools and strategies to optimize the business as a system. It was one of those pivotal points in an individual’s life that changes one’s path from one interest to another. A few years later, my wife happened to notice an ad for a consulting firm that was looking to hire someone who could implement these technologies in a major metals manufacturer, and the unusual name of “Luftig” caught her eye. I applied for the job and shortly thereafter had the experience of a lifetime working with Jeff and the other consultants in a variety of industries. During this time, the model that would eventually become the BPE model was being created and modified in the crucible of the real business environment. And while it was an exciting time to be in on the ground floor of this development, it is no less exciting now to be able to introduce the model to a wider audience. First off, if we are going to show you a roadmap to a place, you probably want to know about the destination. As Dr Luftig will tell you, business performance excellence is achieved when an organization is generating the maximum level of profitability possible given the human, financial, capital, and other resources it possesses. The real question, of course, is how to achieve that, and the chapters in this book will focus on the tools to do so. That said, there is an overarching structure that we have found to be effective in structuring the efforts of businesses to achieve excellence. It is not enough to just list a number of useful tools and techniques. Many management fads have come and gone not because the tools themselves were bad, but because they got lost in the crowd in the absence of the knowledge of when to use them and how they fit together with other management technologies. This causes confusion and the perception in the workforce that management changes the direction of the company apparently in response to some “book of the month club” to which they belong.

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Instead, these tools and strategies need to be organized into a rational and interconnected series of activities to frame the approach and show how the different areas interact and support one another. This is the real strength of the BPE model I have the privilege of describing. You will note that there are bits and pieces from a number of different management technologies that all work fine for their specific task, but these have not previously been linked to show how they all work together. You will also see some new approaches and insights, and these too have been linked in their appropriate places. One unique aspect of this model is that the strategic plan is not the starting point, but rather the logical output of the previous activities to understand the purpose and performance of the business. The more common alternative to this model is to start with an assessment of what the executive management thinks needs to be done, perhaps generated from a SWOT (strengths, weaknesses, opportunities, and threats) analysis, or perhaps from their collective experience. Some companies stop here and wonder why their plans are never achieved. Others may generate metrics associated with accomplishing these identified improvements, only to find at the end of the year that these metrics indicate small or negative results. A few companies may identify specific projects to accomplish the strategic plan thus generated, but getting everyone aligned to work on a plan that has not been designed to close strategic performance gaps means that, by definition, the company is underperforming. There are three phases to achieve business performance excellence. The key here is that any company can maximize their profitability given their constraints if they correctly follow this path. However, it is obviously not the case that maximum profitability is above zero if, for example, they have the wrong product or choose the wrong market. The good news is that it will become clear very quickly in this process that there is something wrong, and the company can either make the necessary changes or find a way to gracefully retire from the field.

Phase I: Hoshin Kanri or Policy Deployment

The first phase of achieving BPE is to decide on a strategy and to deploy that strategy or policy throughout the company so that every individual knows that what they do that supports that strategy. In order to rationally decide on strategy, though, the correct process and results measures need to be available to the policy makers, and in order to have the correct measures of success throughout the organization, that organization needs to know what they are trying to accomplish as a business. We will explore this process generally in Section 1, and specifically the first chapter, “Hoshin kanri: Deploying your strategic intents to achieve business excellence” (pp. 3–17).

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Figure 1. Phase I of BPE: policy deployment Establish/ reaffirm vision

Establish/ reaffirm mission

Generate matrix of level I and level II KPIs and NFIs

Identify/reaffirm model for strategic differentiation

Strategic plan developed at corporate/ company level I

Business/operating plan developed at level I

U/ TA m m ste ro sy tf R pu CP

In

Perform gap analysis to generate strategic plan (strategic intents, objectives, focal points, tactical objectives, and check points)

Establish/ reaffirm value proposition

CQ Inp A ut sy fro st m em

Cascade to span all of control levels

Perform construct analysis to generate KPIs and NFIs

Deploy focal and check points; repeat process (e.g. II and III; III and IV) at all levels

This gives managers and workers at every level the correct metrics to measure the health of the process for which they are responsible, assesses gaps between where they are now and where they need to be in order to accomplish their vision, and the strategic and tactical activities that need to be accomplished in order to close those gaps. Quarterly reviews track the progress of the strategic projects in order to insure that they do not encounter roadblocks to their successful completion—by definition, these are the most important projects that the company needs to work on in order to achieve their vision, and so nothing can be allowed to prevent these teams from being successful. If they are allowed to be blocked, the company must admit that the vision will not be achieved, the vision rephrased, and the metrics measuring the performance of the company re-targeted to reflect the new mission. However, in our experience with this integrated approach, companies achieve their strategic plans, often for the first time ever, and the perception that strategic plans are a sort of aspiration (“Wouldn’t it be nice if…”) changes to a rational list of actions that can be accomplished. Section One, Strategic Planning and Policy Deployment: our contributors will explore topics relevant to Phase I of the BPE Model. In this section, you will read how risk management, business structure , innovation, the global economy, benchmarking, critical performance measures, and the balanced scorecard all have a part to play to allow you to more effectively and efficiently create and subsequently achieve your business objectives.

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Upon completion of the first business plan, progress is reviewed, performance measures examined in the light of new market requirements, and the strategic plan is updated for the next iteration.

Phase IIA: TAU/CPR

In Figure 1 there are two inputs into developing the strategic plan that will be unfamiliar to many readers. These two elements can be developed in parallel with each other. The first of these is to create a model for total asset utilization (TAU) which, when combined with allocated costs, is used to generate a customer product/ process rationalization (CPR) model. TAU examines how effectively assets are being used to generate salable product or provide services. This allows a company to understand the trade-offs between products, services, customers, and alternate production processes. It does not by itself, however, include anything about profitability. Unfortunately, many companies still use average cost accounting, hiding differential costs for different products, customers, and flowpaths, and these purported profitability numbers can be highly misleading. Only when costs are properly allocated can we understand true profitability. Thankfully it is not necessary to implement a complete activity-based cost (ABC) accounting, since in our experience this level of detail is costly to achieve and is not really needed in order to capture most of the benefit. A cost allocation system that takes into account average differences between products, customers, and alternate flowpaths is sufficient. Once the allocated costs are combined with the TAU model, a company can, for the first time, assess a profitability rate that accounts for all the trade-offs in the manufacture or provision of what the company sells and to whom they sell it. This gives the marketing function the data they need to rationally craft a future portfolio of products, services, and customers that maximizes profitability, while also identifying high-profit impact projects for strategic attack. In Section Two, Finance and Cost Reduction, the authors will review a number of topics related to understanding and achieving true profitability, including a complete TAU/CPR analysis (interpreting the Voice of the Business).

Phase IIB: Customer Quality Assurance

The other input into the strategic planning process is a customer quality assurance (CQA) system. It doesn’t matter if a company knows where its profit is generated if they can’t make a product with sufficient quality for the market. CQA consists of a proactive cycle, whereby the company researches emerging trends in their market and designs products that fulfill, or even create, those trends. Additionally, CQA has a reactive component, where the company asks their customers about their impression of product quality. This serves as an “early warning system” for emerging product or service quality problems. The outputs from both the proactive and reactive parts of the CQA process constitute vital sources of strategic projects. In Section Three, Systems and Tools in Business

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Performance Improvement, we will examine a number of ways to monitor and improve customer satisfaction, which in turn is intended to lead to improved profit.

Phase III: Daily Management

The final phase of achieving BPE is managing the day-to-day activities of the organization. We call this “daily management” and it is the process that provides the ability to manage departments, functions, and processes, wherein processes are defined, standardized, controlled, and improved by the process owners. If advanced problem-solving (a.k.a. Six Sigma) uses a small cadre of highly trained individuals to attack strategic projects that will have a large impact on the business, daily management is what the other 95% of the company is doing. Our model for daily management is shown in Figure 2. Figure 2. The house of daily management

Daily work Data-based communication Daily control

Daily work improvement

Process quality management

Define and standardize Establish ownership The “roof” of the house consists of those daily activities that this process exists in order to perform. However, if we only ever do those activities, we never have the time set aside to improve the process. People want to make their process better on an ongoing basis, but they must be provided with the time away from the process, the resources, and the structure to do so, and that is what the rest of the “house” represents. The “foundation” of the house is establishing ownership of the process into the people responsible for running it. This is accomplished in many ways, but mainly by insuring that the process owners are empowered. “Empowerment” is a term that is often bandied about without real understanding of how to achieve it. In our terminology, empowerment is only achieved when the process owners have the tools and knowledge to do the job, are responsible and accountable for their results, and have authority within their span of control to change things if the results are not what is needed. In the absence of any of these elements, people will not and cannot take ownership of a process.

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The first “room” in the house encompasses those activities that define and standardize the process. The absence of process definition and standardization results in excessive process variability, and thus in poor quality. “Daily control” is monitoring the process over time to assure that its outputs and critical variables remain stable and predictable. The best one can do with a process while it is running it to make sure that it is performing within the expected variation as established by historical data. Control charts (examined in “Statistical quality control for process improvement”; pp. 161–170) are one of many powerful tools to do this. Maintaining stability or control is not, however, necessarily getting the output needed from a process. In cases where a process is unstable or where it is stable but not capable of achieving the requirements, time must be set aside to examine the process and identify, prioritize, and deploy local improvement opportunities. The daily work improvement room represents these activities, which are typically performed at meetings away from the process with the process owners. Sometimes these teams are called process management teams (PMTs), whose job it is to manage the quality of the process in order to achieve quality in the process output Sub-teams typically are assigned local improvement missions, and report back to the PMT. This is how continuous improvement is performed using only local resources and how everyone can participate in improving their own process gradually over time. Should a process improvement activity require resources beyond that of the local process, the PMT can pass this along to upper-level management, and this becomes a project which is fed into the hoshin planning process of Phase I. In this way, daily management becomes a pull system requesting the help of resources external to the process, unlike the more typical imposition of these resources to solve problems, making true the often disingenuous phrase, “We are from corporate and we are here to help.”

Book Structure

Underpinning all of BPE is the ethical treatment of all of an organization’s stakeholders including its suppliers, employees, customers, and the surrounding community. In Section Four, Ethics and Creating Value through Employee Management, our authors explore how to provide an ethical work environment within which BPE will flourish. With this brief overview of how BPE is achieved, one can see how a large number of apparently disconnected tools, techniques, and systems, and process wisdom all falls under one or another well-defined area of the BPE process, and this is how we have ordered the chapters in the rest of this text. While not a complete list of everything a business needs to know in order to achieve BPE (that book would be much longer), we hope that the following explorations of these different aspects of BPE will give you a greater understanding of various elements of the process, while the structure I have described here provides the framework for understanding how and when such understanding is applied in business. We wish you the very best on your journey towards Business Performance Excellence!

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Contributors R. Brayton Bowen is author of Recognizing and Rewarding Employees (McGraw-Hill) and leads the Howland Group, a strategy consulting and change management firm committed to “building better worlds of work.” His documentary series Anger in the Workplace, distributed to public radio nationally in the United States, continues to be regarded as a benchmark study on the subject of workplace issues and change. A Best Practice editor and contributing author to the hallmark work Business: The Ultimate Resource (Bloomsbury Publishing and Perseus Books), he has written for MWorld, the online magazine of the American Management Association. He currently serves as executive adviser for the Center for Business Excellence at McKendree University. Terry Carroll headed up corporate finance and advisory services for Broadhead Peel Rhodes, following a highly successful career as finance director and CEO of a range of businesses. He was also for some years a business and financial consultant, working especially with SMEs and growing businesses. A qualified banker, corporate treasurer, and chartered accountant who trained with KPMG, Carroll has experience of many different corporate finance projects, including banking, financing, business restructuring, mergers and acquisitions, MBO/MBI, and venture and private capital. With five books and scores of published articles, he is also an established business author. Peter Casson is a senior lecturer in accounting at the School of Management of the University of Southampton. He graduated with BTech and PhD degrees in psychology from Brunel University and an MSc in occupational psychology from Birkbeck College, University of London.

He is a fellow of the Institute of Chartered Accountants in England and Wales. After holding a number of research posts in psychology, he trained as a chartered accountant before starting an academic career in accounting. His research interests are mainly in accounting for financial instruments, stock option compensation, corporate governance, and company taxation. Subir Chowdhury is chairman and CEO of ASI Consulting Group, LLC. A respected quality strategist, Chowdhury’s clients include global Fortune 100 companies as well as small organizations in both the public and private sectors. He is the author of 12 books and has received numerous international awards for leadership in quality management and major contributions to various industries worldwide. He has a graduate degree in aerospace engineering from the Indian Institute of Technology, Kharagpur, a postgraduate degree in industrial management from Central Michigan University, and an honorary doctorate in engineering from Michigan Technological University. Chowdhury is frequently cited in national and international media. Paul Davies is managing director of Onshore Offshore Ltd. He has been responsible for a wide range of business transformation projects, whether establishing companies offshore, providing consultancy for entering offshore markets, creating the most appropriate offshoring approaches and environments, recruiting the appropriate staff and management, managing the procurement of offshore services, providing interim management, transferring contracts under employment legislation, or creating new business strategies. With a management background in the United Kingdom and

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India and sales and marketing experience across Europe, Dr Davies has formed a team of professionals who can address a wide range of business issues and provide solutions in management, finance, business efficiency, and global talent management. John Elkington is cofounder and executive chairman of Volans (www.volans.com), cofounder of Environmental Data Services (ENDS) in 1978 and SustainAbility in 1987 (www.sustainability.com). He is the author of 17 books, including The Power of Unreasonable People: How Social Entrepreneurs Create Markets That Change the World (Harvard Business School Press, 2008). His personal website is at www.johnelkington.com. Beverly Goldberg is senior fellow and editor-at-large at the Century Foundation. She is the author of Age Works: What Corporate America Must Do to Survive the Graying of the Workforce (Free Press, 2000) and Overcoming High-tech Anxiety: Thriving in a Wired World (Jossey-Bass, 1999) and coauthor of Corporation on a Tightrope: Balancing Leadership, Governance, and Technology in an Age of Complexity (Oxford, 1996) and Dynamic Planning: The Art of Managing Beyond Tomorrow (Oxford, 1994). Goldberg was the former vice president and director of publications at the Century Foundation. Edward E. Gordon is a consultant, writer, speaker, academician, and president of Imperial Consulting, a firm specializing in human capital development (www. imperialcorp.com). He has taught at three Chicago-based universities, appeared on television and radio, and is the author or coauthor of ten books, including bestsellers such as Skill Wars: Winning the Battle for Productivity and Profit (Butterworth/Heinemann, 2000) and FutureWork: The Revolution Reshaping American Business (Praeger, 1994).

Ray Halagera is founder/partner of the Profit Ability Group, Inc., a consulting and training company specializing in finance and strategy. Over the past 20 years he has held leadership positions in other global training companies serving Fortune 500 clients. Before his career in the learning industry, Halagera was vice president of planning and management information systems for Chromalloy American Corporation, a Fortune 100 conglomerate, and a senior associate at A.T. Kearney, an international broadline management consulting firm and subsidiary of EDS. Rita Herron Brown has been a business educator and editor for more than 25 years. She is editor-in-chief at BrownHerron Publishing and an editor of Business Strategy Review, the quarterly journal of the London Business School. Previously she developed the curriculum for marketing programs at Honeywell’s Aerospace Management Development Center in Minneapolis. She also served as associate director of the executive program at Indiana University’s Kelley School of Business, where she was involved in both curriculum development and marketing. She gained her BA and MBA degrees from Indiana University. Zahirul Hoque is associate dean (research) and professor of accounting in the Faculty of Law and Management of La Trobe University in Australia, where he is also deputy director of the Public Sector Governance and Accountability Research Centre. Prior to that he held a number of faculty posts at universities in Australia, New Zealand, Bangladesh, and Saudi Arabia. His research interests include accounting and organizational change, management accounting, performance management, public sector accounting, and organizational design.

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Professor Hoque has published widely, including two books, Handbook of Cost and Management Accounting and Strategic Management Accounting. He is founding editor of the Journal of Accounting and Organizational Change. Masaaki Imai is one of the most widely acknowledged theorists on incremental change. As well as being a lecturer and consultant, he is founder and chairman of the international Kaizen Institute, an organization that helps Western companies introduce kaizen concepts, systems, and tools. As one of the leaders of the quality movement and a champion of the kaizen philosophy, he has written several best-selling books on the subject. Daniel T. Jones is a world expert on supply chain management and coauthor of the bestseller The Machine That Changed the World (with James P. Womack and Daniel Roos; reprint, HarperCollins, 1991). His main interest has been understanding the differences in industrial performance and the transfer of a set of ideas called lean thinking, from the Japanese auto industry, to a wide range of other industries across the globe. He has led a series of pioneering benchmarking and action research programs, articulating and carrying lean thinking through to pilot implementation. He is chairman and founder of the nonprofit Lean Enterprise Academy, part of the Lean Global Network (see www.leanuk.org). Vinod Lall is a professor in the School of Business at Minnesota State University Moorhead, teaching supply chain management, operations management, management science, project management, and management information systems. Lall has developed and taught online and face-to-face graduate courses at business schools in Bulgaria, Ecuador, India, Thailand, and

the United States. Active in research, he has published numerous papers in peer-reviewed journals and presented at conferences. He is a certified supply chain professional (CSCP) by APICS, the American Association for Operations Management, and is the vice president of education for the Red River Valley chapter of APICS, leading certification training for a number of regional manufacturing and service organizations. Jeffrey T. Luftig is the Lockheed Martin professor of management and director of the Lockheed Martin Engineering Management Program, University of Colorado, and the director of Vector, the university’s center for business performance improvement. He is also president emeritus of Luftig & Warren International, which developed and delivered training and consulting services in the quality sciences to businesses and industries throughout the United States, Europe, Asia, South America, and Australia. Clients included Alcoa, Hughes Aircraft, IBM, Ford Motor Company, and Motorola. Luftig is a past recipient of the endowed chair for research, development, and training in the quality sciences, funded by Ford Motor Company, and the W. E. Deming chair at the University of Colorado. David Magee is an award-winning columnist for newspapers that include the Wall Street Journal, the New York Times, and the Boston Globe, and he is the nonfiction author of eight books, including The South is Round and How Toyota Became #1. He is the co-owner of Chattanooga’s largest independent bookstore, Rock Point Books, and the founder of Jefferson Press, a niche publisher distributed nationally by the Independent Publishers Group. A former newspaper editor, columnist, freelance writer, business owner, and small-town politician, Magee was named

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one of Mississippi’s top business leaders under the age of 40 in 1998. Since 1999 he has been writing full-time. David Maister is a leading authority on the management of professional service companies. For two decades he has advised companies all over the world, covering strategic and managerial issues. He spent six years teaching courses in managing service businesses and production operations at Harvard Business School, during which he published seven books on business topics. He has written and coauthored several books since then, including The Trusted Advisor (Free Press, 2000) and First Among Equals (Free Press, 2002). For more information, see www. davidmaister.com. Robin Mann is head of the Centre for Organisational Excellence Research, New Zealand, chairman of the Global Benchmarking Network, advisory board member of the Hamdan bin Mohammed e-University, and cofounder of BPIR.com Ltd. Dr Mann’s experience includes managing the UK’s Food and Drinks Industry Benchmarking and Self-Assessment Initiative (1995–98), the New Zealand Benchmarking Club (2000–04), the Sheikh Saqr Government Excellence Program, UAE (2005–07), and leading TRADE benchmarking projects in Singapore (from 2007 on). He worked in Edinburgh (1992–95) for Burton’s Biscuits as a process improvement manager and obtained his PhD in total quality management at Liverpool University in 1992. Andrew Mayo is associate professor of human capital management at Middlesex Business School, where he teaches human resource strategy, and his main research interest is in people-related measures. He is also a fellow and program director for in-company programs at the Centre

for Management Development at the London Business School, where he has worked since 1996. He runs his own consultancy company, MLI Ltd (Mayo Learning International), specializing in organizational strategies for growing human capital and translating the rhetoric of “people are our most important asset” into reality. Mayo is president of the HR Society in the United Kingdom and is a frequent speaker at conferences around the world. John Milton-Smith is a graduate of Sydney, Monash, and Cambridge universities. He worked in international trade, marketing, and consulting while completing his earlier studies on a parttime basis. Between 1990 and 2007 he held appointments at Curtin University, Western Australia, as deputy vice chancellor, Curtin Business School (1990– 97) and Curtin International (1998– 2002) and as professor of management (2002–07). The author of nine books and more than 60 refereed articles, Curtin University appointed him emeritus professor in 2007. Professor MiltonSmith is currently a senior management consultant specializing in corporate coaching and leadership development with the Catalyst Group, Perth. Sue Newell is Cammarata professor of management at Bentley University in Waltham, Massachusetts, and a part-time professor of information management at Warwick University in the United Kingdom. She gained her BSc and PhD from Cardiff University and is currently PhD director at Bentley University. Professor Newell’s research focuses on understanding the relationships between innovation, knowledge, and organizational networking (IKON)— primarily from an organizational theory perspective. She was one of the founding members of IKON, a research center

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based at Warwick University. Newell has published more than 80 journal articles on organizational studies and management and information systems, as well as numerous books and book chapters. Steven M. Ouellette is an instructor on the Lockheed Martin Engineering Management Program, University of Colorado. He is also the lead consultant for Vector, working with a number of the university’s clients on implementations of the TAU/CPR model. Ouellette earned his undergraduate degree in metallurgical and materials science engineering at the Colorado School of Mines. After graduation, he won a Thomas J. Watson fellowship and spent a year in Europe studying the evolution, fabrication, and social impact of the European sword. He then worked for Alcoa, achieving the rank of senior metallurgical engineer, and subsequently joined Luftig & Warren International. He is now president and owner of The ROI Alliance and director of EMP’s Center for Statistical Solutions. He writes a monthly column for Inside Six Sigma called “The Six Sigma heretic.” Neuman F. Pollack teaches entrepreneurship at Florida Atlantic University and has been director of the Stuart-James Research Center, the Adams Center for Entrepreneurship, and the Office of Executive Relations at the Kaye College of Business. As founding dean of the Huizenga School of Business and Entrepreneurship at Nova Southeastern University, Dr Pollack developed business partnerships in the United States, Caribbean, Southeast Asia, and Western Europe. As president of the Building Owners and Managers Institute (BOMI) he

promoted research and development in the property management industry. He is a director of Emotional Endurance Institute, a nonprofit entrepreneurial support organization, FreshPeek, an entrepreneurial development company, and Parking and Security Systems, a technology-based security enterprise. John Surdyk is director of the Initiative for Studies in Transformational Entrepreneurship at the Wisconsin School of Business in Madison, Wisconsin. He has advised companies bringing emerging technologies to market for international consultancies for 10 years. Surdyk spent more than a decade consulting with high-technology start-ups, Fortune 500 firms, and nonprofit organizations at SRI International in Menlo Park and, later, Navigant Consulting in Chicago. He has also evaluated policy initiatives at the National Center for Environmental Economics at the US Environmental Protection Agency. He now teaches on social entrepreneurship at the University of Wisconsin, Madison. Priscilla Wisner is a distinguished lecturer at the University of Tennessee. She formerly taught at Montana State University and the Thunderbird School of Global Management, and her research has been widely published in journals and books, including Management International Review and the Harvard Business School Balanced Scorecard Report. She also has more than 15 years’ experience of consultancy with corporations. Dr Wisner earned her PhD at the University of Tennessee, an MBA degree from Cornell University, and a BA in international economics from the George Washington University.

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Hoshin Kanri: Deploying Your Strategic Intents to Achieve Business Excellence by Jeffrey T. Luftig and Steven M. Ouellette Lockheed Martin Engineering Management Program, College of Engineering and Applied Science, University of Colorado, Boulder, USA

This Chapter Covers 8  Introduction to hoshin kanri, a technique to align a company to achieve its strategic goals. 8  Strategic planning in the absence of hoshin. 8  The strategic planning process. 8  A real-world case study of hoshin planning in a turnaround crisis.

Introduction

Many companies strive to be the best in their market. Most never succeed. Many of those that do, do so only temporarily, and subsequently lose their position through misunderstanding how they got there and what is needed to stay there. Very few, as Jim Collins (2001) has stated, are capable of going from “good to great.” Companies that achieve, and subsequently maintain, business excellence have a number of traits in common. One of the most fundamental, though, is that the company has a vision of where it is going and everyone there knows what they need to do in order to support the company’s objectives. This does not happen by accident. The first phase in attaining business performance excellence is the process of strategic planning and policy deployment. In this chapter we will demonstrate a proven method called hoshin planning (also referred to as “policy deployment”), a process that is designed for identifying and deploying activities in order to make progress toward business performance excellence. The outcome of an effective hoshin planning process is hoshin kanri, a Japanese phrase that means “controlling the compass” and which is interpreted to refer to the actions needed to align everyone in an organization to achieve the company’s goals (Akao, 1991). In the absence of companywide direction, cascaded through the organization, each person in the company has no alternative but to guess at what they should work on to add value. Using hoshin planning, employees know exactly what to do and how that supports the company’s objectives.

Strategic Planning in the Absence of Hoshin

In our experience, most companies perform strategic planning in exactly the reverse order that they should. The second author has experience of an organization that had just been through a large-scale and expensive strategic planning session. The results certainly looked impressive—a 20-page brochure with beautiful four-color photographs and a professionally designed layout on glossy paper. On closer examination, however,

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Business Performance Excellence although each page corresponded to what each area or discipline was going to work on that year, there was no unifying theme and no direction for the organization as a whole. Contrary to conventional wisdom, the last step in the strategic planning process is the strategic plan. The strategic plan is an output of all the preceding work, not a starting-point to figure out what to measure. In this case, the strategic planning had been done by first asking each discipline to identify its SWOTs—strengths, weaknesses, opportunities, and threats. Each disparate division had done so, and from there found a number of strengths to leverage, weaknesses to improve, opportunities to exploit, and threats to avoid—and metrics to measure all of that. There was, however, no integration showing how these divisions were going to work toward a common goal, or how they would support one another on their path to excellence. Instead, each area focused on its own expertise, working on what it thought it should rather than on what the organization as a whole needed. With disparate goals such as these, divisions compete for resources and upper-level attention and the organization as a whole makes little or no progress toward an objective. In fact, in such a situation there is no objective for them to make progress toward. We will define the proper strategic planning process in general terms first, and then follow up with a real-world case study of a business in need of a major turnaround in order to survive.

The Strategic Planning Process Step 1: Who Are We?

In order to arrive at a destination, it is a good idea to know where you are going first. Yet many businesses have, at most, a plan for the future that consists of trite phrases that no one really believes influences policy. At worst, these statements are a cruel joke: for example, “People are our most important resource” in the face of downsizing. Is it any wonder that companies fail to arrive at success if they have never defined what success looks like? The first step of strategic planning is to answer the questions: “Who are we, where are we going, what will we look like when we arrive, and how are we going to get there together?” These four questions are answered by four main statements: the vision, the mission, the value proposition, and the method of strategic differentiation.

The Vision

In our terminology the vision is not an empty statement of ideals, but a statement of how we define our success. The vision is a word-picture of where the organization will be in 10 or 15 years—a description of the destination that will result in the measures that will let us know if we are there.

The Mission

The mission is a statement about what milestone(s) we will accomplish and measure over the next three to five years in order to make progress toward the vision. If the vision is the destination, the mission identifies signposts along the way that will tell us we are on track.

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Hoshin Kanri: Deploying Your Strategic Intents The Value Proposition

The value proposition is why our customers give us money. This requires a clear-eyed understanding of what exactly our customers expect and how we get it to them. A value proposition should be focused on and be appealing to your customers. A value proposition that resonates with management more than with customers is a recipe for disaster.

The Method of Strategic Differentiation

The authors favor Treacy and Wiersema’s (1993) model of how companies differentiate themselves from their competition. This provides a clear objective for the company: excel in one area while maintaining parity in the others.

Step 2: What Do We Measure?

Now that we know where we are going, we can examine the words that we used to identify what to measure so we can know the current performance of the company in those areas that are necessary to achieve the vision.

Construct Analysis

Construct analysis is the means we use to identify themes in the words chosen to describe our destination and turn them into measurements. Constructs describe—even to an external observer—how the company will appear if successful. Words or terms such as “recognized (as),” “dominate,” “safe(ty),” “reliable,” and “quality” describe common constructs in vision, mission, and value proposition statements. This step prevents empty slogans, since measurements drive behavior and the flow of resources. This encourages the organization to use the vision, mission, and value proposition statements to make management and resource decisions.

Metrics Cascade

Once the construct analysis has defined the measures of success for the organization (level I metrics), these measures must be translated to every level of the organization. A CEO is not likely to achieve his or her metrics if no one else in the company knows how what they do relates to those metrics. A useful tool for this translation is a control matrix that shows the relationship of each management level to the next level down, similar to a quality function deployment (QFD) matrix. During the creation of the metrics, the owner of the companywide level I metrics challenges his or her direct staff (level II) to come up with measures for their areas of responsibility and within their span of control that relate to the level I metrics. This negotiation takes place at each level of the company, until every individual has an opportunity to propose output metrics for their area of responsibility. This step ensures that everyone knows what to measure and how it relates back up the chain to the company’s measures of success. As a side benefit, most individuals see the number of metrics they are responsible for go down; the ones that remain are important, and they have had an opportunity to take ownership in their own process by proposing their own measures of success rather than having them imposed from above. Of course, later analysis will confirm or disprove the strength of the linkage to the next level up, so some iteration is expected in the early stages of metric development.

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Business Performance Excellence Step 3: What Do We Need To Work On?

When appropriate measures are in place (in some cases for the first time), the company finally has the correct tools to assess its progress toward the vision. Comparing actual performance to what is needed to achieve the vision is a gap analysis, which allows the company to identify those few, most important things to work on during the next planning phase. In addition, the customer quality assurance, supplier quality assurance, total asset utilization, and customer product rationalization systems’ feed information into this decision.

Step 4: The Strategic Plan

The large gaps that the company has decided to target as objectives or policies (hence the term “policy deployment”) are defined within our model as “strategic intents.” Juran (2010) refers to these intents as the “vital few.” Strategic intents are broad goals or objectives that it is necessary to achieve in order to make progress toward the vision. Upper management must then decide which of the potential strategic intents can be accomplished over the next planning cycle given the time and resource constraints of the company. Regardless of size, most companies will find that they can only address two or three strategic intents while maintaining performance in other areas. However, unlike most strategic plans, since these intents will be appropriately supported (so that they are accomplished), once those gaps are closed the intents should not require large amounts of resources to be maintained. This means that during the next planning cycle resources can be reallocated to the next set of strategic intents, continuously closing gaps and making progress toward the vision.

Step 5: Hoshin Planning

Up to this point, upper management has selected the few large gaps to be closed, but individual workers cannot be left to try to figure out on their own what they need to do to support these noble goals. This is the start of traditional hoshin planning—a step-by-step deployment of activities throughout the organization that will result in achieving the strategic intents. In order to achieve a given strategic intent, there will be multiple objectives, both strategic and tactical, that need to be accomplished. Some of these objectives require focused effort and dedicated resources to achieve a strategic breakthrough, while others require monitoring to make sure that there is no backsliding which would result in them becoming next year’s problems. Strategic objectives are breakthrough improvement activities with numerical goals and required completion dates. Tactical objectives likewise have numerical goals, but just require monitoring and continuous improvement. Each strategic objective will have one or more specific projects that need to be accomplished. These projects, or focal points, show how the strategic objectives are to be accomplished. Each tactical objective will have one or more metrics, referred to as “check points,” that roll up to produce the metric that needs to be maintained and slightly improved. This process prevents the situation where everyone meets their goals, but the strategic plan is not accomplished. At times, an organization will find that it is missing some system that is needed in order to even work on making the progress that it needs to achieve its vision, or to

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Hoshin Kanri: Deploying Your Strategic Intents intelligently set targets for the defined objectives. These systems, called “enablers,” which have to be built prior to working on or setting targets for some objectives, can appear wherever they are needed in the strategic plan.

Harnessing Employee Creativity Notice that, while the required improvements are defined by the organization’s management, how these improvements are achieved rests with each organizational level. This allows each manager the creative freedom to propose breakthroughs in the areas in which he/she is expert, and results in better solutions and significant emotional attachment to success. Contrast this with the results of traditional top-down dictates where the CEO tells his/her staff what to do, who in turn tell their staff, all the way down. That approach robs employees of significant input into the strategic plan and leads to suboptimal solutions. Ultimately, these top-down plans will fail to achieve their stated goals. The hierarchy of the strategic plan will resemble the following, with enablers occurring wherever necessary. Strategic intent 1. Strategic objective 1.1. Focal point 1.1.1. Focal point 1.1.2. Subpoint 1.1.2.1. Strategic objective 1.2. Focal point 1.2.1. Focal point 1.2.2. Strategic objective 1.3. Focal point 1.3.1. Enabler 1.3.1.a. Tactical objective 1.1. Check point 1.1.1. Check point 1.1.2. Tactical objective 1.2. Check point 1.2.1. Check point 1.2.2. Strategic intent 2. Strategic objective 2.1. Focal point 2.1.1. Focal point 2.1.2. Strategic objective 2.2. Focal point 2.2.1. Focal point 2.2.2. Tactical objective 2.1. Check point 2.1.1. Check point 2.1.2. Subpoint 2.1.2.2.

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Business Performance Excellence Case Study

A Bakery Corporation A large bakery was created as a result of a spinoff from its parent firm. The business consisted of 53 manufacturing plants across the United States, each with approximately 600 workers. The firm’s headquarters was in Dallas, Texas, where upper-level management, sales, and marketing personnel were positioned. The company produced a large variety of baked and refrigerated dough products, both under its own name and for the private-label market. A significant business unit within the company was the Refrigerated Dough Products (RDP) division. At the first strategic planning session following the spinoff, the new RDP management team was presented with the financial “state of the firm” shown in Figure 1. Figure 1. Starting state for the RDP division: net sales and earnings before interest and tax (EBIT) on rolling 13-period basis

FY 1996

FY 1997 30

230

210

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190

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Net sales (US$ million)

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Note that, although sales revenue was up slightly, profit was falling precipitously. If this business was to survive, it needed to turn its profitability around rapidly and, more fundamentally, to understand where its profit was originating. In order to do so, the company needed to focus its resources only on those things that would result in understanding and improving profitability. The mechanism used to achieve this was hoshin planning. This process requires an organization to establish (usually) a vision, mission, and value proposition that will be used for short- and long-term decision-making. These three statements are also the source of the constructs that will be used to generate the firm’s critical performance measures (CPMs). In the two sections that follow constructs are identified with bold lettering.

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Hoshin Kanri: Deploying Your Strategic Intents

Vision Given the firm’s financial condition, management decided to generate a combined vision/ mission statement focused on financial performance. This is not an unusual strategy for companies that require a short-term turnaround in business conditions before additional metrics associated with a balanced scorecard can be considered.

8 Vision: RDP will grow profitably by dominating the private-label market for the products we choose to manufacture.

Value Proposition The RDP division is a private-label manufacturer. This means that it makes the store-brand alternatives to brand-name products. As such, it had to clearly understand what it was that its customers (grocery stores) perceived as valuable. The following two value propositions were defined.

8 Value proposition 1: Allow the customer to build consumer loyalty through the dependable provision of equal or superior-quality products.

8 Value proposition 2: Provide our customers with competitive balance capability through the provision of equivalent products at lower prices.

Method for Strategic Differentiation Using Treacy and Wiersema’s (1993) terminology, there is only one model that is applicable to this business. The prices of the brand-name products are determined by the company owning the name brand; store brands are sold at a discount to this price. The gap between the stores’ purchase price and the discounted price to the consumer is a major source of profit to the grocery stores. Stores do not care to take a chance on a new product—they just want to offer products that are equivalent in type and quality to the name brands. Thus, the only way to make a profit in this market is to relentlessly drive operational costs down while maintaining quality at or above that of the name brands. Treacy and Wiersema call this “operational excellence.” There are a number of ways to drive down operational costs, including restricting stockkeeping units (SKUs) to a limited range, limiting services only to those that the grocery stores are willing to pay for, and carefully selecting grocery customers whose expectations and requirements allow for profit to be made. Other cost options were off the table— current employees and factories had to be retained over the time span of the vision.

Construct Analysis The constructs from the vision and value proposition(s) must be turned into measurable critical performance measures, which fall into two broad categories: key performance indicators (e.g. return on investment (ROI), return on capital employed (ROCE), return on assets (ROA), economic value added (EVA), market value added (MVA), cost of goods sold, etc.) and nonfinancial indicators (e.g. safety indices such as total injury rate (TIR), lost workday rate (LWDR), lost workday case rate (LWDCR), and market share as measured by the percentage of units sold in a particular category). Additionally, the concept of the balanced scorecard (Schneiderman, 1999) was utilized

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Business Performance Excellence as a “sanity check” to add an additional (safety) metric. The results of the RDP division’s construct analysis and the critical performance measures that were selected are summarized in Table 1. Table 1. RDP division’s construct analysis Source Vision

Construct

KPI or nonfinancial indicator

Growth/domination

Market share by category

Profit

Capital employed Return on capital employed (ROCE) Profit (EBIT)

Value proposition

Dependable provision

Orders shipped complete and on time (OSCOT)

Equal in quality

Comparative quality (benchmark) Price gap (US$)

Balanced scorecard

Safety

Safety indices

Metrics Cascade The metrics indicated in Table 1 would be the measures of success for the company. However, they needed to be translated to all levels of the organization. A control matrix, shown in Figure 2, was used to document the different metrics for each level. At the intersection of the row for the level I metrics and the column of the level II metrics is a box with a figure that indicates the strength of the relationship.

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Hoshin Kanri: Deploying Your Strategic Intents Figure 2. RDP division’s level I to level II control matrix

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Business Performance Excellence Each level II manager then takes his or her measurements, places them on the left of a similar matrix, and then challenges those who report directly to them to identify metrics in their area of responsibility and within their span of control. The process is repeated throughout all levels of the organization, with the metrics being documented in a cascading series of matrices.

Gap Analysis Given the requirements of the vision, targets can now be set for the level I metrics, and these targets in turn are cascaded down through the organization on the control matrices. By identifying the gaps between what is needed to achieve the vision and actual performance, areas can be targeted for improvement. As an example of this, a total asset utilization–customer product/process rationalization (TAU/CPR) model showed the following interesting relationship between customer revenue and profitability. Each customer was ranked according to its actual contribution to the profit of the company and graphed, as shown in Figure 3. Figure 3. Ranked customer contributions to sales revenue and profit 140%

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Proportion of customers (%)

Examination of the graph reveals the following details:

Sales

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25% of customers provided: 50% of customers provided:

84% 91%

116% 123%

This naturally raises the question: If 50% of the customers provided 91% of the revenue and 123% of the profit, where did the 23% profit above 100% go? The answer is helpful in providing strategic direction. The company lost an additional 23% of its profit by accepting the business of the remaining 50% of customers who provided only 9% of the total revenue.

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Hoshin Kanri: Deploying Your Strategic Intents In this case, a large number of small customers cost the company profit with each order taken. This validates the fallacy of the “feed the beast” mentality that accepts any order offered because any revenue must be good revenue. As is clear from Figure 3, sometimes a company cannot afford low-quality revenue. Many business school undergraduates are taught that “the customer is always right.” Unfortunately, they are often not taught that not every customer is the “right customer” for the mission and value proposition of the firm (Knowlege@Wharton, 2002).

The Strategic Plan Management examined the gaps between actual performance and the performance needed to achieve the vision and identified four strategic intents.

8 Significantly improve the profitability of the RDP division. 8 Grow market share in the profitable segments of the refrigerated dough sector. 8 Significantly improve the dependability of delivery to customers. 8 Significantly improve employee safety. Following this activity, a data-based set of high-level improvements were selected. However we do not want to leave undefined what each individual should do over the course of the strategic plan in order to help to accomplish this. Business improvement does not happen by accident but by design, and this is where hoshin kanri comes into play.

Hoshin Planning Starting at the top of the organization, each manager examines the strategic intents and identifies ways in which their part of the company can support achieving these breakthroughs. Their proposed approach is negotiated and finalized with the previous level of management. Numeric results are set such that the level I metric goals for this cycle are achieved, ensuring that if the plan is followed the identified breakthroughs will be captured. In order to show this, selected portions of the strategic plan (with some proprietary items shown as “X”) are shown below. Strategic intent 1: Significantly improve the profitability of the RDP division Strategic objective 1.1: Obtain a breakthrough reduction in the cost structure of RDP by achieving a $X million reduction in manufacturing cost during the third and fourth quarters of financial year 1997.  Focal point 1.1.1: Reduce controllable overuse by at least X% during the third and fourth quarters of financial year 1997.  Focal point 1.1.2: Reduce labor $/revenue $ by at least X during the third and fourth quarters of financial year 1997.  Subpoint 1.1.2.1: Improve total asset utilization (TAU) by at least X during the third and fourth quarters of financial year 1997.  Subpoint 1.1.2.1.1: Reduce unscheduled downtime by at least X during the third and fourth quarters of financial year 1997.  Subpoint 1.1.2.1.2: Improve duty cycle (through scheduling improvements) by at least X during the third and fourth quarters of financial year 1997.  Enabler 1.1: Implement TAU data collection system by the end of the third quarter of financial year 1997.

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Business Performance Excellence  Tactical objective 1.1: Maintain or slightly improve sales and distribution costs to at least X% of sales. T actical objective 1.2: Maintain or slightly improve general and administrative costs to at least X% of sales. Check point 1.2.1: Monitor corporate share.  Check point 1.2.2: Monitor and reduce divisional administrative costs as necessary. T actical objective 1.3: Maintain or reduce indirect manufacturing costs at not more than X% of sales.  Tactical objective 1.4: Maintain or grow net revenue at or above $X million. S trategic objective 1.2: Significantly improve RDP’s profit margin through an improved product/customer mix and business strategy.  Focal point 1.2.1: Conduct a customer/product mix analysis within each channel (retail and contract) to develop select customer lists by November 30, 1996. Focal point 1.2.2: Design (by January 1, 1997) and implement (during fourth quarter of financial year 1997) a business strategy to establish a model of operational excellence within RDP. Enabler 1.2.2.a: Updated market information. Enabler 1.2.2.b: Profitability data by product and customer. Strategic intent 3: Significantly improve the dependability of delivery to our customers  Strategic objective 3.1: Achieve a breakthrough increase in orders delivered complete and on time.  Focal point 3.1.1: Achieve at least a X% order fill rate to select customers by January 1, 1997. Focal point 3.1.2: Achieve at least a X% departed on time by January 1, 1997.  Focal point 3.1.3: Achieve at least a X% arrived on time to select customers by January 1, 1997.  Focal point 3.1.4: Achieve at least a X% order fill accuracy to select customers by April 1, 1997.  Enabler 3.1: Implement arrival data collection by January 1, 1997, on both time and accuracy. Tactical objective 3.1: Maintain at least X% order fill rate to key customers. Tactical objective 3.2: Maintain at least X% departed on time to key customers. Strategic intent 4: Significantly improve employee safety  Strategic objective 4.1: Achieve a breakthrough decrease in employee accidents and severity.  Focal point 4.1.1: Reduce lost workday index rate (calendar year cumulative rate) below X by January 1, 1997.  Focal point 4.1.2: Reduce total accidents index rate (calendar year cumulative rate) below X by January 1, 1997. Tactical objective 4: Maintain improvement in employee empowerment. Check point 4.1: Top two issues from 1994 employee opinion survey should be at least X% improved by time of next survey.  Enabler 4.1: Perform a follow-up employee opinion survey by September 1, 1997.

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Hoshin Kanri: Deploying Your Strategic Intents Results—Achieving Business Performance Excellence The plan was well executed by bakery management and, subsequently, by the workforce. Quarterly meetings were held at which the highest levels of management participated in presentations by those in charge of the various projects, roadblocks were discussed and overcome, and resources allocated and when necessary reallocated to ensure the completion of everything necessary to achieve the required progress toward the vision. Of course, one would naturally wonder if this effort was worth the time and trouble needed to execute the strategy. Recall the financial situation presented in Figure 1, where the company was watching its profit fall in the presence of increasing sales revenue. After the initial intervention and a laser-like focus on identifying only those things that were most important to accomplish and on getting them done, the effect on profit was clear. This is shown in Figure 4. Figure 4. First two years’ results for RDP division: net sales and EBIT on rolling 13-period basis Time period shown in Figure 1

FY 1996

FY 1997

230 220

30

25

210 20

200 190

15

180

10

EBIT (US$ million)

Net sales (US$ million)

FY 1998

Start of turnaround activity

170 5

160 150

1 2 3 4 5 6 7 8 9 10 11 12 13 1 2 3 4 5 6 7 8 9 10 11 12 13 1 2 3 4 5 6 7 8 9 10 11 12 13 1 2 3

Net sales

EBIT

0

Period

As can be seen, there were various decreases in revenue as the company priced itself beyond the reach of customers that were losing them money (and passed them on to their competition) and replaced that volume with more profitable customers. In addition, the profitability reversed sharply in trend and kept on going up for the next 23 accounting periods. Could this activity continue to be profitable? The same hoshin process was used in each planning cycle to identify the most important new areas to work on, while maintaining performance in those other areas. As Figure 5 shows, the profitability trend continued. In the later periods the company acquired another firm. In the last quarter of 1999, new customers that came in from an acquisition was analyzed, low-quality revenue was driven out and replaced with higher-quality revenue, and we see another marked rise in profit.

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Business Performance Excellence Figure 5. RDP division’s results over the four years after implementation of the strategic plan: net sales and EBIT on rolling 13-period basis. Note the change in both axes vs Figure 1 Time period shown in Figure 4 250

FY 1996

FY 1997

FY 1998

FY 1999

FY 2000

Start of turnaround activity

240

40

35

230

25

210

20

200 190

15

EBIT (US$ million)

Net sales (US$ million)

30 220

180 10 170 5

160 150

1 2 3 4 5 6 7 8 9 10 11 12 13 1 2 3 4 5 6 7 8 9 10 11 12 13 1 2 3 4 5 6 7 8 9 10 11 12 13 1 2 3 4 5 6 7 8 9 10 11 12 13 1 2 3 4 5 6 7

Net sales

EBIT

0

Period

It is important to note that the profitability increases evident in Figure 5 did not come from a reduction in workforce head count—in fact the opposite. As management understood where its profitability was coming from, it was able to increase employment, thus achieving the vision of “growing profitably.” The company was in fact so profitable that in 2001 a major international food brand acquired it, and those executives who in 1997 were worried about the survival of the company were able to reflect on their own years of hard work and that of their employees in achieving business performance excellence. During that same period, the bakery's major competitor executed a number of downsizing efforts, culminating in a Chapter 11 bankruptcy declaration.

Summary and Further Steps

8 For hoshin planning to be effective, it needs the firm foundation of an understanding by the business of what it is and where it is going, and an ability to correctly measure its performance in achieving its hoshin plan goals. Using the resulting data to identify gaps between the current state and what is needed to achieve those goals will help the business to identify the most important issues on which it needs to work. 8 At that point hoshin planning takes those high-level strategic intents and, through a creative process of negotiation between each level of management, all individuals in the company identify what they must do to preserve performance in nontargeted areas while supporting breakthrough improvements in those areas that are targeted. 8 Hoshin kanri is key to helping a company or other organization to allocate its resources in order to achieve its vision. Companies that plan their strategic activities in this way

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Hoshin Kanri: Deploying Your Strategic Intents more often than not tend to achieve their goals. Companies that do not use hoshin planning, or policy deployment processes, often attempt to execute strategic plans that seldom, if ever, actually come to pass. Even an imperfect strategic plan that is well executed will succeed where a beautifully perfect one that is never effectively deployed within the company will fail. 8 Companies that cannot plan and deploy a strategy are subject to the whims of forces beyond their control. In today’s business environment this often spells doom for an organization that was successful only a few years ago. Hoshin planning is the first step toward taking control of the future of a company and planning—and subsequently deploying—for success.

More Info Books: Akao, Yoji (ed). Hoshin Kanri: Policy Deployment for Successful TQM. New York: Productivity Press, 1991. Collins, Jim. Good to Great: Why Some Companies Make the Leap... and Others Don't. London: Random House Business, 2001. Imai, Masaaki. Kaizen: Key To Japan's Competitive Success. New York: McGraw-Hill, 1986. Juran, Joseph M., and Joseph A. De Feo (eds). Juran's Quality Handbook: The Complete Guide to Performance Excellence. 6th ed. New York: McGraw-Hill, 2010. Articles: Knowlege@Wharton. “The customer profitability conundrum: When to love ’em or leave ’em.” Strategy+Business (April 12, 2002). Online at: tinyurl.com/77zy6zy Schneiderman, Arthur M. “Why balanced scorecards fail.” Journal of Strategic Performance Measurement (January 1999): 6–10. Online at: tinyurl.com/8x2t9km [PDF]. Treacy, Michael, and Fred Wiersema. “Customer intimacy and other value disciplines.” Harvard Business Review (January/February 1993): 83–93. Online at: tinyurl.com/7s5ozdt [PDF]. Websites: Center for Business Performance Improvement, University of Colorado at Boulder: www.csscu.com

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A Holistic Approach to Business Risk Management by Terry Carroll Broadhead Peel Rhoades, Leeds, UK

This Chapter Covers 8  The events of 2008 make it unsurprising that we are preoccupied with financial risk. 8  Financial risk is part of overall business risk—business risks have financial consequences. 8 As well as being viewed individually, risks should be viewed holistically. 8 A holistic approach to risk means looking at each risk in the context of others. 8 Managing business risk can be positive and offer opportunities. 8 The credit crunch is an example for all companies, not just banks. 8 There is a simple, clearly defined process for managing business risks. 8 Risk pervades every element of the overall business process. 8 The whole organization should be engaged in the risk management process.

Introduction

After arguably the greatest credit crisis in history, it is unsurprising that lenders, borrowers, and investors alike have become preoccupied with financial risk. Its magnitude seems to have dwarfed all other business risk considerations. It can be hard to take a pragmatic view when the strictures in the financial markets may have put the corporation at risk, but the correct perspective is for all risk to be captured in a holistic framework. Apart from the consequences of events in the financial markets, some recent risk considerations have been imposed rather than occurring naturally. Among those that were more prevalent prior to the credit crunch were the issue of corporate manslaughter and the need to comply with burgeoning health and safety regulation. What seems sometimes to have been overlooked is that all financial risks are business risks (i.e. a risk to the business), and all business risk has financial consequences. There are those, especially in the public sector, who seem preoccupied with budgets and spending, rather than planning. The advent of business process reengineering (BPR) in the 1980s seemed to coincide with downsizing or rightsizing, as companies trimmed or even slashed their budgets. What BPR and business planning have in common is the need to put the horse in front of the cart. Financial transactions are the consequence of business decisions. Budgets are the consequence of business planning. Cost efficiencies should only arise from BPR where the exercise is to design or redesign the organization to deliver the current strategy in the current markets and circumstances.

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Business Performance Excellence In summary, all risks have potential consequences for financial and business continuity. A holistic approach means looking at each risk in the context of others, and of the business and financial risk as a whole.

Risk Is a Natural Consequence of Business

Financial risk is a subset of business risk, which is a consequence of business decisions. You cannot be in business without taking risks. Whether you accept these risks or not is a function of whether your business thinking is proactive or reactive. No one can eliminate all business or financial risk. Either you don’t have a business, or the premiums you would need to pay to eliminate risk would transcend any prospect of profit. It could be argued that in the public sector, and with the latter’s growing influence in commerce (for example through public/private partnerships), risk has become an industry in itself. The public sector does not have a profit imperative. If it is decreed that risk shall be actively managed or insured against, the cost is picked up by the taxpayer. The growth of the health and safety industry in the United Kingdom has undoubtedly saddled the taxpayer with burgeoning costs. It has impacted industry in much the same way, but with less chance to pass this on to the customer.

What Is Business Risk?

“Risk is a threat that a company will not achieve its corporate objectives.”1 A typical dictionary definition would be: “Risk is the possibility of suffering harm or loss.” Such a definition characteristically has implicit negative connotations. Here we are talking about a more objective approach, where risk is recognized as part and parcel of enterprise. The management of risk is fundamentally about ownership and accountability for the management and business processes, and their possible opportunities and consequences. The process can be characterized by four simple components: 8 8 8 8

evaluation; control; transfer; constructive damage limitation (insurance or hedging).

Managing risk is a continuous process, as opposed to something that you do just once. Starting from strategy, and considered throughout the organizational processes, risk is present and has potential impacts at every step of the way. The trick is in being able to see it in a positive and opportunistic way rather than in a negative light. Ideally, the whole organization should be constructively engaged and empowered in the recognition and management of risk.

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A Holistic Approach to Business Risk Management Case Study

The Credit Crunch and the Irresponsible Creation of Financial Risk The credit crunch has been a highly illustrative case study in dysfunctional risk management. What brought the financial markets to their knees was the irresponsible and inadequately controlled creation of excessive risk, with little or no consideration of the consequences. In a climate where interest rates were historically low from 2001, and with bonus-fueled incentives to grow the balance sheet, US financial institutions identified a new group of customers. These were people at the bottom of the economic food chain, living in rented property, who were persuaded that with interest rates so low it was cheaper to buy their homes than to rent them. As interest rates rose and fixed-rate deals matured, a growing proportion of this new army of borrowers found they could not meet the repayments. Unsophisticated, many of them simply defaulted on the payments, and some even walked away. The result was what became known as subprime assets. The problem was compounded in at least two further ways, however. The new assets had been securitized into packages that could be sold on to fund new lending, and some had even been disaggregated into their component parts, to be sold on to other investors such as hedge funds and other investment funds. So long as the returns were good nobody complained, but as the markets unraveled investors became increasingly concerned about where their money was invested. Many of these assets were off balance sheet, and even offshore. Often they weren’t regulated. When, in August 2007, BNP Paribas found that it couldn’t value three of its funds because there was no longer a sound market for these esoteric assets, the whole global financial system began to crumble.

Lessons for Companies

In the infamous 1980s’ Barings case, the board either was not aware of the scale of risk being created, and/or it did not have sufficient or satisfactory controls, including the separation of functions. Nor does it appear to have had a sufficient, or a holistic, view that would have considered the burgeoning risk in the context of the whole of Barings’ business, which the materialization of this risk ultimately brought down. We don’t have enough information to be sure whether the boards of the US institutions had sufficient oversight over the nature and scale of the risks being created. We do, however, know that the financial authorities, and especially the Bank of England, had become increasingly concerned about the lack of control or regulation of what have been labeled “toxic assets” long before the problems became critical to the markets. This is a clear lesson for the boards and executives of companies. Not just in relation to financial risk, but to business risk in general. We do not propose a new industry of risk management, but we do strongly recommend that risk management should be a core

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Business Performance Excellence business function. It does not sit apart from business planning and decision-making, but it is a close cousin of audit, and may ideally be viewed as internal consultancy, informing and improving the quality of management decisions. Similarly, in the public sector, risk management in its many guises has come to resemble a core function that is sometimes “the tail that wags the dog.” The risk management function should be woven into mainstream decision-making; it should start with, and encompass, the whole of business risk; and it should enrich and inform management rather than constrain and curtail, otherwise it misses the point.

A Simple Formulation

Holistic business risk management starts with strategy formulation and goes right through to business and financial planning, and ultimately implementation. At every stage, the simple question is “What are the consequences of this decision?” For some, risk management or risk review seems to be more of an afterthought. For example, prospectuses and project plans seem always to finish with a summary and evaluation of the risks. This is done with an eye to investors or stockholders, to satisfy them that management has thought of all the significant consequences of a plan or proposal. Often it amounts to little more than a rhetorical flourish: “See, we’ve done the risk evaluation.” It would be better if management wove risk evaluation into every stage of planning and decision-making. It should be at the heart of all high-quality management thinking, and should be seen to enrich the quality and rigor of decisions, rather than holding them back or, worse still, being a mechanical afterthought, and only when demanded or requested. There is a simple pattern to the consideration of risks as part of business decision-making: 8 8 8 8 8 8 8 8

determine the risk; analyze it; evaluate it; manage it; ignore it; insure against it; control it; improve the management and business processes that are the basis of the risk.

A Whole Organization Enterprise

It has been characteristic for management to be directive rather than consultative. Managing risk in a holistic way can be time-consuming, but, like success, it touches the whole enterprise. Singular decisions were taken for US institutions to drive into subprime assets. Would it have been different if the whole organization had been engaged in the decision? It is important to see managing risk as a central business need, woven throughout the fabric of the organization.

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A Holistic Approach to Business Risk Management Ultimately, the management of risk is the responsibility of the board. As the governance medium of the organization, the board approves and oversees strategy and policy. At the strategic level, some other questions and issues that arise are: 8 8 8 8 8 8

What is risk in the context of our business organization? What does managing risk imply for us and our management processes? Where does responsibility for the management of risk lie? Why should we manage risk? What are the benefits of managing risk? Are we complying with legislation, good practice, standards, regulation, and sound governance?

Managing risk will always be a balance between evaluating and optimizing opportunity on the one hand, and identifying and dealing with the potential related risks on the other. Do you need a specific department to manage risk? Might one actually create confusion within other departments? If you were establishing your organization from scratch today, would you set up a specific function called risk management? Ideally, it should be woven as an integral part into the management and business processes. The mature organization instinctively scans for, and is aware of, risk in everything it does.

So How Do We Do This?

World class organizations have world class management practices and processes. By all means set up a risk management function, but it should be a servant to, not a constraint on, the organization. It should be participative, engaging, and integrated with the internal audit process, in the nature of an internal consultancy. It should be engaged end to end in the entire management processes—from strategy formulation to implementation and delivery. It should especially facilitate management, and indeed the whole enterprise, to make the consideration of risk fundamental to every business decision in a positive, objective, and contributory way, rather than as a constraint on enterprise. Where such risk evaluation results in a decision to insure against risk, rather than manage it, this should also be the consequence of objective evaluation rather than defensiveness. Excess insurance is a brake on enterprise, and has financial consequences for the bottom line. Where it comes in the form of derivatives or hedges, it can sometimes create more rather than less risk if there is not a “total balance sheet” approach. Summary and Further Steps

Conclusion Risk management was born out of the insurance industry. It has become endemic in the public sector, with consequent burgeoning costs. It has had negative rather than positive results. All great entrepreneurs are risk-takers. The best either have a sound, intuitive awareness of risk and its balance with enterprise, or are secure enough to lead the evaluation of possible consequences, so as to enrich rather than inhibit business decisions.

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Business Performance Excellence Now is the time to see the management of risk as a holistic business process that is inherent in every decision. As opposed to being seen to hold back enterprise, the consideration and evaluation of risk should be seen as enriching the quality of business decisions. It is, however, sensible to capture the risk evaluation alongside the decision. You make the decision including the risk consequences, rather than despite them. As well as being woven into the management and business processes, holistic risk management should embrace as much of the organization as is practicable. What-ifs, constructive challenge, and objective review should be celebrated rather than shunned. Financial transactions are the consequence of business decisions. Negative risk outcomes and their financial costs should not be a surprise, except where they arise from chance. Insurance, whether through premiums or derivatives, should not merely be a safety net. It should be the result of mature identification, consideration, and evaluation of risk scenarios and consequent management decisions. That way, the net financial outcomes can be predicted with reasonable accuracy and consistency. Those organizations that take a holistic, constructive, and proactive view of risk are less likely to be caught out, are more likely to succeed in the long run, and produce more predictable and manageable results. Where they engage as many of the staff as possible in the process, the by-products could well be better reputation and trust with investors, customers, and staff, and better long-term market value. Above all, this objective, positive, holistic approach to business risk management empowers organizations, management, and individuals to grow through openness and mature evaluation, rather than feel constrained by a process that seems to sit apart from the core enterprise.

More Info Book: Carroll, Terry, and Mark Webb. The Risk Factor: How to Make Risk Management Work for You in Strategic Planning and Enterprise. Harrogate, UK: Take That Books, 2001. Article: Carroll, Terry. “A risky business.” Exec online magazine (August 2007). Website: Association of Corporate Treasurers (ACT): www.treasurers.org

Notes 1. Harris-Jones, Judith, and Louise Bergin. The Management of Corporate Risk—A Framework for Directors. London: Association of Corporate Treasurers, 1998.

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Aligning Structure with Strategy: Recalibrating for Improved Performance and Increased Profitability by R. Brayton Bowen The Howland Group, Inc., Louisville, Kentucky, USA

This Chapter Covers 8 Aligning organizational structure with corporate strategy requires financial “rethinking.” 8  In difficult economic times, it is not unusual for organizational leaders to demand across-the-board cuts of some arbitrary percentage to achieve bottom-line results. 8 Unfortunately, that approach often cuts into the “muscle” of critical functions that are vital to the successful performance of the enterprise and its future viability. 8  As an alternative, activity-based cost accounting quantifies the cost of specific work activities throughout organizational systems. 8  This approach to redesign helps the organization recalibrate how and where work can be better aligned with corporate direction. 8 The enterprise can achieve not only better organizational performance with this method, but also bottom-line efficiencies that improve financial results.

Introduction

Phlebotomy—the ancient practice of bloodletting—seemed logical when medical science centered on the belief that four humors made up the human body: yellow bile, black bile, phlegm, and blood. It was thought at the time that an ailing person could be brought to good health by vomiting, purging, starving, and bloodletting. Unfortunately, in the latter instance, any number of the sick bled to death! By today’s medical standards, the practice is considered quackery. Now when a patient is ill, the condition is diagnosed extensively until the source of the problem is identified. If an operation is required, the repair is made with surgical precision. Oddly enough, phlebotomy continues to be practiced on the body “corporate” in any number of organizations, where the four key elements are considered to be: capital, equipment, product (services), and people. A poor-performing organization, like an ailing patient in ancient times, is “bled” of its people resource. If the economy turns down, more blood is let, until the enterprise either recovers, or dies. In rough economic times, it is not unusual for organizational leaders to demand acrossthe-board cuts of some arbitrary percentage to achieve bottom-line results—not unlike phlebotomy, where cuts were made on almost all parts of the body. Unfortunately, that approach often cuts into the “muscle” of critical functions that are vital to the successful performance of the enterprise, and its future viability. And, the reality is that once an organization goes through a major bloodletting, a.k.a., “downsizing,” “rightsizing,” or “rationalizing,” management will resort to doing it again and again. Invariably, the organization fails to achieve its performance objectives, and

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Business Performance Excellence the scars of phlebotomy serve only to remind the employees who remain that they too may be the subjects of such savagery in the future. Trimming excess resource is certainly necessary from time to time, but keeping trim and fit on a regular basis should be the norm.

Designing from the Outside In Why Are We in Business?

Ask anyone why he or she is in business, and the answer ultimately is “to make money.” Certainly, that should be the final result, but the mission is “to serve customers,” and the outcome should be “customer satisfaction.” Without customers, there is no business. Consequently, the design of an organization must be built from the outside in. In other words, it must begin with the end-customer in mind. Slywotzky and Morrison (1997; p. 23) make the point: “The value of any product or service is the result of its ability to meet a customer’s priorities.” Structuring a business strategically requires a careful analysis of what the customer priorities are. To design from the outside in, it is important to know what the customer values: does the customer have a need, either actual or perceived? How much is the customer willing to pay? How quickly does he or she want delivery? Does the customer expect ongoing support? Does the product (service) fulfill a lifestyle or ego need? Does the customer wish to participate in an interactive process of design and fabrication? Will the customer return for replacement and/or enhanced products (services)? When businesses make across-the-board cuts without regard to customer priorities, it is as though they have compromised the outcome for the customer and jeopardized the integrity of the relationship for the future. Entire industries have reneged on their promises of product quality and customer commitment, for example General Motors promised a unique customer relationship with its Saturn division; now it is eliminating the line to save money. Delta Airlines has continuously cut services and increased fees, reportedly to survive, while management has continued to receive generous compensation and pension benefits; today it is merging with Northwest. Circuit City, a big box retailer, lost its way with customers a long time ago. Today, it is out of business. Cost-cutting measures for all these businesses were applied without regard to the ultimate value proposition for the customer.

What Is the “Essence” of the Business?

Continuous realignment requires the ongoing process of taking time out of the design, fabrication, and delivery cycles. Time savings equal cost savings. Increasing the value proposition for customers and shareholders requires the ongoing process of assessing the cost of doing business, as well as the return on investment. But, downsizing structure for the sole purpose of reducing cost, in and of itself, is not a sustainable strategy. Form must follow function. Structure must follow strategy. Consequently, any restructuring must begin with outcomes in mind, and the quintessential outcome in business is the value proposition for the customer. So, recognizing that businesses change constantly, how does one go about the process of continuous realignment? Rather than acrossthe-board cutting—like phlebotomy—consider the alternative: activity-based costing,

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Aligning Structure with Strategy more commonly referred to as “ABC” accounting. This approach more accurately assigns value to discrete activities, business functions, cross-organizational processes, and, ultimately, specific products and services. It even identifies the cost of what is not being done, like “waiting for instructions” or “idling in traffic.” Indeed, it is a process that encourages long-range thinking and strategic decision-making rather than a short-term, knee jerk reaction.

Structural Redesign

Begin with Outcomes in Mind

Establish expectations from the outset by beginning with the outcomes to be realized, for example: 8 The proposed redesign will be aligned with the organization’s vision, mission, values, and major strategies. 8 The overall design will enhance the value proposition for the customer. 8 Opportunities for income generation will be identified, and a more effective allocation of resources will be proposed according to the income opportunities identified. 8 The new structure will be at least 80% aligned with the primary, valueadding initiatives of the organization. 8 Organizational members will be empowered to work in self-directed work teams to enhance the exchange of diverse opinions and the sharing of ideas and solutions. 8 The number of organizational levels will be reduced to facilitate the rapid transference of information. 8 Quality assurance and continuous improvement will be built into the collective cognition and processes of the new organizational design. Of course, one of the expected outcomes might be a targeted reduction in the cost of people resources; but even if it is not a stated outcome, typically an organization will realize a 10% reduction in the cost of human resources as a result of more efficient and effective organizational design. Once outcomes have been established, the next step is to identify all work activities.

Taking Stock of Work Activities and Their Importance

Taking stock requires identification of every work activity performed throughout the organizational system. For example, in the area of finance (partial list): 8 accounts payable; 8 accounts receivable; 8 general accounting. In the area of manufacturing (partial list): 8 requisitioning materials; 8 assembling parts; 8 testing finished products.

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Business Performance Excellence The next step is to identify those activities that are “primary,” i.e., value-adding and essential to the organization’s primary mission; and those that are “secondary,” albeit important, but, nevertheless, ancillary to the core mission of the organization. Hence, for a marketing firm, an example of a primary activity would be “advertising layout,” while an example of a secondary activity would be “accounting.” (If an enterprise is in the business of advertising, it is not in the business of accounting; therefore, accounting is a secondary activity.) In the final stage of design, it is important to retain 80–90% of the primary activities for the integrity of the organization. Only the most important support activities should be retained, roughly 10–20%. The remaining support activities would be targeted for outsourcing and/or elimination. In this way, the essence of the organization is preserved and, indeed, strengthened.

The Process of Redesigning

To ensure acceptance of proposed changes in the new structure and enhance the effectiveness of the design itself, utilization of a cross-organizational/ cross-functional design team is recommended. Using the inventory of activities suggested above, the design team proceeds with surveying the organization to determine what activities are being performed by people throughout the organizational system, as well as the amount of time expended in performing each activity. This survey feedback is integrated with a reporting system that contains a comprehensive listing of all positions, and the payroll associated with each person. The process is also effective in capturing non-productive time. Once data collection is complete, and the data are integrated with the payroll reporting system, reports can be generated that allow the design team to assess what work is being done currently, where it is being done, who is doing it, and what the associated costs are. Armed with this knowledge, the design team can go on to look at design alternatives that better align with the outcomes expressed at the outset of the process.

Sample Reports

Data can be arrayed in several formats to provide the right information to facilitate the redesign process for the team. Table 1. Activity costs by function Code

Activity description

Cost US$ (000)

Cost %

FTE

Avg. time

0400

Finance

238.3

16.1

12.36

26.3

0401

Accounting

88.9

6.0

5.02

15.2

0249

Accounting—general

7.7

0.5

0.35

5.8

0250

Accounting—revenue

4.3

0.3

0.10

5.0

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Aligning Structure with Strategy Table 2. Activity costs—high to low Code

Activity description

Cost US$ (000)

Cost %

Cumulative %

FTE people

Avg. time

0001

Managing

179.8

12.1

12.1

2.55

14.2

0356

Marketing

75.1

5.1

37.3

2.20

44.0

0534

Customer service

68.0

4.6

41.9

4.38

24.3

…

…

…

…

…

… # OF ACTIVITIES: 29

1,186.2

46.44

27% of 109 activities cost 80% of payroll

Table 3. Activity costs by primary and support designation Code

Activity description

Cost US$ (000)

Cost %

FTE

Avg. time

0100

Primary work

606.6

40.9

24.63

58.6

0315

Product development

161.2

10.9

6.20

36.5

0356

Marketing

75.1

5.1

2.20

44.0

…

…

…

…

876.6

59.1

32.97

55.9

… 0200

Support work

0249

Accounting—general

7.7

0.5

0.35

5.8

0250

Accounting—revenue

4.3

0.3

0.10

5.0

…

…

…

…

…

The activity cost by function report (Table 1) allows team members to see the actual cost of each function within the organization. The high to low activity cost report (Table 2) gives an instant snapshot of where the organization is spending its money. In the example shown, 80% of the payroll cost is being expended on 27% of the total activities performed within the system. And, finally, Table 3, identifying primary and support work, provides a ready assessment of how aligned organizational activities are with the primary mission, vision, and strategies of the organization. Ideally, primary activities account for 80–90% of all the activities in the organization. Typically, at the start of a redesign process, it is not unusual to see only 55–65% alignment. The difference between the actual and ideal allocation constitutes the “gap” in alignment that then has to be addressed in the redesign process.

Continuous Redesign

Building quality into the system means incorporating the ability of organizational members to redesign continuously—taking time and cost out of organizational processes, while imbedding flexibility and resiliency into the fabric of the corporate

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Business Performance Excellence being. Embracing this competency and cultivating its continuous application can potentially stave off the need for major restructuring in the event of severe economic downturns, or increased competitive forces in the marketplace. Indeed, as many times as GE’s Appliance Division faced potential closing, continuous reengineering and structural redesign prevented the threat from ever being realized.

Conclusion

In a global economy flexibility, adaptability, and quick response times are critical attributes for any organization that wishes to compete in today’s competitive environment. Traditional accounting methods and other management metrics fail to capture the true cost of organizational processes, “hidden work,” and even “non-work.” Activity-based cost accounting provides a level of accountability and transparency that is not achievable with more traditional systems. Moreover, the team-based approach suggested here not only builds relationships among organizational members and understanding throughout the organizational system, it also facilitates the management of change, as design team participants prepare themselves for the implementation of changes in organizational structure they have designed. And, finally, this approach allows for continuous and systematic analysis of the organization and its processes to ensure the ongoing alignment of organizational structure with the strategic goals and desired outcomes of the enterprise.

Making It Happen

Aligning organizational structure with strategic goals and objectives requires intelligent planning and detailed analysis. The benefits of an ABC approach to organizational design far exceed those realized as a result of executive fiats or corporate bloodletting. The following steps are needed to ensure optimum results: 8 Determine the desired outcomes of any restructuring—begin with the end in mind. 8 Plan to design from the outside in, by identifying customer needs and expectations. 8 Assemble a cross-organizational and cross-functional team to conduct the analysis and propose structural change. 8 Identify and catalog the unique work activities that exist throughout the organizational system. 8 Conduct a comprehensive analysis of the work that is being done, capturing cost, people units, and time quantities. 8 Compare the feedback with personnel data, specifically pay and hours worked. 8 Generate meaningful management reports that will allow intelligent analysis by the team. 8 Train the team in organizational design concepts that will result in a more horizontal organization and self-direction. 8 Secure management approval of the changes and encourage continued analysis of organizational processes and related structures.

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Aligning Structure with Strategy More Info Books: Bruns, William J., and Robert S. Kaplan (eds). Accounting and Management: A Field Study Perspective. Boston, MA: Harvard Business School Press, 1987. Ostroff, Frank. The Horizontal Organization: What the Organization of the Future Actually Looks Like and How It Delivers Value to Customers. Oxford: Oxford University Press, 1999. Pfeffer, Jeffrey. The Human Equation: Building Profits by Putting People First. Boston, MA: Harvard Business School Press, 1998. Slywotzky, Adrian J., and David J. Morrison. The Profit Zone: How Strategic Business Design Will Lead You to Tomorrow’s Profits. New York: Times Books, 1997. Website: The Howland Group, Inc.: www.howlandgroup.com

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Innovation and the Path to Growth, Profitability, and Competitiveness by John Milton-Smith The Catalyst Group, Perth, Australia

This Chapter Covers 8 Disciplined managerial leadership and teamwork are keys to innovation. 8 Innovation should be driven by the end customer, not by R&D. 8 Aim to create unique market space and make competition irrelevant. 8  The 7Es innovation framework identifies seven essential stages in the innovation process. 8  The Cochlear case provides an instructive example of a structured innovation process. 8  Organic growth based on innovation is the surest path to sustainable growth and profitability. 8 Mergers and acquisitions (M&A) are a high-risk substitute for innovation strategy. 8 Innovation should be managed as an open process involving a variety of partners.

Introduction

As management guru Peter Drucker pointed out, entrepreneurial management and innovation were the drivers of the exceptional employment and profit growth in the United States during the 1970s and 1980s. Drawing on insights from this period, Drucker argued that innovation is due more to purposeful, systematic hard work rather than simply “a flash of genius.” It is, therefore, important to distinguish innovation from invention.1 Whereas creative ideas and discovery are at the heart of invention, innovation involves the creative management and application of invention. As companies such as 3M and IBM have demonstrated, innovation should be treated as a standard organizational function responsible for finding new sources of customer value.2 There are three major categories of innovation. According to Christensen, two of the categories—sustaining innovation and disruptive innovation—are complementary, but significantly different. Sustaining innovation is incremental, and reflected in continuous improvements to the safety and efficacy of pharmaceutical drugs, whereas disruptive innovation includes major breakthroughs, such as the automobile and digital photography.3 Some of the most successful disruptive innovations are products, services, processes, and experiences that apply or combine existing elements in different ways to produce radically new customer benefits and experiences. Examples include Apple iPod, YouTube, Star Alliance, and Starbucks. The third category is “business concept innovation.” Because of the intensity of competition and turbulence in the market environment, Hamel argues that “companies must adopt a radical new innovation agenda,” and apply systematic innovation “design rules.”4 This view is endorsed by Bill Gates, who, warning of the risks confronting

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Business Performance Excellence complacent incumbents, has claimed that “Microsoft is always two years away from failure.”5 Neither the iPod nor YouTube rely on disruptive technology, yet both have created new global markets. Whereas the iPod offers a unique experience through the quality of its design, customer interface, and product extensions, YouTube has invited millions of people worldwide to become amateur broadcasters by creating and sharing original videos. In the case of Star Alliance, a group of otherwise competing airlines collaborates to provide passengers with seamless global routing options, ticketing arrangements, and loyalty benefits. Starbucks, on the other hand, reinvented the traditional Italian coffee shop to create a global coffee culture and experience, based on market development, line extension, and mass customization.6 Once the focus is on the end-customer, every element in the design and delivery of the value chain becomes a potential opportunity for innovation. As in the examples given above, radical innovation lies in the bundling and branding of multiple value-adding elements, rather than in any single element.7 Service and experience innovation—easily the biggest generators of wealth-producing added value—are the areas most neglected by R&D communities and the “innovation industry.” Kim and Mauborgne (2005) use Cirque du Soleil as an example of a company which has created “the blue ocean of new market space,” and made competition irrelevant. In “achieving both differentiation and low cost by reconstructing elements across industry boundaries,” Cirque du Soleil invented a unique, live entertainment experience, involving elements of circus, theater, opera, and ballet. It is different from traditional circuses. There are no animals or star performers, and the target audience is sophisticated adults rather than children. New shows tour the world regularly, partly financed by regional sponsors and a loyal customer base.8

The 7Es Innovation Framework

Innovation is complex, involves risk, and cannot be reduced to simple templates.9 However, a systematic and disciplined innovation strategy has a number of common elements. Under the direction of a CEO who is strongly committed to organic growth and innovation, there should be an “open market for ideas, capital, and talent.”10 Innovation project team leaders should be given responsibility for critical functions and processes, including the following, which, for the sake of convenience, could be designated “the 7Es:” 8  Explore by generating and vetting ideas from a wide variety of internal and external sources; 8  Evaluate by assessing and prioritizing options, making a selection, and giving feedback; 8  Extend by involving and co-opting partners and opinion leaders, and progressively demonstrating “small wins”; 8  Experiment by designing, testing, demonstrating, and reviewing a prototype or pilot study; 8  Engage by winning the management’s support for a proposed business model; 8  Evangelize by publicizing, showcasing, celebrating, and involving all stakeholders; 8  Execute by implementing the business model, including launch and marketing strategies.

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Innovation and the Path to Growth, Profitability, and Competiveness Case Study

Cochlear: The Triumph of Organic Growth Strategy Cochlear Limited provides an excellent demonstration of the innovation processes listed above. Cochlear is a Sydney-based medical technology business with a long-standing mission to help the hearing-impaired. Despite humble beginnings, Cochlear produces the world’s best-selling hearing implant. By early 2009, it had a global market share of 70%, and approximately 2,000 employees in more than 20 countries. Cochlear was built on the entrepreneurial drive and single-minded passion of Professor Graeme Clark. Even as a young ear, nose, and throat specialist in Melbourne in the 1960s, his father’s deafness drove him to explore new ways of overcoming hearing impairment. In order to win over skeptics, Clark was extremely careful to evaluate his experiments with the utmost rigor. In fact, the early tests were unsuccessful. Finally, he concluded that an implant with single-channel stimulation of the inner-ear auditory nerves would not lead to speech understanding in deaf people. The bionic ear concept emerged gradually, and involved the integration of research from numerous disciplines. Clark consolidated and extended his research while undertaking a doctorate, and after becoming chair of a new department at the University of Melbourne. During this time, Clark partnered with a leading expert in sound quality and a small local company experimenting with heart pacemakers. Finally, he confirmed that multi-channel stimulation was a feasible option, and began to pursue it with vigor. Clark’s major experimental phase began in the 1970s. The lengthy delay was due largely to the indifference of the medical community, and the lack of financial support. Fundraising continued to be a major obstacle, and the leading Australian research bodies repeatedly rejected Clark’s applications for research grants. Forced to operate outside the normal research channels, and adopt a direct crusading approach, Clark became a full-time evangelist, undertaking a hectic round of fundraising lunches and meetings. After more than seven years of struggle, Clark’s first major breakthrough came in 1974, when he persuaded the proprietor of a new television channel to conduct a telethon to finance the first prototype. When the telethon money ran out, Clark persuaded Prime Minister Malcolm Fraser to help. However, it was not until 1982 that Cochlear Limited finally floated on the stock exchange, and the systematic execution of Clark’s vision began. Because of the strict regulation of medical technology, and notwithstanding the enormous credibility which Cochlear has earned, there is no respite for top management. They will always need to be evangelists. In recent years, 13 new territory outreach specialists have been added to the US field force to help educate hearing-aid professionals, a training and education center has been established in Beijing, and a Cochlear Awareness Network has been created so that volunteers can be enlisted to provide information to potential implant recipients. Most of Cochlear’s growth took place during 2003–08.This period was marked by consistent annual growth in sales, revenue, and net profit, while gross margin increased to 72%.Whereas in April 2002, there were 35,000 cochlear implant users worldwide, by 2008 this figure had more than tripled to more than 120,000. Since 2003, the company has been reinvesting 12–

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Business Performance Excellence 13% of revenue into continuing R&D activities, and set up partnerships with more than 80 universities worldwide.11 According to Cochlear’s half-yearly results, reported on February 11, 2009, the growth trajectory has been maintained, despite the global financial crisis, with a further net profit increase of 22%.12 Even as a relatively small SME, Cochlear continued to pursue a global strategy based on organic growth and strong branding. Despite the general preference for growth by M&A, Cochlear remains committed to the philosophy that you get bigger by being better. There is still a huge unserved market. According to its latest annual report, Cochlear estimates that there are about 278 million people with moderate to profound hearing loss in both ears, and this figure will rise as the population ages and life expectancy increases. Apart from upgrades and repairs, Cochlear is also developing specialized products for different types and degrees of hearing loss.13

The Critical Link between Innovation, Growth, and Competitiveness

The synergistic relationship across innovation, growth, and competitiveness demonstrated in the Cochlear case is well documented. For example, there is a significant body of research confirming that a record of ambitious organic growth is the main determinant of a company’s stock-market value. Investors regard strong organic growth as a reliable indicator of a sound business model. Furthermore, commitment to the discipline of organic growth is evidence that managers think strategically about the future, believe that innovation is the key to competitive advantage, and stay focused on creating value for customers.14 The sustained growth and market capitalization performance of companies such as GE, Google, Samsung, Dell, and Procter & Gamble (P&G) further underline the importance of innovation-driven organic growth. For example, between 2004 and 2006, soon after adopting a radical “connect and develop” open innovation model, more than 100 of P&G’s new products had elements which originated outside the company.15 More recently, in 2008, A. G. Lafley, P&G’s CEO, confirmed the transformation, stating that, “P&G has delivered, on average, 6% organic sales growth since the beginning of the decade, virtually all of it driven by innovation.”16 In a comprehensive study of corporate growth conducted over a ten-year period, Hess found that the companies most committed to organic growth outperformed the S&P 500 by a factor of 10. He concluded that, in the long term, “the companies that succeeded to a greater degree than their peers were found to follow an organic growth strategy.” By contrast, attempts to generate growth through M&A failed to achieve their objective, indicating that M&A is opportunism rather than strategy and frequently involves a “quick fix” approach to expansion and market share.17

Strategic Partnerships Facilitate Innovation and Growth

As opposed to M&A, strategic alliances and partnerships are increasingly successful organic growth options, as the Cochlear case demonstrates. Open innovation, working closely with customers, suppliers, service providers, and other firms, is generally the most cost-effective method for identifying value-creating opportunities, sharing knowledge, expanding into new markets, and lifting competitiveness.

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Innovation and the Path to Growth, Profitability, and Competiveness According to Lendrum (2003), the benefits of partnerships relate not only to increased growth and profits for shareholders and other stakeholders, but also include improvements in leadership effectiveness, workplace relations, and innovation capability. Based upon his extensive research, Lendrum concludes that innovation “is a key factor in the evolution and revolution of partnering/alliance relationships, and the driving force behind the process.”18 The link between partnerships and innovation is critical. Indeed, “the more radical the innovation, the more deeply and broadly must other players, especially customers, be involved.”19 Market leaders such as Philips, IBM, and Toyota have hundreds of inter-firm partnerships, which have played a major role in their growth and competitiveness. Groupings such as science parks and clusters (geographic concentrations of interconnected companies) offer the same potential partnership benefits to SMEs, which tend to be nimbler and more innovative than their larger counterparts. Successful replications of the so-called “Silicon Valley Effect” can now be found in most parts of the world, including Tromso in Norway, Cambridge in England, the Emilia-Romagna region of Italy, Malaysia’s Cyberjaya, and Doha’s Education City. Summary and Further Steps The practical action steps for implementing an innovation-based organic growth strategy are as follows: Top management focuses on mission-driven organic growth, treats M&A with great caution, and aims to create strongly branded, unique market space. The CEO becomes a highly visible innovation leader and champion, stimulates the discussion of new ideas, and encourages information sharing and learning. Innovation is at the center of the mission statement, strategic goals, job descriptions, performance targets, etc. The CEO provides innovation leadership, and, with a top-level team, approves and supports major innovation projects. Cross-boundary innovation project teams operate throughout the organization. All innovation projects demonstrate how they will contribute added value in providing a unique experience to the end-customer. The initial criterion for an innovation project is “possibility,” not “probability” but projects that fail an initial feasibility study are killed off quickly. The operating protocols for all innovation project teams specify criteria for an open process, including suppliers, customers, and other partners.

More Info Books: Hess, Edward D. The Road to Organic Growth: How Great Companies Consistently Grow Market Share from Within. New York: McGraw-Hill, 2007.

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Business Performance Excellence Kim, W. Chan, and Renée Mauborgne. Blue Ocean Strategy. How to Create Uncontested Market Space and Make the Competition Irrelevant. Boston, MA: Harvard Business School Press, 2005. Lendrum, Tony. The Strategic Partnering Handbook. New York: McGraw-Hill, 2003. Article: McKinsey Quarterly. “How companies approach innovation: A McKinsey global survey.” October 2007. Online at: tinyurl.com/27j5gf6 Websites: Asian Productivity Organization: www.apo-tokyo.org Cambridge MIT Institute: www.cambridge-mit.org The Conference Board: www.conference-board.org Hay Group: Your Challenges: www.haygroup.com/ww/challenges Knowledge@Wharton Innovation and Entrepreneurship: knowledge.wharton.upenn.edu/category.cfm?cid=12 PricewaterhouseCoopers Center for Technology and Innovation: www.pwc.com/us/en/technology-innovation-center

Notes 1. Drucker, P. F. Innovation and Entrepreneurship. New York: Harper Business, 1993, pp. 30–36, 138, 150. 2. O’Connor, G. C., R. Leifer, A. C. Paulson, and L. L. Peters. Grabbing Lightning: Building a Capability for Breakthrough Innovation. Hoboken, NJ: Wiley, 2008, pp. 169–170, 202–203, 259. 3. Christensen, C. M. The Innovator’s Dilemma. New York: Harper Business, 2000, pp. xv, 10–19. 4. Hamel, G. Leading the Revolution. Boston, MA: Harvard Business School Press, 2002, pp. 59–118, 251–282. 5. Hamel, G. “The challenge today: Changing the rules of the game.” In Leibold, M., G. J. B. Probst, and M. Gibbert (eds). Strategic Management in the Knowledge Economy. New York: Wiley-VCH, 2005, p. 119. 6. Winter, S. G. “Appropriating the gains from innovation.” In Day, G. S., and P. J. H. Shoemaker (eds). Wharton on Managing Emerging Technologies. New York: Wiley, 2000, pp. 245, 256. 7. Ibid. 8. Kim and Mauborgne (2005), p. 18. 9. Lord, M. D., D. deBethizy, and J. Wager. Innovation that Fits. Upper Saddle River, NJ: Prentice Hall, 2005, pp. 18, 134, 230. 10. Hamel, op. cit. 4, pp. 299–302. 11. Cochlear. Annual Report 2008. pp. 8–20. 12. Ooi, T. “Dollar’s decline boosts Cochlear hopes.” The Australian Business (February 11, 2009): 1. 13. Cochlear, op. cit. 11. See also World Health Organization. “Deafness and hearing impairment.” Fact Sheet No. 300. March 2006: 1. 14. Day, G. S. “Closing the growth gap: Balancing ‘big I’ and ‘small I’ innovation.” Knowledge@Wharton, February 1, 2006: 1. Online at: knowledge.wharton.upenn.edu/papers/1333.pdf 15. Huston, L., and N. Sakkab. “Connect and develop: Inside Procter and Gamble’s new model for innovation.” Harvard Business Review (March 2006): 1–3. 16. Lafley, A. G. “P&G’s innovation culture.” Strategy+Business Enews (August 28, 2008): 2–10. 17. Hess (2006), pp. 1–3, 27. 18. Lendrum (2003), pp. 5, 39, 155–156. 19. Moore, J. F. The Death of Competition. Leadership and Strategy in the Age of Business Ecosystems. Chichester, UK: Wiley, 1996, p. 61.

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What Entrepreneurs and Small Business Owners Can Do to Increase Their Chances of Success in the Global Economy by Neuman F. Pollack Florida Atlantic University, USA

This Chapter Covers 8  Advances in technology, communications, and transportation have transformed the world into a global village, and small and medium-size enterprises (SMEs) can take advantage of this. 8  Beyond any short-term gains they may make, SMEs also gain experience in performing on a larger stage. 8  Entrepreneurs and SMEs often go global in response to the state of their domestic market environment. 8  To be successful, SME managers and entrepreneurs who engage in international trade must demonstrate high levels of passion, motivation, competence, and advocacy support. 8  Development of an international perspective, or global mindset, facilitates engagement in international business. 8  From a practical perspective, entrepreneurs and SME managers must broaden their horizons and sharpen their skills to successfully engage with the international arena.

Introduction

Entrepreneurs and small business owners are motivated to solve problems or deliver services better, faster, and cheaper than others in the market. Entrepreneurs harness creativity and innovation to seize opportunities and offer alternatives in the marketplace. Successful entrepreneurs manage risk by closely monitoring business processes and financial obligations, as well as by focusing intently on their market and the challenges of building market share. With democracy encircling the globe and once-rigid barriers to free trade being eroded, the entrepreneur in many industry sectors seeks opportunities beyond his/her local region or country in a worldwide market. Adopting a global strategy can enable a small company to enhance its growth in the face of increased competition. In some instances, a global strategy is necessary, especially when facing competition from abroad. Today’s more open world business environment is not risk-free; indeed, no market strategy is risk-free. Small and mediumsize enterprises (SMEs) must recognize that doing business internationally involves added dimensions of uncertainty and risk, such as fluctuation in world currencies, global (regional), economic, and political unrest, and inconsistencies in the global supply chain. The US Small Business Administration estimates that approximately 25% of all US export volume (in dollars) is attributable to small businesses.1 In terms of the number

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Business Performance Excellence of US companies engaged in international trade, “97% of all exporters are small and medium size companies.”2 A recent survey of SME CEOs revealed that 56% look favorably on engaging in international business, with fewer than 20% considering it a threat.3 Among countries in geographical proximity, as in Europe, the prevalence in terms of both the value of international trade and participation by SMEs is infinitely greater. It must be remembered that international trade is a two-way street. Indeed, import activity among American companies is far greater than export activity, a fact that shows up in the year-on-year trade deficits recorded by the United States in recent decades.

International Trade: Growth and Challenges

The recent acceleration of international trade provides greater opportunities for SMEs. Government efforts around the world promote and assist small businesses in expanding the value of their international operations. Advances in technology, communications, and transportation have transformed the world into a global village. SMEs can penetrate markets by relying on the ubiquity of telecommunications, increasing access to the global supply chain, and engaging with world markets. Language, once a barrier to small firms in the international arena, is no longer an issue, with the widespread acceptability of English as the global language of business. The growth of trade alliances, such as NAFTA, CAFTA, ASEAN, and Mercosur, the expansion of the European Union, and efforts to consolidate currencies across national boundaries, such as the adoption of the euro by a dozen Western European countries and of the US dollar in Ecuador facilitate integration in the international community. The sheer growth of China, India, Brazil, and Russia, as well as other states of the former Soviet Union, provides both great opportunities and risks for SMEs around the globe. Global telecommunications have greatly reduced the technical barriers to trade, with even the smallest firms able to operate in a virtual 24/7, 24 time-zone environment. The key to success for SMEs, however, is learning how to overcome the many internal barriers that exist. SMEs face a lack of resources related to acquiring and understanding information, managerial knowledge and experience, short time horizons, and inadequate planning.4 Yet, despite such limitations, many SMEs engage in international trade with varying degrees of success. At best, international trade activities can be risky for all firms due to regional and global political instability, exchange rate fluctuations, climatic and other environmental uncertainties, the pace of change in telecommunications and transportation, shifting markets, and new entrants (competition) in those markets. Some understanding of these factors and adopting the right mode and timing of internationalization—for example, whether to export directly or through intermediaries—can minimize the inherent risks. The worldwide economic downturn in 2007–08 presented a particularly difficult set of circumstances for SMEs around the world. Firms that view their initial foray into international trade as part of a business learning curve or as an investment in their future are more apt to succeed in the long term, especially compared to firms that are monetarily or psychologically unprepared or are unwilling to adopt a long-range view.5 Indeed, research has long suggested that, for

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Entrepreneurs and Small Business Owners in the Global Economy firms that are developing a capacity to operate abroad, success in the international arena depends on proceeding gradually. This gradualism is often referred to as staged or incremental internationalization.6 Enhanced knowledge and an incremental approach, however, are not sufficient for success, particularly for SMEs with limited resources. SME managers also need to develop an outlook based on contextual factors7 and their inherent operating environment, industry structure, and marketing strategy.8 Beyond the short-term gains, SME managers also gain confidence and experience by performing on a larger stage. Horizons are broadened, and they become sensitive to economic and geopolitical changes to which they formerly paid scant attention. This learning can affect manager’s perspectives and strategies more than short-term financial success, reinforcing the decision to engage in international trade. As SME managers gain more experience, their knowledge increases, enhancing their confidence to further expand international activities. This learning not only provides reassurance, but it also reinforces their decision-making.9 As a group SMEs differ from large, established firms in terms of complexity and formality. Small, entrepreneurial firms are generally more flexible in developing their strategies and are swift to embrace the global environment as a learning opportunity. However, SMEs will only be successful if they are able to manage the multitude of dimensions associated with globalization. For example, success in the international arena correlates with an ability to engage in highly complex relationships.10 These may include the establishment of subsidiaries and joint ventures, or the initiation of subcontracting and materials importation as core elements of the business plan. SMEs learn and benefit from such activities, but they become successful only if they take advantage of them. Mastering the learning curve reduces the complexity of doing business globally, enhancing the prospects of financial success.

Engaging the International Arena and Developing a Global Mindset

Entrepreneurs and SMEs may go global in response to the state of their domestic market environment.11 If domestic conditions are good, SME managers are less likely to take on the risks associated with overseas activity. Conversely, if there are few prospects for growth in the domestic market, they have more inclination to accept such risks. In going global, SME managers tend to choose an entry mode that minimizes risk. The least risky, least costly, and most frequent entry mode is the export of finished goods. More complicated modes involve sourcing, manufacturing, equity, and partnership arrangements. However, SME managers will engage in more complex and costly entry modes as an alternative to simply exporting if they need to exercise greater control over foreign resource availability or over their access to foreign markets. Similar strategies may be followed in sourcing (importing) raw materials or components for further fabrication, or finished products for direct sale. While these decisions are the result of some strategic thinking, the underlying basis for international trade activity and the degree to which it is pursued are related more to economic necessity than to opportunity. Although a high percentage of SMEs in developed economies engage in some form of international business, such activity is not necessarily maintained on a continuous basis. Firms that are only marginally engaged in international activities tend to disengage, often due to a “lack of strategic

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Business Performance Excellence planning” and commitment.12 Such firms may redirect their efforts back to their domestic markets when the business climate is once again supportive. Increasingly, though, this can be a perilous decision, leading to competitive disadvantage in their home markets. Sustainable international engagement and success require: Understanding the market for one’s products or services; Delivering quality in the design, manufacture, and distribution of products or services; Demonstrating a commitment to outstanding customer service; Maintaining capable and dedicated personnel; Operating with financial and ethical integrity. Not surprisingly, these are the same factors that are essential for success in the domestic market. SMEs engaging in international trade must demonstrate high levels of passion, motivation, competence, and support in order to succeed.13 Indeed, it is as much the “soft side” of business engagement that leads to success as the “hard side” of technical know-how. Balancing these factors is essential for success. If the entrepreneur or SME owner is not personally able to provide this balance, he or she must be prepared to share the responsibility for the success of the firm with others. Firms can be characterized as either “born global” or “late starters.” A born global firm is one in which the entrepreneur engages in international trade from the onset of operations. For these entrepreneurs, being global is simply their state of being. The late starter is an existing firm that begins to engage in international business some time after inception. The development of an international perspective, or global mindset, provides a foundation and supporting commitment to embrace the global market as a permanent player. The global mindset is characterized by a realization that domestic boundaries are not a limit and that the entrepreneur must adopt a virtual “locus of control” beyond his or her immediate environment. By adopting this perspective, entrepreneurs and SMEs enhance their potential for success. External enablers, such as the European Union, NAFTA, CAFTA, Mercosur, ASEAN, and other free-trade arrangements among countries, set the stage for engagement. SMEs operating with a global mindset will develop a competitive edge over their domestic competitors as a result of the knowledge gained from international trading partners, as well as their broadened perceptions and attitudes.14 Case Study

The Great American Hanger Company15 The Great American Hanger Company was founded by 25-year-old entrepreneur Devon Rifkin in 1999. Rifkin’s vision was to create a company dedicated solely to providing solutions for clotheshanging needs. The company supplies a broad range of hanger products in both wood and metal, some with fabric overlays, to leading hotels and also sells directly to wealthy individuals worldwide. The company grew from an idea to a US$100 million firm in less than 10 years. Design, marketing, and distribution of an extensive product line is coordinated at the company’s corporate headquarters in Miami, Florida. Manufacturing, however, takes place at

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Entrepreneurs and Small Business Owners in the Global Economy several sites in Asia, initially in India and now also in China. Rifkin established his first Asian link over the internet through the sourcing website Alibaba.com. The Wooden Enterprises and Trading Cooperative in India was able to produce his wooden and metal designs with high quality at low cost, enabling Rifkin to grow his company rapidly by being highly competitive. The Great American Hanger Company now uses Hong Kong as its sourcing hub. Rifkin is able to meet suppliers, view finished products, and schedule follow-up visits to manufacturing facilities in a time- and cost-effective manner. He was quoted in the Hong Kong Trader as crediting much of the growth and success of his company to this strategy: “The air that we breathe, so to speak, has everything to do with our suppliers and our supply from China, and our relations through Hong Kong as the door that opens for us to the rest of our supply world. I give Hong Kong and China single-handedly the credit for allowing me the opportunity to grow my business as successfully as we have thus far.” Once the supply chain was firmly established, the key to success has been the focus on a single product category—hangers. Growth was based on marketing to selective targets— hotels, retail stores, and now celebrities and other wealthy individuals—both domestically and internationally. This is a good prescription for any entrepreneur to follow.

Supplier Quality Assurance

Global sourcing of products and product components has proven beneficial for start-up enterprises. Entrepreneurs and SME owners can reap cost efficiencies in terms of plant and production, overhead, and human resources costs. However, they are also faced with potential quality assurance problems resulting from poor workmanship, ignorance, fraud, and poor management oversight at production and/or shipping installations. These problems can arise anywhere along the supply chain. The closer the SME is to the supplier, the easier it is to monitor product quality, sourcing, and manufacturing. With just-in-time sourcing, supply lots tend to be smaller, thus lessening the overall impact of any one problem. However, shipping costs when procuring products in the global supply chain—potentially half the world away—often result in entrepreneurs and SME owners purchasing larger quantities of goods, for both current and future needs, exacerbating the impact of any material and/or production problems. For companies faced with quality-compromised products, the impact is likely to be greater than the cost of lost production time, return and disposal of items, and settlement with the supply chain partner. Start-up companies and SMEs can ill afford prolonged periods of disrupted cash flow resulting from such situations. Additionally, no business can long withstand damage to its brand image and, in the case of serious health risks associated with any banned or corrupted chemical properties of affected products, there may be litigation and consumer settlement costs and/or government penalties. Insurance and supply-chain partners may cover some items, but the cost of lost customers and damaged consumer trust may be too much for entrepreneurs and SME owners to bear. A recent example of how devastating this can be is the case of children’s toy maker Mattel. In 2010 it was discovered that products promoting the Walt Disney-branded The Princess and the Frog line of toys contained toxic levels of cadmium, a carcinogen which stymies brain development in young children.16 As a result of this situation, Mattel bore substantial costs, lawsuits, and government fines, in addition to its

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Business Performance Excellence corporate and brand images being tarnished. Subsequently, Mattel implemented a major quality assurance program system-wide. Comprehensive quality management systems (QMS) take time to develop and implement, and can be quite costly. The elements of such program must be tailored to the particular business and industry. While assuring quality is not free, “a proactive corporate ethos on quality management—and supply chain traceability in particular— will not only save time and costs long-term, it will ensure products exceed minimal regulatory requirements and avert potential public relations and brand image crises. A comprehensive QMS that enables enhanced supply chain traceability is the hallmark of such an approach and will inevitably save costs in the long run.”17 Summary and Further Steps

Making It Happen From a practical perspective, entrepreneurs must broaden their horizons and sharpen their skills if they are to engage successfully in the international arena. They will have already navigated barriers to entering their own domestic market, as well as economic, social and political hazards. They now must learn to navigate international barriers, such as tariffs, quotas, and embargos, along with the economic, political, social, and cultural challenges associated with doing business across oceans, continents, and hemispheres. Specific points that entrepreneurs and SME managers must consider are:

8 Research the feasibility of engaging in international business. 8 Assess the firm’s competitive advantage in target countries or regions. 8 Calculate the market value of the firm’s products or services. 8 Establish the true financial costs associated with importing and/or exporting. 8 Be mindful of differing business, social, political, and cultural mores. 8 Be cognizant of legal standards to safeguard investments and intellectual property. 8 Preplan activities, leaving no loose ends to be determined later. 8 Develop strong relationships with foreign partners, employees, and clients. 8 Adopt a global mindset for themselves and their firm. 8 Transform the firm into a global enterprise. As in all business enterprises, a key factor associated with both strategy and operations is the leaders, managers, and rank and file personnel. People make all the difference. Thus, it is more than just necessity and opportunity that drive the internationalization of SMEs; it is also the wisdom and familiarity that can be acquired through the desire to expand beyond local and domestic environments. Today’s entrepreneurs are highly educated; they manage risk by gaining understanding and developing experience. To be successful, they must think global and act global.

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Entrepreneurs and Small Business Owners in the Global Economy More Info Websites: There are many useful resources that entrepreneurs and owners of SMEs can readily access. Articles, books, and information guides are produced by academics and practitioners alike. In addition, governmental, nongovernmental agencies, organizations, and consulting groups provide valuable information through their websites and web-based newsletters. The following listing provides some resources that will be useful to entrepreneurs and owners of SMEs in the United States and around the globe. Alibaba is the world’s leading B2B e-commerce company serving SMEs in China and around the world: www.alibaba.com Entrepreneur Press is a provider of books, information, and guidance for entrepreneurs and small businesses on all aspects of business: www.entrepreneurpress.com Entrepreneurship.org is the website of the Ewing Marion Kaufman Foundation and the US Commerce Department’s International Trade Administration’s public– private partnership. The focus is on encouraging best practices in entrepreneurial leadership, to promote economic growth around the world, and to assist all nations in developing the environment to allow entrepreneurs to organize and operate business ventures, create wealth, and employ people: www.entrepreneurship.org International Entrepreneurship provides entrepreneurs from around the world with access to import and export information, general business data, financing sources, and entrepreneurial success stories for over 100 countries. Links to domestic entrepreneur help sites are provided for each country: www.internationalentrepreneurship.com MarketResearch.com has the world’s largest and continuously updated collection of market research, with more than 160,000 market research reports from over 600 leading global publishers. Country reports provide strategic insight into geographic, political, and business environments and their effects on economic performance and potential: www.marketresearch.com The Indus Entrepreneurs’ (TIE) mission is to foster conscious entrepreneurship globally by educating, mentoring, and networking: www.tie.org World Franchising’s website provides a comprehensive directory of franchise opportunities, leading you to the most up-to-date franchise information available on the internet: www.worldfranchising.com

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Business Performance Excellence

Notes 1. Gatewood, E. J. “External assistance for startups and small businesses.” In William D. Bygrave and Andrew Zacharakis (eds). The Portable MBA in Entrepreneurship. 3rd ed. Upper Saddle River, NJ: Wiley, 2004; p. 239. 2. Burpitt, W. J., and D. A. Rondinelli. “Small firms’ motivations for exporting: To earn and learn?” Journal of Small Business Management 38:4 (2000): 1–14. 3. Grant Thornton International Business Owners Survey 2006. “Focus on the global market.” Online at: tinyurl.com/cy43rpz [PDF]. 4. Ali, A., and P. M. Swiercz. “Firm size and export behavior: Lessons from the Midwest.” Journal of Small Business Management 29 (1991): 71–78; Baird, I. S., M. A. Lyles, and J. B. Orris. “The choice of international strategies by small businesses.” Journal of Small Business Management 32:1 (1994): 48–59; Karagozoglu, N., and M. Lindell. “Internationalization of small and medium-sized technology-based firms.” Journal of Small Business Management 36 (1998): 44–59; Li, L., D. Li, and T. Dalgic. “Internationalization process of small and medium-sized enterprises: Toward a hybrid model of experiential learning and planning.” Management International Review 44:1 (2004): 93–116; and Naidu, G. M., and V. K. Prasad. “Predictors of export strategy and performance of small and medium-sized firms.” Journal of Business Research 31 (1994): 107–115. 5. Burpitt and Rondinelli, op. cit. 2. 6. Johanson, J., and F. Weidersheim-Paul. “The Internationalization of the firm—Four Swedish cases.” Journal of Management Studies 12:3 (1975): 305–322; Johanson, J., and J.-E. Vahlne. “The internationalization process of the firm—A model of knowledge development and increasing foreign market commitments.” Journal of International Business Studies 8:1 (1977): 23–32; and Li et al, op. cit. 4. 7. Welch, L. S., and R. K. Luostarinen. “Inward–outward connections in internationalization.” Journal of International Marketing 1:1 (1993): 44–56; Jones, M. V. “The internationalization of small high-technology firms.” Journal of International Marketing 7:4 (1999): 15–41; and Roberts, J. “The internationalization of business service firms: A stages approach.” Service Industries Journal 19:4 (1999): 68–88. 8. Turnbull, P. W. “A challenge to the stages theory of the internationalisation process.” In P. J. Rosson and S. D. Reid (eds). Managing Export Entry and Expansion. New York: Praeger, 1987, pp. 21–40. 9. Burpitt and Rondinelli, op. cit. 2. 10. Kalantaridis, C. “Internationalisation, strategic behaviour and the small firm: A comparative investigation.” Journal of Small Business Management 42:3 (2004): 245–262. 11. Rasheed, H. S. “Foreign entry mode and performance: The moderating effects of environment.” Journal of Small Business Management 43:1 (2005): 41–54. 12. Crick, D. “The decision to discontinue exporting: SMEs in two U.K. trade sectors.” Journal of Small Business Management 40:1 (2002): 66–77. 13. Shooshtari, N. H., and J. Reece. “Global business and the smaller company.” Montana Business Quarterly 38:2 (2000): 17–20. 14. Spears, M. C., D. F. Parker, and M. McDonald. “Globalization attitudes and locus of control.” Journal of Global Business 15:29 (Fall 2004): 57–64. 15. Material for this case study was obtained from the company’s website: www.hangers.com; Bianchi, Alessandra. “Take your business global.” Fortune Small Business Open Forum (October 15, 2007); and Anon. “Effective business hub gets deals done.” Hong Kong Trader (January 2, 2008). Online at: www.hktrader.net/200801/trade/products-hanger200801.htm 16. See Leavoy, Paul. “Toy recall crises could have been mitigated with comprehensive QMS.” Quality Digest (April 1, 2010). Online at: tinyurl.com/cgppmwm 17. Ibid.

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Everything You Need to Know About Benchmarking by Robin Mann Massey University, New Zealand

This Chapter Covers 8  Benchmarking is much more than a comparison of performance. 8  Benchmarking focuses on learning from the experience of others and can be defined as “identifying, adapting, and implementing the practices that produce the best performance results.” 8  Benchmarking is a powerful method for breakthrough thinking, innovation, and improvement, and for delivering exceptional bottom-line results. 8 New benchmarking methodologies aim to ensure that benchmarking projects result in major benefits, both financial and nonfinancial. 8  New tools available on the internet make benchmarking easier.

Introduction

Organizations are constantly looking for new ways and methodologies to improve their performance and gain a competitive advantage. As they seek improvements to their own business processes, many organizations recognize the importance of learning from best practices that have been achieved by other organizations. By removing the need to reinvent the wheel and providing the potential to adopt proven practices, benchmarking has become an important methodology for providing a fast track to achieving organizational excellence.

Types of Benchmarking

It is useful to distinguish between the main types of benchmarking. First, there is informal benchmarking. This is a type of benchmarking that most of us do unconsciously at work and in our home life. We constantly compare and learn from the behavior and practices of others—whether it is how to use a software program, cook a better meal, or play our favorite sport. In the context of work, most learning from informal benchmarking comes from the following: 8 Talking to colleagues and learning from their experience (coffee breaks and team meetings are a great place to network and learn from others); 8 Consulting with experts (for example, business consultants who have experience of implementing a particular process or activity in many business environments); 8 Networking with people from other organizations at conferences, seminars, and internet forums; 8 Websites, online databases, and publications that share benchmarking information provide quick and easy ways to learn of best practices and benchmarks.

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Business Performance Excellence Second, there is formal benchmarking, of which there are two types: performance benchmarking, and best practice benchmarking.

Performance Benchmarking

Performance benchmarking describes the comparison of performance data obtained by studying similar processes or activities. Comparisons of performance may be undertaken between companies, or internally within an organization. It is useful for identifying strengths and opportunities for improvement. Performance benchmarking may involve the comparison of financial measures (such as expenditure, cost of labor, cost of buildings/equipment, cost of energy, adherence to budget, cash flow, or revenue collected) or nonfinancial measures (such as absenteeism, staff turnover, the ratio of administrative staff to front-line staff, budget processing time, complaints, environmental impact, or call centre performance). Most people equate benchmarking to performance benchmarking. This is unfortunate, because performance benchmarking on its own is of limited use. Too often performance benchmarking data are collected (often at significant cost) and no further action is taken after the data have been obtained. While performance benchmarking enables a performance gap to be identified, it does not provide the idea, best practice, or solution as to how performance can be improved and the gap closed.

Best Practice Benchmarking

Best practice benchmarking describes the comparison of performance data obtained by studying similar processes or activities and identifying, adapting, and implementing the practices that produced the best performance results. Best practice benchmarking is the most powerful type of benchmarking. It is used for learning from the experience of others and achieving breakthrough improvements in performance. Best practice benchmarking focuses on “action”—i.e. doing something with the comparison data and learning why other organizations are achieving higher levels of performance. Best practice benchmarking projects typically take from two to four months to identify best practices. The practices then need to be adapted and implemented. The time taken for the whole project varies depending on the project’s scope and importance, and on the resources used. Projects are usually resource-intensive (in terms of the project team’s time), and so care needs to be taken that they focus on issues of high strategic importance that will deliver major bottom-line benefits.

Popularity of Benchmarking

Research by the Centre for Organisational Excellence Research (COER), on behalf of the Global Benchmarking Network, identified the popularity of benchmarking in comparison to other business improvement tools.1 This research was based on a survey that was completed by over 450 companies from more than 20 countries. Figure 1 shows the results in terms of the popularity of 20 business improvement tools. Mission and vision statements and Customer (client) surveys were the most popular (used by 77% of organizations), followed by Strengths, weaknesses, opportunities, and threats (72%), and Informal benchmarking (69%). Performance benchmarking was used by 49% and Best practice benchmarking by 39%.

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Everything You Need to Know About Benchmarking Figure 1. Use of business improvement tools worldwide. (From study by COER, 20082) Mission and vision statement Customer (client) surveys Strengths, weaknesses, opportunities Informal benchmarking Quality management system Improvement teams Employee suggestion scheme Plan-do-check-act (PDCA) Performance benchmarking Knowledge management Business process reengineering (BPR) Balanced scorecard Total quality management (TQM) Business excellence Best practice benchmarking Corporate social responsibility system Lean Industrial housekeeping (5S) Quality function deployment (QFD) Six Sigma

77% 77% 72% 69% 67% 65% 64% 58% 49% 47% 46% 43% 41% 40% 39% 37% 36% 30% 24% 22%

0

10 20 30 40 50 60 70 80 90 100

Yes (%)

What Is the Payback from Benchmarking

This depends on the type of benchmarking used. For informal or performance benchmarking it is difficult to assess as these types of benchmarking are focused on organizational learning and/or better decision-making, and usually the benefits are not quantified by organizations that employ these techniques. However, it can be assumed that these methods, and benchmarking in general, are very important if an organization wishes to compete nationally and internationally—it makes sense for an organization to have management processes and systems of a similar or better standard than competitors. Certainly, business excellence models, which are used in over 80 countries to encourage companies to apply the principles of business excellence, have as a core element the need for organizations to benchmark, identify performance gaps, and learn from others. The most popular business excellence models are the Baldrige Criteria for Performance Excellence (developed in the United States), where benchmarking accounts for approximately 50% of the model score, and the European Foundation for Quality Management (EFQM) Excellence Model. For further details, see under Websites at the end of the article. For best practice benchmarking, the payback can be calculated on a project-by-project basis. Payback, from a financial perspective, is likely to vary depending on the specific aims of the project. If projects are carefully selected, planned, and managed, there is

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Business Performance Excellence no reason why major benefits (financial and nonfinancial) should not be obtained. A study of 30 organizations that used best practice benchmarking indicated an average financial return of $100,000 to $150,000 per project, with some reaping benefits of more than $1,000,000 per project.3 There are many case studies that focus on the success gained through benchmarking. The best known of these describe the experience of Xerox, which was the pioneer in applying benchmarking concepts (Dr Robert Camp, previously of Xerox, wrote the first book on benchmarking in 1989). It was in the late 1970s and early 1980s that Xerox, faced with ruin due to more-efficient Japanese competitors, first undertook some performance benchmarking, and the findings were astonishing. The results showed that: 8 Xerox’s ratio of indirect to direct staff was twice that of the direct competition; 8 It had nine times the number of production suppliers; 8 Assembly line rejects were in the order of ten times worse; 8 Defects per 100 machines were seven times worse; 8 Product time to market was twice as long. To address this crisis, Xerox developed its benchmarking approach to identify not only performance gaps but also to learn why other organizations were performing better. Much of this learning came from studying the practices of organizations from outside their industry, as this often resulted in identifying breakthrough practices. For example, Xerox benchmarked L.L. Bean, a Maine outdoor sporting goods retailer, because of their excellent warehouse procedures (which are now the standard at most companies). In total, over a period of ten years, almost 230 performance areas were benchmarked. This resulted in Xerox becoming an industry leader and recognized as world class. Xerox won the Malcolm Baldrige National Quality Award in the United States in 1989.

Methodologies for Best Practice Benchmarking

There is no single benchmarking methodology that has been universally adopted. The wide appeal and acceptance of benchmarking has led to the emergence of a range of benchmarking methodologies. TRADE is one such methodology. The TRADE benchmarking methodology (Figure 2) focuses on the exchange (or “trade”) of information and best practices to improve the performance of processes, goods, and services. TRADE consists of five stages: 8 Terms of reference: Plan the project (aims, objectives, scope, resources, cost/benefit analysis); 8 Research: Research the current state/performance; 8 Act: Undertake data collection and analysis to compare against others; 8 Deploy: Communicate and implement best practices; 8 Evaluate: Evaluate the benchmarking process and outcomes to ensure that the project has achieved its aims.

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Everything You Need to Know About Benchmarking Figure 2. TRADE best practice benchmarking methodology

Learning from the experience of others

Evaluate Evaluate the benchmarking processes and outcomes

Deploy Communicate and implement best practices

Act Undertake data collection and analysis

Research Research current state

Terms of reference Plan the project

Benchmarking projects should be targeted at a process area or activity that will deliver the best value to an organization. The project aim can be broad, or it can be specific. The aim may relate to improving the performance of a process, activity/ task, business improvement tool, equipment, strategy, or behavior. Examples of project aims are: 8 To improve a customer complaint management process to world-class standard; 8 To identify and implement best practices in the application of the balanced scorecard; 8 To become an industry leader in ways of providing financial information to clients; 8 To develop a winning team culture; 8 To reduce the time taken to recruit new staff. Once a project aim is set, the process or activity to be studied should be broken down into its component parts, and current performance measured. Benchmarking partners to learn from can then be identified for the component parts, and their practices studied through surveys or site visits. An analysis is then conducted to determine which processes or activities should be adopted and, after any necessary adaptations, implemented.

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Business Performance Excellence The Use of Technology to Make Benchmarking Easier

In the 1980s and 1990s benchmarking was mainly confined to large, successful, private-sector organizations with projects that tended to be extremely costly but brought in very high returns. Today’s technological advancements have transformed communications and opened up a whole new information-based world. Any organization can now access low-cost, internet-based benchmarking services and opportunities such as consortia, surveys both on- and off-line, virtual common interest groups such as forums, and best practice information resources. These resources are a real boon to organizations that want to access best practices and expert advice/opinion but do not have the resources for full-scale benchmarking projects. The Business Performance Improvement Resource (BPIR; see under Websites at the end of the article) is one of the new resources that are a valuable support to benchmarking projects. The BPIR is a vast knowledge repository containing databases with thousands of benchmarks, measures, best practices, enchmarking partners, case studies, and studies/trends that cover virtually very aspect of business. The resource can help to improve any business practice, from handling customer complaints, through undertaking performance appraisals, to improving strategic planning processes. PricewaterhouseCoopers summed up the potential that this new generation of tools can have. In a Trendsetter Barometer Survey,4 it concluded that evidence suggested that users of benchmarking databases can achieve 69% faster growth and 45% greater productivity than nonusers. Case Study

Benchmarking Leads to Cost Reduction of the Finance Function An Australian company conducted a global benchmarking exercise on its finance function and found that it had an outdated infrastructure that cost more than 4% of company revenues to run, that staff spent more than half of their time collecting data, and that the information did not meet its global business information needs. A reengineering team redesigned the company’s business processes and proposed that the company create a shared services centre (SSC) to process common transactions, drive down costs, and improve the quality of the service delivery. The company achieved the following:

8 Selected a location for the SSC based on the quality/skill/cost/flexibility of the workforce, taxation, communications costs and infrastructure, real estate cost, travel accessibility, political stability, language suitability, and company infrastructure; 8 Established three teams in the SSC: a supplier process team, a customer process team, and a general accounting team; 8 Teams were trained and a new mind-set was developed to service the business units; 8 A service level agreement was introduced and customer satisfaction surveys, employee satisfaction surveys, the balanced scorecard, and Six Sigma were used to measure performance; 8 Salary reviews and promotion were aligned with performance.

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Everything You Need to Know About Benchmarking Within two years, the SSC began to provide high value-added services to the business units, including financial reporting and analysis, treasury management, tax and legal consulting, and credit and collection management. The cost of running the SSC was less than 1% of sales revenue and achieved world-class standards. The SSC reduced the cost of the finance function globally by more than 50%.

Summary and Further Steps

Conclusion Benchmarking is a proven, powerful tool that can facilitate improvements to efficiency by organizations, increase value added, and enable them to gain a competitive edge. The rationale underpinning benchmarking is sound, and the benchmarking concept of learning from others should be embedded throughout all improvement-focused organizations. Benchmarking projects should be linked to key organizational objectives, and support from senior management needs to be both strong and visible. There is little doubt about the potential and versatility of benchmarking as a tool. It has been successfully applied by organizations of different sizes and in different industry sectors and has become one of the most popular management tools. However, it is thought that most organizations use performance benchmarking (comparing performance) rather than the more powerful but resource-intensive approach of best practice benchmarking (comparing and learning from others and implementing best practices). Using best practice benchmarking methodologies, such as TRADE, and website resources, such as the BPIR website, will help more organizations to reap the benefits of benchmarking.

Making It Happen

Benchmarking—learning from the experience of others—makes common sense. How should this technique be used to reap the most benefits? Here are some tips:

8 Undertake a self-assessment (a business excellence self-assessment is best) or quality audit, or have a brainstorming meeting to identify key opportunities for improvement in your organization. For those key practices or processes that require improvement, undertake a best practice benchmarking project to seek out best practices. If you do not have the resource to do this, search for benchmarks and best practices using a literature or website search. 8 Have at least one person within your organization who is trained in benchmarking and who acts as your benchmarking champion. This person can help to facilitate your benchmarking projects and/or conduct benchmarking research. 8 When undertaking reviews of your organization’s processes and practices, always ask the question “Is this a best practice?” If evidence is not forthcoming that it is a best practice, then it suggests that the process or practice will benefit from benchmarking. 8 When undertaking benchmarking, ensure that your organization follows an internationally recognized benchmarking code of conduct.5 A code of conduct provides ethical guidelines and protocols on the exchange of information between organizations.

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Business Performance Excellence 8 Benchmark your benchmarking process. Learn from others how to conduct benchmarking successfully, and continually strive to refine your process to achieve better outcomes. More Info Book: Camp, Robert C. Benchmarking: The Search for Industry Best Practices That Lead to Superior Performance. Portland, OR: Productivity Press, 1989. Websites: Baldrige Performance Excellence Program, on the National Institute of Standards and Technology (NIST) website. A US government website that promotes the Baldrige Criteria for Performance Excellence: www.baldrige.nist.gov Business Performance Improvement Resource (BPIR) has a large collection of information and resources on benchmarking and best practice: www.bpir.com Centre for Organisational Excellence Research (COER), a New Zealand-based research and consultancy organization headed by the author. The website provides information on business excellence and TRADE benchmarking projects: www.coer.org.nz European Foundation for Quality Management (EFQM), developers and custodians of the EFQM Excellence Model: www.efqm.org Global Benchmarking Network (GBN) provides a listing of the main promoters/experts in benchmarking from over 20 countries: www.globalbenchmarking.org

Notes 1. Centre for Organisational Excellence Research (COER). “Report on the global use of business improvement tools and benchmarking.” November 2008. 2. Ibid. 3. Ibid. 4. PricewaterhouseCoopers (PwC). “Fast-growth companies that benchmark grow faster, are more productive than their peers.” May 1, 2002. Online at: tinyurl.com/btxswly 5. Global Benchmarking Network (GBN). “Benchmarking code of conduct.” 2006. Online at: tinyurl.com/d8ca7bt [PDF].

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Enhance Competitive Performance via Critical Performance Measures (CPMs) by Zahirul Hoque La Trobe University, Melbourne, Victoria, Australia

This Chapter Covers 8 Measuring performance is a fundamental part of every organization, whether it is run by a private sector or a government sector. 8  Performance measures are used to evaluate organizational as well as managerial performance. 8  A critical performance measure (CPM) is a quantitative value that can be scaled and used for performance evaluation. CPMs fall into two categories: financial (KPIs—key performance indicators) and nonfinancial (NFIs—nonfinancial indicators). Organizations should use both KPIs and NFIs when measuring employee as well as firm performance. 8 CPMs should be aligned with business strategy, work environment, and employee incentives. 8  Too many CPMs should be avoided, to maximize their usage by employees in their day-to-day operations. 8 “It is much more difficult to measure nonperformance than performance.”

Introduction

Measuring performance is a fundamental part of every organization, whether it is run by a private sector or a government sector. A performance measurement system (PMS) highlights whether the organization is on track to achieve its desired goals. Performance measures are primarily used to evaluate organizational, as well as employee performance. A PMS develops critical performance indicators (CPMs), or metrics, depending on the nature and activities of the organization. CPMs can serve as the cornerstone of an organization’s employee incentive schemes. CPMs are used as guidelines and incentives to facilitate the coordination of managers and business unit goals, with those of the overall corporation goals, that is, they encourage goal congruency. Through these metrics, the organization communicates how it wishes the employees to behave, and how this behavior will be judged and evaluated. Effective organizational managers rely on CPMs to set direction, make strategic decisions, and achieve desired goals.1 It has been suggested that, in today’s competitive and global financial crisis environments, organizations need to be masters at anticipating customers’ needs, devising radical new product and service offerings, and rapidly deploying new production technologies into operating and service delivery processes.2 For several decades, performance measurement has been used as an internal informational tool to evaluate business units’ operations, and make program and budgetary decisions.

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Business Performance Excellence PMS and CPMs: Definitions

A PMS typically comprises systematic methods of setting business goals, together with periodic feedback reports that indicate progress against those goals.3 Within a PMS, an organization develops some key performance metrics or indicators. A CPM can be defined as “a quantitative value that can be scaled and used for purposes of comparison.”4 There is also the view that CPMs are quantifiable performance measurements used to define success factors, and measure progress toward the achievement of business goals.”5 The PMS literature classifies performance measures into two major groups: financial (KPIs) and nonfinancial (NFIs). Financial measures may include return on investment (ROI), earnings per share (EPS), revenue (sales) growth, profit margin, etc. Nonfinancial measures may include customer satisfaction, employee satisfaction, production efficiency, quality, customer services, etc.

Balanced Scorecard Measures

In today’s competitive environment, one that encompasses fierce global competition, advancing technology, and increased customer awareness, traditional CPMs such as ROI and EPS can be inadequate for a business organization. Traditional CPMs, although they can aid in detecting weaknesses with respect to the use, or non-use, of individual investment or assets, and focus management’s attention upon earning the best profit possible on the capital available, tend to avoid isolating individual business units, in that it may not be reasonable to expect the same ROI for each unit. If the unit sells its respective products in markets that differ widely, with respect to product development, competition, and customer demand, lack of agreement on the optimum rate of return might discourage managers who believe the rate is set at an unfair level. For the sake of making the current period performance measure look good, be it ROI or EPS, managers may be influenced to make decisions that are not in the best long-run interests of the firm. A major concern with traditional CPMs is that these performance metrics focus on results largely internal to the firm. During the last decade, there has been an overemphasis on the use of financial KPIs to measure firm performance. This has resulted in organizations losing sight of important indicators (NFIs) which measure levels of customer satisfaction, process flexibility, or adaptation in response to changing needs. A strategy which concentrates on financial criteria is too closely related to shortterm profit maximization. Broader measures such as customer-based measures, product and process measures, and continual improvement and innovation measures, enable the organization to establish longer-term improvements which further effects competition. Further, the imperative for improved performance measures cannot be ignored with today’s worldwide competition and advancing technologies. Once new technologies are introduced, major organizational changes are required, as the interaction between people and technology is essential to ensure business processes become more and more effective, and, therefore, performance measures which focus only on financial criteria will not reflect the new technological and competitive environments. New performance measures, if devised strategically, will profoundly influence business performance. Thus, more attention also needs to be placed on generating suitable nonfinancial performance measures to be a successful competitor, given today’s global financial crisis. Significant attention is now being given by academics and managers to building a more extensive and linked set of measures for appraising and directing

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Enhance Competitive Performance via CPMs corporate and divisional performance, influenced largely by Kaplan and Norton’s notion of the “balanced scorecard.” The balanced scorecard approach focuses on both financial and nonfinancial measures. The financial measures indicate if improvements in financial performance resulted from sacrificing investments in new products, or on-time delivery. The balanced scorecard includes financial measures that tell the results of actions already taken. Kaplan and Norton suggest that financial measures should not be eliminated altogether, because a well-designed financial performance measurement system can actually enhance, rather than inhibit an organization’s management program. The balanced scorecard supplements the financial measures with operational measures on customer satisfaction, internal processes, and the firm’s innovation and improvement activities. Kaplan and Norton’s balanced scorecard comprises the following four dimensions: 8 Financial—applying appropriate financial performance measures to ascertain whether the company is profitable. 8 Customer—assessing customer satisfaction (the customer perspective). In a competitive market, customers must be content, or market share will drop. Customers care about price, faster and reliable deliveries, design, quality, and level of services. 8 Internal business processes—tracking inter-organizational indicators to determine whether the business units are efficiently using resources, and ascertaining competitive performance in developing “next generation” products. 8 Learning and growth dimension—this measures such things as training and development, information systems, employee satisfaction, employee productivity, etc. Kaplan and Norton suggest that the use of the balanced scorecard may motivate breakthrough improvements in critical activity areas such as products, processes, customers, and market developments. They further suggest that, while traditional financial measures report on what happened in the last period without indicating how managers can improve performance in the next, the balanced scorecard functions as the cornerstone of a company’s current and future success. Table 1. CPMs in a PMS within a manufacturing setting Perspective

CPMs

Financial (KPIs)

Operating income Sales growth Return on investment Earnings per share

Customer (NFIs)

Market share Customer response time On-time delivery Number of customer complaints Number of warranty claims Customer satisfaction survey Sales return due to poor quality (Continued overleaf)

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Business Performance Excellence Table 1 (cont.) Perspective

CPMs

Internal business processes (NFIs)

Material efficiency variance Labor efficiency Ratio of good output to total output at each production process Rate of material scrap loss Number of new patents Number of new product launches

Employee learning and growth (NFIs)

Employee satisfaction survey Employee education and training Employee health and safety

Case Study

Aligning CPMs and Strategy6 Omega is a water utility company that provides five core services to its customers, namely bulk water supply, water purification, reticulation of water and wastewater treatment, and wastewater disposal. On average, Omega provides services to more than 157,000 residential properties. In July 2003, Omega introduced a multidimensional PMS to improve accountability, and to communicate to organizational members the objectives and targets of the entity. As shown in Table 2, Omega developed a total of 33 CPMs for each of its six major activities. Table 2 shows this new CPM system, which, consistent with the balanced scorecard, combines a series of nonfinancial and financial CPMs. According to Omega’s senior management, one of the advantages of adopting a multidimensional PMS is that it gives a better indication to employees of the long-term organizational priorities. It also helps to communicate any crisis to all of Omega’s divisions, which was important to ensure that any impact is minimized. Each KPI is tailored, not to a division but to one of the five major activities of Omega, consistent with its attempts to become more outcome-focused. For instance, the percentage of lost working days or absentees is aimed at measuring Omega’s ability to be a chosen employer. Similarly, the return on net operating assets is a new KPI, which is used to measure the commercial sustainability of Omega. In setting the CPMs, Omega employees suggested that it was common when the information was available to benchmark against other water entities, to ensure that the divisions are providing a service at a similar standard as their private and public counterparts, so that they are not seen to be performing poorly when the contractual period ends. Some of Omega’s subdivisions also suggested that this had put the division under pressure to improve its performance. Table 2. CPMs of Omega Major strategic focus

CPMs

Customer focus

% Customer satisfaction % Compliance with verbal service-request response times Number of water supply interruptions per 1,000 properties Number of planned water supply interruptions per 1,000 properties Number of unplanned water supply interruptions per 1,000 properties

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Enhance Competitive Performance via CPMs Major strategic focus

CPMs

Customer focus (cont.)

% of water and wastewater service interruptions within 5 hours Number of customer complaints per 1,000 properties Number of water quality complaints per 1,000 properties Number of odor complaints per 1,000 properties % of meters installed within 14 days from date of payment

Chosen employer

% lost working days Training expenditure versus total operating expenditure (%)

Environmental sustainability

% tests meeting WWTP EPA license criteria Quantity of treated water supplied per property, not seasonally adjusted Number of uncontained wastewater spills % of wastewater spilt per wastewater treated % effluent reused

Commercial sustainability

Combined operating costs per property % expended of revenue-funded capital expenditure Water and wastewater renewals expenditure as a percentage of current replacement cost of system assets % unaccounted water Operating profit Return on turnover (net profit after tax/sales) Return on net operating assets (EBIT/total net assets) Debt-equity ratio (total interest-bearing debt/total equity) Total financial distribution to council (as a % of post-tax profits)

Quality water service provision

% tests meeting NHMRC (1996) bacteria criteria % tests meeting NHMRC (1996) chemical criteria Water main breaks per 100km of water main Sewer chokes per 100km of wastewater main Wastewater main (gravity and pressure) breaks per 100km of main

Accountability

% Compliance with wastewater spillage procedure (ensures spillages are properly reported and remedied) Maintenance of ISO 9000 and 14000 third-party certification

Conclusion

An English-born American communications executive, who was president and CEO of ITT, suggests that, “the best way to inspire people to superior performance is to convince them by everything you do and by your everyday attitude that you are wholeheartedly supporting them.”7 This short article suggests that measuring performance is important for all businesses. However, it is much more difficult to develop CPMs for each area of performance within the organization which can be measured effectively. Effective CPMs are those that enhance business performance in all areas of businesses—financial and nonfinancial. Harold Green remarks: “Performance stands out like a ton of diamonds. Non-performance can always be explained away.” CPMs need to be developed to fit to the business process flow, and focus attention on the critical success factors of the business.

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Business Performance Excellence Making It Happen

Developing CPMs is a critical decision-making process for any organization. Effective CPMs are those that help the organization to achieve its desired outcomes. Performance indicators must advocate the firm’s internal and external environment. However, for many firms the difficulty is that there are too many CPMs, ones that are outmoded, and that are not harmonious. CPMs should observe changes in the market environment, determine and assess progress towards business strategies and goals, and affirm achievement of performance goals. This is elaborated in turn. Robert Simon at Harvard University developed three tests to assess whether a measure or metric is suitable to support a performance goal. 1. Does the CPM align with business strategy? 2. Can it measure effectively (that is, metrics should be objective, complete, and responsive)? 3. Is the measure linked to economic value?8 According to Robert Simon (2000, p.239): “To be effective as communication devices, managers must use measures to focus attention. As you all know, what gets measured gets managed.”

Linking CPMs to Business Strategy and Competitive Environments

Strategy plays an important role in the choice of CPMs, and effective CPMs must be able to assess the organization’s progress on strategic priorities. Business strategy has been broadly conceptualized as a continuum spectrum between two extreme orientations: at one extreme, prospector or differentiator firms; and at the other end, defender or cost-leader firms. However, some business units may stand between both defenders and prospectors, which are often refereed to as “analyzers.”9 As defender or cost leaders focus on searching for new ways to reduce production and distribution costs, to cut marketing expenses, and to improve product quality, shortterm, retrospective financial and efficiency indices (for example, cost control, internal business processes, quality and efficiency, operating profit, cash flow from operations, return on investment, etc.) are relatively informative CPMs of performance. In contrast, as prospectors or differentiators compete in a broad product market domain by introducing new products and developing new markets, CPMs for focuses such as these would necessarily come from knowing what the customer wants, the level of staff involvement in creativity, and the ability of the organization to produce and market new products. Hence, a greater usage of NFIs (for example, new product development, market share, and customer satisfaction), as opposed to short-term financial indicators, would be prominent in this type of firm. Analyzer strategies combine both defender and prospector strategies. As a result, an analyzer firm’s organizational problem is how to accommodate both stable and dynamic areas of operations. The first concentrates on being efficient, and the second concentrates on watching its competitors closely, so as to determine the possibility of introducing new products or services as rapidly as possible. In relation to the first area, analyzers may tend to emphasize stability, defense of the firm’s position in the market, and to earn the best profit possible. The key rationale being that too many firms are

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Enhance Competitive Performance via CPMs able to provide the same product at the same price, hence the incentive to increase sales, or the profit margin, is to ensure its internal processes are acting as efficiently and cost-effectively as possible. As a result, analyzers may place emphasis on shortterm KPIs. The second area focuses on new market opportunities by developing new brands in response to emerging environmental trends. Consequently, the level of uncertainty would be high in organizations pursuing analyzer strategy. Consistent with this strategic position, analyzers are also likely to rely more on NFIs. Thus, since analyzers operate in two combined market areas, these firms would then be more prone to incorporate a much broader range of CPMs, such as that required by the balanced scorecard. It is felt that for analyzers, four dimensions of the balanced scorecard, as outlined above, can be regarded as meeting organizational performance measurement requirements, as they provide useful insights into the firm’s performance evaluation paradox in one report. In conclusion, different types of strategy will require different types of PMS and CPMs, and an appropriate fit between PMS and strategy is likely to enhance a firm’s performance.

Aligning KPIs and Incentives

Are CPMs linked to employee incentives? If CPMs are not linked to employee incentive schemes they tend to be overlooked by employees and therefore they are likely to result in no desired outcomes. CPMs must be aligned with employees’ individual goals and job descriptions. As a rule of thumb, Robert Simon suggested a maximum of 10 CPMs for each individual; otherwise individuals may suffer from information overload. With a reasonable number of CPMs, at the individual level, employees use CPMs to track their performance against agreed targets. Further, when developing CPMs for individuals, financial indicators should integrate nonfinancial or operational indicators on customer satisfaction, internal processes and the firm’s innovation and improvement activities.

Implementation of KPIs

Organizations also need to place greater emphasis on implementation issues when designing and implementing a PMS, and relevant CPMs. A recent study in Australia identified several factors (such as top management support, adequate technology, greater employee involvement in the design stage, adequate staff training and education, and linking PMS and CPMs with other financial control models) that impact on the successful implementation of a new PMS.10 More Info Books: Hoque, Zahirul. Handbook of Cost and Management Accounting. London: Spiramus, 2005. Hoque, Zahirul. Strategic Management Accounting: Concepts, Processes and Issues. 2nd ed. Sydney, Australia: Pearson Education, 2003. Johnson, H. Thomas, and Robert S. Kaplan. Relevance Lost, the Rise and Fall of Management Accounting. Boston, MA: Harvard Business School Press, 1987. Kaplan, Robert S., and David P. Norton. The Balanced Scorecard: Translating Strategy into Action. Boston, MA: Harvard Business School Press, 1996. Lynch, Richard L., and Kelvin F. Cross. Measure Up! Cambridge, MA: Blackwell Publishers, 1991.

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Business Performance Excellence Niven, Paul R. Balanced Scorecard Step-by-Step: Maximizing Performance and Maintaining Results. 2nd ed. Hoboken, NJ: Wiley, 2006. Simons, Robert. Performance Measurement and Control Systems for Implementing Strategy. Upper Saddle River, NJ: Prentice Hall, 2000. Articles: Ittner, Christopher D., David F. Larcker, and Madhav. V. Rajan. “The choice of performance measures in annual bonus contracts.” Accounting Review 72:2 (April 1997): 231–255. Online at: www.jstor.org/stable/248554 Kaplan, Robert S., and David P. Norton. “The balanced scorecard—Measures that drive performance.” Harvard Business Review (January–February 1992): 71–79. Online at: tinyurl.com/3p9jcpu Kaplan, Robert S., and David P. Norton. “Putting the balanced scorecard to work.” Harvard Business Review (September–October 1993): 134–147. Online at: tinyurl.com/2d593lh Nanni, Alfred J., J. Robb Dixon, and Thomas E. Vollmann. “Integrated performance measurement: Management accounting to support the new manufacturing realities.” Journal of Management Accounting Research 4 (1992): 1–19. Websites: Website of Better Management: www.bettermanagement.com Website of the Balanced Scorecard Institute: www.balancedscorecard.org

Notes 1. Simon (2000), p.3. 2. Kaplan and Norton (1996). 3. Simon (2000), p.7. 4. Ibid., p.234. 5. See tinyurl.com/7qts4vt [via archive.org]. 6. Based on Moll, Jodie, and Zahirul Hoque. “New organizational forms and accounting innovation: The specifier/provider model in the Australian public sector.” Journal of Accounting and Organizational Change 4:3 (2008): 243–269. Online at: dx.doi.org/10.1108/18325910810898052 7. See www.thinkexist.com/English/Author/x/Author_3037_1.htm, accessed on February 19, 2009. 8. For further details, refer to Simon (2000), pp. 234–238. 9. Miles, Raymond E., and Charles C. Snow. Organizational Strategy, Structure, and Process. New York: McGraw Hill, 1978. 10. Hoque, Zahrul, and Carol Adams. Measuring Public Sector Performance: A Study of Australian Government Departments. Melbourne: CPA Australia, 2008. Online at: tinyurl.com/boa9vuj [PDF].

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Multidimensional Performance Measurement Using the Balanced Scorecard by Priscilla Wisner University of Tennessee, Knoxville, USA

This Chapter Covers 8  An organization’s financial performance results from decisions made by its managers and employees. 8  Managers and employees need operational performance metrics that are aligned with the daily decisions being made, rather than a high-level set of financial metrics that are reported on a monthly or a quarterly basis. 8  The Balanced Scorecard (BSC) represents a set of financial, customer, operational, and organizational metrics that capture multidimensional aspects of performance. 8 Using a BSC, top management can signal strategic objectives to managers and employees. Top management can then gather data that shows whether or not performance at the individual and the strategic business unit levels is aligned with the strategic objectives of the firm.

Introduction

For generations, many businesses have measured organizational success based on a narrow set of financial performance measures, such as operating and net profit, return on investment, and earnings per share of stock. Financial performance measures are valuable in that they capture the economic consequences of business decisions; however, they tend to be “lagging” indicators of performance that report the financial effects of operational business decisions weeks or months after the decisions have been implemented. Organizational managers and employees typically manage their work in terms of physical flows and other nonfinancial resources. For example, sales managers focus on market size, sales volume, share of wallet, customer satisfaction, and similar measures. Production managers concentrate on production capacity, throughput time, quality, and productivity metrics. Human resource managers are responsible for hiring appropriately skilled personnel, maintaining a safe and legal workplace, and organizational development outcomes. Managers and employees throughout the organization make decisions and use resources that eventually impact the financial outcomes of the firm; to do so effectively, they need performance feedback that links the outcomes of their decisions to the strategic and financial goals of the firm. This feedback is most useful when it is a “leading” performance indicator, or one that is closely related to the work being performed. The Balanced Scorecard (BSC) was developed as a management tool to help managers better understand and link customer, operational, and organizational decisions to financial outcomes, and to the strategy of the organization.

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Business Performance Excellence BSC Basics

While General Electric has been credited with developing one of the first balanced scorecard performance models,1 the BSC concept was first described by Dr Robert Kaplan and David Norton in a series of Harvard Business Review articles in the early 1990s, and was subsequently expanded upon in books and articles by these and other professionals. The BSC as a management tool has gained widespread acceptance in the corporate world. In a survey of more than 700 companies operating in five continents, Bain and Company reported that 62% of the respondents used the BSC.2 BSC perspectives typically include financial, customer, operational (internal business processes), and organizational (learning and growth) aspects. By identifying key performance measures within each of these perspectives, top management signals strategic objectives and organizational goals to managers and employees. By receiving feedback on achieved outcomes for each of these measures, management is able to evaluate how closely performance is meeting strategic objectives. As shown in Figure 1, the four traditional BSC perspectives are interlinked, and are linked to the overall vision and strategy of the organization. Each perspective reflects a focus area for the implementation of strategy and, therefore, for performance measurement:3 Figure 1. Linking of BSC perspectives Financial perspective How should we look to our shareholders? Measures

Actual

Target

Initiatives

1. 2. 3.

Customer perspective

Internal business processes perspective

How are we creating customer value? Measures

Actual

Target

Initiatives

1.

Vision and strategy

What business processes must we excel at? Measures

Actual

Target

Initiatives

1.

2.

2.

3.

3.

Learning and growth perspective Measurement of organizational change and growth Measures

Actual

Target

Initiatives

1. 2. 3.

8 Financial perspective—focuses on financial aspects of performance, and links strategic objectives with financial impacts. Balance sheet, income statement, and cash flow performance measures are often included in this dimension. Some firms include alternative measures of financial performance, such as economic value added, recycling income, and sales growth by channel.

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Multidimensional Performance Measurement 8 Customer perspective—contains measures that reflect how the firm is creating customer value. Customer satisfaction measures are typical, but leading firms will include measures such as share of mind and share of wallet, consumption per capita, customer retention, and product accessibility measures. 8 Internal business processes perspective—focuses on how a company is performing through an operational lens. Internal business processes encompass many facets of operations, including engineering design, purchasing, manufacturing, distribution, and environmental and social performance. In a customer service organization, measures might include response time, process quality, employee productivity, and bridge to sales ratios. 8 Learning and growth perspective—assesses how well the organization is preparing itself and its employees for the future. This perspective often includes measures of organizational practices, employee development and satisfaction, and systems development and deployment. Aspects commonly measured in this perspective include employee turnover, diversity, promotions from within, training hours or expense by employee, innovation measures, and surveys of corporate climate.

Implementing a BSC

The BSC is not a “one size fits all” management tool. Each BSC is unique to the strategy, objectives, and culture of the individual organization. However, the following guidelines are important to any successful BSC implementation. Stakeholder participation in BSC development: Every top management team employing a BSC must carefully translate the organization’s strategy into meaningful and actionable performance measures. This process requires the participation and input of the organizational stakeholders who are either impacted by the strategy or responsible for implementing the strategy. For example, building a set of customer-related performance measures is difficult without understanding customer needs and perceptions. Similarly, requiring a firm’s workers to focus on improving quality metrics without involving these employees in discussions about quality creates a disconnect with those responsible for implementing the improvements. Create cascaded scorecards that are organizationally appropriate: At higher levels of the organization, management will be focused on performance outcomes that reflect the overall company strategic objectives. But, a high-level scorecard would not be appropriate throughout the organization. Some firms develop scorecards at the individual employee level. For example, a high-level objective in a firm’s BSC might be “increase market share.” In the marketing area, this objective might be broken down into mid-level objectives, for example, “increase market share in Europe,” “increase market share in Asia,” or “increase market share of customers aged 18–25 years old.” At the individual level, this objective could be further defined in a way that reflects the responsibilities of that marketer, such as “increase market share in France” or “increase market share in China.” Alternatively, the objective might be related to a specific product or service. The goal of cascading is 1) to translate the strategic objective into specific objectives for the hundreds and thousands of

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Business Performance Excellence employees throughout the organization that carry out the day-to-day work; and 2) to link the work of each employee and strategic business unit to the overall strategic goals of the organization by defining measures appropriate to the employee and business unit. Define linkages between measures: Value creation in any organization is accomplished by understanding and creating synergies between the various aspects of organizational performance. Increasing sales without having the corresponding production or service capabilities will likely lead to loss of value rather than a longterm increase in value. Increasing production output at the cost of reducing product safety and reliability will negatively affect quality, costs, and reputation. An effective BSC explicitly shows the cause and effect linkages between key performance indicators. A leading insurance company was concerned about its market stock price. By evaluating company data, company managers determined that the amount of time it took a claims adjuster to contact the customer following an accident could influence market stock price. How was this so? The study showed that the length of contact time influenced customer satisfaction, which influenced policy renewal rates, which led to revenues from premiums, which ultimately influenced operating income and stock price. Choose a small set of focused measures: Each BSC should contain a small set of performance measures, generally with not more than 15–20 recommendations for any single BSC. Developing a limited set of measures is challenging, but forces managers to focus on the most important aspects of organizational performance. Having too many measures tends to create “noise” in the process, both for the managers and for the employees who are working toward the stated goals, leading to uncertainty about which measures are key drivers of success. Create balance in the scorecard: To be “balanced” does not mean to be equal in all dimensions. A balanced scorecard is one that contains: 8 multiple perspectives of performance; 8 leading and lagging measures; 8 internally focused and externally focused measures; 8 short-term and long-term measures; 8 quantitative and qualitative measures. Link the BSC to employee compensation: An effective BSC sends a message to employees that “strategy is everyone’s job.” If this is the case, then firms need to reward employees for carrying out the strategic intent of the organization. If the objectives and measures within the BSC are aligned in such a way that value is created by carrying out these actions, then employees should be rewarded for increasing the firm’s value proposition. Organizational development research has shown that linking reward systems to explicit and controllable expectations creates strong linkages between employee behaviors and the achievement of organizational goals.

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Multidimensional Performance Measurement Figure 2. Revenue growth strategy Revenue growth

Nongasoline revenue • Increase nongasoline revenues and margins Premium brands revenue • Increase volume of premium (versus industry) • Increase percentage of premium mix

Case Study

Mobil Corporation In the early 1990s, Mobil Corporation’s North America Marketing and Refining group (Mobil) implemented a strategy that resulted in an increased return on capital from 6% to 16%, and an improved operating cash flow of over $1 billion per year.4 This dramatic improvement in financial results was achieved in just three years, and was aided by a BSC implementation to help focus and align the organization. In 1994, Mobil began a BSC project as a means to help communicate and implement a strategic organizational change. Mobil’s new strategy was twofold: 1. increase volume and revenues of premium products; and 2. reduce costs and improve value chain productivity. Mobil began by defining its high-level financial objectives—return on capital employed and net margin—and then disaggregated these objectives into specific objectives related to its revenue growth and productivity strategies. An example of Mobil’s objectives in relation to its revenue growth strategy is shown in Figure 2. After developing the financial perspective of the BSC, Mobil’s managers developed the customer, internal, and learning and growth perspectives. The customer perspective focused on customer satisfaction and dealer relationships, using specific performance measures to capture achievement on each objective. The largest set of measures were the internal business processes measures, which included new product volume and profitability, dealer quality, refinery performance, inventory management, order quality, and safety measures. In the learning and growth perspective, the firm focused on measures such as an employee climate survey, core competency achievements, and the availability of strategic information. Each perspective contained a small set of focused and interlinked measures that were keys to achieving corporate strategy. The development of the BSC was accompanied by a realignment of organizational structures, the use and communication of the new measurement system, and linking compensation with meeting the explicit goals and objectives. The outcomes for Mobil were dramatic—surveys showed that employee awareness of strategy increased from 20% to 80%, safety and environmental statistics improved, lost yield was reduced by 70%, new products were being introduced, volume growth exceeded the industry averages by over 2% annually, cash expenses were reduced, and Mobil’s relative profitability within the North American oil industry improved from last to first in class. Each of these improvements had an impact on increasing Mobil’s operating cash flows and return on capital employed. The BSC helped management to communicate corporate strategy through a set of strategic objectives and specific goals, essentially aligning the organization toward a common set of objectives.

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Business Performance Excellence Summary and Further Steps

Conclusion The BSC is a powerful concept that enables organizational change. The BSC is not just a performance measurement tool, but a multidimensional system that requires management to define strategy in operational terms, and to understand and communicate the cause and effect relationships between the work performed at all levels of the organization and the high-level strategic goals. An effective BSC communicates strategy throughout the organization, thereby signaling to the employees what achievements are needed to implement strategy. A BSC also serves to communicate results back to management, using measures that link into specific strategic objectives. By having such a detailed map of strategic intent and accomplishments, both managers and employees can become more effective in their work.

Making It Happen 8 Top management involvement is key—The BSC is a strategic management system that is used to change organizational culture, making strategy everyone’s job. This change cannot happen without the involvement of top management. 8 Translate strategy into operational terms—Strategic objectives must be linked to specific operational perspectives, objectives and indicators. In effect, the BSC “tells the story of the work.” 8 Link measures within and between the perspectives—All measures should lead to increasing value for the organization. Management should be able to articulate the cause and effect relationships between the measures, and the paths by which the measures link to each other and to organizational value. 8 Cascade the BSC throughout the organization—BSCs can be created for each strategic business unit, for departments within each business unit, and, ultimately, for each employee. These cascaded BSCs help to define the performance objectives into meaningful metrics that link the work being performed at all levels of the organization to the strategic goals of the firm. 8 Link the BSC to compensation—By rewarding employees for specific performance outcomes that are linked to strategic objectives, alignment is created between the work being done and the broader strategic goals of the firm. There is a cause and effect relationship between “what gets measured, gets managed” and “what gets rewarded, gets attention.” By rewarding the specifically defined actions that create value, management is assuring that employees are focused on doing the right things.

More Info Books: Epstein, Marc J., and Bill Birchard. Counting What Counts: Turning Corporate Accountability to Competitive Advantage. Reading, MA: Perseus Books, 1999. Kaplan, Robert, and David P. Norton. The Balanced Scorecard: Translating Strategy into Action. Boston, MA: Harvard Business School Press, 1996.

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Multidimensional Performance Measurement

Kaplan, Robert, and David P. Norton. The Strategy-Focused Organization: How Balanced Scorecard Companies Thrive in the New Business Environment. Boston, MA: Harvard Business School Press, 2001 Websites: Balanced Scorecard Institute: balancedscorecard.org Balanced Scorecard Report: web.hbr.org/se/ Management and Accounting Web: www.maaw.info Optima Media Group Business Intelligence. “Performance Measurement Portfolios”: www.business-intelligence.co.uk/portfolio/perf.asp

Notes 1. Hendricks, Kevin, Larry Menor, and Christine Wiedman. “The Balanced Scorecard: To adopt or not to adopt?” Ivey Business Journal (November/December 2004). 2. Ibid. 3. Adapted from: Kaplan, Robert S., and David P. Norton. “Using the Balanced Scorecard as a strategic management system.” Harvard Business Review 74:1 (January–February 1996): 75–85. 4. Data from this case study was reported in: Kaplan, Robert S., and David P. Norton. The Strategy-Focused Organization. Boston, MA: Harvard Business School Press, 2001.

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Turning Around Financial Performance by David Magee SDI, Philadelphia, USA

This Chapter Covers When financial performance lags, a full-scale, company-wide plan of action is required to get the best and longest-lasting results. Merely dictating cost reductions is not enough to foster true change within the organization. At Nissan, CEO Carlos Ghosn, who now runs both Nissan and Renault, implemented a grass-roots process designed to force employees to find cost-saving solutions. Ghosn drastically turned around the company’s performance over a span of two years using the following tools: 8  cross-functional teams; 8  identifying root problems; 8  eliminating costs the customer does not see; 8 investing in product design.

Introduction

No business, big or small, is immune from needing to address and correct financial performance. Often the reason is obvious, such as when a once-reliable bottom line turns negative, placing employee jobs, ownership equity, and product or service quality at risk. Sometimes, however, the need and potential benefits are not so obvious. Take General Electric as an example. This stalwart American blue-chip corporation, in business for more than 100 years, was considered one of the world’s best-managed companies when Jack Welch took over as company chairman and CEO in 1981. GE was profitable, but the period was recessionary in the United States, and the stock had languished for years. So, Welch made the assumption that good was not good enough. He began drastic cost-cutting measures across the board, eliminating more than 100,000 jobs and millions of dollars in costs. At the same time, Welch put processes in place to strengthen the organization from within, focusing on human resources development, while investing heavily in leadership training. By the end of the 1990s, GE’s stock was recognized for its consistently high returns, and Welch was known as one of the 20th century’s top business leaders. Case Study Nissan’s position as a profitable and viable global automaker was in complete default by 1999. The once-strong company had lost money for six of seven consecutive years, beginning in 1992. Its global market share was in decline and the company was losing, on average, US$1,000 per vehicle sold in the United States. Carlos Ghosn knew that regeneration of the company product was imperative, but the product alone would not save the company. Thus, he devised a cost-saving strategy to improve financial performance, allowing Nissan to ramp up its product development, thereby saving the company and sending it on a path to profitability.

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Business Performance Excellence The reasons identified by Ghosn, and the team he charged with solving the company’s financial crisis, included:

8 lack of profit orientation; 8 lack of cross-functional communication and teamwork; 8 no sense of urgency; 8 protection of long-standing, nonbeneficial relationships; 8 lack of shared vision and long-term goal orientation.

Listen Deeply

Typically, the need to address financial performance comes when that of a business has fallen below acceptability, either losing money or is not up to normal bottom-line standards. Such was the case with Japanese automaker, Nissan, in the late 1990s. A one-time industry leader, Nissan was losing millions of dollars annually, and teetering near bankruptcy, when French automaker Renault took a controlling stake in the company. Renault infused Nissan with much-needed capital, but that was the least of its contributions to the company. A young, relatively unknown leader named Carlos Ghosn became the CEO of Nissan, and his mission was to turn around financial performance in three months. The company’s demise had taken years, so there were many skeptics, yet Ghosn formulated a turnaround strategy designed to deliver quick and lasting results. First, he traveled to all of Nissan’s factories and facilities, spending most of his time with middle-management workers, asking questions about their jobs and facilities, and listening deeply. Management, he assumed, did not have the answers. He needed to listen to the core employee group of the company. Then, Ghosn returned to Nissan and implemented a plan designed to cultivate solutions to the company’s problems from the ground up. Creating nine cross-functional teams to assess each area of the business, including purchasing, research, administrative, and finance, Ghosn challenged them to find, within 90 days, cost-cutting solutions worth hundreds of millions of dollars. Each team was assigned a top company vice-president as a member, but that person was not placed in charge, as Ghosn believed lower-level employees would not then speak up enough. Instead, middle- and upper-middle-level employees were named as pilots, charged with guiding the team on its mission. Ghosn’s reasoning for creating a cross-functional structure for the task was simple: by creating teams with employees from different disciplines, members would be forced to challenge one another objectively and give answers honestly. And by forcing the teams to work to a tight deadline, he gave them less time to find excuses. “Three months was the longest time I could imagine,” said Ghosn. “Multitask work is simply a question of exercise. If you work on trying to act quickly, you will be good at it. When you know that time is important, you learn to work faster.”

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Turning Around Financial Performance Many believed Nissan could not be fixed, because the company was part of Japan’s interlinked business network, or keiretsu, which dictated many banking and supplier relationships that were not necessarily in the company’s best interest, yet nobody wanted to break the long-held ties. For instance, the company had literally hundreds of bank accounts, spreading its wealth throughout its keiretsu, but finance had previously refused to consolidate them, thus saving costs, arguing it would end vital cross-company relationships. Ghosn did not buy that argument, however, giving the cross-company teams a firm directive: “No sacred cows, no taboos, no constraints,” he said.

Send Teams Back to the Drawing Board

In the beginning, the cross-functional teams were hesitant, and the process did not go as fast as Ghosn had hoped. Most members did not know each other well, if at all, so at first, they had to find ways of working with one another. Ghosn asked for weekly updates, and for the first few weeks recommendations were not at all aggressive, shying away from what they thought was not possible. Ghosn pushed them back to the drawing board, urging them to go and see for themselves when necessary, to find the root cause of problems. If, for example, bolts used in car manufacturing were costing the company more than they should, the team needed to find out why, and recommend eliminating the problem. If banking costs were too high, the team should benchmark (a point of reference for measurement) against other companies and other industries to find a standard. Then, Nissan should recommend cost-cutting to meet that standard, regardless of longstanding company relationships. Similarly, even though Japan practiced “jobs for life,” if the company needed to eliminate positions to restore financial credibility, the teams were responsible for providing that information. By the end of the 90 days, Nissan’s cross-functional teams had made considerable progress. Ghosn had instructed them to present him with two sets of numbers: 1. Recommended cuts, those they deemed were sufficient to meet the aggressive demands. 2. Stretch cuts, the highest conceivable number they could come up with. He assessed each of the recommendations himself, line by line, and reached a firm decision.

Implement to the Maximum Level

There are many benefits from using cross-functional teams to solve a company’s financial woes. Nissan employees say they experienced dramatic professional and personal growth, for instance. However, the company as a whole benefits the most, perhaps because solutions are provided from within, not from above. Certainly, Ghosn was orchestrating the teams’ direction in response to his own deep learning before the process. He was not, however, simply placing demands upon employees who did not believe in the cuts. Had Ghosn ordered drastic cuts without the teams having found solutions themselves, for example, most would never have bought into them. By forcing them to find solutions, however, he showed them possibilities, thus increasing the odds of successful implementation.

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Business Performance Excellence When presented with the findings, involving some 2,000 areas that the nine teams assessed before making recommendations, Ghosn decided some changes and cuts would not be nearly as effective as all the changes and cuts. “It was a tough call,” said Ghosn, “but I decided to go for it completely…the maximum level.” Ghosn did more than just announce the cuts, however. He personally took responsibility, saying that if the company was not profitable again within a year, he and the entire company board of directors would quit. Other board members did not know about this, yet Ghosn made the comment to show employees he stood with them in the drastic action, which broke up Nissan’s keiretsu relationships, eliminated jobs, and closed factories.

Invest in Product

Cost reductions alone are not enough to transform a company’s bottom line, however. Ghosn believed cuts must be made in conjunction with product or service enhancement, providing plan sustainability instead of just a one-off impact on the profit-and-loss statement. So, just as the cost-cutting plan was announced, Nissan revved up its product investment, ramping up the number of automobiles it built, and spending millions on redesign, with an emphasis on customer-recognized functionality and flair. In other words, as the organization the customer never sees was de-engineered through the cost-saving plan, the product reaching the customer was enhanced across the board, increasing sales and raising the company’s brand image. One year after Nissan implemented the plan, the company was profitable again, so Ghosn did not have to quit his job (he was named Nissan’s CEO, and several years later became CEO of Renault as well, in a dual-leadership capacity). Purchasing costs were reduced by 11% in one year, manufacturing plant utilization rates increased from 51% to 74%, and sales increased. Within three years of implementing the plan, Nissan posted its best-ever profits for a full year, and began a second-phase revival strategy, cutting more costs and investing more in a new and redesigned product. Today, Nissan is considered one of the healthiest of all global automotive manufacturers, far from its position a decade before when bankruptcy was an option. Summary and Further Steps Nissan’s position as a profitable and viable global automaker was in complete default by 1999. The once-strong company had lost money for six of seven consecutive years, beginning in 1992. Its global market share was in decline and the company was losing, on average, US$1,000 per vehicle sold in the United States. Carlos Ghosn knew that regeneration of the company product was imperative, but the product alone would not save the company. Thus, he devised a cost-saving strategy to improve financial performance, allowing Nissan to ramp up its product development, thereby saving the company and sending it on a path to profitability. The reasons identified by Ghosn, and the team he charged with solving the company’s financial crisis, included: 8 lack of profit orientation;. 8 lack of cross-functional communication and teamwork;

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Turning Around Financial Performance 8 no sense of urgency; 8 protection of long-standing, nonbeneficial relationships; 8 lack of shared vision and long-term goal orientation. Through the deployment of problem-solving, cross-functional and cross-company teams (Renault had just became the owner of Nissan), Ghosn and Nissan arrived at a solution. Cost savings would be achieved through the following tactics:

8 changing relationships with suppliers (none were off-limits);. 8 leducing staff overheads; 8 closing nonviable plants and eliminating nonprofitable products; 8 debt reduction; 8 establishing clear pay-for-performance guidelines for all employees, including executives; 8 establishing a clear leadership succession plan for the long term. The results, implemented in all their aspects, led to immediate financial improvement, allowing Nissan to invest more in the product while giving more to shareholders. The Nissan Revival Plan was completed one full year early, with better-than-expected outcomes. Profits soared to record heights (more than US$3.8 billion in 2002), although market share remained relatively flat.

Making It Happen Cross-functional teams are established under the premise that solutions to a company’s problems lie within the organization. In establishing team rules, make nothing off-limits to explore or discuss—nothing. Teams should not be hindered by tradition or sensitive corporate issues. Teams should have no decision-making power, only the ability to make powerful recommendations. Teams should include one to two leaders from top company ranks, but the power to run meetings should rest with a pilot from middle management. Membership of the team should be made up of five to nine members from different disciplines, and they should have different leadership qualities. Subteams can be established in larger companies to facilitate information and solution finding.

More Info Books: Ghosn, Carlos, and Philippe Riès. Shift: Inside Nissan’s Historic Revival. New York: Currency/ Doubleday, 2005. Magee, David. Turnaround: How Carlos Ghosn Rescued Nissan. New York: HarperBusiness, 2003. Article: Ghosn, Carlos. “Saving the business without losing the company.” Harvard Business Review (January 2002). Online at: tinyurl.com/7w3crsg

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Cash Flow Best Practice for Small and Medium-Sized Enterprises by Rita Herron Brown BrownHerron Publishing, Louisville, Kentucky, USA

This Chapter Covers 8 Cash is the oxygen of a business: it must have cash in order to operate. 8 Cash flow management entails measuring cash coming in (receivables) and cash going out (payables). 8 It’s not uncommon for smaller businesses to need a line of credit to bridge the gap between receivables and payables—but this facility comes at a cost. 8 Many cash flow issues are due more to inattention or sloppy management than to problems with customers. Nonetheless, it’s important for managers to know who they are doing business with, and customers need to know the terms of any sales transactions.

Introduction

In late summer 2008, a Californian company that helped businesses to cut their power consumption costs, BluePoint Energy, found itself in very hot water. BluePoint’s CEO, Guy Archbold, had stated a year earlier that the company would soon lock down contracts to bring in more than US$50 million in revenue. However, this didn’t happen. And when newspapers reported that Archbold had been suspended, they also reported that the company had lost US$14.3 million on sales of only US$1.3 million. The story ended unhappily for all involved, and there are many management lessons that could be learned from it—with the importance of cash flow management at the top of the list. A 2008 survey by Discover Financial Services showed that some 44% of small-business owners said they had experienced cash flow problems.1 In a tough economy, that number is assuredly higher. What can a manager do?

Master Day-to-Day Financial Metrics

Every business needs a budget that allocates income and outgoings in well-defined categories. The best budget system is based on the history of the business, i.e. a detailed listing of where money was earned and spent in the past; but, essentially, what a manager is trying to do is pin down (on at least a quarterly basis) their yearly receivables, and from whom and where, and their yearly expenditures. Then, against that budget, the manager should track business operations to see whether budget projections are turning out to be reality. It’s important for a manager to account for every dollar that comes into the business and every dollar that goes out. And, in a pinch, they need to know where the business is, against budget, right now.

Track and Forecast Receivables

The part of any budget that is most critical, of course, is the cash coming in—not the cash that might possibly come in (projected or booked business), but the cash for which a business has performed work, or for which it has a contract with a firm payment

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Business Performance Excellence schedule. Yet here too, the tieback to a budget is quite important: Every manager needs to know (based on past experience as well as future plans) when they can reasonably expect those dollars to be in the mailbox or, better, electronically transferred to a business bank account. Thus, managers need to know on a weekly (some say daily) basis whether the to-date income projected is actually in hand. If it is, a manager can then start to disburse payments (salaries, supplier invoices, and so forth); if the business is running short of income, a manager needs to take other forms of action (as will be discussed later).

Know the Customers and Set Terms

It’s not hard to find stories of businesses that did work for a new customer only to have the order canceled just as the product is about to be shipped. Worse still is the customer who takes delivery and pays with a check without having enough cash in the bank to cover it. On any substantial customer order, it’s not improper to ask for references (which must be checked!)—and, on any order, it’s not unusual to state before beginning the work how the business expects to be paid and when. Does a customer pay on completion of work? If the customer takes 30 days or more to pay, are there any penalties? What if a customer pays immediately or within a week: Is there a discount? Is the amount due the same if the bill is paid with cash rather than a credit card, or in installments? Knowing the customer—and making sure that each customer knows the terms of any business transaction—is key to cash flow management.

Bill Promptly and Offer Discounts

Many businesses, of course, do the work and bill later. Amazingly, many businesses are lax when it comes to cutting the invoice, and often this is because it’s viewed as too much work to take time to raise invoices when there’s “real” work to be done. Nonsense. The quicker a business bills for completed work (no matter what the terms of payment are), the quicker that business can expect cash to show on the balance sheet. That’s why many businesses offer incentives to customers to pay earlier. Incentives can be as high as 3%, although a manager needs to decide the discount rate by judging how much it’s worth to receive payment sooner rather than later.

Don’t Let Cash Sit Around

It’s easy to allow the work in process to dominate one’s attention, yet there’s no excuse for allowing checks received for past work to lie in an inbox, unattended for days. But a manager doesn’t have to have checks sitting on a desk to be guilty of cash flow dereliction. Even if all receivables arrive on time and are deposited in the bank promptly, many businesses allow their cash to sit in business checking accounts that often pay zero interest. This, too, is letting cash sit around. Depending on when a business will need the cash to pay its own bills, there are ways to put that money to work, via short-term certificates of deposit or other financial instruments that bankers can quickly explain.

Track and Forecast Payables

Each time a manager pays anything, it should be logged properly via a chart of accounts that lists the category of the expense and ties it to a specific business check or direct-from-bank payment. There are many software programs that can help a small business to manage these details. Yet the most important thing is that a business has

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Cash Flow Best Practice for Small and Medium-Sized Enterprises a precise plan in place for any expense that a manager can project. When a manager is surprised that “payroll ran so high this month,” or complains that “energy prices are way out of line,” such comments reveal that their attention to cash flow detail is lacking. If, in fact, the business is large enough that such details can’t be managed by the senior manager, they should be delegated to someone who can report on income and outgoings—in precise detail—at a moment’s notice. The list of payables should be divided into those that must be paid (required spending) and those which can be deferred or delayed (discretionary spending). Payroll and rent are required payments; new carpeting for the manager’s office is discretionary.

When Cash Flow Dips

In 1997, Francine Glick started a company, Hands2Go, that sells hand-sanitizing products. Glick says that, from day one, she was on top of the financials of her successful business. But has her company always had more cash on hand or coming in than it needed to operate? As with the vast majority of businesses, she’d be the first to say hers did not. For those times when she might need cash in a downturn, or when receivables were running late, Glick set up credit lines before she needed to draw on such resources. “As long as you only use it for emergencies and don’t become dependent on it, a line of credit is a useful tool,” she says. The key, of course, is to use a line of credit (a company credit card is, in essence, the same thing) only when a manager can, with certainty, pinpoint when the business will receive income that can be used to pay down that credit line. Otherwise, one is borrowing blindly or on faith; either way, that’s not good business. One more point: Many a small business has borrowed liberally when facing a cash flow dip, received income in due course, and then failed to pay down its debt. Cash that comes from a line of credit should be considered as receivables that have already been spent. Keeping credit line balances close to zero will mean that a business has full access to dollars it may critically need during even tougher times to come.

Case Study

Omni Graphics Printing & Copying Jim Hahn runs Omni Graphics Printing & Copying in Kentucky, a small firm that handles all kinds of printing jobs—from business cards to publishing booklets such as annual reports for sports teams. In business since the mid-1980s, Hahn’s operation increased its year-on-year revenues by 3–5% without the need to market extensively. His five-man business serves both walk-in customers and large business-to-business clientele. Word of mouth sustained his business growth; and, as his business grew, he added printing equipment and employees to boost his productivity and profits. Yet, by the end of 2008, Hahn could sense that something was wrong. As the American economy started to tank, Hahn could feel that his revenue was sliding and that his bills and payroll were starting to exceed income. But he didn’t know exactly what was happening. That’s because Hahn did not really use a budget or cash flow tracking. “For years, I didn’t need to worry about such things,” he says. “Revenues always handily exceeded expenses.”

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Business Performance Excellence The economic downturn has actually helped to make Hahn an even better businessman. “Now, I have a budget that pins down all my expenses; I’ve even listed how much my advertisement in the local phone book costs me. More than that, I have identified where 80% of my income has been coming from, so I know who my best customers have been, their industries, and thus, the probable source for potential future income.” Hahn’s cash flow management is now a daily activity. First, Hahn has quadrupled the amount of time he is spending on marketing; he now personally checks on his top customers and is attending group business luncheons and making dozens of cold calls to attract customers with a profile that matches those of his best customers in the past. Second, on payables, Hahn has been reducing expenses by tracking every dollar that flows out of his business. He has found that employees have been flexible in temporarily reducing work hours and salaries, that he doesn’t need to stock as much paper and other supplies, that his expensive advertisement in the local phone book doesn’t have the return on investment that he thought, that every large equipment purchase planned for the next year can be deferred, and that numerous other expenses—once deemed essential, such as four telephone lines—can be cut back. Third, Hahn is documenting his case to establish a business line of credit at his bank, so as to be ready to handle downturns in the future. Hahn admits that this new attention to cash flow management has not been easy. Nevertheless, although these practices were implemented during harsh business times and have boosted his chances of sustaining his business for another 20 years, the exercise in cash flow management has taught him an enormous lesson: “If I can find ways to eke out a profit using these techniques in tough times, imagine how much more profitable my business can be if I manage exactly the same way when the good times return.”

Summary and Further Steps

8 Create systems for budgeting, receivables, and payables to establish how healthy the business is in a financial sense. Create a cash flow statement.

8 Don’t perform work for customers that can’t be relied on to pay promptly. Share with all customers the terms of payment, including any incentives and penalties.

8 Keep a close eye on both payments the business will be required to make and payments that could be delayed or deferred because they are not essential to current business operations. 8 When the business is cash negative, don’t panic. As long as the business has predictable, reliable income from customers in the near future, a manager can access lines of credit—if they have been wise enough to establish those before they become a critical need. And when income arrives, such short-term debt should be paid down immediately.

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Cash Flow Best Practice for Small and Medium-Sized Enterprises More Info Books: Forsyth, Patrick, and Frances Kay. Tough Tactics for Tough Times: How to Maintain Business Success in Difficult Economic Conditions. Philadelphia, PA: Kogan Page, 2009. Jordan, Caroline Grimm. Stop the Cash Flow Roller Coaster, I Want to Get Off! What Every Small Business Owner Should Know About Cash Flow…But Most Don’t. Lincoln, NE: iUniverse, 2007. Articles: Bernabucci, Bob. “Improving your cash flow problems.” Entrepreneur.com (August 2, 2005). Online at: www.entrepreneur.com/article/79084.html Campbell, Philip. “The 10 rules of cash flow 101.” About.com Small Business Information. Online at: sbinformation.about.com/cs/accounting/a/uccashflow.htm Glick, Francine. “Get your hands around cash flow.” Open Forum (September 18, 2007). Online at: tinyurl.com/7zb3w4r ScotiaBank. “A blueprint for cash-flow success.” Get Growing for Business. Online at: tinyurl.com/3cf5bp8 Websites: About.com Small Business Resource Center: smallbusiness.specials.about.com Business Owner’s Toolkit, “Managing your cash flow”: www.toolkit.com/small_business_guide/sbg.aspx?nid=P06_4001 Inc., the daily resource for entrepreneurs, “Cash management basics”: www.inc.com/guides/start_biz/20675.html

Notes 1. “Small business economic confidence continues to slide. 2 in 3 small business owners rate economy as poor; 3 in 4 see it getting worse.” Discover Financial Services Small Business Watch, November 2008.

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Employee Stock Options by Peter Casson School of Management, University of Southampton, UK

This Chapter Covers 8 Employee stock options are call options on the employer company’s common stock, and are usually not transferable. 8 Most employee stock options have a vesting period, during which the holder is not unconditionally entitled to the option, with options vesting at the end of the period if performance conditions are met. 8 Employee stock options may be used by companies to recruit, retain, and provide incentives to employees and executives. Companies with weak cash flows that cannot afford to pay employees the market rate entirely in cash may use stock options in lieu of cash. 8 Companies may use employee stock options to capture tax or accounting benefits that may be associated with their use.

Introduction

Employee stock options are a component of the compensation package of many employees and executives. As well as providing a mechanism for linking pay with the performance of the company’s stock price, stock options can facilitate the recruitment and retention of employees. The effectiveness of stock option compensation derives from the basic characteristics of options and from particular features found in many employee stock options. This article describes the essential features of employee stock options and explores the ways in which they are used by companies.

Characteristics of Employee Stock Options

Employee stock options are call options granted by an employer on the company’s common stock. Call options are contracts that give holders the right, but not the obligation, to acquire stock at a specified price (the exercise price), either on a specified date or over a specified period. The fair value of a call option has two components. The first, known as intrinsic value, is the amount that the holder would receive were the option to be exercised today. This amount, which cannot be negative, is the greater of zero and the difference between the fair value of the underlying stock and the exercise price of the option. The second, known as time value, is the difference between the fair value and the intrinsic value of the option. The fair value of a call option on a company’s common stock is sensitive to changes in: 8 The fair value of the underlying stock—the value of the option rises with increases in the fair value of the stock. 8 The expected volatility of the returns on the underlying stock—the value of the option increases with increases in expected volatility. 8 The risk-free rate of interest—the value of the option increases with increases in the risk-free rate.

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Business Performance Excellence 8 The time until the option expires—the value of the option decreases as time to expiry decreases. 8 The dividends expected to be paid on the underlying stock over the life of the option—the value of the option decreases with increases in the expected dividend payments. Stock options granted to employees usually have an exercise price equal to the fair value of the underlying stock on the date the option is granted, and have a life of seven to ten years. Stock options generally have additional features that affect their fair value. First, there is usually an initial period, often three years, after the grant of the option (the vesting period), during which the employee is not unconditionally entitled to the option. Rather, the employee’s entitlement to the option at the end of the vesting period only comes about if performance conditions are met. The performance condition for employees is usually to remain in the employment of the grantor company during the vesting period. Options, especially those granted to senior executives, may have additional performance conditions relating to company and/or personal performance. Second, once vested, options are usually forfeited if the employee leaves the grantor company. However, it is usual for employees to be able to exercise options within a period, often 90 days, after leaving the company. The forfeiture provision normally means that employees are forced into an early exercise of in-the-money options. Third, employee stock options are usually nontransferable, which means the employees can only realize value by exercising the option and selling the stock. In so doing, they forego the time value of the option.

Why Companies Use Employee Share Options

Companies may grant stock options to attract, retain, and motivate employees and executives. In addition, start-up companies and companies with weak cash flows may grant stock options to compensate for the below-market cash wages that they can afford. Finally, options may be granted to capture any available taxation and/or accounting benefits. Stock options may attract employees and executives for the following reasons. First, individuals whose abilities match the needs of the company may be attracted by stock options because they believe that their abilities will improve company performance and that this will be reflected in an enhanced stock price. Second, the offer of stock options may attract those employees who are most optimistic about the company’s future prospects. Their optimism may lead them to overvalue the options, so reducing the company’s overall employment costs. Finally, stock options may attract relatively less risk-averse employees who meet the needs of the company. Employee stock options may be used as a way to increase employee retention. The vesting conditions usually found in the options may encourage employees to remain with the company until the options become exercisable. In addition, employees will forego the time value of vested options if they are forced into early exercise by leaving the company. Finally, as employees build up a portfolio of options over time, it becomes more costly for a competitor to attract the company’s employees, as the competitor may have to compensate them for the value foregone from forfeiting unvested options or from suboptimally exercising options.

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Employee Stock Options Holders of employee stock options may have an incentive to act in a way that increases the value of the options. The fair value of employee stock options is, as described above, sensitive to the company’s stock price, the expected volatility of the stock, and the dividends expected to be paid on the stock during the life of the options. Employees may act, through enhanced performance, to increase company performance, and that in turn may be reflected in the stock price. Although the incentive effects of grants to non-executive employees are questionable, as there are significant free-rider problems, grants of stock options to senior executives may be effective in increasing company performance. There are nevertheless questions about the incentive effects of stock options granted to senior executives on company performance. Changes in stock prices are related to general market factors as well as specific factors associated with the company. Executives may therefore be rewarded when markets are rising, even when company performance is weak. It is also suggested that stock options encourage executives to spend time and energy on focusing on, and in acting in a way to manipulate stock price performance, to the exclusion of other appropriate behavior. Finally, there are suggestions that incentives such as stock options crowd out intrinsic motivation, for example the satisfaction that comes from doing a job well. The other incentive effects of stock options are confined to options held by senior executives, especially CEOs. Senior executives holding stock options may make riskier investment decisions and/or increase the company’s leverage with a view to increasing the expected stock volatility. Stock options may also reduce the dividend on the company’s stock. Stock options may be used by start-up companies and companies experiencing cash constraints. Here employees may sacrifice part of their cash compensation in exchange for stock options. Although financial institutions are usually seen to be in a better position than employees to bear the risks associated with lending, employees may be willing to do so because: (1) options attract risk-seeking individuals, who, if the company fails, will move to another company; (2) they possess superior knowledge and so perceive the risk differently to financial institutions; or (3) they do not understand the risks. Companies may use stock option compensation because of preferential tax policies, although this depends on the tax regime of the country in which the employee and the company are resident. Stock option compensation may, depending on the jurisdiction, be taxed at the time of grant, or at the time the option is exercised, or when the stock acquired on the exercise of the option is subsequently sold. Employees may be charged either to income tax or to capital gains tax on their stock option compensation. Finally, the cost of stock option compensation to the company may or may not be tax-deductible. A country's tax regime may offer favorable tax treatment to stock option schemes that have particular features. In such cases, the provisions of the tax regime may shape the option scheme that companies use. Stock option compensation may also be used because of the way it is accounted for in company financial statements. The accounting treatment of stock options was seen in the past to be advantageous when stock options were recorded at their intrinsic value at the time of grant. As options are usually granted with an exercise price equal to the fair value of the stock on the date of grant, the intrinsic value of the option is zero. This

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Business Performance Excellence meant that there was no charge against income. However, both international and US accounting standards now require companies to charge the fair value of stock options, as measured at the time of grant, against income. Case Study

BG Group plc1 BG Group plc is a UK-listed company engaged in the discovery, extraction, transmission, distribution, and supply of natural gas. BG has about 5,000 employees, more than 60% of whom are located outside the United Kingdom. The company operates two stock option schemes, a company share option scheme (CSOS) and a sharesave scheme. The CSOS is open to UK and overseas employees above a certain grade. The number of CSOS options granted to individuals depends on their past performance and their expected contribution to the company. The CSOS scheme aims to “drive real earnings growth over the long term.” Options granted under this scheme, which have an exercise price equal to the fair value of the company’s shares at the time of grant, have a vesting period of three years, and vested options may be exercised at any time until the tenth anniversary of the grant. Options vest to the extent that there has been real growth in earnings per share (EPS) over the vesting period. All the options will vest if EPS growth over the vesting period is at least 30% more than growth in the retail prices index (excluding mortgage payments) (RPIX), and half the options will vest if EPS growth is at least 15% more than RPIX growth. The sharesave scheme, which is approved by the UK tax authority, allows eligible employees to acquire shares in the company using the proceeds of a tax-exempt monthly savings plan. BG Group uses the scheme as a way of encouraging share ownership in the company.

Summary and Further Steps

Conclusion The structure of employee stock options facilitates their use by companies to attract, retain, and motivate employees and executives. In particular, the vesting provisions provide incentives for employees to remain with the company. Employee stock options may have a role in aligning employees’ and executives’ interests with those of stockholders. Performance conditions attached to the vesting of some stock options may also align the objectives of employees with those of the company. The structure of stock options may be shaped to take advantage of tax and/or accounting rules.

Making It Happen The decision to establish stock options schemes usually rests with the board of directors, and it may require stockholder approval. In designing a scheme it is necessary to consider:

8 Why the company wants an employee stock option scheme. 8 Which employees should be included within the scheme. 88

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Employee Stock Options 8 The characteristics of the stock options. This includes consideration of the exercise price, the vesting period (if any), vesting conditions, the forfeiting of vested options if the employee leaves the company, and the life of the option. 8 The tax and accounting implications of the scheme.

More Info Book: Wheeler, Peter R. Stock Options and Grants: The Executive’s Guide to Equity Compensation. Sunnyvale, CA: AdvisorPress, 2004. Article: Hall, Brian J. “Six challenges in designing equity-based pay.” Journal of Applied Corporate Finance 15:3 (Spring 2003): 21–33. Online at: dx.doi.org/10.1111/j.1745-6622.2003.tb00458.x Website: National Center for Employee Ownership (NCEO; US): www.nceo.org

Notes 1. Information from BG Group plc Annual Report 2007.

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Customer Product Rationalization (CPR) for Ailing Businesses by Jeffrey T. Luftig and Steven M. Ouellette Lockheed Martin Engineering Management Program, College of Engineering and Applied Science, University of Colorado, Boulder, USA

This Chapter Covers 8  The customer product/process rationalization (CPR) model—a tool for profit optimization. 8  The total asset utilization (TAU) model. 8  Average (standard) vs allocated cost accounting. 8  Calculating actual vs apparent profitability. 8  Product/process rationalization. 8  Understanding potential market opportunities. 8  Ramifications, implications, and cautions related to the CPR model.

Introduction

Every organization knows that some of its products or services, and perhaps even some customers, lose money with every sale. The problem, of course, is in figuring out which they are. There is a complex interplay between production or service provision rates, differential revenue, and costs, which all needs to be accounted for in order to make rational decisions about the product and service portfolio and customers selected. This is further hindered by antiquated average cost accounting methods which obscure true profitability and the lack of connection between profitability and production trade-offs. Accordingly, most businesses make decisions to simply increase revenue while acknowledging, but rarely cost justifying, loss leaders. In this chapter, we propose a method to combine true profitability and production trade-offs to make the identification of current profitability sinks easy to identify, giving managers the ability to make data-based management decisions to maximize profit given market constraints.

Scenario

You are considering resigning your job as a high-powered (and highly paid) vice-president of a major corporation. You have risen about as far as you can expect in that company, and you have an opportunity to trade your current level of job security for the opportunity to become a CEO and run a corporation by accepting an offer from the board of directors of an existing, but troubled, manufacturing business. This organization has existed for quite some time, but recently, while revenue has increased, profit has not. Benchmarked against its competitors, this company’s profitability is in the lowest quartile of its group. Could you be the one to turn things around? Is there a tool to help you to use the company’s own data to do so? Indeed, is there a tool which might help to identify

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Business Performance Excellence companies that have great potential but are currently performing at a lower level of profitability than they should? In this chapter we are going to present such a tool, termed “customer product/ process rationalization” (CPR). This offers a way to not only resuscitate a failing or underperforming business, but indeed to assist organizations to move, as Jim Collins (2001) would state, from “good to great” through the optimization of profitability.

CPR: A Tool for Profit Optimization

The CPR model is the result of the merger of three contributory models: the total asset utilization (TAU) model; an allocated cost accounting (ACA) model (although an activity-based cost accounting model will work equally well); and a strategic product/ market capability analysis model (which most firms of any significant size will already possess). CPR is useful when a company has multiple customers, processes, and/or products which may contribute differently to the profitability of the corporation. It should be noted, as will be discussed in a later section, that the differentiation in profit contribution may not be apparent to management if an average or standard cost accounting system is being employed. However, those differences will surely exist, and this model will reveal them. The CPR model provides a technique for modeling profit differences using real data, and subsequently allows management to plan and achieve a profit-optimized customer, product, and process portfolio in the presence of growth. The model will also provide key information that can be used to drive future strategic improvements.

The Total Asset Utilization (TAU) Model

Your first step in building a CPR model and its associated database is to create a TAU model for your firm. The purpose of the TAU model is to help understand the effectiveness of how your processes use time to produce salable products and/or services.1 The model may be deployed in a manufacturing environment for a single machine, a single production center, multiple centers or lines, or for an entire facility or company. Similar applications are possible for services-based organizations. A considerable modification of the well-known total productive maintenance (TPM) approach, the TAU model has unique characteristics that allow it to be used in building our CPR model. In fact, without the use of the data generated by TAU, CPR cannot be accomplished. A TAU model consists of four ratios, two based on time and two based on numbers of units produced, which are then employed in a multiplicative expression. World-class firms operate at a TAU level of 85%, or at the 85th percentile of their sector or technology. The four components of the TAU model are Availability (AV), Duty Cycle (DC), Efficiency (Eff), and Yield (Y) and are described in the following sections.

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Customer Product Rationalization for Ailing Businesses A TAU model consists of four ratios, two based on time and two based on numbers of units produced, which are then employed in a multiplicative expression.

Availability

Availability refers to the proportion of time that a process is actually available to run versus the total amount of time. Availability is sometimes referred to as “uptime” or “run” time. It is not the amount of time that the process is actually generating products or services. The “total” in “total asset utilization” refers to the base time period to be employed for indexing Availability. This value should reflect the total possible time for which our process could have run—basically, 24 hours a day, seven days a week, 365 days a year. For our illustrative scenario, let us index against a full work day, which has three eight-hour shifts, which we run seven days per week, or 43,200 minutes per month. To calculate Availability, we simply subtract from the total available time those time periods that the process was not available to run, and then divide by the total time. The process might not have been available for a number of reasons, of course. For example, the process might not have been in operation due to planned or unplanned maintenance (PM or UM); an absence of orders (NO); no raw materials on hand (NM); a simple choice not to run the process (CNR); or perhaps due to missing personnel or breaks. Not all of these sources of downtime will apply to all firms and applications. Also, notice how breaking Availability into its components in this way highlights that a number of different process owners control run time, not just maintenance. The actual formula that considers these possible sources of downtime would appear as: Availability =

Total time – (PM + UM + NO + NM + CNR) Run time = Total time Total time

Duty Cycle

The Duty Cycle component is important enough to be broken out as a separate item. Although often considered as simply another component associated with downtime in the Availability component, such as unplanned maintenance or breaks, it is absolutely essential that the Duty Cycle component of the model stand on its own. The primary reason for this assertion is that the process owners of losses associated with this component (sales and marketing) are completely different than those process owners responsible for losses in the Availability portion of the model. This is why throughput improvement initiatives often fail in business and industry when the root causes of those losses are due to deficiencies related to the Duty Cycle component. This is because the responsibility for improvement is assigned to operations or maintenance personnel, when in fact the primary responsibility for improving throughput (number of units generated) is actually in the hands of those who determine the firm’s portfolio, or what will be sold. Duty Cycle is the proportion of the run time or uptime, after losses due to Availability, during which the process is actually generating products or services. The two sources of lost time associated with Duty Cycle relate to (1) getting a process up and running

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Business Performance Excellence (set-up time) and (2) the time loss incurred by less significant pauses to the process when, for example, switching from one package to another, but not for changing the set-up from one product to another. These losses, which are relatively lower in their comparative significance, are collectively referred to as losses due to changeover time. The Duty Cycle component is calculated as: Duty cycle =

Run time – Set-up and Changeover time Run time

Multiplying Total Time by the Availability index, and subsequently by the Duty Cycle index, we now have the amount of time during the study period that the process was actually producing products or services.

Efficiency

Now that we have accounted for all of the time that the process was producing a product or service, we need to account for how well we are using the production time that we do have. This Efficiency ratio considers our actual production rate versus the theoretical maximum production rate. For CPR purposes there is an additional critical consideration; this rate must be in “units we get paid for” and not in engineering terms, such as “number of strokes per minute.” This will allow us to employ the Efficiency ratio later in the CPR process to account for trade-offs between, say, two different products with different profitability and different production rates. Efficiency =

Actual production rate Theoretical maximum production rate

Yield

The final component of the TAU model accounts for the fact that most processes do not produce products or services that are totally free of defects or defective units. Yield is the proportion of salable (“good”) units to the total units produced for the period in question and is calculated as: Yield =

Number of good units produced Total number of units produced

In order to calculate the final TAU index, we simply multiply the values of the model’s four components: TAU = Availability × Duty cycle × Efficiency × Yield

Linking TAU to a Metric of Interest

The TAU index accurately shows how well a process creates salable units, but it does not by itself show or imply what to do about it. For example, there may be a product that nets $100 of profit per unit but has a terrible TAU index, and another product that has a high TAU index but loses $0.25 per unit sold. As a result, maximizing TAU is oftentimes not the best business decision. However, TAU does provide the basis to

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Customer Product Rationalization for Ailing Businesses model productivity trade-offs in order to optimize profit. Additionally, TAU may or may not correlate with a metric of interest, such as “throughput” (the number of units produced per unit of time), so simple or multiple regression may be needed to identify the components of TAU that relate back to the metric of interest (throughput for the TAU model, profitability for the CPR model). For our scenario and for purposes of brevity, let us assume that the TAU analyses have already been performed (see Table 1) and that they have resulted in the following conclusions. 8 All the customers are equivalent—they purchase about the same mix of our products at about the same price. There is, therefore, no customer-based differential cost allocation for our illustrative firm—they all demand about the same amount of time and resources to serve. As a result, we will ignore minor customer differences at this time. 8 The four products evaluated have quite different TAU and component values for the time period studied; these are given in Table 1. 8 A multiple regression of the individual components of the TAU model as independent variables against the period throughput values (gross, not net) for the different products reveals that although gross throughput can in fact be predicted from the model components, each of the products has a different prediction equation (Table 2). Table 1. Average TAU values Product 1

Product 2

Product 3

Product 4

Availability

0.8504

0.7536

0.9220

0.5522

Duty cycle

0.6834

0.6252

0.5048

0.9694

Efficiency

0.4834

0.6620

0.8542

0.9520

Yield

0.8498

0.9532

0.8026

0.9736

TAU

0.2387

0.2973

0.3191

0.4962

Table 2. Regression results for total asset utilization components by product Product 1

Product 2

Product 3

Product 4

Constant

143,697

210,366

101,160

178,556

Availability

210,364

n.a.

562,093

211,252

Duty cycle

n.a.

100,118

554,851

n.a.

136,962

524,122

112,153

n.a.

n.a.

256,454

458,877

125,212

Efficiency Yield

n.a.: not applicable (statistically insignificant)

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Business Performance Excellence The values shown in Table 2 relate to the partial regression coefficients for each TAU component in the prediction equation, by product. The general equation for a product would be: Throughput = Constant + BAV × Availability + BDC × Duty Cycle + BEff × Efficiency + BY × Yield

where “Throughput” is a prediction for the average number of units per month produced (both good and bad) if we only ran that product, and BX the factor for the X component from Table 2 for a given product. Note, however, that not all of the components of the TAU model actually impact throughput for all of our products. When “n.a.” appears in Table 2, it is because that particular TAU component was not a statistically significant contributor to throughput for that particular product. Also, note that even when a particular component is significant in predicting throughput for two products (e.g. Availability as related to Products 1 and 3), the partial regression coefficients are not identical. So, if we were to make only Product 1 at our historical TAU levels (not that we would necessarily choose to do so), we would expect to generate an average of: 143,697 + 210,364 × 0.8504 + 136,962 × 0.4834 = 388,798 units per month

However, while that is the total number of units that would be produced, on average from month to month, given the Yield for Product 1 of 0.8498, we could only sell an average of 388,798 × 0.8498 = 330,400 units per month. Note that this calculation must still be executed, even though Yield was not statistically significant in the prediction of gross unit production levels. One might be tempted at this point to look at the TAU components for opportunities to improve throughput, but we are missing one very important bit of data—the actual profitability of each product, which we must obtain from our ACA system. Perhaps the assumption about essentially equal profitability per unit is flawed. If that were the case, we might maximize throughput but actually reduce profitability. But in order to do that, we need to understand the weakness of standard cost accounting.

Average (Standard) vs Allocated Cost Accounting

As you are designing and installing a TAU model, you want to gather data on the true, rather than apparent, profitability within the company. You have found that the company uses a simple average (often referred to as a “standard”) cost accounting system, where all costs are divided equally among all customers and products. Average costing hides the true costs (and therefore true profitability) of customers and products alike, leaving management with an assessment of apparent profitability and a likelihood of making misguided decisions. Should you find that your firm is using this accounting method, one of your first steps will be to institute a rational cost accounting system.2

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Customer Product Rationalization for Ailing Businesses It has been the authors’ experience that while many proponents of the use of activitybased cost accounting (ABC) contend that this is an ideal toward which one might strive, it turns out that most of the benefit generated by an ABC system can be captured by implementing an allocated cost accounting (ACA) system that tracks costs stratified by product, customer, and production line, while avoiding the additional costs required by a complete ABC system. For our scenario, let us simplify the illustration of our model by assuming that we are operating a single production line, so that our costs are stratified only by customer and product. Average cost accounting has unfortunately led to the assumption at this company that all products manufactured and all customers served generate the same level of profitability. As a result, the sales force has sold whatever products it can, to every and any customer, under the illusion that by maximizing revenue it will be maximizing profit for the firm. Suppose that last year’s portfolio of products appeared as shown in Table 3. Since our theoretical firm is using an average cost accounting system, nothing is known about the true contribution to profit for each product. We do, however, know from the overall financial data that the firm’s total profit, which was an average of $1,177,648.25 each month. Therefore, each unit sold produces on average a profit of $2.21 for our firm. Table 3. Historical volume of products per month Product

Units produced

Units sold

Proportion of product mix as sold

Revenue per unit

Total revenue

1

150,000

127,470

23.96%

$20

$2,549,400.00

2

200,000

190,640

35.83%

$10

$1,906,400.00

3

115,000

92,299

17.35%

$7

$646,093.00

4

125,000

121,700

22.87%

$15

$1,825,500.00

Total

590,000

532,109

100.00%

—

$6,927,393.00

Calculating Actual vs Apparent Profitability

Now that the ACA and TAU models have been concurrently implemented, you are about to obtain data from the two new systems. By tracking overhead, maintenance, machine time, and numerous other costs and properly allocating them to the different products (recall that we are assuming that, for the purposes of this simplistic example, all customers are equivalent and you have only one production line), your accounting department can calculate per-unit costs and subtract them from the per-unit revenue to find, for the first time at this business, the true profitability of its products. Today you received the data set out in Table 4.

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Business Performance Excellence Table 4. True profitability by product Product

Revenue per unit

True profit per unit sold

1

$20

$1.25

2

$10

$3.30

3

$7

$1.25

4

$15

$2.25

This information was quite a surprise to everyone involved. Using average cost accounting has for years hidden from the company the fact that there are real and significant differences in the profitability of the four products. Now it is clear how driving up revenues (for example, by selling more of Product 1) could actually reduce profits, since it comes at the expense of the potential profitability of Products 2 and 4, as you can see in Table 4. However, this illustration highlights a limitation of allocated costs and even of activitybased costing if used in isolation. A natural response to the data in Table 4 might be “Let’s sell more of Product 2!” But what if Product 2 requires 10 minutes to make one unit, as compared to Product 3, of which you can make 10 per minute? The goal should be higher dollar profit per minute of total time, not just profit per unit. Only by combining the business’s overall ability to manufacture the product units in time (using the TAU model data and the subsequent throughput regression analyses) and the actual profit per unit from the ACA model will we be able to maximize profits. Using our current understanding, we can now show in Table 5 how the true potential profitability breaks out for each product (note that the units sold column contains yield-corrected data). Table 5. Itemized average monthly profitability (current state) Product

Units produced

Units sold*

Revenue per unit

Total revenue

True profit per unit sold

Average profit

1

150,000

127,470

$20

$2,549,400.00

$1.25

$159,337.50

2

200,000

190,640

$10

$1,906,400.00

$3.30

$629,112.00

3

115,000

92,299

$7

$646,093.00

$1.25

$115,373.75

4

125,000

121,700

$15

$1,825,500.00

$2.25

$273,825.00

Total

590,000

532,109

$6,927,393.00

$1,177,648.25

* Yield-corrected data.

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Customer Product Rationalization for Ailing Businesses Market Penetration

It would be nice to simply manufacture and sell the one product that will generate the most profit during the production time you have available, but you suspect that it won’t be that easy. The market you are in is not an infinite one, and you don’t have a huge marketing budget. You call a meeting with marketing and sales personnel to determine what the market potential is for the four products you produce. Given their budget, how much of the current market is available to you? Table 6. Analysis of potential market for the firm’s four products Product

Total monthly market demand

Estimated proportion of market demand that can be captured by your firm

Total number of units that can be sold by your firm

1

1,000,000

15%

150,000

2

900,000

23%

207,000

3

800,000

40%

320,000

4

900,000

20%

180,000

Table 6 shows the limit of the current demand that the marketing department thinks it can capture without price changes. This has never really been a question it has had to answer before, since it has always been assumed that all of the products contributed equally to profit. Now that we know better, we must move away from the “sell whatever we can” paradigm and focus on selling those products that make us the most profit per unit time. As an aside, giving the marketing department numerical goals by which to measure its success can only be beneficial for the company. We are now ready to conduct the CPR analysis.

Product/Process Rationalization

You now possess all of the constituent data required to optimize the profit generated from the products you sell given the market constraints as they currently exist. The first step is to estimate the production rates for the products we generate as things stand today. These values may originate from a historical database, or from throughput values recorded during the TAU implementation study period. The regression equations built from Table 2 will allow us to estimate how many units can be made (on average) if we run at our historical average TAU values (Table 1) for each product, if we run only that product. Then all we need to do is divide the predicted value by the time frame we used in creating our regression equation—in this example, 43,200 minutes. The results are given in Table 7. Again, keep in mind that this production rate is the total number of units produced (good and bad) and will need to be adjusted for yield loss in subsequent calculations.

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Business Performance Excellence Table 7. Predicted current production rates per month and per minute Product

Maximum capability (units per month)

Production rate (units per minute)

1

388,797.98

9.00

2

864,380.49

20.01

3

1,363,594.30

31.56

4

417,115.76

9.66

Using these numbers, we can estimate the monthly average profit we could generate if the company chose to exclusively run (and was able to sell) each of the products in its current portfolio, adjusted for yield loss. That allows us to rank the products by their potential contribution to profit. This is done in Table 8. Table 8. Profit per product if product is run exclusively for a month Product

Revenue Maximum Product per unit capability maximum (units per capacity × month) Revenue × Yield

True profit per unit

Product maximum capacity × True profit

Product rank

1

$20

388,797.98 $6,608,010.41

$1.25

$413,000.65

4

2

$10

864,380.49 $8,239,274.83

$3.30 $2,852,455.62 $2,718,960.70

1

$7 1,363,594.30 $7,660,945.52

$1.25 $1,704,492.88 $1,368,025.99

2

$2.25

3

3 4

$15

417,115.76 $6,091,558.52

$485,997.47

Profit after yield adjustment

$938,510.45

$913,733.78

Table 8 highlights some interesting findings. Product 3 is second after Product 2 in potential profit, but the higher yield loss of Product 3 drops it down further. How did Product 3, one of our two lowest profit-per-unit products, end up being the second most profitable after Product 2, which is more profitable per unit than Product 3 by more than two times? As is clear from the maximum capability column, while Product 3 doesn’t make a lot of money per unit, we can make a lot more of Product 3 per unit of time. Table 8 should make clear: 8 Why selling more of the highest-revenue units does not mean you will make more profit (here it is the worst scenario). It isn’t even the highest-revenue option due to its low TAU numbers, primarily due to losses associated with Efficiency. 8 Why we had to use “units we get paid for” in the Efficiency calculations. 8 That true per-unit profit from ABC or even allocated cost accounting is insufficient by itself to allow us to maximize profitability. 8 How maximizing total potential revenue would mislead us into selling more of Product 1, and as a result we would actually earn less profit as our revenues increased.

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Customer Product Rationalization for Ailing Businesses Unfortunately, the entire market does not consume 864,000 units of Product 2 per month total, and we believe we can only capture part of that anyway (as shown in Table 6). In order to find the optimal product mix, we make as much of Product 2 as possible, followed by Product 3, and so on until we run out of production time. We again have to take into account the fact that the company needs to manufacture more units than it sells to allow for the yield losses. That larger number dictates the average number of minutes of production consumed, as calculated in Table 7. The actual number of units sold after yield loss gives us the actual profit for each product, which in turn adds up to our optimized monthly profit (Table 9). Table 9. Optimum product mix Units sold Minutes Units Product Max unit Production Minutes Planned needed minutes of remaining produced (truncated) for max sales (rounded) for max production possible sales (rounded) sales

Planned profit after yield adjustment

2

207,000

217,163 10,853.37

10,853.37

32,346.63

217,163

206,999

$683,096.70

3

320,000

398,704 12,631.33

12,631.33

19,715.30

398,704

319,999

$399,998.75

4

180,000

184,881 19,147.82

19,147.82

567.47

184,881

180,000

$405,000.00

1

150,000

176,512 19,612.55

567.47

0.00

5,107

4,339

$5,423.75

43,200.00

0

805,855

Total

—

—

—

711,337 $1,493,519.20

Note that if the company could have sold just a few more units of Products 2, 3, or 4 it would have had no time left to make Product 1 at all. Due to the change in the product mix, the average profit per unit actually goes down from $2.21 per unit sold to $2.10 per unit sold, but since the number of units sold increases from 532,109 to 805,855, the total profit generated by the firm will increase. This is another reason why the data generated by average cost accounting systems will not allow a firm to maximize profitability without the concurrent use of the TAU model. Finally, how does the optimized product mix’s profitability compare to the company’s historical profitability? The comparison is made in Table 10. Astonishingly, the company captures a 26.82% increase in profits per month by changing nothing but the product mix. Again, it is worthwhile to point out that the potential to increase the profit was there all along, but hidden because the firm was using an average cost accounting system and was not employing any form of a TAU model. Table 10. Effect of CPR on monthly profitability Increase in production (units)

Increase in sales (units)

215,855.00

179,228.00

Increase in profit ($) 315,870.95

Increase in profit (%) 26.82

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Business Performance Excellence In addition to increasing our profit, we have moderately increased our total revenue even as we reduced our highest revenue per unit product (Table 11). This is not always the case with CPR—often the initial increase in profits is accompanied by a drop in revenue as high-revenue but low-profit products or customers are purged from the process. Table 11. Effect of CPR on revenues by product Product

Revenue per unit

Units sold (truncated)

Monthly revenue

2

$10.00

206,999

$2,069,990.00

3

$7.00

319,999

$2,239,993.00

4

$15.00

180,000

$2,700,000.00

1

$20.00

4,339

$86,780.00

—

711,337

$7,096,763

Totals

These are planning numbers—real markets tend to be more dynamic. Sales is given a ranked order of products to sell and rewarded for the “richness of product mix” rather than revenue, or (worse) concentrating on the simple number of units (products) sold.

Ramifications, Implications, and Cautions Related to the CPR Model

In the illustrative analysis we have presented the current product mix was optimized to achieve a 27% improvement in profit. The company did not downsize or spend money on new capital projects to capture this improvement in the bottom line. In the authors’ experience, implementing CPR at a typical business will result in a profit improvement of somewhere between 15% and 20%, typically without the need for headcount reduction or capital investment. Once CPR is operational, a business can use the model to strategically enhance its profitability even further. For example, a team could be charged with reducing the yield loss for Product 3. With the state of the current market, the business may not be able to sell any more of Product 2, 3, or 4, but if some capacity were freed up, more of Product 1 could be made and sold, which would generate additional profit. Marketing could be given a larger budget to see if the business could capture a higher percentage of the market in Product 2, 3, or 4 (in that order, with Product 1 as minimally profitable filler). Or perhaps dropping the price for Product 2 to less than what competitors are demanding will allow the business to undercut the competition while still making more profit than it does today. Right now the business is not capacity-constrained but market-constrained, so improving process TAU is probably not a high priority, since any additional capacity will just go toward the tepid Product 1. It probably can make more money by investing

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Customer Product Rationalization for Ailing Businesses those resources in the marketing department at this point. However, if marketing is able to generate more demand for Products 2, 3, and 4 than plant capacity allows, the TAU data in Table 1 show that there may be untapped potential capacity, so purchasing new production equipment is unnecessary if we can find ways to better utilize the existing equipment. The CPR model allows these questions to be asked and answered with data, and it becomes a very important input into the strategic planning process. For the purposes of this chapter we have presented a highly simplified example. In reality, most businesses are rather more complex. However, the increased complexity allows the CPR model to shine all the more brightly. Summary and Further Steps A CPR model provides a model from which management decisions can be made, hypotheses tested, and profitability improved based on actual data and process trade-offs. To implement a CPR model:

8 Build a TAU model of the process, indexing off of total time and units you get paid for. 8 Use multiple regression techniques to understand how TAU and its components of availability, duty cycle, efficiency, and yield relate to a metric of interest to the company.

8 Create an allocated cost model (either by simplification or statistical sampling) that properly allocates costs and is stratified by at least three important determinants, for example product, customer, and production line. 8 Combine the true profitability with the TAU model to account for opportunity costs and profit per unit of time. 8 Use this information to generate a new portfolio mix in order to maximize profit generation. 8 Reward Sales and Marketing on profit contribution, not revenue. 8 Going forward, use this information to generate ideas for future process improvements. After implementing CPR in your new business, you are pleased to note a bottom-line profit increase of about 20%. Now your profitability puts you in the top tier performers in your industry. By understanding where your company makes money (and just as importantly, where it does not) you now have many more options on the table. Rather than becoming a corporate hatchet man stuck in never-ending downsizing hoping you can shrink your way to prosperity, you are a hero to the employees with whom you are entrusted, your community that relies on those good jobs, and your family, who might have originally questioned your sanity at giving up that cushy position in the first place. Perhaps now is the time to aggressively expand your market or product line, or maybe to work on projects to improve your own processes. Any way you go, you will have data from your CPR model informing you at each step of the way. You and your company have a bright future ahead.

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Business Performance Excellence More Info Book: Collins, Jim. Good to Great: Why Some Companies Make the Leap... and Others Don't. London: Random House Business, 2001. Articles: Luftig, Jeffrey T. “Total asset utilization.” Measuring Business Excellence 3:1 (1999a): 20–25. Online at: dx.doi.org/10.1108/eb025561 Luftig, Jeffrey T. “Customer/product rationalization: CPR for profitability.” Measuring Business Excellence 3:2 (1999b): 4–8. Online at: dx.doi.org/10.1108/eb038871 Websites: Jim Collins: www.jimcollins.com Simple article on TAU/CPR: tinyurl.com/86qu4vh

Notes 1. For an extensive explanation and treatment of this model, see Luftig (1999a). 2. For additional information on this topic, see Luftig (1999b).

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Reducing Costs through Change Management by Beverly Goldberg The Century Foundation, New York, USA

This Chapter Covers 8  When senior management decides to move a business in new directions or adopt new methods, processes, and/or technologies in order to remain competitive, it must work to prepare its employees for the changes that will take place as a result. 8  Making formal change management programs a part of the process of change from its inception is necessary to ease employees’ uncertainty and anxiety about the effects of the coming changes to their jobs. This can create resistance to change, slowing or even derailing the adoption of what is new. 8  The board and CEO must make it clear to everyone in the company that they fully support the planned changes, explaining the danger that the business will face if it does not change. 8  The CFO must ensure that change management programs are part of the financial planning for every new process and/or technology that a business intends to adopt, which requires recognizing the time change management programs take and the personnel needed to implement such programs, including staff from various departments such as public relations and human resources as well as outside consultants.

Introduction

Today, globalization, technological advances, scientific developments, and new business theories and processes are forcing businesses to make changes over and over again, often introducing yet another change before the last round undertaken has been implemented. The changes that must be made to ensure success in so highly charged a business environment requires changes in the work that people do, the way they do it, the environment they work in, and/or the skill sets they have. Unfortunately, change often meets resistance because it threatens the security and comfort of employees at all levels and in all areas of the business. Senior management must take responsibility for seeing to it that this natural resistance to change is planned for and that programs are put in place to overcome it before it can delay or even derail the new direction the business is taking. Change management may be described as a process for opening an enterprise’s culture to new ways, gaining individual employee buy-in, and training employees to be a part of the new and better enterprise. If management fails to anticipate the need for change management, projects will inevitably cost more than anticipated—or fail. The CFO is responsible for making certain that plans for managing change and the costs of doing so are included in proposed budgets for implementing new processes and new technologies. By reducing resistance to what is new from the start, costly delays in implementation can be avoided and projects are far more likely to be finished on time and on budget.

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Business Performance Excellence Change Management Has Changed

TIn the past, change management theory involved three stages:1 8 first, unfreezing the current culture by making people understand that there would be a new way of doing things and that management was behind the change and would brook no arguments about it; 8 second, introducing what was new and providing training and education to open employees to the new processes and/or technologies; 8 third, refreezing the culture once the change was made. Now that change seems to come about every twenty days rather than every twenty years, a different approach is necessary. Although the first step in successfully implementing change remains explaining to employees that the organization is changing and senior management wholeheartedly endorses and supports the changes being made, it also requires: 8 providing people with information about the new ways of doing things; 8 convincing them of the validity of the new approach; 8 showing them the personal as well as corporate benefits that the change will bring. The second stage begins when employees are brought to understand that in order to gain a competitive advantage or keep abreast of competitors, the company has to adopt new processes and new technologies. They also are shown that if they do not learn new ways to work, they will join the ranks of the unskilled. Putting those two facts together, they are helped to realize that if the company they work for suffers because it cannot produce as quickly and inexpensively as its competitors, they will be in the uncomfortable position of seeking employment without having the skill sets that are becoming the standard in their industry. Then, breaking with the classic idea of refreezing the culture as a final stage, the culture is moved to a dynamic stage where people become comfortable with the new machines, processes, and/or technologies but await—and even anticipate—the next changes that will be made. In other words, openness to change and anticipating change become the organizational mindset, thus lowering the costs and time involved in subsequent changes.

Communication: The Key to Change Management Success

Successful change management programs involve intensive communication efforts. Internal company media are used to present the determination of senior management to make the changes and explain its reasons for doing so in terms of long-term profitability. Frequent meetings are used to: 8 discuss similar moves being made by competitors; 8 explain the training that will be provided; 8 convey to employees their roles in the newly shaped organization.

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Reducing Costs through Change Management By helping employees understand what is happening early on, frequent communications prevent the anxiety created by rumor and speculation that may lead a company’s most valuable employees to leave, exactly the ones who are likely to learn the new system or process most easily. By communicating the news that change is taking place, explaining the nature of the process, assuring employees that training in the new skills will be available, and that those skills are leading edge, potential problems can be eliminated. Effective communication efforts can:2 1. Stop rumors from creating turmoil by easing anxiety and quelling speculation, both of which reduce productivity and create groups determined to band together to foil change. 2. Make employees aware of what is happening in the outside world so that they understand that the company will become less competitive unless the planned changes are made. 3. Help employees to understand what will be going on, making it easier for them to adjust to the requirement of the new reality. 4. Convey management’s commitment to the planned change by explaining that what is going to happen is part of the business’s new mission, perhaps in the form of a specific mission statement for the team most involved in the change (the mission statement should be presented as equivalent to a constitution that can neither be overthrown nor rewritten). 5. Assure employees that training will be available when they need it and explain that such training reflects the organization’s commitment to continuous learning. 6. Achieve buy-in at all levels of the organization, which is critical because experience shows that top-level acceptance of change is not enough. 7. Develop change agents from those employees who demonstrate an eagerness to try new things. (When embarking on a specific change, be certain to select at least a few such employees to take part, even if they may not have been your first choice based on seniority or skill sets.) 8.  Break down the barriers between employees. Cross-functional relationships are necessary to realize the benefits of the new technologies and processes, because these usually require employees from different functional areas to work together. 9.  Ensure that the change management program builds flexibility into the organization’s culture by continually reminding everyone, once the change has been made, of the successes achieved and keeping them abreast of other changes on the horizon in their industry.

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Business Performance Excellence Case Study

A Major US University Press A major university press in the United States renowned for its books on art also publishes many scholarly books in other fields. It has long been known for the beautiful interior design and covers of all its books, even those on arcane subjects that were projected to sell as few as 600 copies. Because of recent budget constraints imposed as a result of cuts in financial support from the university, the head of the press decided that books that were not about art or that did not involve numerous illustrations (such as books about philosophy) would in the future be produced by desktop typesetting in order to reduce costs. Knowing that this decision would be resisted by many of the press’s long-term employees, he brought in a change management team to help ease the transition to the more cost-effective system. The change management team began by having the director of the press and the CFO meet with senior managers to explain the need for budget cuts and the scope of the financial losses incurred by many of the books they published. The presentation to the managers included projections of how many fewer books they would be able to publish in the future if the current production methods were not changed. The managers realized that publishing fewer titles would result in a need for fewer employees. Included in the materials distributed at the meeting were some books produced on desktop systems and a set of job listings posted by other publishers showing that experience in desktop publishing was becoming a part of the requirements for design and production jobs. At the end of the meeting, the managers were encouraged to tell those on their staff who were likely to be most resistant to the planned change what they had learned. A few days later, those employees who had been forewarned (who were among the most talented and experienced) took part in a meeting that gave them the opportunity to discuss their concerns and helped them see that the appearance of those books of value primarily to small groups of scholars was of less importance than making them available. The goal was, at the very least, to prevent this group of employees from banding together to try to influence others against the new system. An organization-wide assembly was then held to announce the change to desktop typesetting and design and to present the opportunity for anyone interested in learning the new systems to volunteer for a pilot project. When two senior designers indicated their interest, a number of younger employees joined them in volunteering. The senior designers soon became change agents for the project. The pilot project was set up in a central room that almost everyone in the organization walked by at some point during the day. People were encouraged by the trainers to come in and watch, creating interest in and comfort with the desktop system. Showing the ease with which those in the pilot project were adapting was critical because the next change, which was already in the planning stage, was to speed production and further cut costs by moving away from editing texts on paper to online editing. The openness of the process and the influence of the change agents eased the transition. (Although some very senior designers left, those who remained were able to take on the design of more art books because they no longer worked on other titles; the result was that the inevitable staff reduction was relatively painless.) The following year the press produced the usual number of titles, almost within the parameters of the new budget, and the change in the editing process—aimed at bringing costs down to where they needed to be—was launched.

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Reducing Costs through Change Management Summary and Further Steps

Conclusion Most people are comfortable with the way things are and tend to resist change because they fear the unknown. As a result, when businesses decide to adopt new methods, processes, and/or technologies, a variety of problems tend to emerge, ranging from rumors of staff cuts that result in the loss of the best employees to other organizations, to employees who fail to engage fully in or try to sabotage training programs slowing the implementation of the change. Unfortunately, management too often fails to anticipate these problems until the change they are trying to make runs into some of these obstacles to success. At that point, a decision is made to set up formal change management programs. The costs of those programs—in addition to the costs in time and money that result from the delays because of resistance—can create enormous budget overruns. That is why, when evaluating the proposed budgets of programs that will bring change, CFOs must raise the issue of the need for change management from the outset, the point at which such programs will be most effective in lowering the total costs of a project.

Making It Happen If new methods, processes, and/or technologies are needed, the importance of the planned changes and the organization’s commitment to them must be made clear to employees at all levels by senior management, especially the board and CEO. The CFO’s role includes assessing and then explaining the financial benefits of the changes, making certain that the costs of change management programs as well as training are included in the costs of what is being planned, and, when it comes to new technologies, he or she may be responsible for the change management programs needed to overcome the tendency of people to resist change, which can slow implementation. Such change management programs must:

8 Relate the proposed change to strategic business objectives to ensure buy-in and support for the new initiative.

8 Communicate evidence that direct competitors are implementing such changes and present examples from other industrial sectors that have made gains from making similar changes. 8 Present strong financial data showing the benefits of the proposed change to the organization in terms of increased efficiency and lower costs and/or more sales or increased revenue. 8 Explain what is likely to happen to employees as a result of the changes; for example, there will be a reduction in the number of employees, but it will be less than the number of cuts that would take place if competitors who make the changes win a certain percentage of customers. 8 Provide early evidence, even if only projections, of the benefits of the change being made, so that the importance of change becomes clear and gains increasing support as it proceeds.

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Business Performance Excellence More Info Books: Hughes, Mark. Change Management. London: Chartered Institute of Personnel and Development, 2006. Jellison, Jerald M. Managing the Dynamics of Change: The Fastest Path to Creating an Engaged and Productive Workplace. New York: McGraw-Hill, 2006. Kotter, John. Leading Change. Boston, MA: Harvard Business School Press, 1996. Website: Change Management Learning Center: www.change-management.com

Notes 1. S  chein, Edgar. Organizational Culture and Leadership. 3rd ed. San Francisco, CA: Jossey-Bass, 2004. 2. G  oldberg, Beverly, and John Sifonis. Dynamic Planning: The Art of Managing Beyond Tomorrow. New York: Oxford University Press, 1994.

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Reducing Costs and Improving Efficiency by Outsourcing and Selecting Suppliers by Paul Davies Onshore Offshore Ltd, Goring, UK

This Chapter Covers 8  Start outsourcing by constructing the exit clause; this will tell you and your outsource partner what you are focused on and will save you time and expense if things go wrong. 8  Focus on the downsides first and understand the management changes required, the communication strategy, the training needs, and your regular engagement with the outsourcer. 8  Outsourcing is a process, not an event. What and how you outsource will change over time. 8 Outsource chore and focus on core. Keep value creation for your clients in-house. 8  In general, outsource a process as is. Let your outsource partner reengineer processes. 8 Do not manage your outsource partner; rather, monitor, review, and reassess. 8 Choose a partner, not a supplier—one that you can work with through good and difficult times. 8 The lowest-priced outsourcer will usually be the most expensive in the long term. 8 Outsourcing can not only save money and increase efficiency, but can also rejuvenate your business by refocusing your attention on what makes you great.

Introduction

As a tool for the CFO, outsourcing has an important role to play in reducing costs and improving efficiency. It is important, however, to bear in mind that in addition to the direct and indirect benefits of outsourcing, there are also direct and indirect disadvantages. Outsourcing isn’t the answer on its own, and it has to be part of a holistic analysis to be successful.

Start with the Exit Clause

Without putting a damper on the idea, whenever you contemplate outsourcing always consider how you will exit. This may seem curious, but over the years I have found it to be absolutely essential. If outsourcing does not deliver what you expected, if your strategy changes, if the outsource partner decides on a different business model, or if the whole market turns in a different direction—all of which can happen—you need to be able to regain control of what is often a vital, if not mission-critical, process. In such circumstances, you will need to be able to take it back yourself or pass it to another outsourcing company. Think carefully about this because what you take back won’t be what you outsourced. There may well be new IT systems being used, and certainly the processes won’t be as you left them. If you haven’t an exit agreement, working out who owns the intellectual property underlying the new processes is very difficult and is just one example of the problems that can occur.

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Business Performance Excellence The moment to decide how you want to be able to exit is before it becomes a necessity and, preferably, when you are negotiating the contract. If this sounds obvious, many companies fail to do so and suffer as a result. Understanding your exit strategy will also tell you a great deal about what you want from the outsourcing process. You may be rightly seduced by the idea of not having to spend management time on human resource back-office processing, or by the advantages of not having to worry about expense account processing. If at this same moment you think rationally about what would prompt you to exit from the contract, you will understand most clearly what your business drivers for outsourcing are. If, for example, you put in the exit clause that you have the power to terminate if the proposed savings are not realized, you know what your real objective is. It may be that you insist on a range of triggers and if, for example, you focus on service levels and your end clients’ satisfaction with your overall service, you have the same knowledge about your objectives and, more importantly, so does the outsource provider. In short, brainstorm why you might want to get out of the contract—preferably together with the company that you intend to outsource to—and you will find that not only do you have the comfort of being able to get out of the contract effectively, but that you are also much less likely to have to do so. You will have a much better sense of the advantages and disadvantages of working with your outsourcing partner—and that company will better understand you.

Disadvantages as a Pointer to the Benefits

Let us continue by considering the disadvantages of outsourcing, and, by doing so— paradoxically perhaps—you will better understand what you have to do to be successful. You will discover, despite your efforts to communicate, that your current employees do not fully understand why you are taking the outsourcing route. They will probably be fearful that their roles are next, and this can harm performance. In addition, you will lose the sense of immediate control that you had and, instead of going down to the relevant office, you have to go through a process to achieve something that was very simple. You may find that your outsource partner doesn’t give you the service you thought you were buying and, without proper review processes, correcting this can waste time and effort. You may find that the insights that cross-departmental meetings and discussions bring are no longer informed by the different perspective that the outsourced department brought. Some of the drawbacks will be relatively obvious, but others will come into your perspective just at the wrong moment, such as when you can’t make sense of some information just prior to a board meeting. These disadvantages point out how your approach to outsourcing must be holistic and built on solid communications. One area that nearly always gets less attention than it needs is training. It is a significant extra cost that rarely makes itself known until after the deal is signed off. Typically, you will focus on the training of the staff of the outsourcing company, only to discover that your own people have largely been ignored. There will have been a communication to your existing staff about what is going on, but very little to show them how to get, for example, HR support now that it has been outsourced beyond a telephone number.

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Reducing Costs and Improving Efficiency by Outsourcing Figure 1. Reasons for outsourcing—CFOs’ responses. (Source: Computerworld and InterUnity Group, Inc.) 10%

20%

30%

40%

50%

Reduce/control costs Free up internal resources Gain access to world-class capabilities Increase revenue potential Reduce time to market Increase process efficiencies Follow company philosophy of outsourcing noncore activities Compensate for lack of appropriate skills

To get the best out of the new arrangements, you have to train your staff how to deal with accounts payable now that it is remote. Your managers have to move beyond control and micromanagement into monitoring. That can be very difficult to achieve. You will have noted the focus on communication—and this, as in any serious business reengineering, has to be well thought through and effective. The best way to achieve this is to ensure that there is a feedback mechanism both on the information and the quality of the way it is presented, not to say its timeliness.

Outsourcing Is a Process

Outsourcing is often presented as an event that you get right once. When you find that the service isn’t delivering what you thought you were paying for, you will be grateful that you included in the review mechanisms not just a focus on whether the service level agreement (SLA) has been met, but a real, hard look at the SLA itself. Your review process, including market testing on a periodic basis, is more important and should be given more attention than you may at first imagine. If you have a clear-eyed perspective on the downsides, it will help you appreciate the benefits of outsourcing. If you have outsourced a process to your outsourcing partner, the amount of management time devoted to that process can be reduced—and refocused. You can devote the time you spent agonizing over the process to instead considering the outputs and, more importantly, the outcomes. That is probably the greatest benefit of outsourcing, but you will have to train yourself and your organization to get there.

Core and Chore

Choose carefully what you outsource. Think of core and chore. Ask yourself what the focus of your business is, what gives you competitive edge, and what gives you your unique qualities. Anything fitting that description is core to you—and should only be considered for outsourcing as a last resort. Another way of deciding whether a process or processes can be outsourced is to ask yourself how close the process is to value creation; that is, how essential it is to your relationship

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Business Performance Excellence with your customers. To appreciate the distinction, look at the difference between sales, which is generally very customer-focused and vital to your value proposition, and marketing, which is equally focused on your customers, but at one stage removed from value creation. You may well, for example, already use a marketing agency, which is a form of outsourcing, and you may use a logistics company to fulfill your orders. They both touch your customers, but what they do doesn’t have the immediate effect of a salesperson. That is not to say that sales cannot be outsourced, and I have seen very successful franchise arrangements, again a form of outsourcing. You just have to be pretty sure that the real value in your goods and services isn’t affected by outsourcing sales. There is a strong line of research that says that outsourcing your core business processes can be very detrimental to your business. You should analyze this carefully, with particular attention to concerns such as impacts on customer satisfaction. Chore, on the other hand, includes all processes that make precious little difference to your effectiveness in the marketplace. By outsourcing them to a specialist company you gain from economies of scale, as the outsource company will provide the service to more than one company. To you, saving 30 seconds on processing an expense claim is probably neither here nor there. To an outsourcing company, it can mean the difference between profit and loss, with savings also passed to you. What you will find over time is that you are presented with an incredible, shrinking core. What you initially regarded as a fundamental element in your value proposition can be broken down into smaller processes, and those from which you are not directly gaining value can be outsourced. In the IT world, for example, it is normal for programming to be outsourced. The work of system specification remained inhouse, until it was realized that value creation resides in the business analysis that underpinned the specification. In turn, the business analysis was really only a service, parts of which could be outsourced, as the real value lay in understanding the client and the client’s business model. It should be no surprise, then, that in the IT world major corporations keep only two things in-house: sales and strategy. You may not choose that route for your business—and imagine the exit strategy needed if you ever brought it all back in-house. But part of your internal debate once you have started outsourcing processes has to be focused on what is next, and if there is nothing else that you want to consider outsourcing, why not?

Case Study A property management company wanted to expand, but also wished to minimize disruption and stay in the same offices. Through our discovery phase, we identified that by outsourcing some of the chore—rent collection, invoicing, accounting—not only could they do that and save money, but they could release their experienced staff to address higher-value business opportunities. These included, for example, identifying additional properties, working more closely with their clients, and increasing the range of services.

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Reducing Costs and Improving Efficiency by Outsourcing We achieved these major aims—and reduced the cost per property managed. Over a relatively short period, what was outsourced expanded to include insurance policy processing, legal secretarial work, and, as the property development side of the business came into the picture, land development applications. From the company’s retail interests, the back-office processing of accounts receivable and accounts payable was brought into the contract. The key was the relationship between the property company and the outsourcer—and the trust that was built up—so that either side could suggest further areas for outsourcing. Finally—and this might be an interesting challenge for CFOs—the company’s CFO realized that his function, as currently understood, had almost entirely been taken over. He was faced with a dilemma. His alternative, however, was to take a more strategic role, which was what the company wanted, and he was persuaded to view the role differently and become the strategic planner rather than a deliverer of information.

As Is or Reengineer First?

Consider next the major stumbling block to decisions on outsourcing. Most internal debates, once you are persuaded that outsourcing will achieve cost savings and efficiency gains, focus on whether you should outsource your processes as is, or whether you should reengineer them first. There is no absolutely right answer, but in practice allowing a fresh pair of eyes to reengineer your processes usually produces immediate benefits. Just ensure that the contract allows you to share in your outsourcing partner’s gains! The real message is that you shouldn’t allow such debates to delay any decisions on outsourcing. So the best course usually is to outsource as is. You didn’t reengineer your cleaning or your security before you outsourced them, and yet your outsourcing partner will have done so and provided a better service. Choosing a company with which to outsource your processes is clearly a major decision. You should be looking for a partner. While you may think that outsourcing your cleaning will not require a solid partnership, devoting time to working with your outsourcer—in HR processes, in accounts payable and receivable, in expenses administration, in property management—is essential. If there is one rule about outsourcing, it is that you should not outsource and forget. Outsource and review; outsource and monitor; outsource and work with your outsource provider as a partner, exploring what should be outsourced next, what should come back in-house, and what is needed to be even more successful. If you do that, it becomes obvious that you need to select a company to take on your processes that you can work with as a partner, taking formal time to meet and review regularly. Selecting such a company relies on matching your company’s culture, sharing an explicit set of values, and relying on their integrity and honesty. You need a company that you can say no to and one that you can discuss your exit requirements with when there is no intention of doing anything but signing the contract. This is a challenge to your procurement department—but one that will pay real dividends. The short-term lowest price is always the most expensive route in outsourcing, because a low-price provider will usually be one that hasn’t built in the time required to continually partner with you or find new and better ways to serve you more efficiently.

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Business Performance Excellence Rejuvenation

Outsourcing can, as one of our clients said to us, rejuvenate your business, reduce your costs, and increase your efficiency—and remind you why you are in business. Summary and Further Steps

Making It Happen 8 Understand your exit issues and strategy. 8 Identify core, and only outsource chore. 8 Don’t manage your outsourcer—monitor. 8 Have formal and regular reviews of SLAs as well as assessing performance against them. 8 Don’t outsource and forget. 8 Outsource and create added value. 8 Work in partnership with your outsource supplier. 8 Understand the training requirements in full. 8 Communicate—before, during, and after—with every stakeholder, and evaluate how well your communication strategy is working.

More Info Books: Benn, Ian, and Jill Pearcy. Strategic Outsourcing: Exploiting the Skills of Third Parties. London: Management Consultancies Association, 2002. Halvey, John K., and Barbara Murphy Melby. Business Process Outsourcing: Process, Strategies, and Contracts. 2nd ed. Hoboken, NJ: Wiley, 2007. Reports: Syntel “The keys to successful service level agreements: Effectively meeting enterprise demands.” Online at: tinyurl.com/6wws9m9 [PDF]. Whitaker, Jonathan, Mayuram S. Krishnan, and Claes Fornell. “Does offshoring impact customer satisfaction?” May 2008. Online at: papers.ssrn.com/sol3/papers.cfm?abstract_id=1010457 Websites: National Association of Software and Services Companies, (India): www.nasscom.in National Outsourcing Organisation, (UK): www.noa.co.uk Outsourcing Institute, (US): www.outsourcing.com Wharton Business School has incisive research into outsourcing. Search on “out-sourcing” at: www.wharton.upenn.edu

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Reducing Costs through Production and Supply Chain Management by Vinod Lall School of Business, Minnesota State University, Moorhead, USA

This Chapter Covers 8  There are numerous drivers of production and the supply chain, and there are several processes under each driver. These processes are associated with high overheads and offer opportunities for cost reduction. 8  Cost reduction requires a complete knowledge and mapping of all costs, cycle times, purchases, inventories, suppliers, customers, logistics, and other service providers throughout the supply chain. 8  Cost reduction in the supply chain often requires trade-off analysis amongst conflicting alternatives using the total cost approach. 8 Successfully achieving supply chain cost savings requires the use of crossfunctional teams with representation from marketing, design, procurement, production, distribution, and transportation employing an organized approach.

Introduction

IKEA, the Swedish home products retailer, is known for its good-quality, inexpensive products, which are typically sold at prices 30–50% below those of its competitors. While the price of products from other companies continues to rise over time, IKEA claims that its retail prices have been reduced by a total of 20% over the last four years. At IKEA, the process of cost reduction starts at product conception and continues throughout the process of design, sourcing of materials and components, production, and distribution. For example, the “Bang” mug has been redesigned many times to realize shipping cost savings. Originally, 864 mugs would fit into a pallet. After redesign a pallet held 1,280 mugs, and with a further redesign 2,024 mugs could be squeezed into a pallet, reducing shipping costs by 60%. Organizations today are looking for opportunities to improve operational efficiencies and reduce cost without having a negative effect on customer service levels. Production and supply chain management can help to reduce costs by connecting every unit in the supply chain, fostering collaboration among supply chain partners, and offering visibility into the demand and supply side of the chain. Production and supply chain management involves a number of drivers through which acquired raw materials are converted into finished goods for sale to customers. In turn, these drivers involve several processes that offer opportunities for cost reduction. Common drivers include procurement, design of the supply chain, inventory, transportation, warehousing, and collaboration. Cost reduction requires timely and improved decision-making for common processes under each driver.

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Business Performance Excellence Procurement

Procurement, also known as purchasing, is the process of acquiring raw materials, components, products, services, and other resources necessary either for the production processes themselves or for the support of production processes. Procurement processes ensure that supplies are available in the right place, in the right quantity, and at the right time. Buyers can play a major role in reducing supply chain costs by taking actions to reduce costs incurred in the flow of products from the suppliers to the ultimate customers. Some of the actions are discussed below. Buyers must increase the flow of information throughout the supply chain, from the customer to the manufacturer and on to the supplier. This will make each entity in the chain aware of the inventory carried by the others and work towards the reduction of inventory without sacrificing customer service levels. Buyers must also take action to reduce cycle times, which will make the supply chain more responsive. To achieve a reduction in lead times, buyers must track and measure supplier lead-times, analyze trade-offs that result from lead time reduction, and then negotiate shorter lead times. Another action buyers can undertake to reduce supply chain cost is to select suppliers on the basis of their total supply chain capability and not just price, lead time, and quality levels.

Design of Supply Chain

There are several principles under design of the supply chain that can help to reduce costs. These include component commonality, component modularity, and postponement. Component commonality: The principle of component commonality focuses on the design and use of common components for families of products. When there are a large number of products in a supply chain, the inventory of components will naturally be large. Component commonality calls for the use of common components in a variety of products. This reduces costs not only by reducing inventory cost but also through reduced material cost, reduced production cost, and reduced product obsolescence. For example, a computer manufacturer can design common components such as memory and disk drives and use different combinations of these components to produce different finished products. Component modularity: The principle of component modularity recommends that common subsystems be designed as modules to meet a broad range of feature requirements. This reduces the number of components that must be produced, kept in materials and repair parts inventory, and integrated into the product during the production process. This reduces procurement, manufacturing, and inventory costs, leading to a lower supply chain cost. Manufacturers of electronic products, for example, use the principle of modularity to design and assemble printers, computers, and so on. Postponement: Postponement means delaying the bringing of products into their final form until close to the point of sale, when customer demand is known with greater accuracy. This results in a better match between supply and demand, leading to reduced costs mainly through inventory reductions. For example, a traditional garment manufacturer might dye the thread before knitting it into sweaters, whereas a garment manufacturer using postponement would postpone dying until the last point in the supply chain, when customer color preferences are known with a greater degree of certainty.

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Reducing Costs through Production and Supply Chain Management Inventory

Inventory resides at several locations in a supply chain, and the goal of inventory management is to reduce or eliminate inventory wherever it exists in the supply chain. This increases the velocity of movement of material through the chain, reducing the time from the point where material enters to the point of final consumption or sale. Slow movement of material leads to higher average inventories throughout the supply chain and results in higher inventory carrying costs. Techniques that can help reduce these costs include the following. The first technique is to use models such as vendor-managed inventory (VMI) and drop-shipments to reduce the number of locations where inventory is stored. With VMI the buyer of a product provides certain information to a vendor of that product, and the vendor takes full responsibility for maintaining an agreed level of inventory of the material, usually at the location where the buyer uses it. Second, the same strategy should not be used to manage and control all inventory items regardless of their value. Instead, use ABC analysis (not the same as activitybased costing) to classify inventory into different classes and to maintain appropriately safe stock levels based on the class. ABC analysis makes use of Pareto’s Law and classifies inventory into classes A, B, and C. A-class items are high in value and low in number, requiring tight control, while C-class items are low-value, high-number items that can be loosely controlled. Items classed as B include medium-value, mediumnumber items and typically require a blanket policy for control. Other inventory management techniques include reducing the amount of transportation/pipeline inventory, and application of lean and just-in-time techniques to reduce or eliminate waste.

Transportation

Transportation is used to move products from one location in the supply chain to another and is a significant component of the supply chain cost. A responsive transportation system can help to lower supply chain costs by achieving a high level of product availability at a reasonable price. A common technique for making a transportation system responsive is “cross-docking.” Under cross-docking, products from a supplier are aggregated into trucks that arrive at distribution centers. At these centers the process of cross-docking means that products are exchanged between different trucks so that each truck leaving for a given retail location is loaded with products from several suppliers. Transportation planners can reduce supply chain costs by reducing transportation costs, by selecting low-cost modes of transport, and using software to plan optimal routes and delivery schedules. The various modes of transport include water, rail, truck, intermodal, and air, and package carriers such as DHL, FedEx, and UPS. Having a low-cost supply chain depends closely on the selection and use of an appropriate mode of transport. Water is typically the least expensive, although slowest, whereas air is the most expensive and fastest. Transportation planners often use the approach of total cost analysis to select the best mode. This requires finding the total cost for each mode of transportation and using the mode that has the lowest total cost. The total

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Business Performance Excellence cost is made up of, and considers, the trade-off between the cost of transport, cost of inventory at the origin, cost of inventory in the pipeline, and cost of inventory at the destination. Several companies develop and provide software that helps planners to construct transportation routes and schedules. Planners also use satellite-based global positioning systems to lower costs while still maintaining a responsive transport system.

Warehousing

Warehouses are locations in the supply chain to and from which inventory is transported. Supply chain planners can help to reduce costs by making good decisions about warehousing strategies, such as the location and capacity of warehouses, and operational decisions such as the functions to be performed at the warehouse, the order-fulfilment methodology to be used, etc. When deciding on the location of warehouses, planners use a trade-off analysis to choose between a large centralized location, which is more efficient, and multiple decentralized locations that offer a higher level of responsiveness. A number of factors including the quality, cost and availability of the workforce, tax effects, and proximity to customers are used in the analysis. Capacity decisions typically involve decisions on the need for and amount of extra capacity. Warehouses with excess capacity offer flexibility at a cost, while those with little excess capacity are more efficient. Trade-off analysis is also used to make decisions on warehouse capacity. Operational decisions deal with day-to-day processes such as stock placement, stock picking, and cycle counting. Warehouse planners use warehouse management system (WMS) software to plan and execute these processes.

Collaboration

Collaboration in a supply chain focuses on joint planning, coordination, and process integration between the firm and its suppliers, customers, and other partners such as the logistics providers. In addition to cost reduction, collaboration offers the advantages of business expansion to other areas, increased return on assets, improved customer service, reduced lead times, increased reliability and responsiveness to market trends, and a shorter time to market. Several options are available for achieving collaboration in a supply chain. These include: 8 systems that transmit information between partners using technologies such as fax, e-mail, electronic data interchange (EDI), or extensible markup language (XML); 8 systems such as electronic hubs and portals that facilitate the procurement of goods or services from electronic marketplaces, catalogs, and auctions; 8 systems such as collaborative planning, forecasting and replenishment (CPFR) that permit shared collaboration rather than just a simple exchange of information amongst the supply chain partners. The three systems identified above offer different levels of benefits and are associated with varying levels of expected costs. Organizations need to examine and quantify the benefits and costs of the alternative systems before selecting an appropriate system.

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Reducing Costs through Production and Supply Chain Management Case Study

Transportation Analysis Pays Off for Computer Products Firm A leading US manufacturer of computer accessories makes many products in China and then funnels them into a single distribution center on the West Coast that serves hundreds of retail clients. The company contracted with various freight services to send the products to retail customers using different modes of transportation, including small-package air, small-package ground, less-than-truckload, truckload, and heavy-weight air freight. The company wanted to have a better understanding of transportation processes and to control transportation costs. To do so, it hired the services of UPS Consulting (UPSC). UPSC undertook a careful analysis and helped the manufacturer to reduce its domestic transportation costs by approximately 30% by the following means:

8 negotiation of better rates with new freight service providers; 8 setting up a returns program with a single carrier that picks up and returns the product using the most cost-effective transportation mode;

8 development of a user-friendly one-page guide to carrier and mode selection that matches the weight and size of a parcel shipment with the preferred shipping method;.

8 helping employees to understand shipping parameters; 8 establishing a compliance system that requires weekly meetings to review shipping activities and handle any special issues that arise.

Summary and Further Steps

Conclusion This article has explored major sources of cost savings in a production and supply chain and identified some techniques used by supply chain personnel such as buyers, inventory managers, and transportation planners. The techniques identified were discussed by grouping supply chain processes under the common supply chain drivers of procurement, design of the supply chain, inventory, transportation, warehousing, and collaboration.

More Info Books: Chopra, Sunil, and Peter Meindl. Supply Chain Management: Strategy, Planning & Operations. 3rd ed. Upper Saddle River, NJ: Prentice Hall, 2006. Jacobs, F. Robert, and Richard B. Chase. Operations and Supply Management: The Core. Boston, MA: McGraw-Hill/Irwin, 2008. Websites: Council of Supply Chain Management Professionals: cscmp.org Supply Chain Council: www.supply-chain.org UPS Supply Chain Solutions: www.ups-scs.com

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Reducing Costs and Improving Efficiency with New Management Information Systems by Beverly Goldberg The Century Foundation, New York, USA

This Chapter Covers 8 A management information system (MIS) enables businesses to provide answers to managers in search of knowledge. MIS does this by combining raw data about the organization’s operations (contained in its basic information technology systems) with information gathered from employees in expert systems that reflect the organization’s procedures. 8  As organizations grow, MIS allows information to move between functional areas and departments instantly, reducing the need for face-to-face communications among employees, thus increasing the responsiveness of the organization. 8  Putting in place the advanced technological systems needed to collect and sort data and employee information can be costly unless senior management, especially the CFO, controls the purchasing of the basic systems needed by different functional areas from the outset. 8  Well-constructed and well-organized MIS can provide management with the knowledge it needs to reduce operating costs and increase profits. 8  MIS can help management increase efficiency by quickly providing critical information about procedures and operations.

Introduction

Management information systems (MIS) make it possible for organizations to get the right information to the right people at the right time by enhancing the interaction between the organization’s people, the data collected in its various IT systems, and the procedures it uses. It brings together the raw data collected by the various business areas of the organization, which, while useful for specific functions such as accounting, does not provide, by itself, information that can be used to make decisions. Moreover, in older companies, the systems in which the data reside may be incompatible and need to be migrated to a data warehouse (DW)1 before they can be used. Once all the basic data are pulled together, they can be combined with information collected in more advanced systems meant to simulate human reasoning, such as expert systems2 and decision support systems.3 This enables the data mining (DM)4 of all the collected information in response to the needs of management involved in operational, strategic, and tactical decision-making. In many companies, functional/departmental systems are being replaced by enterprisewide systems—such as enterprise resource planning (ERP), customer relationship management systems (CRM), and supply chain management (SCM)—that ease the problems that arise from having multiple, incompatible systems. Whatever move is made to modernize and simplify data collection, however, the key to using a company’s systems to increase efficiency is the technical business analyst, whose job, according

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Business Performance Excellence to a guide by the International Institute of Business Analysts, is to “collaborate with business stakeholders to build a strong relationship between the business and the technical communities when implementing a new IT-enabled business solution.” In most organizations today, the person overseeing the work of the technical business analyst is the chief financial officer. In the past, when people thought about the role of CFO, they considered it primarily an accounting role. That is no longer the case. As Pfizer CFO David L. Shedlarz says, “when you take a look at a CFO’s responsibility today, you also have operations planning and analysis, information technology, strategic planning, and M&A.”5

The Cost Aspect of MIS

When it comes to costs and MIS, there are three parts to the story. The first involves the costs of MIS itself. 1. Adopting MIS can be costly. Market-neutral asset allocation. Older, larger companies usually have accumulated huge amounts of data stored in various systems adopted at different times in the company’s history, usually well before the idea of mining those data for decision support was a possibility. These older systems, known as legacy systems,6 include critical historic data about finances, sales, inventory, customers, and suppliers. The problem is that these systems tend not to be compatible, often using different definitions of key concepts. When the organization needs information, the raw data in these disparate, incompatible systems need to be extracted and migrated to a database designed to organize the raw data and make them available for analysis. Building these databases is both expensive and time-consuming. Smaller companies, especially start-ups, can avoid this problem by adopting suites of applications for various functional areas that have been developed to be compatible. Ensuring that the heads of the business’s functional areas do not purchase incompatible components simply because of their familiarity with them is critical. The CFO must work with the IT department to make sure that everyone in IT knows that they have his or her backing to refuse to support unauthorized purchases. When there is no formal IT department, the CFO should review the purchasing decisions of various departments frequently to ensure that their managers have not used discretionary funds to buy applications that are not part of the chosen suite. If the CFO can discover such purchases quickly, he can work with the CEO to stop their use before time and money is spent adopting them—and creating problems as the company expands. The second and third cost considerations show that in the long-run, the costs of not adopting MIS can far exceed the costs of adopting and implementing a system. The second bullet shows the ways in which MIS can lower operating costs once in use, and the third reveals the profits that MIS can help to generate. 2. MIS can lower operating costs in many ways. By using MIS to share information across functional areas, redundant efforts can be eliminated. This is particularly important as a small business grows. When a company has only a few employees, it is relatively easy for them to be in contact with one another often enough to share knowledge directly. As the number of employees increases, however, and people are

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Reducing Costs and Improving Efficiency divided into teams or functional areas, it becomes more difficult to keep the lines of communication open and encourage the sharing of ideas. As a result, for example, the sales and marketing departments may each spend time developing descriptions of new products that highlight different features of the product, creating confusion that ends up with customers not understanding exactly what a product does and leading to product returns or even the loss of customers. If there was a database that contained information about all the products in development that employees were mandated to use, this kind of duplication of effort and the resulting confusion could be avoided. The same principle would apply to any two departments with overlapping functions. 3. MIS can increase profits. By pulling together information, MIS can help identify ways to improve products and expand the customer base, as in the following situation: A manager in a company with a good MIS thinks that one of the components used in manufacturing scooters has been ordered with unusual frequency at certain times of the year. She can access the company’s database to see if and when there might have been unusual spikes in sales of that part and find out who is doing the unusual ordering. She discovers that a spike in sales takes place in winter, a time when other components needed to manufacture that product are not usually ordered. By identifying and then calling companies that are ordering the parts out-of-season, she discovers that the product develops problems in regions where the temperature changes are often sudden and significant. After some research, the company changes the metal compound used in making the part to one that is less affected by temperature changes. This presents the company’s sales force with an opportunity to reach out to all companies that use that type of component to explain the improvement made, giving them an opportunity to capture new clients and increase market share.

A Road to Improved Efficiency

MIS provides a valuable time-saving benefit to the workforce. Employees do not have to collect data manually for filing and analysis. Instead, that information can be entered quickly and easily into a computer program. As the amount of raw data grows too large for employees to analyze, business analysts can build programs to access the data and information in response to queries by management. With faster access to needed information, managers can make better decisions about procedures, future directions, and developments by competitors, and make them more quickly. For example, MIS, drawing on past experience and knowledge gathered about competitors, can be used to predict the effect on sales if a product’s price were to be altered. In addition, MIS can help businesses to: 8 enhance communication among employees; 8 reduce expenses related to labor-intensive manual activities; 8 reduce product development and marketing life cycles; 8 increase their understanding of customers’ needs; 8 engage in business process reengineering; 8 optimize their utilization of resources; 8 identify and manage risks; 8 make strategic decisions.

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Business Performance Excellence Case Study

A Major Northeastern Music School The music school’s endowment was not sufficient to support its plans for growth, which would require, among other things, building a new dormitory. In the past, the institution had relied primarily on members of the board and the president of the college to raise funds for the endowment through personal appeals to friends and associates, but it was clear to senior management that the amount now needed was far in excess of what they could possibly raise themselves. So they decided to hire a fundraiser. Once the fundraiser was hired, he held a number of meetings with the board, the president, the CFO, and the faculty, many of whom are world-renowned musicians. Among other things, he discovered that the faculty had not been asked to help in fundraising in the past and that there had been little effort to solicit contributions from alumni—or their parents. He also gained the agreement of the faculty to provide him with lists of potential donors. He then turned to the head of the information technology department to ask about the data available about current students, alumni, and their parents; subscribers to the various programs that the school offered, such as operas, jazz events, and instrumental performances; and past donors to the school. He explained that he needed to combine all these data— along with the information he hoped to get from the faculty and his own extensive lists of people who supported the arts—into an integrated fundraising data program. He suggested a fundraising program that he had worked with before. On looking into it, the information systems manager discovered that the program would not be compatible with the school’s systems. When he explored other programs, he found that while some were somewhat more compatible, the difference was not great enough to force the fundraiser to adapt to a new system. Inevitably, there were going to be major legacy issues because most of the programs that needed to be integrated had been bought on a noncentralized purchasing plan over the years. It was clear that a new comprehensive database would have to built to combine the data from the student information database, the donor database, the subscriber mailing lists, and the new lists of potential donors. During a follow-up board meeting that included the president and the CFO, building the new database became a point of contention because of its cost, the time it would take, and the added costs of hiring additional technology staff to ensure that the normal running of the school would not be affected by the work involved. The fundraiser presented information about his past results in fundraising that convinced the CFO, after careful analysis, that the effort eventually would bring in enough to cover those costs and raise the needed funds. The CFO also warned everyone involved in the decision-making that the schedule originally proposed would have to be extended, which carried its own costs. In one of the many follow-up meetings, the school’s recruitment officer pointed out that the new database would allow for broad circulation of a newsletter that could be used to attract new students as well as for future fundraising from alumni and potential donors. The value of being able to mix and match data—such as drawing a special audience for an “opening night” performance that could be priced higher than usual because it would be followed by a reception attended by the musicians—became clear to all the players. At that point the plan was approved. The outcome was positive: The funds needed for the dormitory were raised only a few months behind the original schedule.

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Reducing Costs and Improving Efficiency Summary and Further Steps

Conclusion Preparing for the adoption of MIS when a company grows large enough to need such a system is critical to an organization’s success. The CFO, who is usually the first to adopt IT systems for accounting purposes, can begin the process by careful oversight of the IT component of the business from the outset. Ensuring compatibility of the systems put in place as the organization grows—usually by adopting the right suite of applications and insisting that they are the only applications used throughout the organization—will make creation of sophisticated databases a far easier, and less costly, process. It will also facilitate eventual inclusion of programs that collect procedural and other knowledge garnered by employees.

Making It Happen Since knowledge of the business and its customers and competitors is the key to an organization’s continued health, companies must keep in mind from their inception the need for access to data about every aspect of the business, its procedures, and the knowledge of its employees. The important information involved in running the business is easy to handle when the company is small and has few employees. But, with growth, the amount of data accumulated can become overwhelming and the easy, frequent communication among employees can be impaired as people are divided into teams and functional areas. Because the responsibility for accounting systems, which tend to be the first that are automated, belongs to the CFO, the responsibility for adopting other technologies tends to stay with him or her as the organization grows. This means that the CFO should take steps early on to ensure that:

8 The computer systems purchased for the various areas of the business are compatible, so that the data they contain can be merged;

8 The company begins to collect the knowledge of its employees in forms that other people in the company can access when face-to-face communications become difficult; 8 Overarching MIS is developed by talented business analysts, so managers can make decisions based on a combination of the data and information about procedures gathered on various systems over time about such things as: a. customers’ needs; b. the potential value of proposed new products; c. the potential value of procedural innovations; d. the risks inherent in strategic decisions.

More Info Books: Fleisher, Craig S., and Babette E. Bensoussan. Business and Competitive Analysis: Effective Application of New and Classic Methods. Upper Saddle River, NJ: FT Press, 2007. Haag, Stephen, Maeve Cummings, and Amy Phillips. Management Information Systems for the Information Age. 6th ed. New York: Irwin/McGraw-Hill, 2007.

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Business Performance Excellence Kroenke, David M. Using MIS. 2nd ed. Englewood Cliffs, NJ: Prentice Hall, 2008. Kroenke, David, and Richard Hatch. Management Information Systems. 3rd ed. New York: McGraw Hill, 1994. Post, Gerald V., and David L. Anderson. Management Information Systems: Solving Business Problems with Information Technology. 4th ed. New York: McGraw Hill, 2005. Websites: International Institute of Business Analysis (IIBA), Guide to the Business Analysis Body of Knowledge: tinyurl.com/7725rfy Journal of Management Information Systems: www.jmis-web.org

Notes 1. D  ata Warehousing Information Center: www.dwinfocenter.org 2. J ackson, Peter. Introduction to Expert Systems. 3rd ed. Boston, MA: Addison Wesley, 1998. 3. P  ower, D. J. “A brief history of decision support systems.” Online at: dssresources.com/history/dsshistory.html 4. A  non. “Data mining: What is data mining?” Online at: tinyurl.com/90sj 5. N  orton, Rob (ed). CFO Thought Leaders: Advancing the Frontiers of Finance. McLean, VA: Booz Allen Hamilton, 2005. 6. Z  oufaly, Frederico. “Issues and challenges facing legacy systems.” www.developer.com/mgmt/article.php/1492531

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The True Total Quality by Masaaki Imai Kaizen Institute Consulting Group Ltd, Japan

This Chapter Covers 8  It is important to recognize the importance of the commonsense approach of gemba (shop floor) kaizen to quality improvement, as against the technologyonly approach to quality practiced in the West. 8  The production system (batch production) employed by over 90% of all the companies in the world is one of the biggest obstacles to quality improvement. A conversion from a batch to a JIT (just-in-time)/lean production system should be the most urgent task for any manufacturing company today in order to survive in the next millennium.

Introduction

The differences between knowledge and wisdom are very important to our thinking about Total Quality Management. Knowledge is something we can buy. We can gain knowledge by reading books and attending seminars and classroom lectures. Knowledge remains just knowledge until we put it into action. On the other hand, wisdom is something we learn by doing. Practice is the best way of learning, and wisdom emerges from practice. I have observed that Western management has tended to stress teaching knowledge in the classroom over wisdom through doing, whereas the Japanese approach for quality management has been to provide both knowledge and wisdom to employees. This latter approach is particularly effective in solving quality problems in gemba (shop floor).

Gemba Kaizen

“Gemba” means the place where real action occurs. In manufacturing “gemba” means the shop floor. In my book Gemba Kaizen: A Common-Sense, Low-Cost Approach to Management (McGraw-Hill, 1997), I pointed out the three major activities to support good gemba management, namely: standardization, good housekeeping, and muda (waste) elimination. Let me explain the difference between wisdom and knowledge, citing an example from the housekeeping activities. One of the five steps of housekeeping in gemba is seiso, or cleaning, meaning the involvement of operators in cleaning the machines they work with. As they do so, operators often discover oil leaks or loosening of bolts on the machine This gives them the opportunity to take corrective actions and eventually develop maintenance standards. This is learning by doing, and the operators gain valuable wisdom about machine maintenance, which is an important step for quality improvement. I have observed that many managers often neglect these three foundations of good gemba management and are interested in pursuing sophisticated approaches instead.

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Business Performance Excellence There are five golden rules of gemba management: 8 8 8 8 8

 hen a problem (abnormality) arises, go to gemba first; w check with gembutsu (relevant objects); take temporary counter-measures on the spot; find the root cause; standardize to prevent recurrence.

Fabricated Data

In managing gemba, the most critical part is for managers to go to gemba and have a good look. Managers who stay away from gemba, and seldom take the trouble of going there, are in contact with the reality of gemba only through indirect means, such as reports and conferences. In such cases, managers are making decisions based on fabricated data. When you go to gemba where an abnormality occurred, you do not need any data, because what you see there is the reality. A manager on the shop floor is right in the midst of reality, and chances are that the problem may be solved on the spot and in real time by following the five golden rules.

Collect and Analyze Data

Another effective approach for problem solving in gemba has been to collect and analyze data. Generally speaking, when these down-to-earth activities in gemba are carried out, the reject rates should go down to a tenth of their original levels. And yet, I find most Western managers do not take advantage of these effective gemba practices and pursue more academic and sophisticated approaches for quality improvement.

Conversion from Batch to JIT/Lean Production

The second and perhaps more acute issue facing most manufacturing companies today is the fact that their current production systems are the biggest hindrance to achieving quality management. Today, most manufacturing companies subscribe to the traditional batch production system. I define batch production as an antiquated paradigm patterned after agriculture. In agriculture, farm products are sown, grown, harvested, and stored in batches. The more grain you have in the warehouse, the better. Agriculture must take into account the shifting seasons, and it is taken for granted that the lead-time of growing and harvesting grain must be long. When modern manufacturing emerged, it was patterned after this agricultural mentality. Raw materials were bought, processed, and stored in batches. Not much consideration was given to establishing a flow of work, and no effort was made to shorten the lead-time of production. Keeping a large inventory was taken for granted as a way of doing business. Even today, good inventory means high inventory to some managers.

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The True Total Quality As long as the varieties of products offered to customers were small in number, this type of production did not pose many problems. As customers have come to demand diversified products to be delivered on time and in different volumes, it has become increasingly difficult to develop flexibility to meet such demands in the context of the batch production system. To cope with the new demand, efforts have been made by management in such areas as shortening set-up time, quality improvement, adding more lines, and even building new plants. Unfortunately, even to this day, more than 90% of all manufacturing companies in the world still subscribe to batch production, a system that is one of the biggest obstacles to establishing good quality management.

The Drawbacks of Batch Production

The following features of the batch production system stand in the way of quality management: 8 L  arge inventory: As the name batch production suggests, the system is based on producing large batches of inventory at every production process. As a result, 100% quality-control inspection is nearly impossible. Even if quality defects are found at a later stage, it is almost impossible to go back to the previous process which produced the defects, seek out the root cause, and take corrective actions, since such rejects were made several days earlier. Also, the quality of products or parts deteriorates over time when stored in inventory, the only exceptions to this, of course, being red wine and whisky. 8 Long lead time: The long lead time required by the batch production system makes it difficult to take prompt and flexible action to meet the customer requirements for quality and delivery. For instance, the batch production system is far less flexible when design changes are called for. 8 Isolated islands: Batch production is necessitated because each manufacturing process is separated from the others—each on its own isolated island. This necessitates transport between processes, causing damage. Again, the isolated islands make it difficult to diagnose quality problems in real time. When operators do their jobs surrounded by inventory, housekeeping is difficult to maintain, which in turn leads to lower morale and less self-discipline in employees. It becomes clear from the reasons given above that no matter how much effort management may make toward improving quality, batch production destroys those efforts.

The Just-in-Time (JIT) Production System

The JIT production system was developed as an antithesis to batch production by Taiichi Ohno at the Toyota Motor Corporation and, along with many other practical tools like kanban, poka-yoke (fail-safe device) and jidohka (automation), is supported by the following three pillars of production: 8 t akt time versus cycle time (theoretical time versus actual time for processing one work piece);

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Business Performance Excellence 8 p  ull production versus push production (producing only as many items as the next process needs versus producing as many as can be produced); 8 establishing production flow (rearranging equipment layout and processes according to the work sequence). JIT is really a revolutionary production system, and is in every sense just the opposite of the batch production. It employs minimum materials, equipment, manpower, utility, space, time, and money. It produces products within the shortest lead time and meets the diversified demand of customers and delivers the products just-in-time. Quality is ensured by keeping small inventories and through the use of flow production. Small inventories eventually lead to one-piece flow, namely one work piece moving from process to process. This enables operators to make a 100% inspection of each piece. In flow production, unlike in the isolated islands approach of batch production, processes are arranged in a flow, and any quality reject created in one process can be identified in the next process immediately. Summary and Further Steps

Making It Happen How many quality managers and engineers realize that the production system of their own company is a major cause for many quality problems they have to deal with? A review of the production system currently in use should be the first action taken by those engaged in quality improvement. 8  To solve quality problems, help employees to gain wisdom, as well as knowledge. 8  Base total quality on good “gemba” (shop floor) management—meaning standardization, excellent housekeeping, and effective elimination of “muda” (waste). 8  When a problem (or abnormality) arises, always go to “gemba” first, and never rely on secondary information—reports, meetings, etc. 8  When at “gemba,” check “gembutsu” (relevant objects), take temporary counter measures on the spot, find the root cause, and standardize to stop problems recurring. 8  Recognize that batch production itself is one of the biggest obstacles to good quality management. 8  Replace the batch system with JIT production, arranging processes in a flow, so that any quality reject created in one process can be immediately identified in the next.

Conclusion

8 Quality is everybody’s job, even though it is often regarded as the responsibility of the quality manager alone. When serious quality problems arise, the quality manager is the first to be sacked. 8  Inside a company, the flow goes through three processes: the supplier (previous process), one’s own process, and the next process (customer). 8  When the supplier sends a defective product or information, the next process—which is receiving the product or information—is a customer to the supplier. He or she is entitled to send back what he or she has received and request better quality.

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The True Total Quality 8 After adding value on what you have received in your own process, before you send it to the next process (your customer), inspect it and make sure that you are sending only good quality items. 8 Only when everybody subscribes to this commitment do you have a good quality assurance system in operation at work. Management need to realize this. The quality manager establishes the framework of quality and the line manager executes it. Developing such a mindset requires self-discipline. For this reason, good housekeeping is one of the basic activities to be carried out in gemba, as it helps employees to develop that self-discipline.

More Info Books: Imai, Masaaki. Kaizen: The Key to Japan’s Competitive Success. New York: McGraw-Hill, 1986. Imai, Masaaki. Gemba Kaizen: A Common-Sense, Low-Cost Approach to Management. New York: McGraw-Hill, 1997.

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Lean Manufacturing by Daniel T. Jones Lean Enterprise Academy, Ross-on-Wye, UK

This Chapter Covers 8 Lean production is the generic version of the Toyota Production System. It has a long history, beginning in the United States before being fully developed by Toyota. 8  It is based on managing the product value stream from raw material to end customer, rather than focusing on managing separate assets and companies. 8  The objective is to eliminate waste through reconfiguring operations into continuous flow cells linked by leveled pull systems. 8  Well-constructed and well-organized MIS can provide management with the knowledge it needs to reduce operating costs and increase profits. 8  The gains are defect-free products, on-time delivery, big reductions in inventories, and freed-up people, machine time, and space.

Introduction

Although the terms “lean production” and “lean manufacturing” have only been in circulation since the publication of The Machine That Changed the World in 1990, the concepts and practices have a much longer history. Indeed, the core idea of lining production steps in process sequence can be traced back to Colt’s armory in Hartford, Connecticut, in 1855. What Henry Ford later called “flow production” reached its peak at his plant in Highland Park in 1915, where every machine making parts and every step toward assembling them were lined up in single-piece flow, so that it took a matter of hours from raw casting to the finished product. This system could not offer customers enough choice. So when Ford built his next plant at River Rouge in 1931, it was organized quite differently. Large machines able to make large batches of different parts were grouped together in separate departments, maximizing efficiency by ensuring there was always work waiting to be done. Batches of products wandered from department to department and throughput times stretched from several hours to several months. Long lead times entailed making to forecast and selling from several months’ stock of finished cars in dealer lots. Thus the world of mass “production” was born and became the dominant model as long as producers could sell everything they made.

Discovering Lean Production

Across the Pacific the founders of Toyota, Sakichi Toyoda and his son Kiichiro, were working on their own version of flow production in the 1930s. They formulated the two key pillars of what later became the Toyota Production System (TPS): automatic machine and line stopping whenever a mistake is made so that no bad parts are passed forward to interrupt the downstream flow (a system they called Jidoka), and a pull system in which only parts that are actually needed are made (called just-in-time). Later on, the third pillar, involving leveling the workload in a mixed model production flow, was added (called Heijunka).

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Business Performance Excellence It was not until after World War II that Taiichi Ohno, the production chief at Toyota, implemented these principles. Ohno was determined to overcome all the obstacles to producing a range of products in low volumes, using simple equipment laid out in process sequence. His 20-year experiment started in the engine plant before extending to pressing, body welding, and assembly. Only when Ohno needed to extend the TPS to the supply base in the early 1970s was it written down for the first time, though it was another decade before it was published in books and articles. Toyota’s steady and continuing rise to become the largest automaker in the world led others to try to follow its example. This could only be done by understanding the principles behind TPS and then selecting the right tools in the right sequence. Lean production is the generic version of TPS and lean thinking describes the principles behind not just TPS but the whole Toyota business system, including product development, supplier coordination, and customer management. These principles are based on five key insights.

The Five Principles of Lean Thinking

1. Specify value from the standpoint of the end customer. 2. Identify the value stream for each product family. 3. Link value-creating steps so the product can flow. 4. Enable your customers to pull what they need. 5. Manage toward perfection—where every action and asset creates value. If you define value from the standpoint of the end customer, you realize that only a tiny fraction of actions and time actually create value. In a typical factory this might be 5% and in a whole value stream (from raw material to end customer) it is usually less than 1%. The rest of the steps are only necessary because of the way companies are currently organized and because of past decisions about assets and technologies. So the greatest opportunity for performance improvement is to reconfigure operations across the value stream to remove these wasted steps.

Taiichi Ohno’s Seven Wastes That Consume Value 8 Overproduction 8 Inventories 8 Defects 8 Waiting 8 Excess Transportation 8 Excess Movement 8 Excess Processing If you identify the whole value stream for a given product (both the flow of orders upstream and the flow of products downstream) you see that optimizing each asset and activity in isolation creates huge amounts of waste elsewhere. It is only by optimizing the product value stream that you can identify ways of eliminating these interface wastes and can begin to rethink the appropriate equipment, technologies, and locations for the future.

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Lean Manufacturing The ideal way to organize waste-free production is to line up the value-creating steps so the product flows through them in the shortest possible time. This, in turn, means that every activity must be standardized and repeatable, and that every machine must be fully capable of delivering exactly what is needed and fully available to operate when needed. Where machines cannot be colocated and serve several product flows, then products need to be pulled directly as required from the upstream step. Time compression of every step is the only way to maintain these disciplines and to ensure that waste does not creep back when attention shifts elsewhere. Multiple decision points and time lags in processing orders lead to amplification of the variance in orders passed upstream, which in turn requires larger inventories and excess capacity to cover demand spikes. Time compression and direct pull systems are the key to eliminating this amplification and to being able to move away from maketo-forecast and sell-from-stock toward true build-to-order systems able to deliver what customers want within the time available. The final insight is that reconfiguring the value stream to eliminate waste is a stepby-step process: the more waste you remove, the more you can see to remove next time. It starts by understanding the current state of your operations and defining an achievable future state in a short space of time, which then becomes the current state of the next improvement cycle. However, this cyclical process also needs to be guided by a vision of the perfect state to which you should be headed, in which every action and asset creates value for the end customer.

Implementing Lean Production

Lean production is by no means widespread, even in Japan. Indeed, it was only after 1973 that the rest of the Japanese auto industry recognized that Toyota was following a different path. By 1987 the first companies in the United States began to make serious progress with the help of several of Ohno’s disciples, who had by then left to become consultants. The early lean conversion stories of Pratt & Whitney, Wiremold, and Lantech are described in Lean Thinking. Since then lean production has spread across the automotive, aerospace, and engineering industries and, following Alcoa’s example, to raw material processing. It is now also being used in insurance and financial services, utilities, health-care, and government departments. Many companies began implementing lean production by involving the workforce in team-based problem-solving and kaizen or continuous improvement activities. Putting the spotlight on operations should certainly lead to the removal of the most obvious waste in the organization. However, lean production only really begins when you use value-stream mapping to learn to see the product flow from door to door, and when you give someone the responsibility for reconfiguring operations into continuous flow cells linked by leveled pull systems. Once progress has been made within the plant, it is time to involve your suppliers, by linking plants using simple pull systems and your customers, by linking them directly to production using build-to-order systems. Beyond this it is possible to envisage rethinking and compressing the value stream using different technologies and right-

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Business Performance Excellence sized tools colocated close to the point of use. We have in truth only just begun to realize the full potential of lean production. Summary and Further Steps

8 Putting the spotlight on all of your operations should eliminate the most obvious waste and deficiencies in the value chain—from the start of the process to the customer. 8 For a more comprehensive assessment of the areas where your organization’s processes may improve, use value stream mapping to clearly show product flows. 8 Ensure that there is one person with overall responsibility for reconfiguring operations into continuous flow cells, linked by leveled “pull” systems. 8 Knit together different parts of your value stream, using build-to-order mechanisms. 8 Compress your value stream through the development of new and ongoing strategies—and the application of new technologies—to eliminate wastage and continuously improve efficiency. 8 Regularly review your activities—ideally from a customer or end user perspective—to make sure that they are delivered in an effective and profit-centered way.

Conclusion Managing lean value streams is harder than managing individual operations. However, the gains are substantial, particularly when replicated across the whole value stream. First, your customers get defect-free products on time. Second, your suppliers get leveled orders and can deliver to you on time. Third, inventories at every point down the value stream can be cut in half. Fourth, you free up a lot of resources—people, machines, and space— that will not appear on the bottom line until they are used. The challenge in sustaining progress toward lean production is to grow the throughput and bring operations in house as you free up those assets.

More Info Books: Liker, Jeffrey. The Toyota Way: 14 Management Principles From The World’s Greatest Manufacturer. New York: McGraw-Hill, 2003. Rother, Mike. Toyota Kata: Managing People for Improvement, Adaptiveness and Superior Results. New York: McGraw-Hill, 2009. Womack, James P., and Daniel T. Jones. Lean Solutions: How Companies and Customers can Create Value and Wealth Together. New York: Free Press, 2005. Website: Other lean manufacturing classics are listed at www.lean.org. Here you will also find an online community of those actively implementing lean production and the key workbook to help you get started in mapping your value streams.

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Generating Increased Revenue and Profitability through Improved Customer Satisfaction: Essential Elements of a Customer Quality Assurance (CQA) System by Jeffrey T. Luftig and Steven Ouellette Lockheed Martin Engineering Management Program, College of Engineering and Applied Science, University of Colorado, Boulder, USA

This Chapter Covers 8  The importance of having a system to ensure that customers receive a quality product or service. 8  A suggested model for customer quality assurance (CQA). 8  Best practices and common errors in CQA. 8  Unique example output from a CQA system.

Introduction

For most firms, the key to enhancing profitability and achieving steady growth in revenue, sales, and market share is to understand and respond to the needs of their customers. The process, which is often referred to as customer quality assurance (CQA), is that system that allows us to: 8 identify critical customers—those customers who are essential to meeting our strategic and business plans, and who significantly impact the firm’s key performance indicators (KPIs); 8 assess and respond to their needs and desires; 8 track our progress and the customers’ level of satisfaction, as translated into financial terms. It is important to note that a CQA system that is to offer the ability to effectively achieve these goals must be one that is wholly integrated into the organization’s strategic and business planning process and constitutes a major input to the firm’s policy deployment (also known as hoshin planning) activities. Without such integration, the CQA process will become little more than a process of conducting ongoing surveys of customers that have little to do with the day-to-day activities of the workforce. In the presence of such a nonintegrated process, the measured level of customer satisfaction will bear little relationship to critical performance metrics (CPMs), whether they are financial KPIs such as sales revenues, profitability measures such as return on investment (ROI) and return on assets (ROA), or nonfinancial indicators (NFIs) such as market share and on-time delivery. Ultimately, customer satisfaction, measured and real, will quickly erode. Hoshin planning (see pp. 3–17), or policy deployment, is a process whereby the strategic intent of the company is translated from the highest levels of the

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Business Performance Excellence company on down to every individual. This way, not only are all employees aware of the strategic plan, but more importantly they know what they need to do in order to support the company in achieving its goals.

Components of a Suggested Model for CQA

A valid and powerful CQA system will generally consist of two major components: 8 a product design and development process; 8 a customer satisfaction improvement process, which is the primary focus of this chapter.

Figure 1. The product design and development process

Act 9. Track customer satisfaction

8. Sales and after-sales service 7. Plan for process control 6. Plan for manufacture and service

Check

1. Identify targeted market

Plan

2. Identify critical customers 3. Determine customer requirements 4. Identify corresponding design requirements 5. Design and engineer product

Do

The product design and development process of a business, shown in Figure 1, is how that business designs new products, services, and systems to provide customers with whatever the company sells. Many companies do not use a process to perform this function, leading to poorly designed products that do not meet the critical customers’ needs, cannot be economically provided, and do not perform in the field as designed.

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Generating Increased Revenue and Profitability Figure 2. The customer satisfaction improvement process

Act

9. Track customer satisfaction 8. Sales and after-sales service

7. Implement required elements for process control

Check

6. Improve products, services, and/or manufacturing methods

1. Identify market to be served

Plan

2. Identify critical customers 3. Determine customer requirements 4. Translate requirements into internal quality characteristics 5. Select and prioritize opportunities for improvement

Do

The customer satisfaction improvement (CSI) process represented in Figure 2 has been designed as an ongoing nine-step process that is based on the plan, do, check, act (PDCA) model. The purpose of each of the nine steps of this model can be described as follows. Step 1. Identify the market(s) to be served or targeted Generate a strategic plan that identifies the strategic and tactical markets within which the firm must hold or expand market share, sales, profits, or realization prices. Step 2. Perform a critical customer analysis Generate a list of those critical customers who must be targeted within each market segment in order for the strategic and business plans to be achieved. Avoid the error of referring to all other customers as “noncritical.” Choose another label for this group, such as “select” or “key.” The critical customer analysis worksheet shown in Figure 3 illustrates the output of such an endeavor.

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Business Performance Excellence Figure 3. Example of a critical customer analysis worksheet Market/group:

Geographical region:

Other details

Toaster pastries

Retailers $1MM/month

North America

Ranking: 1 = highest/best/preferred Weights: 1 = least important Totals: lowest = critical

Sum (median) rank × Weight

(C)ritical or (K)ey

Insert X where appropriate

1

3

4

2

5

6

1

5

5

7

8

8

138

K(7)

X

5

8

8

5

5

7

138

K(7)

Potential

Cost pressure

Final decision

Logistics

Vital factor analysis Partnership potential

Critical analysis

Market share potential

ACME

Total

Profitability

Customers

Prioritization criteria/weights

Current volume

Customer categories

Past

Selection details

Product/category

Active

Scope

X

R&H Sales C.E.L. Assoc.

X

3

7

3

3

1

3

65

C(4)

Winsome

X

4

4

2

1

2

1

42

C(1)

Kramers

X

8

3

4

2

3

2

64

C(2.5)

Shopping Mart

X

2

2

1

4

4

4

64

C(2.5)

Shopper’s Paradise

X

7

1

6

8

6

5

110

K(5)

Pakulas

X

6

7

7

6

7

6

138

K(7)

An important point when performing a critical customer analysis is that the prioritization criteria are selected by upper management by consensus, but that data determine the rankings within each category. This reduces the human tendency to identify certain customers as critical for emotional reasons rather than on the basis of a true assessment of their importance in achieving the company’s vision. Step 3. Determine/identify customer requirements and barriers to achieving preferred supplier status This is a major and critical element in the successful implementation of a CSI process. The purpose of the research to be conducted in this step is to: 8 discover alarming situations for which existing alarm signals are silent; 8 discover opportunities not disclosed by present sources of information; 8 test existing unsupported beliefs and those held as “axiomatic.” The result of the acquisition of data in this regard is to define, for the critical customers in the key market segments, those deficiencies in product performance, product quality, product defect conditions, delivery, service, and price that are barriers to your company becoming a preferred supplier. This analysis must be done carefully

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Generating Increased Revenue and Profitability and cautiously. Make certain that you do not fall into the trap of the unlinked customer satisfaction index! Frequently, companies make the mistake of establishing customer satisfaction indices, and subsequently devoting significant resources to achieving their associated targets, without properly establishing through empirical methods that a change in the satisfaction index will result in a change of sales, market share, or price from the more satisfied customer(s). Increasing customer satisfaction in the presence of flat or declining financial KPIs is a hollow victory. Often, a survey is utilized to gather these data. Again, there are many pitfalls associated with this data-gathering method. Some of the errors to avoid in conducting customer surveys are: 8 a lack of valid and reliable instrumentation; 8 surveying customer personnel who have no decision-making authority related to supplier sourcing or pricing; 8 failure to separate data for critical vs key customers; 8 improper aggregation of data such that multiple responses from a single customer or location falsely weight the analyses relative to locations where there is a single response; 8 ineffective survey strategies that result in low return rates (for comparative purposes, it is noted here that firms utilizing the survey process designed by the first author’s company often experience response rates from select (critical) customers ranging from 75% to 90%); 8 failure to integrate and assess current performance against the competition; 8 failure to provide survey results and action plans arising from them as feedback to the customer base (for example, customers of Inland Steel receive updates from the vice president of sales and marketing on the status of the company teams assigned to work on their requests and problems as detailed in periodic surveys); 8 and, finally, the worst error of all: commissioning efforts based on an inappropriately designed customer survey that result in utilizing resources to work on issues or tasks which (as discovered “after the fact”) are not translatable to an increase in sales, market share, profits, or some other characteristic that has a positive and significant impact on the business plan. Step 4. Translate customer requirements and barriers into internal quality characteristics These quality characteristics may relate to product performance, quality, service, delivery, or pricing issues. A strategy that may be used effectively in this step is often referred to as quality function deployment (QFD). Step 5. Identify, prioritize, and select opportunities for improvement Again, make certain that you work only on (or, at least, primarily on) those activities which will positively and significantly impact your KPIs and your business and strategic plans. Steps 6 and 7. Execute improvement activities to improve products and/or services, and implement those elements that are necessary to bring critical characteristics into a state of control, capability, and acceptability. Complete this step by standardizing those systems that were the focus of the improvement effort in order to maintain the gains achieved over the long term

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Business Performance Excellence Strategies employed in steps 6 and 7 include the quality improvement strategy, the problem-solving strategy, and reliability and asset utilization improvement strategies. Tools employed in these efforts include design of experiments (DOE) and statistical process control (SPC) charts. Refer to Duncan (1995) for detailed descriptions of these tools and strategies. Step 8. Sales and after-sales service This activity contains all the elements required to effectively follow up on and leverage the gains achieved for increasing sales, share, or price with critical customers. Step 9. Tracking customer satisfaction Finally, the CSI process requires that the critical customers be tracked over time in order to understand or verify the following questions (those listed here are given as examples). 8 Are the critical customers seeing the improvements and/or changes that we believe we have achieved? 8 Are we moving into a preferred supplier status with the critical customers, or has there been “backsliding” in other elements of our products or services that has continued to put us at risk? 8 If we have become a preferred supplier, has this status been effectively translated into increased business or improved profitability with critical customers? 8 If we are improving in the view of the critical customers, how are we performing in comparison to our competition? How has this relative analysis affected our goal of becoming a preferred supplier, increasing our sales, or improving our market share or profitability?

Case Study

Illustration of Step 9: Tracking Customer Satisfaction The components of a good CQA system are numerous and include process and product control charts, QFD charts, control plans, failure modes and effects analyses (FMEAs), and results obtained by problem-solving and quality improvement teams. However, since these are covered in detail in many references (including those at the end of this chapter and other chapters in this book), the authors have decided to present a unique output from step 9 of the CSI process we have presented that shows how valuable this feedback can be. The Inland Steel Company, Chicago (now part of Arcelor/Mittal SA), wanted to use customer input to drive its improvement activities. Unfortunately, for many years it had been sending out surveys much like most businesses: the surveys were sent to the wrong people, they were poorly designed, and no activities were generated based on their results. Starting in Spring 1995, one author (Luftig) designed a new survey and response-tracking system. By targeting the decision-makers at critical customers and confidentially tracking individual customers’ responses over time, the changing picture of customer satisfaction can be revealed.

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Generating Increased Revenue and Profitability As an example, we can examine the “turbo table” shown in Figure 4 and see how individual responses changed from the spring to the fall survey for the question: “Based on your experience during the last six months, please rate your overall satisfaction level with Inland’s performance, in general.” Each respondent’s answer was tracked from the spring to the fall survey. Thus, for example, eight individuals said that they were “somewhat dissatisfied” in the first survey, but that they were “somewhat satisfied” in the second. Improvements in overall satisfaction were highlighted by the use of color: cells that indicated improvement were colored blue, green, or light green (these appear in the top right corner of the diagram). Cells that indicated decline were shaded yellow, orange, or red (those at bottom left in the diagram). Figure 4. “Turbo table” showing changes in responses between Spring 1995 and Fall 1995 to the question: “Based on your experience during the last six months, please rate your overall satisfaction with Inland’s performance, in general.” Survey no. 2 (fall 1995) results 1 Very dissatisfied

5 Very satisfied

+

+

2 2.6% +

2 2.6%

3 3.9% +

8 10.4% +

2 2.6% +

4 5.2%

–

5 6.5% –

7 9.1% +

2 2.6% +

4 Somewhat satisfied

2 2.6% –

2 2.6% –

1 1.3% –

18 23.4%

7 9.1% +

5 Very satisfied

1 1.3% –

1 1.3% –

3 3.9% –

4 5.2%

1 Very dissatisfied

Survey no. 1 (spring 1995) results

4 2 3 Somewhat Neither Somewhat dissatisfied satisfied nor satisfied dissatisfied

2 Somewhat dissatisfied 3 Neither satisfied nor dissatisfied

3 3.9% –

Legend within cells:

–

+

Number of responses Per cent responses +/– change

This table, and others like it, gave Inland Steel a quick way to determine if what it was working on was resonating with its most important customers. Respondents whose opinions were assessed as unchanged are in the white boxes—in these cases, the work Inland was doing was not significantly changing the respondents’ opinions about its performance. Respondents in the yellow boxes (the three lightest gray boxes at bottom left) were slightly more negative than they were in the first survey, while those in the light

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Business Performance Excellence green boxes (the three lightest gray boxes at upper right) were slightly more positive. Those in the two orange boxes (mid-gray, bottom left) were more strongly negative, while those in the two dark green boxes (mid-gray, upper right) were more strongly positive. Those in the red box (dark gray, bottom left corner) had changed their opinion from “very satisfied” to “very dissatisfied” in half a year, while those in the blue box (top right corner cell) had changed their opinion from “very dissatisfied” to “very satisfied” during the same time frame. Subsequent analysis showed that which box in the table a customer fell into was a leading indicator of future business levels. For every question in the survey, respondents were also asked how they evaluated Inland’s competition during the same period. So, for example, customers were asked to assess both Inland’s overall performance and Inland’s overall performance vs its major competitors. This meant that, for those respondents who completed both questions in two subsequent surveys, Inland now had a Net change value = {(% Total positive change) – (% Total negative change)} associated with its own performance, and the same Net change difference as related to the two answers concerning its competition. The two Net change values (Inland, and Inland vs the competition) created a bivariate data point, which was plotted on a variant of a relational diagram developed expressly for this purpose. Similar tables were generated for all of the paired items in the survey (see Figure 5). Figure 5. Customer perceptual map, net change from first quarter 1995 to third quarter 1995

Relative performance net change (%)

20 15 Product quality

10 5 Pricing 0 –5

Delivery

Service

Product performance

–10

Defects

–15 –20 –20

–15

–10

–5

0

5

10

15

20

Inland Steel‘s performance net change (%)

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Generating Increased Revenue and Profitability Summary and Further Steps A comprehensive customer quality assurance system, with an appropriately designed customer satisfaction improvement process, can serve as a major element in assuring the health of any organization as measured by its critical performance measures and the successful achievement of its business plan year after year. The overall CSI process is summarized in Table 1. Table 1. Overview of the customer satisfaction improvement process Step

Activities

Objectives

1

Identify and select market

• Strategic product–market Selection of market(s) in analysis congruence with business • Market analysis: strategy • size of market; • analysis of competitors. • Assessment of business abilities

2

Select customers

•  A priori segmentation methods • Selection of target market segment: • determine size of market segment; • assess competitive position; • list differentiation methods; • customer identification and prioritization.

Target market segment selection based on a priori methods Identify the vital few customers

3

Determine customer requirements

•  Market research: • primary; • secondary. • Identify and prioritize customer needs • Post-hoc segmentation methods • Competitive analysis of needs

Develop a master table of customer requirements and internal quality characteristics

4

Translate requirements into internal quality characteristics

• Identify internal quality characteristics • Assess strength of association between requirements and internal quality characteristics • Update matrix (QFD table)

Develop a master table of customer requirements and internal quality characteristics

5

Select and prioritize •  Assess customer requirements for: Select and prioritize opportunities for • importance to customer; opportunities and strategies for improvement • gap in performance; improvement • competitive position; •  technological feasibility of improvement; • resource requirements. •  Select strategy for improvement •  Get organizational consensus

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Business Performance Excellence 6

Improve products, services, and/or manufacturing methods

• Products: • design or modify product characteristics; • optimize characteristics to assure robustness of design for manufacture and use; • assessment and optimization of reliability. • Service: • design or modify service characteristics; • select service characteristics and optimize. • Manufacturing: • design or modify manufacturing process; • assess strength of association between endof-life product characteristic and manufacturing processes; • utilize advanced quality planning.

Close targeted gaps through optimization of design, service, or manufacturing

7

Implement required elements for process control

• Identify critical process parameters • Implement software quality control and assurance (SQC and SQA); assess control and capability • Link critical process parameters to customer requirements in master table • Standardize (using SOPs) around optima

Identification of critical processes; control plans in place; capability established

8

Sales and aftersales services

• Monitor critical processes • Incremental improvements through daily management and quality improvement strategies (QIS) • Eliminate deficiencies through PDCA and problem-solving

Control and incrementally improve the process

9

Monitor and measure customer satisfaction

• Measure customer satisfaction Control and incrementally with customer feedback improve the process system; identify and prioritize gaps • Periodic focused market research • Evaluation of satisfaction feeds next cycle

For a company to survive in today’s market place, is necessary to understand who your important customers are, what they want, and how well you are performing in providing them with it. In this chapter we have outlined the steps to build a comprehensive and effective CQA system that will allow you to improve customer satisfaction (of the right customers), which in turn will result in increased longevity and health of your business.

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Generating Increased Revenue and Profitability More Info Books: Akao, Yoji. QFD: Quality Function Deployment—Integrating Customer Requirements into Product Design. New York: Productivity Press, 2004. Duncan, William L. Total Quality—Key Terms and Concepts. New York: AMACOM, 1995. Online at: tinyurl.com/bnvx6sn Luftig, Jeffrey T. A Quality Improvement Strategy for Critical Product and Process Characteristics. Farmington Hills, MI: Luftig & Associates, 1991. Luftig, Jeffrey T., and Michael Petrovich. Quality with Confidence in Manufacturing. Chicago, IL: SPSS, 1997. Medlin, C. H. Reliability Methods for Processes and Equipment. Southfield, MI: Luftig & Warren International, 1992. Website: Luftig Warren (marketing solutions and resources): www.luftigwarren.com

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Financial Techniques for Building Customer Loyalty by Ray Halagera The Profit Ability Group, USA

This Chapter Covers 8 Given that one of the three key determinants of customer loyalty is the total cost of owning a company’s product or using their service, financial techniques can play a significant role in building customer loyalty, and ultimately the company’s profitability. 8 Some of the financial techniques that can be used to build customer loyalty include: 8 discounting; 8 frequent buyer programs; 8 loyalty programs; 8 special terms for prepurchasing; 8 enhanced credit terms; 8 bundling of goods or services; 8 discounts on purchasing related goods or services. 8 Since all markets are not the same, not all financial techniques have the same impact across markets. Whether the market consists of consumer or business buyers is the biggest determinant of how effective a financial technique is in building customer loyalty. 8 Implementing a technique to build loyalty with customers may not have a shortterm payoff, and in certain markets it can actually create problems that cost the company more than the increased profitability attributable to increasing the period of time the customer is retained.

Introduction

Every organization knows that in order for it to survive, let alone grow, it has to acquire and then retain profitable customers. And it is loyal customers that generate increasing profits for each additional year they are retained. 8 Acquiring new customers can cost five times more than retaining current customers.1 8 A 2% increase in customer retention has the same effect on profits as cutting costs by 10%.2 8 A 5% reduction in customer defection can increase profits by 25–85%.3 8 The customer profitability rate over the life of a retained customer tends to increase annually by up to 20%.4 8 Extensive and continuing research into customer loyalty has concluded that it is driven by the customer’s ongoing perception of value, which is a combination of: 8 what the customer receives; 8 how the product or service is sold, delivered, and supported;

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Business Performance Excellence

8 how much the product or service costs—that is, the price or total cost of ownership.

Finance professionals can deploy a wide range of techniques that can impact the customer’s total cost of owning their company’s product or using their company’s service, which in turn impacts customer loyalty and ultimately the organization’s profitability. Not only do financial managers need to be aware of the many techniques under their control, but they also need to be aware of some of the problems, where relevant, that may be encountered in implementing a specific technique.

Two Provisos

First, a financial manager’s primary goal is to maximize the organization’s profitability by accounting, analyzing, and reporting the financial implications of actions taken or which it is proposed to take. And they are usually expected to make a recommendation based on their findings. Because many of the suggested financial techniques to increase customer loyalty have short-term benefits that may not cover the short-term costs, financial managers may be reluctant to recommend many of the techniques if they lose sight of the longer-term benefits of customer loyalty and subsequent long-term retention. Second, not all markets and customers are the same, and, accordingly, not all financial techniques will have the same impact on building customer loyalty. The major determinant as to whether or not a specific financial technique will impact customer loyalty is whether the customer is in a consumer market or a business market. In selling to a consumer market (business to consumer, or B2C), the market attributes include: 8 the value of a transaction is usually small; 8 the number of buyers is large; 8 the selling cycle is short; 8 the product, and even the service, can be mass-produced; 8 the selling effort is focused on the end user. Selling to a business market (business to business, or B2B) requires taking into account attributes that include: 8 the value of transactions is usually larger than for B2C; 8 there are fewer buyers than in B2C; 8 the selling cycle can be long, complex, and involve an ongoing relationship between the seller and whoever is in charge of purchasing decisions; 8 the product or service often needs to be customized; 8 the selling effort is often directed toward a decision-maker who is not the end user. The above attributes can render a technique for building customer loyalty in a B2C market inappropriate for a B2B market, and vice versa. These differences will be noted where appropriate.

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Financial Techniques for Building Customer Loyalty A Range of Financial Techniques for Building Customer Loyalty

As discussed above, total cost of ownership is one of three drivers of the customer’s perceived value of a good or service, with perceived value determining how loyal the customer will be to the seller. Accordingly, any financial technique that can positively impact the customer’s perceived total cost of ownership will build customer loyalty. Of the multitude of financial techniques that are in use, the following are the more prevalent.

A Discounted Price over a Contracted Time Period

The seller offers a lower price for a good or service in return for the buyer committing to purchase the good or service for an extended period of time, usually two to three years, thereby locking in the customer’s business over that period. Potential problem: The less unique the product or service is compared to those offered by competitors, the more likely it is that the buyer will use the proposed lower price to negotiate an even lower price under similar terms with one or more competitive suppliers, and then to negotiate a still lower price with the supplier that originally proposed the discounted price. Accordingly, the less unique or customized the good or service is (which usually applies to B2C markets), the less viable this financial strategy is for building customer loyalty.

A Discounted Price for a Committed Volume Purchase with Variance

The seller offers a lower price for a good or service in return for the buyer committing to purchase a certain volume over a period of time. The seller and buyer further agree that if the buyer purchases a certain percentage less than the agreed amount by the end of the period (usually 95% or less), the buyer will pay a premium at the end of the period for the smaller amount purchased, with the premium equaling the difference between the contracted discounted price and the higher price associated with the lower volume times the number of units purchased. Potential problem: Like the problem arising with a discounted price over a period of time, the buyer may use the proposed lower price and terms to negotiate a better price and terms with a competitive supplier. Accordingly, this financial technique is more viable with unique or customized goods or services, and is therefore more appropriate for a B2B market.

Frequent Buyer Program

The seller offers the buyer a rebate or free goods or services subsequent to the buyer purchasing a certain dollar or unit volume. Coffee house chains such as Kaldi’s in St Louis, Missouri, provide a Coffee Club card that is punched every time a cup of coffee is purchased, with the card holder receiving a free cup of coffee after ten purchases. Potential problem: Competitors may decide to offer their own frequent buyer programs, and may even increase the value of the rebate, rendering this an ineffective technique for persuading customers to stay with the supplier and not utilize the competition.

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Business Performance Excellence Loyalty Program

The seller offers preferential treatment or certain services free to buyers who enroll in a loyalty program. National Car Rental’s Emerald Club allows its members to bypass the rental counter and even to select any rental vehicle that is available in their rental class on the lot. Avis’ Preferred allows its members to bypass the rental counter and go straight to the rental cars. Loyalty programs such as American Airlines’ AAdvantage program offer increasing levels of benefits for members who increase their air miles over a given time period, with Platinum members given preferential seating and boarding over Gold members. Potential problem: The added cost of the preferential treatment or benefits may not be offset by the profitability that is expected to be generated by repeat usage by a loyal customer if competitive suppliers offer comparable preferential treatment and benefits, especially if enrollment in a loyalty program is at no cost or low cost. In such a situation the buyer will enroll in multiple competitive loyalty programs and purchase the lowest-priced goods or services.

Prepurchase/Buy Forward

The seller offers a discounted price to a buyer who pays in advance for an amount of goods or services to be delivered at some future date or over a certain time period, with the discount rate being greater than the interest rate paid on money placed in a low-risk investment. The benefit of this technique to the seller is that it locks in the buyer’s business over a certain period. The benefit to the buyer is that it eliminates any price increases during the contracted period. Potential problem: The buyer may try to secure comparable terms with a competitive supplier and then use those terms to negotiate better terms with the original supplier, or the buyer may give the business to the supplier offering the best terms.

Enhanced Buyer Credit Terms

The seller offers to finance the buyer’s purchases at an interest rate and terms equal to or better than the buyer would receive from a third-party commercial source of credit. Potential problem: The buyer may try to secure comparable terms with a competitive supplier. Furthermore, the seller needs to ensure that the buyer is creditworthy.

Bundling Goods or Services

The seller includes ancillary goods or services at no cost to the buyer when a primary or major good or service is purchased. Personal computer manufacturers such as Dell and HP bundle printers, monitors, and even 24-hour help services with the price of the computer. Express oil change services such as Jiffy Lube include topping off all fluids and checking tire pressure in the price of an oil change. Potential problem: The seller needs to have good cost accounting of the services or goods bundled in with the primary good or service to ensure that profit margins are not needlessly eroded by including certain goods or services in the bundled package.

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Financial Techniques for Building Customer Loyalty Discounts on Related Goods

The seller offers a discount on additional units of an item or other items it sells and which are purchased at the same time as the first unit is purchased. This technique for creating customer loyalty is often found in grocery stores where an item is advertised at some percentage off the price of the second unit purchased. Potential problem: Competitors may implement the same pricing strategy and thereby remove any incentive for the buyer to be loyal to the seller that initially implements the strategy.

Trade-Ins

The seller offers to buy back its durable goods at prices better than the buyer can secure on the open market if he or she replaces the goods with another version of the seller’s durable goods. This financial technique for building customer loyalty has been deployed by sellers ranging from automobile dealers to clothing retailers.

Money-Back Guarantees or Penalty Payments

The seller commits to buying back the good or refunding fees for a service delivered if the good or service doesn’t meet the performance standards established at the time of the sale. During its formative years Domino’s Pizza grew in large part through loyal customers retained by its promise “pizza delivered to your house in 30 minutes or it’s on us.”

Benefit Sharing

The supplier offers the buyer a good or service at a highly discounted price under the condition that the buyer shares any cost savings or revenue generated from using the good or service. A select number of companies that provide sales training sell their training programs at deep discounts to buyers who agree to share a portion of the increased revenue attributable to their sales people going through the training. Case Study

Use of Financial Incentives to Secure a Customer’s Loyalty Career Systems International (CSI) is a company that provides training to managers on developing behavior conducive to engaging and retaining their direct reports. CSI successfully used a number of financial techniques to negotiate a multi-year contract for its training programs and services with a major hospitality chain that sought to reduce the high turnover rate of its employees. The financial techniques that were deployed to create a loyal customer who not only accepted the multi-year contract but also agreed to extend the contract at the time of renewal included:

8 A discounted price for a committed volume purchase with variance. The price per participant taking the training program was discounted in return for the hospitality chain agreeing to put 5,000 managers through the program over a two-year period. The buyer agreed that if fewer than 4,500 managers took the program during the two-year period, it would pay a premium of $20 for every participant who did go through the training program.

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Business Performance Excellence 8 Prepurchase/buy forward. The hospitality chain buyer was offered and took an additional 10% discount on the total cost of training the 5,000 managers by paying one-third of the total amount of the training fees at the time of signing, one-third at the first anniversary of the contract date, and the remaining third at completion of the two-year contract. 8 Bundling goods or services. CSI offered, at no cost to the buyer, a website providing suggestions, articles, chat rooms, online coaching, and other information related to management behavior conducive to retaining employees, with the website accessible only to managers who had completed the CSI workshop. 8 Customization. The seller also provided, at no charge to the hospitality chain, customization of the workshop to include the buyer’s terminology, reference to its management practices, and an assessment instrument which the buyer had been using. The above actions built customer loyalty by reducing the buyer’s total cost of ownership for the training initiative once the buyer was willing to make a commitment to buy the training materials and services and ancillary online support, over first a two-year time period, and then for a subsequent two-year period under the same conditions.

Making It Happen

Customer loyalty is one path to increased profitability for an organization. In any organization, marketing, customer service, and/or sales take the lead role in building customer loyalty. However, since the total cost of ownership is one of the three elements that determine the level of a customer’s loyalty, the financial function has the potential to significantly impact customer loyalty. For finance to play a key role in building customer loyalty, certain questions need to be addressed: 8 Is our organization aware of the increased profitability that is attributable to customer loyalty and subsequent customer retention? What information do I need to present to build the case for taking action to improve customer retention? 8 Does my company sell to consumers, or does it sell to businesses? The markets we sell to will determine both the short- and long-term viability of certain financial techniques. Some techniques may require nonfinancial elements to position us as preferable to our competition over the long run. 8 How unique are our goods or services in customers’ eyes? The more our goods or services are perceived as being no different to that of our competitors, regardless of the market we are in, the more likely it is that a financial technique which reduces the price paid by the customer will not increase customer loyalty because our competitors will copy it. 8 What techniques can we use that reduce the total cost of ownership as perceived by the buyer but do not require us to cut our effective price for the good or service or add a good or service that would reduce our gross margin on the sale? Money-back guarantees? Trade-ins? Loyalty programs? 8 Understanding that the profits from a loyal customer increase the longer we retain the customer, what technique can we use that avoids a price cut (though it may reduce our immediate gross margin) but which will

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Financial Techniques for Building Customer Loyalty increase the lifetime profit from the customer? Bundling goods or services? Discounts on related goods or services? 8 In considering price-cutting techniques to build customer loyalty—such as a discounted price over a contracted time period, or prepurchase—are we cost-competitive enough that the competition will not be able to profitably match our price-cutting techniques? More Info Books: Gitomer, Jeffrey. Customer Satisfaction is Worthless, Customer Loyalty is Priceless: How to Make Them Love You, Keep You Coming Back, and Tell Everyone They Know. Austin, TX: Bard Press, 1998. Johnson, Michael D., and Anders Gustafsson. Improving Customer Satisfaction, Loyalty, and Profit: An Integrated Measurement and Management System. San Francisco, CA: JosseyBass, 2000. Reichheld, Frederick F. Loyalty Rules: How Today’s Leaders Build Lasting Relationships. Cambridge, MA: Harvard Business School Press, 2003. Reichheld, Frederick F. with Thomas Teal. The Loyalty Effect: The Hidden Force Behind Growth, Profits, and Lasting Value. Cambridge, MA: Harvard Business School Press, 2001. Websites: American Management Association (AMA): www.american-management-association.org American Marketing Association: www.marketingpower.com Net Promoter, for a loyalty metric: www.netpromoter.com Professional Pricing Society (PPS): www.pricingsociety.com Strategic Pricing Group (SPG): www.strategicpricinggroup.com Word of Mouth Marketing Association (WOMMA): www.womma.com

Notes 1. Murphy, Emmett C., and Mark A. Murphy. Leading on the Edge of Chaos: The 10 Critical Elements for Success in Volatile Times. Paramus, NJ: Prentice Hall, 2002. 2. Ibid. 3. Reichheld, Frederick F., and W. Earl Sasser, Jr. “Zero defections: Quality comes to services.” Harvard Business Review 68:5 (September 1990): 105–111. Online at: tinyurl.com/73swsjh 4. Reichheld (2001).

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Statistical Quality Control for Process Improvement by Priscilla Wisner University of Tennessee, Knoxville, USA

This Chapter Covers 8  Statistical quality control (SQC) is a management philosophy that relies on straightforward statistical tools to identify and solve process problems. 8  Systematically identifying potential problems in process control, helps managers proactively make corrections before quality outcomes suffer. 8  SQC methods are useful in helping managers to measure whether their processes and products conform to design specifications, and they also help organizations to improve productivity and reduce waste. 8  SQC methods are used extensively in manufacturing settings but are also relevant in the service sector.

Introduction

Statistical quality control (SQC) is an optimization philosophy centered on using a variety of statistical tools to enable continuous process improvement. Closely linked to the total quality management (TQM) philosophy, SQC helps firms to improve profitability by improving process and product quality. Although initially used in manufacturing, SQC tools and methods work equally well in a service environment. SQC methods are used extensively by organizations to enable systematic learning. Using methods developed in the 1920s by Walter Shewhart and subsequently enhanced by quality consultants William Edwards Deming and Joseph Juran, organizations are able to use a set of straightforward statistics to find out whether or not their processes conform to expectations. Furthermore, the use of SQC methods can help to identify instances of process variation that may signal a problem in the process. By identifying process variation and potential nonconformance with design expectations early in the production or service environment, managers can proactively make corrections before the process variation negatively impacts quality and customer perceptions.

An Overview

Although SQC is enabled with statistical analysis, the management philosophy that underlies SQC is much broader than a set of statistics. To improve a process systematically, managers must first identify key processes and key variables of interest. Every organization has hundreds, if not thousands, of processes and variables that can affect product and service outcomes, and one challenge is to focus on the processes and variables that are of key concern. SQC tools can be useful in identifying areas that need attention, but managerial insight is needed to use the SQC tools strategically. Managers can directly influence organizational performance using SQC practices. Their choice of key processes and performance variables creates a feed-forward signaling

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Business Performance Excellence device to the organization about key performance indicators. This causes attention to be paid to these processes and variables. Feedback is then received through the SQC information, enabling evaluation of the data and an opportunity for corrective actions to be taken. Thus, SQC is not merely a set of statistical tools, but a management philosophy that helps organizations to improve performance through feed-forward and feed-back loops.

SQC Tools

The SQC toolkit contains a number of tools to help managers to evaluate processes. Many of the tools were first identified as essential to continuous quality improvement by Kaoru Ishikawa, a Japanese quality expert. This section describes a number of the tools that are commonly used by organizations to evaluate and improve quality performance. To learn more about how to construct each of these and other SQC tools, refer to the More Info section at the end of this article, where details and links are given.

Flowcharts

Flowcharts depict the progress of work through a series of defined steps. They can be used to communicate a process to employees who are being trained for the work, and management can use them to evaluate process flows, constraints, and gaps. The symbols used in flowcharting are standardized; some of the more commonly used are rectangles (activities and tasks), diamonds (decision points), rectangles with a wavy base (documents), cylinders (files), and arrows (linkages). The flowchart in Figure 1 demonstrates an order entry process. Figure 1. Flowchart for an order entry process Take order

Input item numbers

Items accepted?

No

Correct item numbers

Yes Process credit card

Card accepted?

No

Correct problems

Yes Verify contact information

Generate confirmation number

Confirm number generated?

No

Create exception report

Yes Email order information to customer

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Statistical Process Control for Quality Improvement Pareto Charts

Pareto charts are graphical demonstrations of occurrences, with the most frequently occurring event to the left and less frequent occurrences to the right. Pareto charts are named after Vilfredo Pareto, an Italian economist who identified that 80% of the wealth is held by a relatively small share of the population. This has been translated into the Pareto principle, which says that about 80% of outcomes are typically created by about 20% of causes. By constructing a Pareto chart, managers can quickly see what problems are most prevalent in their organizations. The Pareto chart in Figure 2 shows the occurrences of accidents in a manufacturing organization. 58% of the accidents in the plant are falls, followed by broken bones at 20%. The managers can see that these two types of accident are the most prevalent, and they are perhaps related. Figure 2. Pareto chart of accidents in a manufacturing plant 100%

Accidents

80%

Cumulative 60% 40% 20% 0%

Falls

Broken bones

Burns

Cuts

Other

Accidents

58%

20%

11%

6%

5%

Cumulative

58%

78%

89%

95%

100%

Ishikawa Cause-and-Effect or Fishbone Diagrams

These diagrams depict an array of potential causes of quality problems. The problem (the head of the fish) is displayed on the right, and the bones of the fish— representing the potential causes of the problem—are drawn to the left. Potential causes are often categorized as materials, equipment, people, environment, and management. Other categories may be included as appropriate. Useful in brainstorming the causes of problems (including potential problems) from multiple perspectives, these diagrams should include all possible reasons for a problem. When completed, further analysis is done to identify the root cause. Figure 3 is an Ishikawa diagram in an airline setting.

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Business Performance Excellence Figure 3. Ishikawa diagram prepared for investigation of cause(s) of delayed flight departures Equipment

Ground crew

Availability

Plane cleaned Luggage loaded

Fueling Safety checks

Passengers loaded

Maintenance checks

Delayed departures Availability Weather

Preflight checks

Control tower clearance

Paperwork

Flight crew

Environment

Run Charts

Run charts are graphical plots of a variable over time. These charts can be made for a single variable, but they are useful in detecting trends or relationships between variables when two are included on the same run chart. In the example in Figure 4, the average wait time for a telephone customer service is plotted along with the number of lost calls—customers who hang up before a customer service person takes the call. As the run chart demonstrates, there is a relationship between average wait time and lost calls: as the wait time increases, customers are more likely to hang up. As the wait time decreases (samples 6 through 8), there are fewer lost calls. The widening gap between the lines shows that the problem of a customer hanging up decreases as the wait time diminishes.

4.5 4.0 3.6 3.0 2.5 2.0 1.5 1.0 0.5 0

550 500 450 400 350 300 250 200 150 100

Average wait time Lost calls

1

2

3

4

5

6

7

8

9

Lost calls

Average wait time (min)

Figure 4. Run chart for telephone customer service

10

Sample number

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Statistical Process Control for Quality Improvement Control Charts

Control charts combine expanded run chart information with statistical control data to help identify process variation over a period of time that is not likely due to random chance. Time can be defined as a production run, a series of batches, a day’s activities, or any relevant time period that captures the process being evaluated. Useful in manufacturing, administrative, and service functions, control charts provide rapid feedback on key variables of interest. Control variables of interest might include those listed in Table 1. Table 1. Examples of control variables in different business sectors Manufacturing environment

Service environment

Liters of liquid in a container Thickness of a coating Tension in a coil Direct labor time per unit Changeover time between batches Defect rates Overhead costs

Wait time in a bank line Delivery time for packages Temperature of a restaurant entrée Time lag between a customer request and a service response Infection rates in a medical setting Loan approval time

Control charts are used to show when a process is in, or out of, statistical control. Statistical control does not imply zero variation—some degree of variation is normal and it is unrealistic to expect zero variation. However, the control chart is able to demonstrate data patterns that indicate that a process is out of control, and it is useful as a tool for making continuous improvement by reducing variability. The most commonly employed control charts are the mean chart and the range chart, often referred to as X-bar and R-charts.

Mean Charts

Mean charts (X-bar charts) show the variation in a process by plotting the actual mean values of a set of sample data. Each set of sample data consists of multiple observations of the process that’s being evaluated. These data are plotted against the background of the mean of all the samples taken and the upper and lower control limits for the data. These limiting bounds are each three-sigma limits, meaning that almost all (99.73%) of the variation in the process is expected to fall within a six-sigma limit. Sigma, represented by the Greek symbol σ, is the standard deviation of a distribution. Signals from a mean chart that a process is out-of-control include the following: 8 Data points that fall above the upper control limit or below the lower control limit. 8 Eight or more consecutive data points that fall above or below the mean line. 8 Two out of three consecutive points in the lower or upper third of the chart. 8 Six or more consecutive data points that trend up or down within the chart, as this indicates a trend or drift of the variation in the process. 8 Fourteen or more points that alternate in an up or down direction, indicating that there may be too much variation in the process. Figure 5 is an example of a mean control chart, constructed for a month’s sample data. The chart shows that samples 2, 9, and 16 are all above the upper control limit,

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Business Performance Excellence indicating a problem. Interestingly, each of these samples was taken on the same day of the week (each is seven days apart). Another problem highlighted by the chart is the set of daily sample means recorded after day 20. Starting on that day, a series of sample means falls below the mean for the set of data. Although these data points are all within the control limits, they indicate a potential problem in the process because more than eight consecutive points fall below the mean. Figure 5. Mean control chart for a production process (y-axis represents mean values) 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 Weekly sample

Upper control limit

Mean

Lower control limit

Sample means

The Range Chart

Range charts (R-charts) are similar to mean charts in having upper and lower (threesigma) control limits, but the data plotted for each sample are now the range between the largest and the smallest value in the sample. By plotting the range of values, variation within each sample is more apparent. Signals from a range chart indicating that a process is out-of-control are similar to those for the mean chart and include the following: 8 Data points that fall above the upper control limit or below the lower control limit. 8 Eight or more data points in succession that fall above or below the mean. 8 Six or more consecutive data points that trend up or down, as this indicates a trend or drift of variation in the process. 8 Fourteen or more points that alternate in up and down directions, indicating that there may be too much variation in the process. The range chart in Figure 6, which has been constructed for the same set of data as the mean chart, demonstrates that there is wide variation in the sample data. As in the mean chart, the three data points that fall outside of the upper control limit indicate a process that is not in control. The strong variability in consecutive data points also indicates a potential problem in process control. As a general rule, although data points may fall within the control limits, variations from the norm can be pointers

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Statistical Process Control for Quality Improvement to performance problems, product returns, possible lawsuits, loss of customer loyalty, and loss of reputation. All of these risks can be costly for an organization. Figure 6. Range chart for same process data as in Figure 5 (y-axis represents difference between largest and smallest values within a sample of data) 3.0 2.5 2.0 1.5 1.0 0.5 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 Weekly sample

Upper control limit

Mean

Lower control limit

Sample means

Other Charts

Statistical process charts that are useful for assessing process variability include the following: SPC Chart

Type of Data

Description

X-Bar & s

Variables (Continuous)

An X-bar shows the central tendency, or average of a group of data. The s chart shows the standard deviation of the data.

X & Moving Range (X-MR)

Variables (Continuous)

An X-chart shows individual data points; a MR-chart shows the difference from one data point to the next.

np Chart

Attributes (Discrete)

A p-chart reports the number of non-conforming units within a sample.

p Chart

Attributes (Discrete)

A p-chart reports the percentage of non-conforming units within a sample. This is especially useful when sample sizes differ.

c Chart

Attributes (Discrete)

A c-chart reports the count of non-conforming instances within a sample. This differs from the p-chart in that the p-chart reports non-conforming units. In a sample, one unit with three defects would be reported as one non-conforming unit in a p-chart, and as three non-conforming instances in a c-chart. C-charts are used with data collected in subgroups of the same size.

u Chart

Attributes (Discrete)

Like the c-chart, a u-chart is used to report the count of nonconforming instances within a sample. But, the u-chart is used when the subgroups are of varying sizes.

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Business Performance Excellence Process Capability Analysis

Process capability analysis is a technique that is used to determine the ability of a process to meet product or service specifications. It is a useful tool to evaluate variation within a process and whether improvements can be made to process control. Although a process may be within control limits as determined by control chart data, capability analysis takes things a step further by evaluating the amount of variation in process outcomes (the product or service) compared to the capability of the process. Capability analysis is based on measures of process capability (Cp) and process control (Cpk). These measures are based on the means and standard deviations of a process variable and are indicators of the aptitude, or capability, of the process to perform. Similarly, measures of actual process performance (Pp) and process control (Ppk) demonstrate how a process is actually performing. A comparison of the actual process control data (Ppk) with the process capability data (Cpk) helps managers to numerically evaluate how much variation there is in an in-control (within control limits) process, and whether modifications of the process will reduce variation. Refer to the iSixSigma website for details of process capability calculations and uses (see More Info).

Taguchi Loss Function

The Taguchi loss function is based on the assumption that all variation has a cost, even when the variation does not violate the data patterns defined by control charts. This concept is most useful where deviations from expectation are expected to be costly. Taguchi posited that all deviations from target values ultimately result in customer dissatisfaction. The Taguchi loss function enables organizations to calculate the financial consequence of process variability, making it useful in reaching design decisions. Case Study

Graco Children’s Products1 Graco Children’s Products, a US manufacturer of children’s equipment such as high chairs, baby swings, and car seats, set itself the goal of improving product quality in the design phase of operations. By identifying problems early in the design process, the firm expected to reap benefits in manufacturing performance, product quality, and customer satisfaction. Using SQC tools, Graco managers were able to analyze multiple design options efficiently. For example, in the plastics injection molding area there were more than 30 variables of interest to evaluate. One analysis was done for a plastic grip handle on a child carrier seat. The handle had a problem with warping, which caused too much curvature in the part, making later assembly of the carrier seat difficult. Eight machine variables were identified as potential causes of the problem. By using SQC analysis data, Graco determined that three variables—hold time, cure time, and material temperature—significantly impacted warping. By modifying these processes, the organization was able to correct the problem and reduce associated costs. The SQC analysis also showed that cooling temperatures did not significantly impact quality outcomes, which led to a decision not to invest in expensive cooling equipment. By using SQC tools to focus attention on process variables that could be controlled in the design phase of the product, Graco managers improved process and product quality, which resulted in savings for the organization.

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Statistical Process Control for Quality Improvement Summary and Further Steps

Conclusion Statistical process control benefits organizations by providing a systematic method for the monitoring and evaluation of process variation. Too often, managers do not notice changes and problems in processes until either the output is inspected or customers make complaints. By proactively identifying potential process problems and using SQC tools to evaluate process outcomes and improve process control, organizations are able to direct their resources more efficiently and can focus management time and attention on the most pressing problems.

Making It Happen SQC tools can be used in the following stages of process evaluation and improvement:

Identify the Problem 8 Flowcharts identify and communicate information about the flow of a process, including constraints and gaps. 8 Pareto analysis identifies the issues that are causing most of the problems.

Identify the Reasons for the Problem 8 Use Ishikawa cause-and-effect diagrams to brainstorm the causes of a problem from a multidimensional perspective.

Analyze the Data 8 Run charts show the variability in data over time and the potential relationships between multiple variables. 8 Control charts identify process variation using a set of statistical tools, enabling the identification of out-of-control variation. 8 Process capability analysis is used to show the amount of variation in an in-control process, and can be useful in improving a process. 8 The Taguchi loss function assigns an economic value to variation, helping to make trade-off decisions in process and product design.

More Info Books: Amsden, Robert T., Howard E. Butler, and Davida M. Amsden. SPC Simplified: Practical Steps to Quality. 2nd ed. New York: Productivity Press, 1998. Crossley, Mark L. The Desk Reference of Statistical Quality Methods. 2nd ed. Milwaukee, WI: ASQ Quality Press, 2007. Pyzdek, Thomas. The Six Sigma Handbook: The Complete Guide for Green Belts, Black Belts, and Managers at All Levels. New York: McGraw-Hill, 2003.

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Business Performance Excellence Websites: American Society for Quality (ASQ), a professional association dedicated to learning about quality and the improvement of quality in organizations. ASQ administers the prestigious Malcolm Baldrige National Quality Award. Membership is available to individuals or organizations: www.asq.org iSixSigma, an online forum and extensive statistical process control resources: www.isixsigma.com Management and Accounting Web (MAAW), dedicated to education, research, and the practice of management and accounting disciplines. Contains links to dozens of management and finance resources: www.maaw.info Managers-Net, an archive of articles and examples of management topics. Click on “Contents” and then on “Index to the Complete Technical Archive” for an alphabetical list of topics: managers-net.com Quality America, Inc., has resources for implementing SQC tools, including articles, an encyclopedia, technical references, and interpretation guides for SQC analysis: qualityamerica.com

Notes 1. Excerpted from Anon. “Graco uses SPC software to improve quality of products (statistical process control at Graco’s Children’s Products).” IIE Solutions 29:1 (January 1, 1997).

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Business Ethics by Sue Newell Bentley University, Waltham, Massachusetts, USA

This Chapter Covers 8  Business ethics focuses on identifying the moral standards of right and wrong as they apply to behavior within and across business institutions and other related organizations. 8  Corporations sometimes behave unethically, having a harmful effect on people or the environment. 8  Unethical behavior is typically not caused by a single “bad apple,” but is a result of complex interactions between individuals, groups, and organizational cultures. 8 Ethical behavior can be defined either as behavior that maximizes happiness and minimizes harm or as behavior that is motivated by principles of duty. 8  While behaving unethically may have some short-term benefit for a company, in the long term it will harm stakeholder support. 8 Long-term sustainability comes from concentrating on the triple bottom line: that is, social, environmental, and financial performance (Elkington, 1998).

Introduction

Look in the newspaper on virtually any day of the week and you will find at least one business scandal in which a corporation appears to have violated the rules or standards of behavior generally accepted by society. Company finances have been manipulated in order to show a better balance sheet than actually exists, toxic waste has been allowed to flow into a river, bribes have been paid to secure a business deal, child labor has been used to assemble a product, discriminatory practices have prevented the employment or promotion of members of a particular group. When businesses behave unethically, they act in ways that have a harmful effect on others and in ways that are morally unacceptable to the larger community. This is very serious because corporate power and impact are increasing as corporations become larger (indeed, global) and as profit-making concerns take over functions that were once publicly controlled, such as the railroads, water utilities, and healthcare. Increasingly, it is the private sector that determines the quality of the air we breathe, the water we drink, our standard of living, and even where we live and how easily we can move around.

Common Ethical Problems Within Corporations

Given the increasing social impact of business, business ethics has emerged as a discrete subject over the last 20 years. Business ethics is concerned with exploring the moral principles by which we can evaluate business organizations in relation to their impact on people and the environment. Trevino and Nelson (2004) categorize four types of ethical problems that are commonly found in business organizations. First are the human resource problems: These relate to the equitable and just treatment of current and potential employees. Unethical behavior here involves treating people unfairly because of their gender, sexuality, skin color, religion, ethnic background, and so on.

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Business Performance Excellence Second are ethical problems arising from conflicts of interest, when particular individuals or organizations are given special treatment because of some personal relationship with the individual or group making a decision. A company might get a lucrative contract, for example, because a bribe was paid to the management team of the contracting organization, not because of the quality of its proposal. Third are ethical problems that involve customer confidence. Corporations sometimes behave in ways that show a lack of respect for customers or a lack of concern with public safety. Examples here include advertisements that lie (or at least conceal the truth) about particular goods or services, and the sale of products, such as drugs, where a company conceals or obfuscates negative data about safety and/or efficacy. Finally, there are ethical problems surrounding the use of corporate resources by employees who make private phone calls at work, submit false expense claims, take company stationery home, etc. The financial scandals that have rocked the corporate world in recent years (Enron, WorldCom, Parmalat, Lehman Brothers, for example) have involved a number of these different ethical issues. In these cases, senior managers have engaged in improper bookkeeping, making companies look more financially profitable than they actually are. As a consequence the stockholder value of the company increases, and anyone with stock profits directly. Among those profiting will be those making the decisions to manipulate the accounts—and so there is a conflict of interest. However, the fallout from the downfall of these companies affects stockholders, employees, and society at large negatively, with innocent people losing their retirement reserves and/or savings, and employees losing their jobs. Another category can be added to this list—ethical problems surrounding the use of the world’s environmental resources. Many organizations have externalized the costs associated with their negative impact on the environment, whether in relation to their own operations to produce goods and services, or in terms of the use and later the disposal of the goods that they have sold. Externalizing means that organizations do not themselves pay for the environmental costs that they create. For example, carbon dioxide emissions, a by-product of energy use for all kinds of organizations, are now recognized as contributing to global warming; computer equipment contains toxic waste that pollutes the land where it is dumped; and packaging of all kinds, including plastic bags that are handed out by supermarkets, are creating mounting problems as local authorities run out of landfill sites. Increasingly, ethical business is seen to require that a business takes into account and offsets its “environmental footprint” so that it engages in sustainable activity. Sustainability broadly means that a business meets the needs of the present without compromising the ability of future generations to meet their needs.

Accounting for Ethical and Unethical Behavior

While it may be very easy to identify and blame an individual or small group of individuals, to see these individuals as the perpetrators of an unethical act—the “bad apple”—and hold them responsible for the harm caused, is an oversimplification. Most accounts of unethical behavior that are restricted to the level of the individual are

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Business Ethics inadequate. Despite popular belief, decisions harmful to others or the environment that are made within organizations are not typically the result of an isolated, immoral individual seeking to gain personally. Although an individual’s level of moral maturity or the locus of control (for example, the degree to which they perceive they control their behaviors and actions) are factors, we also need to explore the decision-making context—the group dynamics and the organizational practices and procedures—to understand why an unethical decision was made. Group dynamics influence the decision-making process. A particularly important group-level influence is groupthink, a phenomenon identified by Irving Janis (1982) in his research on US foreign policy groups. The research demonstrates the presence of strong pressures towards conformity in these groups: individual members suspend their own critical judgment and right to question, with the result that they make bad and/or immoral decisions. Janis defines groupthink as “the psychological drive for consensus at any cost that suppresses dissent and appraisal of alternatives in cohesive decision-making groups.” The degree to which decisions are ethical is also influenced by organizational culture or climate. Organizational ethical climates can differ; some are more egoistic, others are more benevolent, still others are highly principled, and these contexts can shape a manager’s ethical decision-making. Smith and Johnson (1996) identify three general approaches that organizations take to corporate responsibility: 8 Social obligation: The corporation does only what is legally required. 8 Social responsiveness: The corporation responds to pressure from different stakeholder groups. 8 Social responsibility: The corporation has an agenda of proactively trying to improve society. In a company in which the dominant approach to business ethics is social obligation, it is likely to be difficult to justify a decision based on ethical criteria; morally irresponsible behavior may be condoned as long as it does not break the law. Legal loopholes, for example, may be exploited in such a company if these can benefit the company in the short term, even if they might have a negative influence on others in society.

Ethical Dilemmas

Sometimes it is clear that a business has behaved unethically—for example, where a drug is sold illegally, the company accounts have been falsely presented, or where client funds have been embezzled. Of more interest, and much more common, are situations that pose an ethical dilemma—situations that present a conflict between right and wrong or between values and obligations—so that a choice is necessary. For example, a corporation may want to build a new factory on a previously undeveloped and popular tourist site in a location where there is large-scale unemployment among the local population. Here we have a conflict between the benefits of wealth and job creation in a location in which these are crucial and the cost of spoiling some naturally beautiful countryside. Philosophers have attempted to develop prescriptive theories providing universal laws that enable us to differentiate between right and wrong, and good and bad, in these situations.

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Business Performance Excellence Prescriptive Ethical Theories

Essentially there are two schools of thought. The consequentialists argue that behavior is ethical if it maximizes the common good (happiness) and minimizes harm. The opposing nonconsequentialists argue that behavior is ethical if it is motivated by a sense of duty or a set of moral principles about human conduct—regardless of the consequences of the action.

Consequentialist Accounts of Ethical Behavior

Philosophers who adopt the consequentialist approach (sometimes also referred to as utilitarianism) consider that behavior can be judged ethical if it has been enacted in order to maximize human happiness and minimize harm. Jeremy Bentham (1748– 1832) and John Stuart Mill (1806–73) are two of the best known early proponents of this view. Importantly it is the common good, not personal happiness, that is the arbiter of right and wrong. Indeed, we are required to sacrifice our personal happiness if doing so enhances the total sum of happiness. For someone faced with a decision choice, the ethical action is the one that achieves the greatest good for the greatest number of people after weighing the impact on those involved. Common criticisms of this approach are that it is impossible to measure happiness adequately and that it essentially condones injustice if this is to the benefit of the majority.

Nonconsequentialist Accounts of Ethical Behavior

Philosophers who adopt a nonconsequentialist approach (also referred to as deontological theory) argue that behavior can be judged as ethical if it is based on a sense of duty and carried out in accordance with defined principles. Immanuel Kant (1724–1804), for example, articulated the principle of respect for persons, which states that people should never be treated as a means to an end, but always as an end in themselves; leading to the easy to remember maxim—do as you would be done by. The idea here is that we can establish moral judgments that are true because they can be based on the unique human ability to reason. One common criticism of this approach is that it is impossible to agree on the basic ethical principles of duty or their relative weighting in order to direct choices when multiple ethical principles are called into question at the same time, or when decisions cut across cultures with different ethical principles.

Why Behaving Ethically Is Important for Business

Choosing to be ethical can involve short-term disadvantages for a corporation. Yet in the long term it is clear that behaving ethically is the key to sustainable development. When you’re faced with an ethical dilemma in which the immoral choice looks appealing, ask yourself three questions: 1. What will happen when (not if) the action is discovered? Increasingly, the behavior of corporations is under scrutiny from their various stakeholders—customers, suppliers, stockholders, employees, competitors, regulators, environmental groups, and the general public. People are less willing to keep quiet when they feel an injustice has been done, and the internet and other media give them the means to make their concerns very public, reaching a global audience. Corporations that behave unethically are unlikely to get away with it, and the impact when they are discovered can be catastrophic. This leads to the second question.

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Business Ethics 2. Is the decision really in the long-term interests of the corporation? Many financial services companies in the United Kingdom generated short-term profits in the 1990s by miss-selling personal pensions to people who would have been better off staying in their company’s pension plan. However, in the long term these companies have suffered by having to repay this money and pay penalties. Most significantly, the practice has eroded public confidence. The same is true of many banks and mortgage brokers in the first part of the 21st century when they sold mortgages to individuals who could not afford to repay their debts. The eventual result was that large numbers defaulted, causing a meltdown in the global financial system beginning in 2008. 3. Will organizations that behave unethically attract the employees they need? Corporations that harm society or the environment are actually harming their own employees, including those who are making the decisions. For example, corporations that pour toxins into the air are polluting the air their employees’ families breathe. Ultimately, a business relies on its human resources. If a company cannot attract high-quality people because it has a poor public image based on previous unethical behavior, it will certainly flounder. Behaving ethically is clearly key to the long-term sustainability of any business. Focusing on the triple bottom line—the social and environmental as well as the economic impact of a company—provides the basis for sound stakeholder relationships that can sustain a business into the future.

Summary and Further Steps

Making It Happen While the two approaches to evaluating behavior described above are clearly different, they can be integrated to create a checklist that will help an individual or group make sound ethical decisions.

8 Gather the facts: What is the problem, and what are the potential solutions? 8 Define the ethical issues. This is a step that is often neglected, so that the ethical dilemmas raised by a particular decision are never even considered.

8 Identify the various stakeholders involved. 8 Think through the consequences of each solution: What happiness or harm will be caused?

8 Identify the obligations and rights of those potentially affected: What is my duty here? Can I uphold my duty to avoid doing harm and make reasonable efforts toward that end? 8 Check your gut feeling. The last step is crucial. Those involved need to ask themselves what they would feel like if friends or family found out they had been involved in making a particular corporate decision, whether personally or collectively.

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Business Performance Excellence More Info Books: Elkington, John. Cannibals with Forks: The Triple Bottom Line of 21st Century Business. Gabriola Island, BC: New Society Publishers, 1998. Janis, Irving L. Groupthink: Psychological Studies of Policy Decisions and Fiascoes. 2nd ed. Boston, MA: Houghton Mifflin College, 1982. Smith, Ken G., and Phil Johnson. Business Ethics and Business Behaviour. Boston, MA: International Thomson Business Press, 1996. Trevino, Linda K., and Katherine A. Nelson. Managing Business Ethics: Straight Talk About How to Do It Right. New York: Wiley, 2004. Velasquez, Manuel G. Business Ethics: Concepts and Cases. 7th ed. Upper Saddle River, NJ: Pearson Education, 2011. Websites: Aspen Institute: www.aspeninstitute.org Bentley University Center for Business Ethics: cbe.bentley.edu Business in Society Gateway: www.businessinsociety.eu Institute of Business Ethics (IBE): www.ibe.org.uk International Business Ethics Institute: business-ethics.org

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Corporate Social Responsibility: More than PR, Pursuing Competitive Advantage in the Long Run by John Surdyk Wisconsin School of Business, Madison, Wisconsin

This Chapter Covers 8  Consumers increasingly expect companies to act in “responsible” ways. 8  Because of their scale and reach, companies have unusual opportunities to address social concerns in innovative and productive ways. 8  Evidence suggests that corporate social responsibility (CSR) practices produce long-term benefits with financial performance gains. 8 Advancing CSR is made easier with modern risk management tools, reporting guidelines, and committed leadership and employees.

The Emergence of Corporate Social Responsibility

Global greenhouse gas emissions continue to rise. Diseases wreak havoc across entire continents. An entire host of seemingly intractable issues confront governments throughout the world, which are sometimes unable to effect positive changes. With the emergence of companies as some of the most powerful institutions for innovation and social change, more shareholders, regulators, customers, and corporate partners are increasingly interested in understanding the impact of these organizations’ regular activities upon the community and its natural resources. With the world’s largest 800 nonfinancial companies accounting for as much economic output as the world’s poorest 144 countries, the importance of these organizations in addressing trade imbalances, income inequality, resource degradation, and other issues is clear. While companies are not tasked with the responsibilities of governments, their scale and their ability to influence these issues, necessitate their involvement and create opportunities for forward-looking organizations to exercise great leadership. In public opinion surveys, consumers admit that they prefer to buy products and services from companies they feel are socially responsible (72%) and that they sell shares of those companies they feel don’t pass muster (27%). Challenging Nobel laureate Milton Friedman’s notion that companies’ only responsibility is to make profit, executives are increasingly seeking ways to combine economic gain with social well-being in ways that will produce more customer loyalty, better relationships with regulators, and a host of other advantages. CSR practices may, in fact, prove pivotal to the success of a company. Sometimes described simply as “doing well by doing good,” corporate social responsibility initiatives gained traction in the 1990s as consumer interest in management practices erupted in the wake of several substantial incidences of executive malfeasance and of escalating environmental challenges. While originally focused on environmental factors, CSR reports increasingly include social measures. Likewise, company leaders today express interest in business models that weave

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Business Performance Excellence together explicit goals for profit, environmental performance, and social factors, at the same time recognizing that these efforts will likely yield no short-term financial benefits but rather long-term performance improvements.

A Cloudy Concept Begins to Crystallize

The phrase “corporate social responsibility” (CSR) describes both: 8 A social movement; 8 A collection of specific management practices and initiatives. Business leaders, government professionals, and others use these principles and tools to assess and report on organizations’ impact on society. Globally, CSR is an evolving concept without a clear definition, yet it describes a set of corporate obligations and practices somewhere on the spectrum between traditional charitable giving on the one hand and merely strict compliance with laws on the other. While operating definitions remain elusive, the term “CSR” generally refers to a company’s efforts to include social and environmental concerns explicitly in its decisionmaking along with a commitment to increasing the organization’s positive impact on society. Beneath these efforts is a realization that improved CSR reporting and better risk-management systems generally promote the transparency and accountability essential to good company governance and improved financial performance. These systems, in effect, enable a company to anticipate and respond to opportunities when it senses that society’s expectations aren’t being met by its performance.

Benefits from CSR

The benefits of corporate social performance reporting spread over an entire organization. Table 1. Benefits of CSR Business Area

Reduce Costs

Create Value

License to Operate

More favorable government relations; reduced shareholder activism; reduced risk of lawsuits.

Increased community support for the company’s operations (“a bank account of goodwill”).

Reputational Capital

Reduced negative consumer activism/boycotts; positive media coverage/“free advertising”; positive “word-of-mouth” advertising.

Increased customer attraction; increased customer retention.

Human Resources

Increased employee retention and morale.

Enhanced recruitment; increased productivity.

Finance

Social screens and investment funds are attracted to companies perceived as good social performers.

Areas of greatest gain for a company’s market value, operational efficiency, access to capital, and brand value typically come from:

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CSR: More than PR, Pursuing Competitive Advantage in the Long Run 8 Establishing ethics, values and principles for the organization; 8 Improving environmental processes or reducing environmental impact; 8 Improving workplace conditions. Other efforts, such as better governance measures, also tend to yield positive benefits for companies.

Making CSR Real

Traditional rhetoric about “private versus public” responsibilities is diminishing while companies operate more and more with an understanding of an acknowledged (if tacit) role to play in society. In the United States many people feel companies should be doing more to improve society through changing their business practices. Although implementing CSR initiatives in modern companies is a daunting prospect because of their increasingly complex and global operations, many CSR management frameworks have moved onto the international stage. Approximately 400 companies— including many of the world’s largest—use all or some of the Global Reporting Initiative (GRI), and combined environmental and social reports are increasingly common alongside companies’ regular sustainability reports. Launched in 1997 by the Coalition of Environmentally Responsible Economies, the GRI report contains 50 core environmental, social, and economic indicators for a broad range of companies. It also offers additional modules with distinct metrics for companies, depending on their industry sector and operations. The price range for producing a report spans from US$100,000 for a basic GRI to more than US$3 million for complex organizations like Shell. Other major initiatives and reporting standards provide helpful guidance and principles; among them are: 8 The United Nations Global Compact; 8 Global Environmental Management Initiative; 8 International Standards Organization guidelines (for example, ISO14000). The continued growth of the socially responsible investment movement, especially in the United States and Europe, is stimulating companies’ adoption of GRI and other instruments. In the United States alone, capital available to socially responsible companies reached US$2.29 trillion in 2005. Case Study Beginning with US$1,000 in a garage in 1990, Greg Erickson founded a new energy bar company, Clif Bars, Inc., in Berkeley, California. Committed to exercising environmental stewardship, Greg made expensive investments in organic ingredients and renewable energy while pursuing progressive employment practices such as six-month sabbaticals for employees. Refusing acquisition overtures from other companies, Clif Bars’ commitments to corporate responsibility laid a strong, long-term foundation for the growing US$100+ million company and its meteoric rise against titans like Kellogg and Quaker Oats.

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Business Performance Excellence Challenges to CSR

The majority of corporations in the world do not produce any reports on their CSR practices. Executives often cite several concerns, including: 8 Fear that they may undertake a CSR program while competitors do not, meaning they incur expenses and refocus management talent that may put them at a competitive disadvantage. 8 No feeling of urgency to act on many societal issues. 8 No accepted standard of what type of information should be reported or at what depth. 8 Concern that if they only achieve goals they largely establish for themselves, they may appear only half-heartedly committed—or they may even open themselves to lawsuits. 8 Trouble identifying stakeholders, meaning the audience for their reports may be ambiguous, which may, in turn, undermine the quality of the reporting generally. 8 Belief that traditional philanthropy fulfils an organization’s commitment to society. 8 Reporting on the entire scope of a company’s impact on society and the environment is increasingly complex. Recognizing “that one size does not fit all,” more companies are exercising greater discretion in reporting initiatives to highlight key information for their sector or the parts of the world in which they operate.

How to Get Started

These principles must be grounded in an organization for CSR management frameworks to yield their maximum benefit. 8 Ensure long-term organizational commitment by involving the top leadership and the employees. 8 Don’t adopt every reporting system: select one that makes the most sense for your industry and scale. 8 Carefully identify stakeholders to help develop feedback loops so you can adjust your course. 8 Consider benchmarking against peer companies. 8 Communicate your results widely. 8 Don’t be afraid to revise standards or develop new metrics of your own. Summary and Further Steps

Conclusion Evidence is mounting that CSR provides tangible benefits and lasting competitive advantage to organizations. While difficult to implement, corporate social responsibility practices and frameworks provide companies with a chance to influence the rules of competition positively while playing a crucial—and increasingly expected—role in the world.

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CSR: More than PR, Pursuing Competitive Advantage in the Long Run Making It Happen

There is no consensus among government bodies, companies, or consumers about what precisely constitutes a definition—or even a consistent set of management topics— under the umbrella of corporate social responsibility. Several intergovernmental bodies, company federations, and nonprofits have advanced competing definitions. Among the most influential are:

8 World Bank. “Corporate Social Responsibility, or CSR, is the commitment of business to contribute to sustainable economic development, working with employees, their families, the local community, and society at large to improve their quality of life, in ways that are both good for business and good for development.” 8 World Economic Forum. “Corporate Citizenship can be defined as the contribution a company makes to society through its core business activities, its social investment and philanthropy programs, and its engagement in public policy. The manner in which a company manages its economic, social, and environmental relationships, as well as those with different stakeholders, in particular shareholders, employees, customers, business partners, governments, and communities, determine its impact.” 8 Business for Social Responsibility. “CSR is operating a business in a manner that meets or exceeds the ethical, legal, commercial, and public expectations that society has of business. CSR is seen by leadership companies as more than a collection of discrete practices and occasional gestures, or initiatives motivated by marketing, public relations, or other business benefits. Rather, it is viewed as a comprehensive set of policies, practices, and programs that are integrated throughout business operations, and decision-making processes that are supported and rewarded by top management.” 8 Center for Corporate Citizenship at Boston College. “Corporate Citizenship refers to the way a company integrates basic social values with everyday business practices, operations, and policies. A corporate citizenship company understands that its own success is intertwined with societal health and well-being. Therefore, it takes into account its impact on all stakeholders, including employees, customers, communities, suppliers, and the natural environment.” 8 International Business Leaders Forum. “Corporate Social Responsibility means open and transparent business practices that are based on ethical values and respect for employees, communities, and the environment. It is designed to deliver sustainable value to society at large as well as to shareholders.” 8 United Nations. While not advocating a particular definition of corporate social responsibility, the United Nations uses the term “global corporate citizenship” to describe international companies’ obligations to respect human rights, improve labor conditions, and protect the environment. The UN Research Institute for Sustainable Development, which follows academic work in this area, typically concentrates on ethical issues and principles guiding how a company’s management engages stakeholders.

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Business Performance Excellence More Info Books: United Nations Conference on Trade and Development. Disclosure of the Impact of Corporations on Society: Current Trends and Issues. New York: United Nations, 2004. Online at: www.unctad.org/en/docs/iteteb20037_en.pdf Websites: Business for Social Responsibility (BSR): www.bsr.org CSR Network: www.csrnetwork.com Ethical Corporation: www.ethicalcorp.com SustainAbility: www.sustainability.com World Business Council for Sustainable Development (WBCSD): www.wbcsd.org

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Sustainability Management by John Elkington Co-founder and Executive Chairman, Volans; co-founder, Environmental Data Services (ENDS) and SustainAbility, London, UK

This Chapter Covers Some management trends start at the top and cascade down; others evolve from the bottom up. Sustainable development—and the linked sustainable business agenda—has come from both directions. In the process it has caught a growing number of well-known companies off balance—among them Shell, Monsanto, Nike and, most recently, BP and (to a lesser degree) Apple. More positive has been the evolution of a growing number of business-led initiatives in this space, among them the World Business Council for Sustainable Development (WBCSD). In parallel, organizations like the World Economic Forum (WEF) and Clinton Global Initiative (CGI) now routinely cover sustainability issues. But in many respects the process of transforming markets and economic and business models has only just begun. Key drivers of the emerging agenda include the following: 8  Demographic pressures that will create enormous new risks and opportunities. During the 20th century, the planet’s human population rose from 1.6 billion to 6 billion. There is likely to be a further 50 percent increase by 2030. 8  A growing range of environmental problems—including ozone depletion, climate change, the collapse of fisheries, and loss of forests—signals that today’s economic and business models are unsustainable. 8  Globalization: the end of communism in many countries pushed the one-third of humanity who used to live in the old communist world into the globalizing economy. In total, there are some four billion people living in the poorer parts of the world; it will be necessary to meet their needs—resulting in potentially huge "bottom-of-the-pyramid" markets, as the late C. K. Prahalad called them. 8  Business, as a result, is increasingly in the spotlight—and is expected to play a key role in defining and delivering sustainable development. Paradoxically, the governance vacuum created by accelerating globalization has increased the pressures on brand-name companies and on financial markets to act responsibly and effectively. 8  At the same time, however, growing resistance to current forms of economic globalization represents a profound challenge to free market capitalism— pressures fuelled by the two financial meltdowns of the last decade. 8  Since the late 1990s, growing numbers of companies have embraced the sustainability agenda, many using triple-bottom-line strategies,1 focusing simultaneously on economic prosperity, social equity, and environmental protection.2 8  A survey of over 700 CEOs globally, carried out by Accenture for the UN Global Compact in 2010, reported that 93% of the business leaders polled saw sustainability as important for their business—and 88% saw a need to integrate the relevant targets and metrics into the management of their supply chain.

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Business Performance Excellence 8 T he market push for such supply chain initiatives has intensified with the growing pressures coming from major retailers, among them Walmart and Marks & Spencer.

What Is Sustainability?

The answer, first laid out in the 1987 Brundtland Commission report, is that sustainability is the principle of ensuring that our actions today do not limit the range of economic, social, and environmental options open to future generations.

Why Is It Important?

Simply stated, sustainable development is the emerging 21st-century business paradigm. It is increasingly proposed by governments and business leaders as a solution for problems now racing up the international agenda. These range from climate change to human-rights issues.

The Sustainability Agenda

Interest in the sustainability agenda has cycled since the early 1960s, with a succession of four pressure waves to date, the latest probably peaking in 2009–10, with the relative failure of 2009’s UN climate conference in Copenhagen taking the wind out of the sails of many who had previously seen climate change as a market-transforming challenge. That threat is likely to develop further in the coming years, with a further short-term boost to interest likely around 2012, which will mark the 25th anniversary of the publication of the Brundtland Commission Report, Our Common Future, which started the process of mainstreaming the sustainability agenda in politics, government, and business.

Surely This Is a Job for Politicians and Lawmakers?

In part, of course, it is, but industry’s lobbying over the years for less regulation and in some cases active deregulation may now be coming back to haunt it.

What Has Sustainable Development Got to Do with Capitalism?

Simply put, traditional capitalism dealt with financial and physical forms of capital. Increasingly, however, companies are expected to manage, account for, and grow multiple forms of capital, for example, financial, physical, human, intellectual, natural, and social capital. In its Vision 2050 study3, WBCSD summarized the challenge as follows: “The goal was to see what a real, global attempt at sustainable development— with all the radical policy and lifestyle changes this would entail—would mean for business and markets in general and for the individual participating sectors. The elements of the pathway demonstrate that behavior change and social innovation are as crucial as better solutions and technological innovation. All types of ingenuity will be needed over the next 40 years. Although distinct, the elements also show the interconnectedness of issues such as water, food and energy—relationships that must be considered in

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Sustainability Management an integrated and holistic way, with trade-offs that must be understood and addressed. The critical pathway includes: 8 Addressing the development needs of billions of people, enabling education and economic empowerment, particularly of women, and developing radically more eco-efficient solutions, lifestyles, and behavior. 8 Incorporating the cost of externalities, starting with carbon, ecosystem services, and water. 8 Doubling of agricultural output without increasing the amount of land or water used. 8 Halting deforestation and increasing yields from planted forests. 8 Halving carbon emissions worldwide (based on 2005 levels) by 2050, with greenhouse gas emissions peaking around 2020 through a shift to low-carbon energy systems and highly improved demand-side energy efficiency. 8 Providing universal access to low-carbon mobility. 8 Delivering a four-to-tenfold improvement in the use of resources and materials. As WBCSD went on to say: “The transformation ahead represents vast opportunities in a broad range of business segments as the global challenges of growth, urbanization, scarcity and environmental change become the key strategic drivers for business in the coming decade. In natural resources, health and education alone, the broad order of magnitude of some of these could be around US$ 0.5–1.5 trillion per annum in 2020, rising to between US$ 3–10 trillion per annum in 2050 at today’s prices, which is around 1.5–4.5% of world GDP in 2050. Opportunities range from developing and maintaining low-carbon, zero-waste cities and infrastructure to improving and managing biocapacity, ecosystems, lifestyles and livelihoods.”

How Can We Sell This to the Financial Markets?

It’s going to be challenging, but in the coming decades the world’s financial markets will have no choice but to adopt triple-bottom-line (TBL), environment, social and governance (ESG) and/or other sustainability management models to assess value creation. Insurers and reinsurers have been badly affected by issues like asbestos, contaminated land, and toxic and nuclear wastes. Leading banks are increasingly sensitive both to new forms of risk and to emerging opportunities created by new environmental and social standards. The pension fund sector is also increasingly engaged, as shown by the Pharma Futures initiative (pharmafutures.org), convening leading pension funds and pharmaceutical companies. And while some financial analysts have been slow on the uptake, the entry of players like the Dow Jones Sustainability Group has provided a wake-up call. That said, the socially responsible investment (SRI) funds are themselves now coming under scrutiny, as in a highly critical 2010 study of over 100 SRI funds by SustainAbility, Rate the Raters.4

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Business Performance Excellence What the Gurus Say

The ways in which the environmental and wider sustainable-development agendas have been engaged by business have reflected the priorities of those held responsible at the time in the corporate world. To help simplify the evolutionary history, let’s focus on three main phases.

Phase 1—Denial

From the early 1970s, environmental and social issues were handled on the corporate periphery by lawyers or PR people. Most companies were in denial: pollution problems either were not their fault or, if they were, were seen as the price of wealth creation. Key issues include compliance, a company’s license to operate, and risk to reputation.

Phase 2—Cleaning Up

From the late 1970s the spotlight shifted to plant siting, production processes, and products. As a result companies tended to look to field planners, engineers, and new product development specialists, who used a growing range of tools such as impact assessments, audits, life-cycle assessments, and so-called clean technology. Eco-efficiency concepts introduced by the World Business Council for Sustainable Development were adopted by a growing number of companies. Phase 2 activity continues to build, with the European Commission introducing new strategic impact assessment requirements for major industrial projects.

Phase 3—Governance

During the 1990s concepts like that of the “triple-bottom-line” began to draw in more senior business people. CEOs and their boards began to pay attention, often because of the difficult trade-offs involved. A water pollution control investment, for example, might result in higher carbon dioxide emissions, raising climate change issues. Accountants have also been increasingly involved. In the process, the sustainabledevelopment agenda has begun to cross-connect with corporate and global governance agendas. Most mainstream management writers have overlooked these trends. In their classic text In Search of Excellence, first published in 1982, Tom Peters and Robert Waterman made not a single reference to environmental issues. By 1991, however, Peters had published Lean, Clean, and Green. Other mainstream management gurus were soon nibbling at corners of the agenda, including Charles Handy (what is a company for?), James Collins and Jerry Porras (guidelines for long-lived companies), James Moore (business ecosystems), Francis Fukuyama (the role of trust and other forms of social capital), Peter Schwartz (the art of the long view, scenarios), Michael Porter (value chains, green competition), and Peter Senge (organizational learning). However, the greatest impact has come from a number of sustainable-development experts whose books are beginning to be accepted as mainstream management texts. They include Claude Fussler (ecoefficiency, ecoinnovation), Ernst Ulrich von Weizacker (Factor 4–10), and Paul Hawken and Amory and Hunter Lovins (natural capitalism). More recently, people like C. K. Prahalad, Gary Hamel, and Tom Peters (with his book Hot, Flat, and Crowded) have been venturing into this space to good effect.

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Sustainability Management Summary and Further Steps

8 Engage your Board (including nonexecutive directors and/or supervisory board members) early.

8 Consider adopting a triple-bottom-line and/or environment, social, and governance (ESG) strategy, focusing simultaneously on economic prosperity, social equity, and environmental protection. 8 Make environmental, social, and governance issues central boardroom concerns, with compliance, the license to operate, and reputational risk as key issues. 8 Take the initiative by adopting policies that will meet the criteria of sustainable development. 8 Use tools like impact assessments, audits, life-cycle assessments, and clean technology to obtain eco-efficient plant siting, production processes, and products. 8 Consider what sustainable development may mean for your business, the best areas to take action, the people to involve, and the benefits that may result.

Conclusion The first major article in the Harvard Business Review on the sustainable-development agenda was by Professor Stuart Hart in 1997; the number has been growing ever since. Sustainable development is an increasingly significant strategic priority facing organizations. It offers a more efficient system for growth that is acceptable to stakeholders and over time will prove to be both viable and commercially advantageous. It is closely linked (but not synonymous) with concepts like corporate social responsibility, socially responsible investment, social enterprise and clean technology/cleantech.

More Info Books: Benyus, Janine. Biomimicry: Innovation Inspired by Nature. New York: William Morrow & Co., 1997. Brown, Lester. Plan B 4.0: Mobilizing to Save Civilization. New York: W. W. Norton & Co., 2009. Elkington, John. Cannibals with Forks: The Triple Bottom Line of 21st Century Business. Capstone, 1997. Hawken, Paul, Amory Lovins, and L. Hunter Lovins. Natural Capitalism: Creating the Next Industrial Revolution. New York: Back Bay Books, 2000. McDonough, William, and Michael Braungart. Cradle to Cradle: Remaking the Way We Make Things. New York: North Point Press, 2002. Friedman, Thomas L. Hot, Flat, and Crowded: Why We Need a Green Revolution—and How It Can Save America. New York: Farrar, Straus & Giroux, 2008. Schmidheiny, Stephan, Charles O. Holliday, Jr, and Philip Watts. Walking the Talk: The Business Case for Sustainable Development. Sheffield, UK: Greenleaf Publishing, 2002. Watts, Jonathan. When a Billion Chinese Jump: How China Will Save Mankind – or Destroy It. New York: Faber & Faber, 2010.

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Business Performance Excellence Article: OECD. “OECD environmental outlook to 2030.” Mar 5, 2008. Online at: dx.doi.org/10.1787/9789264040519-en Websites: In addition to those mentioned in the text, key sites include: The Clinton Global Initiative, founded by former President Bill Clinton: www.clintonglobalinitiative.org The International Institute for Sustainable Development, an organization that promotes the transition toward a sustainable future through information exchange, policy research, analysis, and advocacy: www.iisd.org The Rocky Mountain Institute, an entrepreneurial nonprofit organization set up by resource analysts Hunter and Amory Lovins: www.rmi.org SustainAbility, leading think-tank and consultancy, founded in 1987: www.sustainability.com The TED conferences and website which feature continuous updates on related themes: www.ted.com World Economic Forum: www.weforum.org The World Resources Institute, an environmental think-tank that seeks practical ways to protect the earth: www.wri.org

Notes 1. The “triple-bottom-line” a term coined by the author in 1994 and popularized in his book (Elkington, 1997), focuses on the economic, social, and environmental added—or destroyed—by business or other activity. In 1995, the author also coined the term “People, Planet & Profit” (alternatively “People, Planet & Prosperity”) to better communicate the concept. 2. www.economist.com/node/14301663 3. tinyurl.com/6y9r5we [PDF]. 4.  tinyurl.com/d6ctr69

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Cultural Alignment and Risk Management: Developing the Right Culture by R. Brayton Bowen The Howland Group, Inc., Louisville, Kentucky, USA

This Chapter Covers 8  Organization culture may vary in definition from country to country, but it is essentially the sum total of the behaviors and styles of the people who drive the system. 8  Organizations that properly align organization culture with business goals and objectives can realize up to 40% improvement in performance compared to peer and competitor organizations. 8  Generally, 80% of acquisitions and mergers fail to perform to management’s expectations, in most instances, because of a failure to understand and manage organization culture. 8  Organizational members have an innate knowledge of what is and is not working within the culture of the organization and, therefore, must be engaged in the process of building the right culture. 8  Culture changes within an organization require total mastery of the change management process. 8  Organization culture ultimately impacts the financial performance and long-term success of an enterprise.

Introduction

The goal was to beat Microsoft at its own game. After rebuffing a takeover attempt by the giant corporation, Novell Nouveau went on an acquisition binge of its own. The strategy was to acquire a premier word-processing company that could rival Microsoft, and Microsoft’s “Microsoft Word” in particular. So, in 1994, Raymond Noorda, CEO for the then second-largest software company, acquired WordPerfect Corp. for US$1.4 billion in stock. Novell was to become a “software powerhouse,” delivering “standalone software suites, groupware, and network applications that were to define new capabilities for information systems,” according to WordPerfect’s leading executive. Two years later, WordPerfect was sold for less than one-seventh of its original purchase price. The reason for the failed strategy: “The cultures were very, very different,” as reported by Novell’s successor CEO, Robert Frankenberg (The Wall Street Journal, 1996). Taking the role of the dominator, management of Novell Nouveau assumed their ways and methods to be superior to those of WordPerfect. They eliminated the sales force, assuming the Novell Nouveau organization could assume the sales and marketing function, and went on to make a host of other mistakes. Indeed, their experience was similar to those of the majority of acquiring firms. Generally, 80% of acquisitions and mergers fail to perform to management’s expectations, and the overarching factor in most instances is a failure to understand and manage organization culture.

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Business Performance Excellence Aligning Organization Cultures What Is Culture?

Culture can be thought of as the organizational context in which behaviors can be characterized and assessed. It is the environmental code that prompts people to act in certain ways to “fit in” at different levels and perform in “expected” ways. For example, customers entering a fine dining establishment understand they are expected to dress appropriately, deport themselves in a dignified manner, wait to be seated at an assigned table, and ultimately, pay a high price for the experience. Yet, there are usually no formal rules that are posted stating how guests are supposed to dress or how they are to behave. Once seated at their table with friends or other guests, they can adjust their behaviors to a more relaxed and interactive mode. This analogy equates to organizational cultures, wherein the overarching culture may prompt people to act one way, whereas once they settle into their own departments or business units, their behavior may change somewhat from the corporate norm. Bringing about change on an organization-wide basis requires considerable understanding of what is needed and why; and it requires superior change-management ability. Elements of organization culture include: How people work together; how responsible they feel for the success of the enterprise; how ethically they behave; how people behave toward customers; how they feel about the quality of the company’s goods and services; how prideful they feel about the mission of the enterprise; and ultimately, how fulfilled people feel in having a say in the business or making a difference in people’s lives as a result of the work they perform. In the end, highly constructive and productive cultures lead to optimum outcomes.

Why Change?

More corporations are coming to appreciate that relationship marketing is leading to increased sales, as compared to transactional marketing. To effect a shift of such magnitude requires a carefully planned migration of both structural and cultural change. Companies such as Globus, the German based hypermarket; DMDrogeriemarkt, a retail chemist; Southwest Airlines and Lufthansa, both commercial airline companies; and Ikea, the Swedish multinational home furnishing retailer— all have created cultural environments that have enabled them to be enormously profitable compared to their industry counterparts. In each of these organizations, employees work as teams. Management provides prescriptive guidance rather than restrictive direction. Employees are entrusted to do the right thing and encouraged to be the best at what they do, namely, providing customers not only with quality goods and services but also with great customer experiences. Up to 40% improvement in performance can be achieved by changing organization culture. According to Stanford Business School professor, Jeffery Pfeffer, providing training, status equalization, employment stability, and strong recognition and reward programs can propel any number of organizations to enviable levels of success. To remain viable and competitive, even service sector entities, for example utilities, financial institutions, and government services, are recognizing the need to shift from transaction-based systems to ones that are more relationship-focused. Such changes require enormous changes in organization culture, as well as in supporting structures,

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Developing the Right Culture i.e., operational, technological, and policy structures. Because “structure follows strategy,” it is virtually impossible to make shifts in organizational culture unless changes in structure occur as well, to support such seismic shifts.

When Is Change Necessary?

Nowhere is the need for cultural alignment more evident than in the case of acquisitions and mergers. What usually happens is that the acquiring entity assumes its culture to be superior to that of the entity being acquired, as in the case of Novell Nouveau cited earlier. Rather than identifying and optimizing the most constructive aspects of the acquired organization’s culture, the culture of the acquirer subsumes the culture of the acquired organization. Consequently, the outcome is not unlike that of Novell Nouveau’s in acquiring WordPerfect. Equally, compelling circumstances exist when organizations are pummeled by downturns in the economy or paradigm shifts in industry standards and/or customer preferences. Organizational transformations are required to jumpstart the business concept or power-charge employees, propelling them in a new direction. Out of the ashes of the past must arise a new phoenix, if the organization is to transform itself into a vital resource for meeting, if not exceeding, customer needs and marketplace demands. Today, Starbucks, the international brand, roaster, and specialty coffee retailer, which operates in 43 countries with approximately 15,000 stores, is being assailed by competitors offering cheaper alternative products. Under Howard Schultz, returning to the company as chairman and CEO, the company is adopting a turnaround strategy of providing customers not only with the distinctive Starbucks “experience,” and innovations, but also, a can-do employee attitude. “Welcome to Starbucks! What can I get started for you?” is the greeting welcoming every customer. While it is still early in the game, the emphasis is on reigniting the emotional attachment customers have had in the past with the product and the people who are the face of the company. Similarly, when organizations determine that their focus must shift from product sales to customer satisfaction and retention, a significant change in organization culture is required. Employees need to be trained and empowered to improve the quality of goods and services, solve problems, and earn the respect and, ultimately, the loyalty of their customers. For example, in 1993, when CEO Louis Gerstner took the reins of IBM, the company had just lost US$8 billion. His challenge was to transform IBM from a stodgy, centralized, mainframe computer company, where customers were expected to come to “Big Blue” and turf wars among departments abounded, to a fast-paced, customer-focused, well-oiled machine, where employees were expected to work as a team to meet and exceed the needs of their customers. In Who Says Elephants Can’t Dance, Gerstner wrote, “Culture isn’t just one aspect of the game. It is the game. In the end, an organization is nothing more than the collective capacity of its people to create value.” As organizations continue to grow globally, it becomes a virtual impossibility for management to be ever-present, critically focused on day-to-day operations. Instead, organization cultures must be designed that are conducive to teamwork, self-direction, ethical decision-making, and the achievement of outstanding results. Team members throughout the organizational system must share a vision and a passion that can only come from an organization culture that is carefully designed and ardently nurtured.

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Business Performance Excellence A Model for the Ideal Culture Organizational Awareness

Ask any employee about his or her organizational culture, and chances are the words chosen to describe the environment will range from “political,” “highly competitive,” “collaborative,” and “team-like” to “stressful,” “mission driven,” even “rewarding.” The collective wisdom of organizational members represents a sort of meta-knowledge about the behaviors exhibited as a result of the cultural context in which they function. These descriptors, in essence, paint a picture of how functional or dysfunctional an organization’s culture is and, in turn, how successful or unsuccessful the organization is as a whole in the way it operates. Moreover, it is this collective conscience, or meta-knowledge, that contains the answers as to how the organizational culture could and should be ideally.

Dimensions of Culture

Various models exist for assessing the culture of an organization. Perhaps the most widely used survey instruments have been developed by Human Synergistics International. Their Organizational Culture Inventory®, for example, measures 12 thinking and behavioral styles, which make up three groupings, termed the “constructive,” “passive-aggressive,” and “passive-defensive” styles. An “ideal” culture is “constructive” when the dominant organizational styles are “self-actualizing,” “achieving,” “humanistic and encouraging,” and “affiliative.” Summary results from completed assessments enable organizations to understand how their cultures operate and where improvements can be made to improve outcomes in a variety of areas, including employee/labor relations, customer relations, organizational performance, and profitability.

Blueprint for Change

The benefit of using such assessments as described above is that organizational leadership is better able to target areas for change. Knowing how the present organizational culture impacts on performance, and where enhancements can be made to improve performance can form the basis of a master plan, or blueprint for change. Moreover, by tapping into the collective conscience of the organization and enlisting the involvement of organizational members, leadership can manage the change process more effectively—simply put, it becomes a holistic process or a “bottoms-up-top-down” approach. In the end, the change effort is sustainable, because all organizational members understand what is needed and how to make it happen—more importantly, they become collaborators in the change process rather than victims or passive spectators. Any number of corporations, including American Eagle Outfitters, Disney, Men’s Wearhouse, and Hewlett Packard, have focused on organizational culture as a means of optimizing performance, while sparking the commitment and active engagement of their employees. They have adopted that strategy from day one, and it has been the foundation for success.

Further Implications

In addition to profiling the culture of an organization, management can extend the evaluative process to assessing the individual behavioral styles of organizational

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Developing the Right Culture members. Consistent with the notion that “a chain is only as strong as its weakest link,” the behavior of every member of the organizational “chain” must be aligned with the desired profile of the organization’s ideal culture to ensure optimum results. Further, individual performance plans should be honed to include the behavioral norms expected of organizational members, and periodic reviews conducted to help determine how well behaviors are aligned, and where improvement in individual behavioral styles is needed.

Summary and Further Steps

Conclusion In a global economy that is becoming more complex and conflicted, there is little room for error, and even less room for guesswork. Organizational culture is as critical an element in managing a business as information technology, or financial controls. Indeed, it is more elusive but equally powerful to ensuring the success of an enterprise. The experience of Novell Nouveau and WordPerfect proves how costly the neglect of organizational culture can be to the financial performance of a business. By way of contrast, those organizations that consciously tend to the process of building the right organizational culture have reaped rewards well beyond those achieved by their peer and competitor organizations.

Making It Happen Culture change requires a strategic perspective on why culture is important to the organization, and how it will make a significant difference in the strategic positioning and success of an enterprise. The process begins with articulation of the vision and mission of the organization. To achieve optimum performance, the culture of the organization needs to be aligned with the vision, mission, and strategic goals and objectives of the organization. The behaviors of senior leadership must model the new standard, and the change and implementation process must begin with senior leadership.

8 Conduct a system-wide assessment of the organization’s current culture. 8 Determine where change is necessary and why. 8 Profile the desired culture of the organization, ensuring that the targeted profile will bring out the best in the organization.

8 Engage organizational members in the processes of assessing the current culture, profiling the desired culture, and implementing needed change. 8 Incorporate the desired behavioral styles into the performance-planning and management process for both individual members, and the business as a whole. 8 Continue to assess progress versus plan. Be certain to obtain feedback from key stakeholders such as customers, vendors, and investors, and make adjustments as needed to improve results.

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Business Performance Excellence More Info Books: Bowen, R. Brayton. Recognizing and Rewarding Employees. New York: McGraw-Hill, 2000. Cameron, Kim S., and Robert E. Quinn. Diagnosing and Changing Organizational Culture: Based on the Competing Values Framework. San Francisco, CA: Jossey-Bass, 2005. Driskill, Gerald W., and Angela Laird Brenton. Organizational Culture in Action: A Cultural Analysis Workbook. Thousand Oaks, CA: Sage Publications, 2005. Gerstner, Louis V. Who Says Elephants Can’t Dance: Leading a Great Enterprise Through Dramatic Change. New York: HarperCollins, 2002. Hennig-Thurau, Thorsten, and Ursula Hansen (eds). Relationship Marketing: Gaining Competitive Advantage Through Customer Satisfaction and Customer Retention. New York: McGraw-Hill/Irwin, 2000. Pfeffer, Jeffrey. The Human Equation: Building Profits by Putting People First. Boston, MA: Harvard Business School Press, 1998. Schein, Edgar H. Organizational Culture and Leadership. 3rd ed. San Francisco, CA: Jossey-Bass, 2004. Articles: Barriere, Michael T., Betty R. Anson, Robin S. Ording, and Evelyn Rogers. “Culture transformation in a health care organization: A process for building adaptive capabilities through leadership development.” Consulting Psychology Journal: Practice and Research 54:2 (Spring 2002): 116–130. Online at: tinyurl.com/6y4tn8g Clark, Don. “Novell Nouveau: Software firm fights to remake business after ill-fated merger.” Wall Street Journal (Midwest ed) 76:62 (January 12, 1996): A1, A6. Singh, Kavita. “Predicting organizational commitment through organization culture: A study of automobile industry in India.” Journal of Business Economics and Management 8:1 (2007): 29–37. Online at: dx.doi.org/10.1080/16111699.2007.9636149 Websites: The Howland Group: www.howlandgroup.com Human Synergistics International: www.humansynergistics.com

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The Human Value of the Enterprise by Andrew Mayo Middlesex University, London, UK

This Chapter Covers 8 People are often spoken of as assets but are generally treated as costs, because we have no credible system of valuing them. 8  The problem is that in today’s knowledge-based organizations value is driven more by people than by any other factor. 8  There are five main approaches to building a measurement system for people, or human capital. 8  The attempt to value people financially has not been successful; however, an index of value factors provides a necessary balance with seeing people as costs. 8  Current best practice looks at connecting the value of people in terms of their characteristics (and the value they produce in both financial and nonfinancial terms) via measures of their engagement and motivation.

Introduction

Our people are our most important asset. This frequent statement from chief executives is often received with justifiable cynicism. The problem is that people within an organization do not always experience decisions and policies in their everyday work life that support such a belief. The accountant who once described people to me (admittedly with a smile) as “costs walking about on legs” is often closer to the reality of organizational experience. The very term “human resources” reinforces this concept of people. Organizations that are driven by an often understandable drive for increased efficiency and minimized costs see “headcount” as the easy target. There are many reasons for this. One is the domination of management by current targets for bottom line results—often resulting in a very short-term mindset. Such single-mindedness is illogical because it is out of balance; the desired final outcomes are driven by satisfying other demands that generally get much less attention. A powerful system of financial processes and targets dominates the life of most managers. Measures of intangibles, such as employees’ capabilities or customers’ loyalty may exist, but they are frequently excluded from appearing in the monitoring and control systems in any serious way. Another problem is that people do not fit the strict financial definition of an asset. They cannot be transacted at will, their contribution is individually distinctive and variable (and subject to motivation and environment), and they cannot easily be valued according to traditional financial principles. However if we view “assets” as value-creating entities, and in an era where knowledge and its application is the key competitive advantage, we will arrive inevitably at the foundational role people play. Organizations do employ some just for “maintenance,” but the vast majority are value adding. Some indeed should be seen as investments rather than costs—but management accounting rarely recognizes this.

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Business Performance Excellence Perhaps the greatest problem is the lack of credible measures that relate to people and their value. We know in detail what they cost; we have no balancing quantity for their value. We feel it when it has been lost, but often too late.

The Value of People

Is There a Problem to Be Solved?

There is indeed a major problem. The valuation of companies has progressively changed over the last 20 years, putting a much higher weight on intangible assets like knowledge, competence, brands, and systems. These assets are also known as the intellectual capital of the organization. The problem is that we have no comparable system of measurement that enables us to give these the same balanced attention we give to financial matters. The result is that decisions about investment and resources are not necessarily in the long-term interest of the stockholders, even though they may appear to be at the time they are made. A classic case is the laying off of key people, particularly after mergers and acquisitions, only to hire them back when the value they contributed is suddenly recognized. David Norton, coauthor of The Balanced Scorecard, says of his experiences in working on performance management that “the worst grades are reserved for the typical executive team for their understanding of strategies for developing human capital. There is little consensus, little creativity, and no real framework for thinking about the subject. Worse yet, we have seen little improvement in this over the past eight years. The asset that is the most important is the least understood, least prone to measurement, and hence the least susceptible to management”.

People-Related Measures

No standardized approach has become widely accepted as yet, but the various ways in which systematic measurement has been applied to people can be summarized as follows. 8 Attempting to value people financially as assets: human resource (or asset) accounting. This will be discussed in more detail below. 8 Creating an index of good HR practices and relating them to business results. Researchers including Mark Huselid of Rutgers University and consulting firms such as Watson Wyatt have shown positive correlation between investment in HR management and stockholder value. 8 Statistically analyzing the composition of the workforce and measures of employees’ productivity and output. The best-known proponent here is Jac Fitz-enz of the Saratoga Institute, California, who has extensively deployed ratios of all kinds and conducts a worldwide benchmarking practice. 8 Measuring the efficiency of HR functions and processes and the return on investment for people initiatives and programs. Dave Ulrich of the University of Michigan is the champion of a measurement-orientated HR function, and Jack Philips is the leading proponent of ROI for HR initiatives and programs. 8 Integrating people-related measures through a performance management framework. These are frameworks that look for balance in performance measures between the needs of the different stakeholders, or in relation to the component parts of the total intangible assets. The best known is Kaplan and Norton’s Balanced Scorecard. An alternative approach comes from

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The Human Value of the Enterprise Karl-Erik Sveiby of Sweden, whose Intellectual Capital Monitor chooses a small number of measures for three kinds of intellectual capital—customer, structural, and human. The most comprehensive approach to the human dimension is found in Mayo’s Human Capital Monitor. This links three areas of measurement: 8 the human capital that people lend to organizations in exchange for the value added to them; 8 the financial and nonfinancial value for stakeholders that this human capital produces; 8 the motivation and commitment of the people, which depend primarily on the environment in which they work.

Valuing People as Assets

There are two criteria for defining any asset: 8 It must possess future service potential. 8 It is measurable in monetary terms. Traditional methods of coming to a valuation include: 8 Cost-based. This method typically looks at acquisition or replacement cost. The costs of recruiting an employee can be assessed and then depreciated over the expected future service of the person hired. Alternatively the person’s gross remuneration can be used as a base. 8 Market-based. The price to be paid in an open market must be a reflection of the value of a person. Value is very difficult to assess, however, and does not take account of the value of service continuity in itself. 8 Income-based. The cash inflows expected by the organization related to the contribution of the human asset, calculated as the present value of the expected net cash flows. This is good for individuals whose efforts are directly related to identifiable income. Human resource accounting, or human asset accounting, has been primarily developed in the United States under the guidance of Professor Eric Flamholz. He sees the value of a person as the product of two interacting variables—his or her conditional value and the probability that the person will stay with the organization for x years. Conditional value is the present worth of the potential services that could be rendered if the individual stayed with the organization, and is a combination of productivity (performance), transferability (flexible skills), and promotability. The latter two elements are heavily influenced by the first. This figure is then multiplied by a probability factor: the probability that the person will stay for the x years. This gives the expected realizable value, which is a measure of the person’s worth. There are a number of difficulties with this approach, not least of which is the estimation of potential future services. It also leads to lower values for older and more experienced people who have less time to render future services. This is not necessarily the reality.

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Business Performance Excellence The truth is that this is not a well-known discipline, and it has not been generally adopted by either the financial or HR communities. A more useful approach was originally developed by UK researchers W. J. Giles and D. F. Robinson in 1973. They developed a factor called the human asset multiplier, which is applied to gross remuneration. This reflects a number of intrinsically valuable attributes of individuals. Mayo, in his 2001 book, came to similar conclusions, namely that although it would be really helpful if we could have a realistic, generally accepted, absolute financial formula, this is unlikely to be achieved. But it would be a major step forward if we could at least enable people’s relative values to be compared against their costs. He proposed a formula for what he called the human asset worth (HAW), where HAW = EC (employment cost) × IAM (individual asset multiplier) ÷ 1,000

(The divisor of 1,000 is used so that the resulting number does not look like a financial one.) The individual asset multiplier is designed to reflect the relevant factors that make individuals valuable in their current context. These factors are not universal and vary for each group of employees sharing a common value output. Examples, however, include: 8 specialized knowledge, skills, and experience; 8 personal skills and behaviors; 8 contribution to stakeholder value; 8 potential to grow and contribute at a higher level; 8 personal productivity in relation to stakeholder value; 8 alignment with organizational values. Each of these factors can be assessed on a scale, weighted for importance, and then added together to give the multiplier. Such a formula can lead to tools such as a human asset register, which can monitor changes and compare teams and units. The process of analyzing the individual components may lead to strategies for change in the organization. It can be argued strongly that such tools are at least as important as those used for cost management.

A Framework of Measures

The following characteristics are suggested as criteria for a framework of peoplerelated measures: 8 with the exception of workforce statistics, measures should not stand alone but be connected to other outcomes for the organization—particularly the value created for stakeholders; 8 a framework should be useful for the users. These might be external (investors, analysts, benchmarking) or internal (managers, other functions). Their needs are different, so more than one framework may be needed. Usefulness means informing actions to be taken; 8 the underlying collection, definitions, and presentation of data need to be valid and reliable, and have credibility with the users;

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The Human Value of the Enterprise 8 they should not be compiled through the lens of an accountant. Quantification does not equate necessarily with dollars. Value added can be both financial and nonfinancial. None of the approaches described above meets all these criteria. An attempt to do so is found in Mayo’s Human Capital Monitor. This links three areas of measurement for specific groups of employees: 8 the human capital that people lend to organizations in exchange for the value added to them. This is measured by the Human Asset Worth approach; 8 the motivation and engagement of the people, which depend primarily on the environment in which they work. Outcome measures are used, such as attrition, absenteeism, opinions, and management judgment—and also “input” measures of the factors that make a difference to the group under study; 8 the financial and nonfinancial value for stakeholders that this human capital produces—often measured as a productivity factor. This provides a tool for managers which stands alongside their financial statements and informs them about people-related actions. Summary and Further Steps The term human capital can be used to describe the asset value of your people. Maximizing human capital through acquisition, retention, and growth should be a major priority of all executives, not an area left to the HR department alone. It is the area in which measurement is least well understood. This is all about sustainable stockholder (or public sector beneficiary) returns. People are the one factor of value growth that drives all others. The value that a company creates results from the way that people apply their skills, energies, and expertise to the capital and raw materials that customers want. Of all the business levers available to leaders, the greatest potential to build value is offered by people. It is time indeed to recognize this through demanding a rigorous and credible approach to both valuing this most significant asset, and linking that value meaningfully to the benefits for stakeholders. What gets measured gets managed—and we need reality behind the rhetoric about our people.

More Info Books: Becker, B. E., Mark Huselid, and David Ulrich. The HR Scorecard: Linking People, Strategy, and Performance. Cambridge, MA: Harvard Business School Press, 2001. Davenport, Thomas O. Human Capital: What It Is and Why People Invest It. San Francisco, CA: Jossey-Bass, 1999.

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Business Performance Excellence Fitz-enz, Jac. The ROI of Human Capital. New York: AMACOM, 2000. Flamholtz, Eric G. Human Resource Accounting: Advances in Concepts, Methods, and Applications. 3rd ed. New York: Kluwer, 1999. Mayo, Andrew. The Human Value of the Enterprise: Valuing People as Assets—Monitoring, Measuring, Managing. Naperville, IL: Nicholas Brealey, 2001. Phillips, Jack., Ron D. Stone, and Patricia Pullian Phillips. The Human Resources Scorecard: Measuring the Return on Investment. Oxford: Butterworth-Heinemann, 2001.

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Human Capital by Edward E. Gordon Imperial Consulting, Chicago and Palm Desert, USA

This Chapter Covers 8 Accountants and economists are struggling to find a way for a business to measure the intangible assets of human-capital development. What is the added value of skilled talent to the business? 8 But what is human capital? It is the sum total of individual intelligence built on the acquisition of skills, training, and educational experience over a lifetime. It’s the application of this human knowledge to the workplace that creates real value. 8 The merging of three types of capital (“human,” “organizational,” and “customer”) creates the desired outcome—an organization so aligned and balanced as to produce the highest possible financial capital (value).

Introduction

The talent management of human capital is now being driven by three titanic forces: globalization, the increasing pace of technological change, and massive worldwide demographic shifts. Today these factors have combined to demand many new types and levels of skilled talent. This is as profound a change as the shift from manual labor during the early Industrial Revolution in the 1800s. In this talent management environment, harnessing the human capital—the accumulated skills, experience, wisdom, and capabilities of all of the people employed in the organization is fundamental to success. This may seem obvious—after all, why pay for the most vital and expensive resource in terms of results, without using it to the full? However, at a time when skills are more complex and transferable, traditional organizational loyalty is eroding, and the significance and value of knowledge is rising, there is a premium and renewed focus on human capital and strategic talent management. The US departments of labor and education estimate that by 2020, 80% of all jobs will require a good liberal arts education plus post-secondary career preparation. 60% of these jobs will be “middle jobs’ that may not require four-year degrees, but rather twoyear degrees, technical certificates, or apprenticeship preparation. Today only about 25% of US adults have received the post-secondary career training and education appropriate for a high-tech industrial economy. Though this problem can be found in many countries, it is most acute in the United States. The international Organisation for Economic Co-operation and Development (OECD) ranked the United States 15th out of 47 major industrial nations in the education and training levels of its citizens. This study showed about half of the US adults reading below eighth-grade level, with much of the population performing below sixth-grade level.

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Business Performance Excellence In another comparative study of 18 nations, the OECD found that of US highschool graduates who do not go on to acquire further education, nearly 60% perform below a literacy level that international experts consider necessary to cope with the complex demands of the modern workplace. That percentage was the highest among the nations studied, with Finland the lowest at 10% and other countries falling in between—20% in Germany, 35% in the United Kingdom, 50% in Poland. Instead of becoming knowledge workers, it would seem that many members of the current US workforce, as well as students about to emerge from school, are in danger of becoming the new techno-peasants. “Investment in human capital is necessary for any nation to reap the benefits from information technology,” says John Martin, director of education for the OECD. In this section, we will assess the importance of human capital: what it is, where it is, and how skilled talent can be managed to best effect.

Where Are the Knowledge Workers?

As the world economy has grown during the past 10 years, a demographic time bomb is in the making. The US Census Bureau, Department of Labor, and Immigration and Naturalization Service concur that the population younger than 34 is declining. Increasing retirements will combine with this shrinking labor pool to produce a dramatic knowledge-worker shortfall until 2020. The same trends hold true throughout Western Europe and Japan. In some countries the total population may even decline. With skilled workers in such high demand, US companies have repositioned operations overseas, and they now lure up to 600,000 skilled workers to the United States on temporary H-1B visas to fill vacant positions. Some projections estimate that by 2020 there will be a shortfall of skilled talent for up to 24 million US jobs. The European Union (EU) and Russia forecast a 14 million worker labor gap. The United States and the EU share the same human-capital strategy—import the workers. But there is not enough skilled talent worldwide to fill the knowledgeworker gap. Germany, Japan, and South Korea are now reporting shortages of workers particularly to fill science, technology, engineering, and mathematics-related jobs. While India and China yearly graduate huge numbers of engineers, only 10–25% meet multinational employment standards. Business sustainability requires the development of more human capital through incumbent worker education and training to produce skilled talent who will then be able to create more high-value-added products and services at extremely low cost.

Developing Human Capital Investment

For the past decade, it appears that the predominant culture of American management has been that businesses exist only to drive up stock options, cut operating costs, and enrich shareholders as fast as possible. Business does not apply fiscal management thinking in making human capital talent investments because of the lack of realistic metrics that can be tracked on a financial statement. Current US business accounting standards are stacked against workplace learning. The accounting system classifies training and educating people as a business “expense,” and purchasing equipment, machines, and buildings as an “investment.”

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Human Capital Carol Corrado and Dan Sichel of the Federal Reserve, and Charles Hulten of the University of Maryland studied (2006) the scale of business intangible investment including such things as research and development, computer software and databases, brand equity (advertising and trademarks), and human capital (training and education). They found by the late 1990s US accounting practice was excluding up to $1 trillion in annual economic growth driven by business intangible investment. In our knowledge-driven economy this intangible investment by 1995 had reached parity with the “bricks and mortar” forms of capital investment in driving US economic growth. Between December 2007 and March 2010 the US economy lost about 8.5 million jobs. However, 2.4 million U.S. jobs have remained vacant for six months or more. Many of these are STEM jobs (science, technology, engineering, and math-related jobs) in healthcare, aerospace, advanced metalwork, advanced precision manufacturing, advanced engine repair/maintenance, scientific laboratory occupations, information technology manufacturing, and computer-related design, manufacturing and maintenance. To address this talent crisis, new US accounting standards and IRS regulations need to be developed that will allow businesses to capitalize training, development, education, and internship expenditures. This will help businesses address this strategic talent meltdown and help to reduce unemployment across the US economy. For businesses, capitalizing training also has the potential to enhance worker performance, increase productivity, and raise profit margins.

Measuring Human Capital Investment

Many of the world’s leading industrial powers are beating the United States at its own game simply by understanding that knowledge equals profit. Rather than ignoring the relationships, they are acting on the critical interactions among technology, more skilled employees, and return on investment (ROI). They invest extensively in student career education and employee-retraining programs—and reap the short- and longterm profits. The key is high-quality training and development programs that motivate employees to use their own learning by applying innovative thinking on the job. This strategy will increase personal performance, better their lifetime careers, and in turn raise the human capital ROI of a business. Many organizations are abrogating the responsibility for human-capital development by empowering people to figure out what new knowledge they need and encouraging them just to go and get it. However, this do-it-yourself approach to training is a naive management strategy; for most people it’s too scattered for any meaningful buildup of new personal skills. Too many executives have followed the questionable supposition that Web- and videobased training can do it all. This confuses the delivery system with the content. It’s a huge mistake to think of e-learning simply as a cheaper way to distribute knowledge, without taking into account the factors that really motivate people to learn. First comes acquiring new information; second, trying it out by applying it; third, reaching personal

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Business Performance Excellence understanding. The social aspect of learning is vital for most people. A relationship needs to exist between a good teacher and learner. Web- and video-based training are important components of most well-rounded training programs, but they’re not always the best teaching methods. Study after study show that the teacher/trainer remains central to a successful learning experience, with the latest electronic teaching aids serving as supplementary tools, not a total system solution. Case Study The publication Training in its annual training surveys, “Training Top 100” (2006), and “Training Top 125” (2008) profiles the best corporate learning and performance improvement programs. These companies spend over $5 billion, and provide an average of 52 hours of training per employee. The top five organizations were: Booz Allan Hamilton, IBM, Ernst and Young, the Ritz-Carlton, and KLA-Tencor. They have been in the top 10 for at least four consecutive years. Some of the best were smaller companies: Protis Executive Innovations (30 employees), American Power Conversion (250 employees), and Washington State Employees Credit Union (500 employees). Typical programs range from leadership development to first-line supervisory training, coaching, mentoring, sales training, or succession planning. Some companies offer more innovative training. Shaw Industries of Dalton, Georgia operates the Shaw's Skills Center that offers one-on-one tutoring in math, reading, and writing, as well as small-group and computer-based learning. It also provides a company-based GED program. General Mills offers employees over 1,000 courses including cereal production and other technologies, quality, maintenance, and food chemistry. Allstate Insurance Company partnered with a local university to start an on-site MBA program as part of its succession planning effort. Cerner Corp., Kansas City, Missouri, developed an online process tool that trains and supports employees in the design, testing, and maintenance of its software. Regional/community public–private partnerships or community-based organizations (CBOs) are being formed to provide another way of developing human capital. CBOs in Santa Ana, CA; Fargo, ND; and Danville, IL are non-profit organizations that are linking together businesses, educational institutions, unions, chambers of commerce, workforce boards, parent groups, and others to rebuild their education-to-employment systems. They have become most effective in both retraining current workers and preparing more students to fill future jobs through career education programs.

Summary and Further Steps Investing in human capital produces better business returns; it provides cost savings and efficiencies, maximizes the use of available resources, and addresses specific performance and productivity issues. To succeed, it can help if:

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Human Capital 8 Investments in human capital are measured in cash—clearly highlighting the benefits of acting, and the perils of inaction.

8 The personal knowledge of employees across the organization is assessed: this gives managers benchmarks for understanding its human capital strengths and weaknesses. 8 Relevant and appropriate performance development programs in skills, education, and training areas are selected. These should be directly linked to productivity improvement needs and the strategy of the business—what skills are needed to progress towards the desired destination? 8 A human capital measurement system is applied, so that the best return on investment is achieved in the short - and long-terms.

Conclusion Human capital investment has become an issue of strategic importance for most businesses. Over the next decade talent creation will join it as a vital activity to ensure companies can fill key positions to survive and thrive. This includes retraining and reeducating the current workforce to fill open positions. 70% of the workers who will be on the job in 2020 are today’s employees. Motivating more people to engage in high-quality, lifelong learning is not just a nice option, it is now a business sustainability requirement.

More Info Books: Becker, Brian E., Mark A. Huselid, and Dave Ulrich. The HR Scorecard: Linking People, Strategy and Performance. Cambridge, MA: Harvard University Press, 2001. Conger, Jay A., and Beth Benjamin. Building Leaders: How Successful Companies Develop the Next Generation. San Francisco, CA: Jossey-Bass, 1999. Corrado, Carol , Daniel E. Sichel, and Charles R. Hulten. Intangible Capital and Economic Growth. Cambridge, MA: National Bureau of Economic Research Working Paper No. 11948, January 2006. Edvinson, Leif, and Michael S. Malone. Intellectual Capital: Realizing Your Company’s True Value by Finding Its Hidden Brainpower. New York: HarperBusiness, 1997. Gordon, Edward E. Winning the Global Talent Showdown: How Businesses and Communities Can Partner to Rebuild the Jobs Pipeline. San Francisco, CA: Berrett-Koehler, 2009. Websites: The American Society for Training and Development site publishes ongoing research regarding the return on investment of human capital: www.astd.org A human capital ROI worksheet that helps calculate long-term and short-term returns for training and development programs: www.imperialcorp.com

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Creating Value through People by David H. Maister Business author, speaker, and consultant

This Chapter Covers 8  The financial performance of a business is not something you can or should directly control. It is achieved by providing superior value to the marketplace. 8  Marketplace value is a consequence of energizing and focusing employees to create and deliver value. 8  To make money, managers should not spend their time managing money, but should instead devote their efforts to the things that produce the money: the enthusiasm, commitment, and drive of the labor force. Don’t manage money. Manage people.

Introduction

Which of the following does your company report on, monitor, and react to most frequently? Which consume the most management time? 8 Client satisfaction levels. 8 The strength of key client relationships. 8 Employee motivation and energy. 8 Levels of collaboration among staff. 8 Financial result. If you’re like the overwhelming majority of businesses, you will focus primarily on financial results. Consequently, you’re making less money than you could! Why? Because managing a business by looking at financial results is like trying to win a game by keeping your eye firmly fixed on the scoreboard. Financial results are just that: results. They are the outcome of excellence (or the lack of it) in the key processes that produce the value that your customers and clients pay for. What you must manage are the things that produce value: energized employees who deliver outstanding quality and service to the marketplace. Does this mean that you don’t monitor finances in great detail? Of course not. Financial discipline is the bedrock of business success, but it’s not all of it, and maybe not even the greater part of it. The real key is the ability to get your people sufficiently focused so that they eagerly and willingly strive for high standards.

Challenges and Opportunities

Over the years, I’ve been trusted to see the strategic plans of many direct competitors. Remarkably, they are almost always identical. Everyone figures out correctly which client sectors are growing, which services are in rising demand, and which dimensions of competition, such as client service or innovation, clients are looking for. The strategy documents are the same because everyone’s smart! Everyone knows what needs to be done.

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Business Performance Excellence If this is so, then what is competition really about? It’s about who can best complete the work that need to get done. And this in turn is determined by the following set of closely related concepts: 8 energy; 8 drive; 8 enthusiasm; 8 excitement; 8 commitment; 8 passion; 8 ambition. Where these exist the discipline can be found to engage in diligent execution and thereby outperform the competition. The role of the manager is to be a net creator of enthusiasm, excitement, passion, and ambition. Alas, all too often managers are destroyers of excitement. If all they ever talk about is finances (“How are your billings?” “What’s happening to receivables?”), it can deaden the spirit. That doesn’t mean they don’t need to talk about these things—they do. But they shouldn’t talk only about these things. It’s the manager’s job to inspire, cajole, exhort, nag, support, critique, praise, encourage, confront, and comfort, as individual people (and groups of people) struggle to live their work lives according to high standards. All strategies, at some time or the other, involve a trade-off between short-term cash and executing the strategy. If you’re going to get the benefits of a strategy, you need to be willing to make hard choices and act as if you truly believe it. You must be willing to practice what you preach, both when it’s convenient and, most importantly, when it is not. Many people don’t believe that their leaders truly want them to act strategically. Whenever a choice needs to be made between strategy and short-term cash—and it always does—most people feel under significant, if not irresistible, pressure from management to go for the cash. Usually the message from the company’s leadership is clear: strategy can wait for tomorrow (if we can get paid for competence, why strive for excellence?). Rather than leaders being a source of encouragement to execute the strategy, they’re all too often the biggest obstacles to the implementation of strategy. If you want to be known as excellent at something, you have to be reliably, consistently excellent at it. Business life is filled with daily temptations, short-term expediencies, and wonderful excuses for why we can’t afford to stick to high standards today. We take in work that’s off-strategy (after all, it’s cash!), we defer training until some more convenient time (often never), we postpone investments until the ever-escalating profit goals are met, and the marketing principle is: we never met a dollar of revenue we didn’t like! There is nothing inherently wrong about making these choices, but you shouldn’t fool yourself. If you’re willing to sacrifice value to earn short-term cash, you won’t create a market reputation for superior quality. It takes courage to believe that a reputation for excellence is worth more in the long run than incremental cash. In their vision, mission, and strategy documents, companies say that they are aiming for excellence, but that’s not how they operate.

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Creating Value through People Managers must have the courage of the convictions they espouse, maintain a long-term focus, and intervene personally whenever there are departures from the values and vision that create excellence. The problem with the implementation of strategies is the absence of certain and recognizable consequences for noncompliance. If the manager doesn’t have the courage to tackle individuals who aren’t behaving in accordance with the strategy, others will quickly realize that the new strategy is not something they have to do. They’ll quickly cease striving to comply, and the benefits of the strategy will never be attained. Great managers give their people individually and collectively the confidence that greater success, fulfillment, accomplishment, and profits are indeed attainable. They give their people the courage to try. Change is threatening, however, and many, if not most, people operate well within their comfort zone, reluctant to abandon the old habits that brought them to their current success. If managers are often demanding, they must also be supportive. They must manage with a positive, supportive style. Just as management involves a delicate balance between being supportive and being demanding, it also requires a style of insistent patience; it’s the difference between saying Rome wasn’t built in a day and insisting that we are building Rome. People must believe that the manager has the courage to believe in something and, more importantly, will stick with it. There’s no greater condemnation of managers than to say that they’re expedient, and no greater commendation than to say that a manager truly lives and acts in accordance with what he or she preaches.

Being Effective—and Successful An effective manager must be:

8 articulate and vocal about his or her personal beliefs; 8 disciplined about standards; 8 even-handed and even-tempered; 8 genuine and sincere; 8 able to read people’s characters and skill levels effectively; 8 honorable, with high integrity. What do the most successful managers believe? 8 First you build your people, and the rest will come. 8 Fun and discipline combined get the job done. 8 It’s important how people treat each other: monitor it and manage it. 8 People have to trust management and trust each other. 8 Success is about character, respect, integrity, trust, honesty, empowerment, confidence, loyalty, and keeping promises. 8 You must bet on the long term and not get stampeded by short-term pressures. 8 You need to balance your focus on people, clients, and finances. 8 You should live up to your values every day. 8 Your agenda as a manager is to create a great place to work, not to work at making your own star rise.

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Business Performance Excellence Finally, here are the rules on which the most successful managers model their behavior: 8 Act as if not trying is the only sin. 8 Act as if you want everyone to succeed. 8 Actively help people with their personal development. 8 Always do what you say you are going to do. 8 Do what’s right over the long term for clients and for your people. 8 Don’t regard yourself as separate and distinct from your people. 8 Facilitate, don’t dictate. 8 Let people know you as a human being, not just as their manager. 8 Show enthusiasm and drive; they’re infectious and addictive. 8 Speak regularly about your vision and philosophy so that people know where you stand. 8 Take work seriously, but don’t take yourself too seriously. 8 Understand what drives individuals. 8 Know all your people as individuals. Summary and Further Steps To get started take out the documents that describe your company’s mission, vision, values, and strategy. Turn them into a questionnaire and ask your people how well they think you’re currently living up to the things you espouse. If you find out that there are some things that you’re not doing so well, either fix them or drop them from your declarations: there’s no point lying, pretending to advocate things you’re not willing to live up to. Practice what you preach! Make it the short-term immediate priority to make the company live up to its overarching vision. Another vital step is to involve as many people as possible in the process of implementing, if not actually setting, strategy. The task of energizing, mobilizing, and motivating action is easier with people feeling involved, rather than being imposed on from above.

Conclusion A person doesn’t build a business. A person builds an organization that builds a business. Many managers are appointed because of their financial skills, their business development skills, or their technical excellence. However there comes a point where the central question is, “Can you manage?” Are you a net creator of energy, drive, and ambition in others? Can you cause others to strive to achieve high standards?

More Info Books: Collins, James C., and Jerry I. Porras. Built to Last: Successful Habits of Visionary Companies. New York: HarperBusiness, 2004. Heskett, James L., W. Earl Sasser, Jr, and Leonard A. Schlesinger. The Service Profit Chain: How Leading Companies Link Profit and Growth to Loyalty, Satisfaction, and Value. New York: Free Press, 1997.

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Creating Value through People

Kaplan, Robert S., and David P. Norton. The Balanced Scorecard: Translating Strategy into Action. Cambridge, MA: Harvard Business School Press, 1996. Pfeffer, Jeffrey, and Robert I. Sutton. The Knowing–Doing Gap: How Smart Companies Turn Knowledge into Action. Cambridge, MA: Harvard Business School Press, 2000.

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Return on Talent by Subir Chowdhury ASI Consulting Group, LLC, Michigan, USA

This Chapter Covers 8 The performance of an organization is determined by the performance of its employees. 8  Organizations must therefore measure return on talent as well as return on investment. 8  Knowledge is one of the most important factors for business success. If knowledge assets are increased, related factors such as sales will also increase. 8  Talent—or intellectual capital—has fast become one of the most significant areas of business activity and competition.

Introduction

The performance of an organization is entirely determined by the performance of its employees. This bold statement deserves further study. If the determinant of corporate performance is not its employees, what is? Is it strategic intent? Core competencies? Manufacturing? Is it proprietary technologies? The best equipment and laboratories? A visionary CEO? Yes, it’s all of these things. And all of these things are created and constantly improved by employees. Talented employees are the agents of change. Good employees join in to help implement new initiatives. Others follow at various times, depending on when they can break the bounds of their comfort zone to enter the area of change, uncertainty, and opportunity. They fall by the wayside because they were in the wrong job. It is broadly recognized that past performance is not a reliable indicator of potential or future success. Yet many organizations continue to use past performance to identify high-potential employees. How much true talent is overlooked by this practice? Overlooked and misplaced high-potential employees stagnate. The problem of identifying, positioning, and compensating high-potential employees spans all disciplines and levels, from the loading dock to the boardroom. Lost and underused employees represent enormous, largely unreckoned financial loss. A second problem is the difficulty of measuring the financial contribution of employees beyond global measures such as revenues per employee. To focus a successful organization, managers must use a new tool called return on talent (ROT). Most organizations focus on return on investment (ROI), and fail to understand the key strategy of how to increase ROI by increasing ROT.

Harnessing Talent

ROT has the power to revolutionize business. ROT is calculated by dividing the knowledge generated and applied by the investment in talent. You need to address the dilemma of how to measure an intangible asset and how to generate high ROT value. For decades, organizations have used key metrics like ROI and ROA (return on assets)

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Business Performance Excellence to determine value. But increasingly an effective new-economy organization will use ROT. Current business measurements merely measure the use of capital, but ROT is expressed as follows: ROT = Knowledge generated & applied ÷ Investment in talent

If you have talented people, knowledge is just one component. The generation of knowledge is the most important thing talent can provide. Now you may realize that knowledge generated by the talent doesn’t equal knowledge applied, right? And if knowledge isn’t applied, the company loses most of the market value of that knowledge. Whatever knowledge a person generates in a year divided by how much is invested in that particular person is the value. If an employee generates many innovative ideas but never implements any of them, that person fails to generate any value because the return to the company is zero. Knowledge generated does not necessarily mean knowledge applied. So value is knowledge generated and applied. Knowledge becomes an asset only when it’s captured and used effectively; if it isn’t effectively applied, it can’t generate any yield or ROI. Generating a lot of knowledge within organizations doesn’t add any value unless that knowledge is used in effective strategy formulation. Knowledge assets, like money or equipment, are worth cultivating only in the context of strategy. You can’t define and manage intellectual assets unless you know what you are trying to do with them. This is the backbone of the knowledge economy; success in this field depends on mastery of talent, just as success in manufacturing relies on the skilful employment of plant and supply chains.

The Value of Knowledge Return on Talent

The value of knowledge generated increases with its effective deployment. Effective knowledge generated means high ROT. It leads to a creative workforce, innovations, smooth processes, continuous product improvements, and improved communications. It helps management to be flexible, to capitalize on opportunities, and to keep pace with the changing business climate. Talented people influence those around them, and their knowledge is shared over time. Top knowledge generators should be rewarded. If managers expect top talents to achieve their maximum performance and produce maximum return, they must not place them in routine jobs. ROT measures the payback from investment in people; it shows whether managers are hiring the right people and how effectively they use them to achieve business success. It can be a quantitative or qualitative measurement, based on management’s viewpoint. Are managers getting the maximum payback on their investment? If managers want to see quantitative results, they need to put a price on knowledge generated, based on the results achieved. Talent generates knowledge, which is one of the greatest assets in the global economy. True knowledge brings creativity and innovation, and adds value to the company. Knowledge has become a key production factor, along with traditional resources such as raw materials, buildings, and machinery. Companies that measure the knowledge generated and applied by their talent can make their investments in talent more profitable. Further, companies cannot improve what they do not measure. Effective managers use ROT measurements to make their investments in talent more

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Return on Talent profitable. ROT measurements help monitor performance, forecast opportunity, and determine the profitability of their investment in talent. To make their investment more profitable, management must constantly measure ROT, continuously improve ROT, and nurture, develop, and refresh talent.

Return on Knowledge

Return on knowledge generated and applied is more difficult to calculate and track. Knowledge creates real wealth through multiple applications, for example, repeating the same application pervasively through a corporation, or finding new applications to new situations. Knowledge applications have breadth (across organizations) and length (in time). Years may pass between the generation of knowledge and its first application, let alone subsequent applications. In order to properly account for the value of knowledge generated, initial estimates need to be made and refined yearly as applications appear on the horizon and then are realized. Leading indicators of return are based on projections of the probability of each anticipated application and the monetary value of each application summed over all anticipated applications. Forward-looking projections and backward-looking allocations are both judgments, and there’s no reason to believe that one is any better than the other. Indeed, projections made while focusing on the knowledge generated may be the more reliable of the two. It is certain that the combination of early projections, after-the-fact allocations, and annual updating and tracking between knowledge generated and the first of a series of applications, greatly improves the capability to measure and link return on knowledge generated and applied, and investment in talent. Summary and Further Steps

Making It Happen 8 Build a team focused on developing talent. To reach high ROT scores, you need a talent team. Often you find one or two good people who can generate knowledge and perhaps even apply that knowledge, but you don’t have a talent team that can leverage their ideas. Most of the individual talent in a company can be innovative if the team dynamics are right. If you have a low ROT score, you may have a dysfunctional team. ROT scores are not fixed; they change over time. 8 Measure and monitor ROT. If you are a manager who hires and invests in talent, you need to monitor ROT closely. In a company the size of General Motors or General Electric, you probably view salaries as a regular fixed cost that is standard. The portion that may vary is how much you invest in certain ideas. If you see that certain employees are not generating enough knowledge and success relative to your investment in them, that should be a big red flag because your ROT value might become negative, or much lower than your competitor’s ROT value. 8 Decide how to increase ROT throughout the organization. If you were hired to manage talent with a low ROT score (perhaps even a negative value), you need to do some things to boost the ROT fast. How do you turn around an organization and achieve higher ROT scores? You do it person by person, function by function.

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Business Performance Excellence You have to assess the talent on your team and find out who and what is bringing the most profit to the company, who and what is winning and keeping the best customers. Your first task is to perform talent diagnostics. You might easily spend six months identifying all your talent and determining which ones you can work with to turn the company around. But usually you don’t have six months to do talent diagnostics. So you need to do it faster, even in a large company. There is much to be said for focusing on quick, high-profile actions that build support and momentum behind the need to increase ROT. Many managers assess employees’ talent intuitively—they don’t necessarily need a measurement tool. Every manager, however, benefits from having a tool to measure and monitor ROT. Apple soared when Steve Jobs was CEO, and faded when he left. It soared again when he returned as Apple’s CEO. It doesn’t mean that Jobs was a good or bad person. He was a very effective person in that environment. Many good CEOs fail in environments in which there is no structure. They go by intuition. After you identify the key talents, give them the authority and resources to boost the ROT team score. The talent diagnostic may show that in one division you have a lot of talented people, while in a different division you have very few. You have to cross functions, making sure you balance the talent according to the needs of the organization, and then challenge each talent and team to reach a financial goal.

Conclusion Organizations that constantly improve ROT grow at a rapid rate. Management can monitor the performances of individuals as well as teams. Knowledge is one of the most important factors for business success. If knowledge assets are increased, then all other related factors like production and sales will be automatically increased. Consequently, organizations should try to improve ROT continuously to sustain sales growth. ROT is a superb key performance indicator, and one that is set to be measured and managed in much the same way as financial issues.

More Info Books: Becker, Brian E., Mark A. Huselid, and Richard W. Beatty. The Workforce Scorecard: Managing Human Capital to Execute Strategy. Cambridge, MA: Harvard Business School Press, 2005. Brockbank, Wayne, and David Ulrich. The HR Value Proposition. Cambridge, MA: Harvard Business School Press, 2005. Chowdhury, Subir. The Talent Era: Achieving a High Return on Talent. Upper Saddle River, NJ: Financial Times Prentice Hall, 2002. Kaplan, Robert S., and David P. Norton. Alignment: Using the Balanced Scorecard to Create Corporate Strategies. Cambridge, MA: Harvard Business School Press, 2006.

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