CORPORATE EXCELLENCE FOR INTERNATIONAL COMPETITION

PROPOSALS BUDGETS _I__ .." -

~arvest tigbs yam Monltw Progress &airat TargetJ

Ashwani K. Dhir, University of Texas at Arlington, 7105 Lake Mead Blvd., Arlington TX 76016, Krishna S . Dhir, Penn State Harrisburg. 777 W. Harrisburg Pike, Middletown, PA 17057-4898.

ABSTRACT Business organizations in many countries now realize that they are operating in a global economy and are subject to threats and opportunities inherent in an environment of international competition. Foreign competition has prompted progressive organizations to take actions that are designed to attain excellence in productivity and quality improvement. This paper presents an approach for achieving corporate (company-wide) excellence by building on the precept that practices related to productivity and quality improvement should be institutionalized. Authors suggest that the potential for producing continuous, company-wide improvement is greater when improvement concepts are integrated with salient company practices. A continuous improvement model is proposed that can be integratcd with company activities of strategic planning, development planning, budgetary controls, and pricing actions to produce a framework for achieving competitive excellence.

l" Foreign competition has prompted many manufacturing and service companies to implement programs designed to improve productivity or quality. Bench-marking, Employee Participation, Problem Solving and Employee Recognition are usually key elements of these programs. However, results have not been consistent. Some companies claim that these interventions are reasons for their survival or growth. Others have encountered difficulties and intempted or slowed program implementation. How should management make certain that competitive goals are met? Do these programs produce optimum results, or are they only capable of suboptimization in those limited areas that are subject to bench-marking? This paper suggests that the potential for achieving company-wide improvement will be greater if productivity concepts are integrated with salient company practices. The paper presents a four-step model of continuous improvement, that can be integrated with company activities of strategic planning, development planning, budgetary controls, and pricing to produce a framework for achieving competitive excellence.

PROVE-

The model, shown in Fig. 1, builds on the precept that practices related to productivity improvement should be institutionalized. It integrates improvement concepts with company's strategic plan. development plan, budgetary controls, and proposal actions. The model adapts these activities as four, progressive stages of thq improvement process.

Strategic plan is used to establish a company's productivity target, or the desired price and value advantage within an industry. In an analogy to fanning, this activity is treated as the first. the "seeding" stage of continuous improvement.

The model proposes that companies can use their development plans to prepare time-phased road maps for achieving productivity targets. Using the fanning analogy, preparation and implementation of the development plan is the "nurturing" stage of continuous improvement. Nurturing part of the improvement process is adequate only if the plan is fully capable of producing desired productivity results. Management must revisit, review and enhance the development plan until it reaches that distinct capability. The process of review and enhancement is shown as a 'decision loop' in the model.

I STRATEGIC PLAN I I DEVELOPMENT PLAN 1

t HCIRMSlWG t t MONffORIM

Fig. 1 Model for Continuous Improvement

Budgets offer means for allocating and controlling expenditure of reqources in support of plans. Companies use budgetary controls to monitor actual expenditures against targets. This practice can also be used to compare 'actual improvements' with 'productivity targets'. Budgeting and controlling activities constitute the "monitoring" stage of continuous improvement.

Companies use bids, proposals and pricing actions to offer their products and services for sale. Productivity gains are directly reflected in pricing actions. in the long run. Consider this activity to be the fourth and final stage of continuous improvement. In the fanning analogy, this is the stage at which results of the improvement effort are "harvested." Harvesting, as if. closes the loop of the improvement process and returns the model to the another cycle of continuous improvement (see arrows in Fig. 1).

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Technoloev Mode- since purchased materials and services are major costs in most companies, economic materials and efficient procurement becomes pivotal.

Problem solving is, of course, impoltant for productivity and quality improvement. This subject has received considerable attention in many companies in recent years. However. it is often overlooLed that preventing regression in areas where a company has previously performed well. is equally impomt. .%me of the problem solving and regression preventing objectives may be stated as follows:

Mentor - proteee' Learmnn 0 ~ 0 0 ~ : examples are. journeymen-apprentice teams and succession-plans for engineem. professionals and managers;

chronic DID-: bad habits and habitual problems can and do impact performance;

to dav. a ic D" I discerning what is right, and correcting what is wrong;

contml and process cycle management (plan, do, act, and check) as schooled by Edward Demming [SI;

vitv Based Costing: for improvement in overheads, materials, pmrement and other costs;

-: problem solving through teamwork. and total quality management initiatives;

Technical. m i o n a l and Cu ltural (as in culture-change) Training and Education.

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1 and FTocess -: statistical

Actions related to employee motivation, and initiatives that have the potential of creating a corporate commonwealth culture. may show some of the following features:

Go&: using

vee hpSperitv with Co-v p r o m : producing teamwork through a culture of corporate commonweala

Lone Term EmDlovment : utilizing

As stated earlier, a development plan is considered acceptable only if judged fully capable of achieving the strategic productivity target. If a plan falls short of that goal, it is either augmented with additional initiatives and resources or. the strategic productivity target is revised through decisions at himst levels of management.

familial loyalties to promote teamwork.

Organizing has been defined as the management function that

can be carried out successNTy [6]. Its relevmce to Continuous impmvemcnt lies in the necessity to organize ancl implement the development plan. Development plan must be evaluated and resource intensive initiatives replaced with better opti6m tb ensure that the plan becomes feasible within the limits of

le resoucces (and budgets). This point of view becomes :gT ally clear. if it is mgnized that. for given levels of sales (revtnues). a company's budgetary limits and productivity targets are mathematically related [7]. Fig. 4 shows a graphic illustration which can be used to establish thismathematical

focuseson allocatioa and a " e n t 0 f rcsoucces so that plans

relationship. wms(mhnan)

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Fig. 3 Graphic representation of productivity

In panel (a), data on sales and costs is shown in current d o h s (with inflation). As the curves for sales and costs are superimposed. their variance displays profits. In panel (b). the same data is shown in constant dollars (without inflation). As umstant dollar curves of sales and costs are superimposed. a part of the variance reveals productivity. Panel (b) graphs are a composite representation of performance in which sales, costs. productivity, and inflation can be seen to be interreiated, Since inflation can be forecasted, it can be treated as a known value, or a constant. It follows that, once a productivity target has been selected, then, for each projection of sales (revenues), there exists a comsponding allocation of costs or budgets. This constraint is especially imponant in the long run. Relationship between revenues, budgets, and productivity can be used to organize the development plan and allocate resources in such a manner that, the plan and budgets. both are true to the strategic productivity w e t .

Controlling has been defined as the management function aimed at regulating activities so that actual perfomme conforms to organizational stpadards and goals 181. Together, strategic productivity targets, development plans, and budgets pmvide management with the means to monitor initiatives, regulate resource allocations, and control improvement outcomes. Nature of the control process as it relates to productivity impvement can be explained with the help of financial and productivity

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information shown in Fig. 5. Financial and productivity results are shown for a hypothetical company for a four year period. Financial results are shown in terms of year-to-year changes in profitability. Roductivity results are also shown as year-to-year changes, that is, in terms of “I productivity improvement or deterioration. Financial data is shown in current year dollars and productivity data in constant dollars. Results in Table 1 essentially interpret the graphic representation of productivity (Fig. 3) and the algebraic productivity equations discussed in the appendix.

Table 1 Financial and productivity results @ypothetical)

35 E (‘52, (fi) - SJrt*r*bcy 581 825 258 1048 223 1062 14

562 758 207 926 167 958 33

1.05 1.09 1.13 1.11 5.9% 1.1% (2.1%)

1013 1WO s52 746 WO MUI 1.08 1.08 113 115

5.5% 3.8% 2.0%

It is evident that financial and productivity concepts. of year-to- year changes, are similar. The similarity is an essential consequence of the mathematical relationship that exists between revenues, costs (or budgets) and productivity. There is natural synergism between wtional company practices of financial and budgetary controls. and the productivity monitoring process proposed in this paper. Little change in customary financial and budgetary processes are necessary in order to arrange that management reviews “financial” and “productivity” results side by side. Traditional methods of control can be used to make sure that financial and productivity results are both visible. Management is then able to take regulatory action, mindful of the effect of their decisions on profits. as well as, company’s competitive future.

Companies often take pricing actions in very competitive environments. Therefore. pricing decisions offer opportunities to, as if, harvest the results of successful improvement initiatives. However, this harvest can yield excellent, fair, or indifferent results, depending on a company’s competence in producing competitive bids or prices. It is helpful to recognize that company cost structures have changed over time. Manufacturing companies have traditionally focussed attention on production and support (direct labor) costs. However, production and support costs have now become lower than costs in other areas like purchased materials and overheads. Michael C. O’Guin. a noted author of ‘‘ activity based costing” technique has discussed the changes in the. cost shuctures of companies in the United States [9]. He suggests that, “Our cost systems are

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obsolete and distort information executivek use to manage business ... Cumnt cost systems typically &sign overhead to products based 011 their direct labor content. This is remarkable considering that direct labor is merely a fraction of overhead costs.” Pointing out that only traceable costs can be controlled, O’Guin recommends that activity based costing technique should be used to make overheads visible. Relevance of changing cost sbuUures to pricing actions is illustrated in Fig. 4. A typical cost estimate. prepared to support pricing decision, may consist of 30% rigorous cost data, 20% subjective cost data, and 50% pro- rated overhead costs. Clearly, competitive pricing decisions cannot be made with a blind-side to 50% of company costs. Companies have a need to support pricing decisions with techniques that make costs visible in all functional areas.

7 1 i j - Fig. 4 Typical structure of cost estimate

CO” Leadership role of management is vital to the continuous improvement process. This point can be appreciated by looking at the vulnerability of companies to market penetration in the absence of an improvement strategy. Please examine performances of two hypothetical companies in Fig. 5.

& P W A - P w

I I I

b .

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Fig. 5 Vulnerability to market penemtion

For each company, graphs show profits, sales, costs, productivity and price recovery. where price recovery is a measure of relative idation in resource prices with respect to product prices. Both, Company A and Company B are shown to be eaming similar profits. However, productivity improvement in Company A is inferior. Company B. on the other hand, has achieved substantial productivity improvement. Profits for Company A are sustained

through price recovery. that is. by inllating the sale price of products and services. Profits for Company B are sustained through productivity improvement, efficiencies and lower costs. Evidently. in the long mn. Company A will be more vulnerable to market penetration by competitors. given its lower productivity, higher costs and higher prices.

Conipanies can mitigate their vulncrability to competition by institutionalizing concepts related to productivity improvement. However, this requires a top down approach. Since productivity improvement is relevant to a company's vulnerability to market penclration. improvement initiatives should be seen as being directly linked to prospects ol a company's survival and growth. Productivity effort. lhereforc. merits commitment and leadership a1 the hiphcst levels of company hicrarchy.

APPENDlX Relalionships in equations ( I ) through (4) provide a nialhcmatical basis for the continuous improvement model proposed in this papcr. Equations can bc examined in two stages:

I . Rclationship bctween Profitability, Productivity and Price Rccovery: 2 . Rclationship between Product Price and Productivity.

RESOURCE P W E

" r 2 T OTV PRXWCT FW2E x -

COST RE-E ClTY

SALES (1) -

PWFIT~ILITY = pmxwnwrv x PRCE REWMRY (2) - w Equation ( I ) expands the ratio of cost to sales. Cost is obtained by multiplying resource quantities by resource prices. Sales is obtained by multiplying product quantities with product prices. To obtain equation (2).

a. Define Profitability as the ratio of cost to sales; b. Define Productivity as the input-output ratio of resource quantities to product quantities; c. Define Price Recovery (a measure of relative inflation) as the ratio of resource prices to product prices

These definitions yield the relationship. "profitability equals productivity times price recovery." Since price recovery is a measure of relative inflation, it can be calculated with the help of commercially forecasted inflation indices. Therefore, inflation becomes a known quantity. Then, for a given value of price recovery , profitability is directly proportional to productivity.

The mathematical rekationship between product price and productivity i s the basis of the strategic pricing concept illustrated in Fii% To develop related equations (3) and (4).

a. Define AProfitability as the annual change in profitability; b Define AProductivity as the annual change in productivity;

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c. Define AResource Price as the annual change (inflation) in Resource Price; d. Define AProduct Price as the annual change (inflation) in Product Price.

Based on these definitions, equation (2) yields equation (3). and, in turn, equation (4). In equation (4), once the change in profitability (cost to sales ratio) is projected by a company, and change in resource price (inflation) is forecasted, we find that AProduct Price is proportional to AProductivity.

The proportionality between AProduct Price and AProductivity is the basis of the competitive pricing concept. As stated, a company can gain competitive price advantage by sustaining productivity improvement at levels above those prevalent in its industry.

[ l ] C. E. Craig and R. C. Harris, Total Productivity Measurement at the firm level. Sloan Manaeement Review, (Spring) 14(3), 1973.

[2] Harvard Business Review (May-June) 62 (3). 1984.

[3] K. S . Dhir, A Svstem for Manaeement Control of Stratcgy ImDlementation. Medical Department, CIBA-GEIGY AG, Basle, Switzerland, 1981.

[4] A. K. Dhir and K. S . Dhir, Office Technology Modemization: the LTV Experience, Proceedings of the Westem Decision Sciences Institute Conference, April 1988.

[5] M. Wallace, The Demming Manaeement Method. Perigee Books, Putnam Publishing, 1986.

[6] Inc., pp 7-10, 1991.

[7] D. S . Sink, A. K. Dhir and C. A. Roberts. Innovative Advances in Productivity Measurement and Evaluation in the Aerospace and Defense Industry, Annual Intemational Industrial Engineering Conference Proceedings. 1985 pp. 329-340.

[8] W. H. Newman, Constructive Control, Prentice-Hall, 1975.

191 M. C. O'Guin, Activity Based Coasting: Unlocking Our Competitive Edge. Manufacturing Systems. pp. 35-43, December 1990.

D, Miller, Profitability = productivity + price recovery,

K. M. Bartol and D. C. Martin, Manaeement. McGraw-Hill,