Block 1: Increasing Efficiency
A business is simply a device for transforming inputs into outputs. Inputs are basic factors of production such as labor, land, capital, management, and technological know-how. Outputs are the goods and services that the business produces.
The simplest measure of efficiency is the quantity of inputs that it takes to produce a given output. The more efficient a company is, the fewer the inputs required to produce a given output.
Efficiency helps a company attain a competitive advantage through a lower cost structure.
Efficiency can be improved along with every activity of the value chain of the company.
In general, high productivity leads to greater efficiency and lower costs. Two of the most important components of efficiency for many companies are (1) employee productivity and (2) capital productivity.
Employee productivity is usually measured by output per employee and capital productivity by output per unit of invested capital.
Holding all else constant, the company with the highest labor and capital productivity in an industry will typically have the lowest cost structure and therefore a cost-based competitive advantage.
The concept of productivity is not limited to employee and capital productivity. Others may be productivity in R&D spending or productivity in salesforce.
Efficiency in R&D
Management in the R&D function might look for ways to simplify the design of a product, reducing the number of parts it contains.
By doing so, R&D can dramatically decrease the required assembly time, which translates into higher employee productivity, lower costs and higher profitability.
Design for manufacturing requires close coordination between the production and R&D functions of the company. One of the best solutions to achieve this coordination level is to utilize cross-functional teams that contain production and R&D personnel who work jointly on the problem.
Efficiency in Production
Management in the production function of a company might look for ways to increase the productivity of capital and labor.
One common strategy is to pursue economies of scale, which means driving down unit costs by mass-producing output.
A major source of economies of scale is the ability to spread fixed costs over a large production volume.
Fixed costs are costs that must be incurred to produce a product whatever the level of output. The key to efficiency and profitability of companies with high fixed costs and trivial incremental or marginal costs is to increase sales rapidly enough that fixed costs can be spread out over a large unit volume and substantial scale economies can be realized.
Another source of scale economies is the ability of companies producing in large volumes to achieve a greater division of labor and specialization.
Specialization is said to have a favorable impact on productivity, mainly because it enables employees to become very skilled at performing a particular task.
In addition to scale effects, management might seek to boost efficiency by pursuing strategies that help to maximize learning effects.
Learning effects are cost savings that come from learning by doing. Equally important, management in new manufacturing facilities typically learns over time how best to run the new operation. Hence, production costs decline because of increasing labor productivity and management efficiency.
Although learning effects are normally associated with the manufacturing process, there is every reason to believe that they are just as important in service industries.
An important source of greater efficiency has been the introduction of flexible manufacturing technology.
The term flexible manufacturing technology, or lean production, as it is sometimes called, covers a range of manufacturing technologies designed to reduce setup times for complex equipment, increase the use of individual machines through better scheduling, and improve quality control at all stages of the manufacturing process.
Flexible manufacturing technologies allow the company to produce a wider variety of end products at a unit cost that at one time could be achieved only through the mass production of a standardized output.
The adoption of flexible manufacturing technologies may increase efficiency and lower unit costs relative to what can be achieved by the mass production of a standardized output, while at the same time enabling the company to customize its product offering to a much greater extent than was once thought possible.
The term mass customization is used to describe the ability of companies to use flexible manufacturing technology to reconcile two goals that were once thought to be incompatible: low cost and differentiation through product customization.
Efficiency in Marketing
The marketing strategy that a company adopts can have a major impact on efficiency and cost structure.
A marketing strategy refers to the position that a company takes with regard to pricing, promotion, advertising, product design, and distribution.
Attaining economies of scale and learning effects can be facilitated by aggressive pricing, promotions, and advertising, all of which build sales volume rapidly and allow for the cost reductions that come from scale and learning effects.
Another important strategy involves reducing customer defection rates.
Customer defection rates are the percentage of a company’s customers who defect every year to competitors. Defection rates are determined by customer loyalty, which in turn is a function of the ability of a company to satisfy its customers.
Because acquiring a new customer entails certain one-time fixed costs for advertising, promotions, and the like, there is a direct relationship between defection rates and costs. The longer a company holds on to a customer, the greater the volume of unit sales generated by a customer that can be set against customer acquisition costs.
Thus, lowering customer defection rates allows a company to amortize its customer acquisition costs and achieve a lower overall cost structure.
To reduce customer defection rates, marketing managers take steps to build brand loyalty, and to make it more expensive for customers to defect.
Efficiency in Logistics
Improving the efficiency of the materials management function often requires the adoption of a just-in-time (JIT) inventory system.
This system is designed to economize on inventory holding costs by having components arrive at a manufacturing plant just in time to enter the production process or goods at a retail store only when stock is almost depleted.
The major cost saving comes from increasing inventory turnover, which reduces inventory holding costs, such as warehousing and storage costs, and the company’s need for working capital.
The drawback of JIT systems is that they leave a company without a buffer stock of inventory. Although buffer stocks are expensive to store, they can help tide a company over shortages on inputs brought about by disruption among suppliers and help a company respond quickly to increases in demand. However, there are ways around these limitations.
Efficiency in Human Resources
Employee productivity is one of the key determinants of an enterprise’s efficiency, cost structure, and profitability.
It is important to make sure that the hiring strategy of the company is consistent with its own internal organization, culture, and strategic priorities. The people a company hires should have attributes that match the strategic objectives of the company.
Organizing the workforce into self-managing teams is a popular human resource strategy for boosting productivity.
In a self-managing team, members coordinate their own activities, which might include making their own hiring, training, work, and reward decisions.
The typical team comprises 5 to 15 employees who produce an entire product or undertake an entire task. Team members learn all team tasks and rotate from job to job. Because a more flexible workforce is one result, team members can fill in for absent coworkers and take over managerial duties such as work and vacation scheduling, ordering materials, and hiring new members.
The greater responsibility thrust on team members and the empowerment it implies are seen as motivators. People often respond well to being given greater autonomy and responsibility.
Performance bonuses linked to team productivity and quality targets can work as an additional motivator. Further cost savings arise from eliminating supervisors and creating a flatter organizational hierarchy, which also lowers the cost structure of the company.
Implementing pay-for-performance compensation systems is another common human resource strategy for boosting efficiency.
It is hardly surprising that linking pay to performance can help increase employee productivity. However, it is important to define what kind of job performance is to be rewarded and how.
Cooperation among employees is necessary to realize productivity gains, link pay to group or team performance rather than individual performance. This link creates a strong incentive for individuals to cooperate with each other in pursuit of team goals. That is, it facilitates teamwork.
Efficiency in Information System
Modern information systems function is moving to center stage in the quest for operating efficiencies and a lower cost structure.
The impact of information systems on productivity is wide-ranging and potentially affects all other activities of a company.
Many companies are using web-based information systems to reduce the costs of coordination between the company and its customers and the company and its suppliers. By using web-based programs to automate customer and supplier interactions, the number of people required to manage these interfaces can be substantially reduced, thereby reducing costs.
This trend extends beyond high-tech companies. Banks and financial service companies are finding that they can substantially reduce costs by moving customer accounts and support functions online.
Efficiency in Organization Infrastructure
The organization infrastructure determines the context within which all other value creation activities take place. It includes organization structure, organization culture, strategic leadership style, and control system.
It follows that improving infrastructure can help a company increase efficiency and lower its cost structure. Above all, an appropriate infrastructure can help foster a companywide commitment to efficiency and promote cooperation among different functions in pursuit of efficiency goals.
Strategic leadership is especially important in building a companywide commitment to efficiency.
The leadership task is to articulate a vision that recognizes the need for all functions of a company to focus on improving efficiency, then facilitate cross-functional cooperation needed to achieve superior efficiency. It is not enough to improve the efficiency of production, or of marketing, or of R&D separately. Achieving superior efficiency requires a companywide commitment to this goal that must be articulated by management.
Block 2: Quality as Excellence and Reliability
A product has superior quality when customers perceive that the attributes of a product provide them with a higher value than attributes of products sold by rivals.
A product can be thought of as a bundle of attributes. The attributes of many physical products include the form, features, performance, durability, reliability, style, and design of the product.
The impact of high product quality on competitive advantage is twofold.
First, providing high-quality products increase the value those products provide to customers which helps the company to differentiate its product from those offered by rivals, thus gives the company the option of charging a higher price for them.
The second impact of high quality on competitive advantage comes from the greater efficiency and the lower unit costs associated with reliable products. When products are reliable, less employee time is wasted making defective products or providing substandard services and less time has to be spent fixing mistakes, which translates into higher employee productivity, lower unit costs, and thus increases the firm’s profitability.
When customers are evaluating the quality of a product, they commonly measure it against two kinds of attributes; attributes that are related to quality as excellence, and attributes that are related to quality as reliability.
Attaining Superior Reliability
A product can be said to be reliable when it consistently does the job it was designed for, does it well, and rarely, if ever, breaks down.
Reliability increases the value a consumer gets from a product, and thus the price the company can charge for that product.
Six Sigma quality improvement methodology is a principal tool that most management now use to increase the reliability of their products.
The Six Sigma methodology is a direct descendent of the Total Quality Management (TQM) philosophy that was widely adopted, first by Japanese companies and then American companies during the 1980s and early 1990s.
The basic philosophy underlying quality improvement methodologies is as follows: (1) Improved quality means that costs decrease because of less rework, fewer mistakes, fewer delays, and better use of time and materials; (2) As a result, productivity improves; (3) Better quality leads to higher market share and allows the company to raise prices; and (4) This increases the company’s profitability and allows it to stay in business.
Among companies that have successfully adopted quality improvement methodologies, certain imperatives stand out.
First, it is important that senior management buy into a quality improvement program and communicate its importance to the organization.
Second, if a quality improvement program is to be successful, individuals must be identified to lead the program.
Third, quality improvement methodologies preach the need to identify defects that arise from processes, trace them to their source, find out what caused them, and make corrections so that they do not recur.
Production and materials management typically have primary responsibility for this task. To uncover defects, quality improvement methodologies rely upon the use of statistical procedures to pinpoint variations in the quality of goods or services. Once variations have been identified, they must be traced to their source and eliminated.
One technique that greatly helps in tracing defects to their source is reducing lot sizes for manufactured products. With short production runs, defects show up immediately. Consequently, they can be quickly traced to the source, and the problem can be addressed. Reducing lot sizes also means that when defective products are produced, their number will not be large, thus decreasing waste. Flexible manufacturing techniques can be used to reduce lot sizes without raising costs.
Fourth, another key to any quality improvement program is to create a metric that can be used to measure quality. In manufacturing companies, quality can be measured by criteria such as defects per million parts. In service companies, with a little creativity, suitable metrics can be devised.
Fifth, once a metric has been devised, the next step is to set a challenging quality goal and create incentives for reaching it. Under Six Sigma programs, the goal is 3.4 defects per million units. One way of creating incentives to attain such a goal is to link rewards, like bonus pay and promotional opportunities, to the goal.
Sixth, shop floor employees can be a major source of ideas for improving product quality, so their participation needs to be incorporated into a quality-improvement program.
Seventh, a major source of poor-quality finished goods is poor-quality component parts. To decrease product defects, a company has to work with its suppliers to improve the quality of the parts they supply.
Eighth, the more assembly steps a product requires, the more opportunities there are for making mistakes. Thus, designing products with fewer parts is often a major component of any quality improvement program.
Ninth, implementing quality-improvement methodologies requires organization-wide commitment and substantial cooperation among functions.
Improving Quality as Excellence
When excellence is built into a product offering, consumers have to pay more to own or consume them.
The important attributes are things such as a product’s design and styling, form, features, performance, aesthetic appeal, its features and functions, level of service associated with the delivery of the product, and so on.
A company can also create quality as excellence by emphasizing attributes of the service associated with the product, such as ordering ease, prompt delivery, easy installation, the availability of customer training and consulting, and maintenance services.
For a product to be regarded as high quality on the excellence dimension, its offering must be seen as superior to that of rivals. Achieving a perception of high quality on key attributes requires specific actions by management.
First, it is important to collect marketing intelligence indicating which of these attributes are most important to customers.
Second, once the company has identified important attributes, it needs to design its products, and the associated services, so that those attributes are embodied in the product, and it needs to make sure that personnel in the company are appropriately trained so that the correct attributes are emphasized.
Third, the company must decide which of the significant attributes to promote and how best to position them in the minds of consumers, that is, how to tailor the marketing message so that it creates a consistent image in the minds of customers.
Although a product might be differentiated on the basis of many attributes, covering all of those attributes in the company’s communication messages may lead to an unfocused message. By stating only one or two central attributes to customers, firms assure that the message is clear and easy to remember.
Fourth, competition does not stand still, but instead produces continual improvement in product attributes and often the development of new product attributes. This is obvious in fast-moving high-tech industries where product features that were considered leading edge just a few years ago are now obsolete, but the same process is also at work in more stable industries.
Block 3: Increasing Innovation
Innovation refers to the act of creating new products or processes.
Many firms seek to develop innovation as a core competence. Firms and organizations achieve strategic competitiveness and earn above-average returns by acquiring, bundling, and leveraging their resources for the purpose of taking advantage of opportunities in the external environment in ways that create value for customers.
In the long run, innovation is perhaps the most important building block of competitive advantage. Increasingly, innovation appears to be a vital path to efforts to develop competitive advantages, particularly sustainable ones.
This is because innovation can result in new products that better satisfy customer needs, can improve the quality of existing products, or can reduce the costs of making products that customers want.
Competition can be viewed as a process driven by innovations. Although not all innovations succeed, those that do can be a major source of competitive advantage because they give a company something its competitors lack.
Competitors, however, attempt to imitate successful innovations and often succeed. Therefore, maintaining a competitive advantage requires a continuing commitment to innovation.
Uniqueness can allow a company to (1) differentiate itself from its rivals and charge a premium price for its product or, in the case of many process innovations, (2) reduce its unit costs far below those of competitors.
There are two main types of innovation: (1) product innovation and (2) process innovation.
Product innovation is the development of products that are new to the world or have superior attributes to existing products.
Product innovation creates value by creating new products or enhanced versions of existing products, that customers perceive as having more value, thus giving the company the option to charge a higher price.
Process innovation is the development of a new process for producing products and delivering them to customers.
Process innovation often allows a company to create more value by lowering production costs.
The High Failure Rate of Innovation
The failure rate of innovative new products is high.
There are reasonably 5 following reasons to explain why so many new products fail to generate an economic return.
First, many new products fail because the demand for innovations is inherently uncertain.
It is impossible to know prior to market introduction whether the new product has tapped an unmet customer need and if there is sufficient market demand to justify making the product. While good market research can likely reduce the uncertainty about the future demand for new technology, it cannot be completely eradicated, so a certain failure rate is to be expected.
Second, new products often fail because the technology is poorly commercialized.
This occurs when there is definite customer demand for a new product, but the product is not well adapted to customer needs because of factors such as poor design and poor quality.
Third, new products may fail because of poor positioning strategy.
Positioning strategy is the specific set of options a company adopts for a product on four main dimensions of marketing: price, distribution, promotion and advertising, and product features.
Forth, companies often make the mistake of marketing a technology for which there is not enough demand.
A company can get blinded by the wizardry of new technology and fail to examine whether there is customer demand for the product.
Fifth, companies fail when they are slow to get their products to market.
The more time that elapses between initial development and final marketing the slower cycle time, which means the more likely it is that someone else will beat the company to market and gain a first-mover advantage.
Reducing Innovation Failures
One of the most important things that firms can do to reduce the high failure rate associated with innovation is to make sure that there is tight integration between R&D, production, and marketing.
Tight cross-functional integration can help a company to ensure that: (1) Product development projects are driven by customer needs. (2) New products are designed for ease of manufacture. (3) Development costs are kept in check. (4) Time to market is minimized. (5) Close integration between R&D and marketing is achieved to ensure that product development projects are driven by the needs of customers.
A company’s customers can be one of its primary sources of new product ideas.
The identification of customer needs, and particularly unmet needs, can set the context within which successful product innovation takes place. As the point of contact with customers, the marketing function can provide valuable information. Moreover, integrating R&D and marketing is crucial if a new product is to be properly commercialized. Otherwise, a company runs the risk of developing products for which there is little or no demand.
Integration between R&D and production can help a company to ensure that products are designed with manufacturing requirements in mind.
Design for manufacturing lowers manufacturing costs and leaves less room for mistakes and thus can lower costs and increase product quality. Integrating R&D and production can help lower development costs and speed products to market. If a new product is not designed with manufacturing capabilities in mind, it may prove too difficult to build, given existing manufacturing technology.
In that case, the product will have to be redesigned, and both overall development costs and time to market may increase significantly.
One of the best ways to achieve cross-functional integration is to establish cross-functional product development teams, composed of representatives from R&D, marketing, and production.
The objective of a team should be to take a product development project from the initial concept development to market introduction.
Block 4: Achieving Superior Customer Responsiveness
To achieve superior customer responsiveness, a company must be able to do a better job than competitors of identifying and satisfying its customers’ needs. Customers will then attribute more value to its products, creating a differentiation based on competitive advantage.
Customer responsiveness is an important differentiating attribute that can help to build brand loyalty.
Achieving superior responsiveness means giving customers value for money. Taking steps to improve the efficiency of a company’s production process and the quality of its products is consistent with this aim. Responding to customers’ needs may also require the development of new products with new features.
There are several aspects of customer responsiveness.
One major aspect of customer responsiveness is the need to customize goods and services to the unique demands of individual customers or customer groups.
Another aspect of customer responsiveness is customer response time. This is the time that it takes for a good to be delivered or a service to be performed.
For a manufacturer of machinery, response time is the time it takes to fill customer orders. For a bank, it is the time it takes to process a loan or that a customer must stand in line to wait for a free teller. For a supermarket, it is the time that customers must stand in checkout lines.
Other aspects of enhanced customer responsiveness include superior design, service, and after-sales service and support. All these factors enhance customer responsiveness and allow a company to differentiate itself from its competitors. In turn, differentiation enables a company to build brand loyalty and charge a premium price for its products.
Achieving superior efficiency, quality, and innovation are all part of achieving superior responsiveness to customers.
Improving the quality of a company’s product offering is consistent with achieving responsiveness, as is developing new products with features that existing products lack. In other words, achieving superior quality and innovation is integral to achieving superior responsiveness to customers.
In addition, there are two other prerequisites for attaining customer responsiveness: (1) a tight customer focus and (2) an ongoing effort to seek better ways to satisfy those needs.
Customer Focus
A company cannot be responsive to its customers’ needs unless it knows what those needs are.
The first step to build customer focus is to start at the top of the organization. A commitment to superior customer responsiveness brings changes throughout a company that ultimately can only be built through strong leadership.
The second step to build customer focus is to develop a mission statement that puts customers first. This is one way to send a clear message to employees about the desired focus.
The third step to build customer focus is to motivate all employees to see the customer as the focus of their activities, whether their function is marketing, manufacturing, R&D, or accounting. The objective should be to make employees think of themselves as customers and to put themselves in customers’ shoes. At that point, employees will be better able to identify ways to improve the quality of a customer’s experience with the company.
To reinforce this mindset, incentive systems within the company should reward employees for satisfying customers.
Satisfying Customer Needs
Another key to superior responsiveness is to satisfy customer needs that have been identified.
Efficiency, quality, and innovation are crucial building blocks that help a company satisfy customer needs. Beyond that, companies can provide a higher level of satisfaction if they differentiate their products by (1) customizing them, where possible, to the requirements of individual customers and (2) reducing the time it takes to respond to or satisfy customer needs.
Customization entails varying the features of a good or service to tailor it to the unique needs or tastes of groups of customers or, in the extreme case, individual customers.
Although extensive customization can raise costs, the development of flexible manufacturing technologies has made it possible to customize products to a much greater extent than before without experiencing a prohibitive rise in the cost structure.
Companies that can satisfy customer demands for rapid response build brand loyalty, differentiate their products and can charge higher prices for them.
We live in a fast-paced society, where time is a valuable commodity. Reducing the time it takes to respond to customer demands is critical to building competitive advantage, whether the transaction is a furniture manufacturer’s delivery of a product once it has been ordered, a bank’s processing of a loan application, an automobile manufacturer’s delivery of a spare part for a car that broke down, or the waiting in a supermarket checkout line.
In general, reducing response time requires (1) a marketing function that can quickly communicate customer requests to production, (2) production and materials management functions that can quickly adjust production schedules in response to unanticipated customer demands, and (3) information systems that can help production and marketing in this process.
Resources
Further Reading
Related Concepts
References
- Hill, C. W. L., & Jones, G. R. (2011). Essentials of Strategic Management (Available Titles CourseMate) (3rd ed.). Cengage Learning.
- Mastering Strategic Management. (2016, January 18). Open Textbooks for Hong Kong.