Author: tomkapostasy

Retired finance and operations executive interested in public policy, especially where data can help to frame the issues.

Managing the Tail in Operations and Product Development

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Marketers and investors have recently discovered the importance of “the tail” in distributions of opportunities, results and risks.  Virtual organizations, micro-marketing and web-based access to tiny clusters of customers has allowed start-up firms to profitably sell products to in truly niche markets.  Nassim Taleb’s book titled “The Black Swan” alerted investors to the rare events with large impacts which are not well-managed by modern portfolio theory and its attendant financial instruments.  Wise investors now consider the impact of once in a generation or once every century type events. 

As processes, product differentiation and product complexity grew following the mass market global recovery of the 1950’s and 1960’s, operations manager and engineers have increasingly faced greater challenges and opportunities “managing the tail”.  Early information technology forced companies to document and standardize their core business processes.  This automation helped companies to see their self-imposed administrative limits and explore computer assisted processes to handle all possibilities.  Product differentiation was pursued for every customer group and product dimension, creating sales, production, quality and support issues.  As customers received more options, higher quality, lower prices and shorter lead-times, they were NOT satisfied, but asked for MORE. 

Managers and engineers found that working in the tail became increasingly more difficult, costly and sometimes just plain impossible.  The number of combined options in production, assembly, catalogs, project steps, flowcharts and diagnostic guides approached infinity due to the potential combinations and permutations.  The challenge of identifying and resolving opportunities increased as remaining failure rates in quality, repairs, out of stock position or on-time shipping fell from 1 in 50 to 1 in 100 to 1 in 500 to 1 in 1,000 to 1 in 5,000 towards the gloriously named six sigma level (2%, 1%, 0.2%, 0.1%, 0.05% …).

In general, an army of scientifically oriented quality, business, marketing, financial, IT and engineering analysts have addressed these opportunities as complexity has risen and customer demands have increased.  Along the way, the quality paradigm was defined, setting zero defects, variability, travel, inventory, waiting and waste as eternal goals.  The financial paradigm’s focus on limiting costly investments to obtain small benefits acted as a resistor throughout this period.  

As organizations have moved deep into the tail for their IT and product development, operations and reverse logistics processes, conflict has become more common.  Analysts and process owners understand the trend and know that eventually any error, combination or possibility will be required by an internal or external customer.  They hate disorder and doing things twice.  They enjoy describing processes, diagnosing problems, designing and implementing complex processes, at whatever cost.  Their product development, IT and operations managers and directors, backed up by finance, tend to focus on the short-run, employ cost-benefit analysis and value compliance with project deadlines and budgets as higher goals.  The conflicts can be gentle comments, indirect negotiations or all out wars.

All of the players agree that demands for systems to handle more complex options with near perfect results will continue to grow.  They differ in how they value the short-run and the long-run.  While the financial paradigm develops a payback period or ROI based upon “solid” financial estimates for 5-10 years, the quality paradigm employs an infinite time horizon where infinitesimal improvements have subjectively valued importance as customer satisfaction, market share or risk management benefits.  As quality guru Dr. Deming said, the most important benefits are “unknown and unknowable”.  Hence, the two approaches are fundamentally incompatible.

Managers should take a number of general and specific steps to manage these situations, especially since they involve highly skilled, compensated and critical resources.  First, help the participants to understand the financial and quality paradigms.  Help them to see that the finance paradigm has great short-term applicability and is no going to be subsumed by the quality paradigm.  Teach staff members to deeply understand the quality paradigm, the transformation it has facilitated in global business and its contribution to long-run success in a consumer driven world. 

Second, encourage functional and project team members to alternately apply both paradigms to specific situations.  Either can help to trigger break-through solutions or to find an obvious next improvement level.

Third, reinforce with staff members the need to have functional hierarchical structures, process improvement resource plans and project management as tools to manage the improvement effort.  Front line staff and analysts may have the best ideas, but they need to be administratively coordinated by managers.  Even in the most dynamic, entrepreneurial environment, there is some need for structure.  Managers and staff can debate the right overall level or need for exceptions, but they need to appreciate the need for limits and ultimate decision-makers when conflicts can not be resolved.

Fourth, help staff to see the long-run commitment to improvements.  Cutting errors in half today, rather than pursuing a 90% reduction, is not a failure, it is a win.  The organization will be back to this process in 3 or 5 or 7 years, with new tools and customer demands, again analyzing 50%, 90% and 99% improvement paths.  Decisions to accept “good enough” are part of the long-run improvement process.

Fifth, employ the best practices of product development, diagnosis, problem solving and project management to reduce variability and meet goals in cost-effective ways.  With 50 years of experience, professionals have found great approaches that can be broadly applied.

Managing the tail of operations processes is an increasingly important role for managers and analysts.  Greater variety and consumer demand makes it ever more challenging to resolve issues or to know when to stop pursuing them.  Teaching staff to understand the complementary roles of the financial and quality paradigms and providing them with best practices tools helps them to produce cost-effective results.

Tools for Managing the Tail

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Managers and analysts who develop and improve products, systems and processes increasingly manage activities in the tail of near-perfect delivery expectations and stunning complexity.  In addition to understanding the finance and quality contexts of their functions, they can manage the tail by simplifying processes and problems, reducing goals and options, optimizing within constraints and monitoring non-critical activities.

Simplify Processes and Problems

  1. Modularize components to reduce the number of processes, flows and points of failure.  Reduce the points of contact between modules.
  2. Incorporate self-testing features to make component outputs fail-safe (poke yoke).
  3. Use a greater common denominator approach to combine options and provide just the higher value option.
  4. Separate A, B, C and D volume/variability items into focused factory, modular production, job shop and true custom flows.  Move D volume processes completely out of the system if required.
  5. Side-track complex evaluation steps to allow human expert consideration.
  6. Require incompatible orders or requests to be split and handled separately.
  7. Design processes to allow them to start again or reboot to eliminate truly random circumstances or operator error.

 

Reduce Goals and Options

  1. Set a short-term level of imperceptible defects or same level as the competition.  Use this to guide short-run choices.
  2. Reduce the number of customer goals from a dozen to six or two or one.  As demonstrated in Eli Goldratt’s book “The Goal”, this can simplify and motivate for long-run improvements.
  3. Use marketing research and Pareto analysis to determine the limits of perceptible differences and material goals.
  4. Incentivize customers to accept achievable goals and options by offering discounts, features, benefits and service.
  5. Leverage IT, technical, safety and regulatory limits to reduce options.

 

Optimize Within Constraints

  1. Set a project scope and resource budget.  Rank order initiatives and deliver within the time allowed.
  2. Simulate processes to determine the probability of occurrence and use this to eliminate low-frequency events from analysis.
  3. Apply best diagnosis practices for intermittent failures.  Set time limits.  Escalate to world-class experts. Set time and dollar limits.
  4. Limit the complexity of the system to a one-page flow-chart.

 

Monitor Non-Critical Activities

  1. Document future improvement options in a project parking lot.
  2. Develop reports and processes to monitor known risk and problem areas to identify root causes or increased frequency of occurrence.

 

There are many other approaches used by experienced product developers, project managers and analysts.  The insights of each functional area can often be used in other functions.

Creating Infinite Customer Value

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Process engineers create structures and use them to create infinite value. Most subscribe to the balanced scorecard view of commercial firms as four linked levels: 1) assets/resources used to create 2) operations excellence which 3) satisfies customers, allowing firms to 4) maximize financial returns. Many use some variation of Richard Schonberger’s six universal customer needs (QSFVIP) to structure strategies for satisfying customers. They have found that there is no practical limit to increasing the value delivered to customers.

In the world of quality, we have seen ISO 9000 type quality management systems become standard and Six Sigma quality levels approached. Informal quality assurance has been supplanted by a variety of formal measurement, feedback and improvement systems. Product defect levels have fallen from 5% to 2% to 1% to 0.1% to even smaller fractions. The improvements show no signs of stopping and customers appear to value each new level. The accident rate in commercial aviation provides a powerful case study. The basic quality feedback loop combined with statistical tools and employee engagement have made this possible.

 Speed, measured as product delivery cycle time, continues to improve. Manufacturing processes are designed in cells, using “unit of one” batches and just-in-time supplies to reduce production from weeks to days to hours. Supply chain coordination reduces production lead times from months to weeks to days. In distribution, lead times have dropped from weeks to days to latest cutoff hours for air, parcel, LTL and truck load service. Customers continue to ask for more, even beyond 2pm cutoffs for 10am next day delivery.

 Flexibility to accept orders of any size or kind at any time continues to improve. Customers no longer order ahead of peak seasons to assure supply. They order when then need goods. Customers share sales forecasts, but have no qualms about ordering 3-6-12 months of supply in a single shot and expect normal delivery. Firms have learned to add low-cost equipment and labor capacity, hold semi-finished goods and outsource peak needs to partners. This pressure has moved up the whole supply chain. Lean manufacturing techniques and integrated supply chain management have facilitated this change.

Value, as measured by unit cost, continues to improve. Labor and total factor productivity increase by 2-4% annually for decades at a time. Quality, supply chain, IT, communications, institutional, engineering and basic science advances drive these benefits.

Value, as measured by combinations of features and benefits that meet individual needs, grows each year. Micro marketing, partnerships and customer intimacy strategies ensure that goods and services better meet expressed customer needs. Data analysis, individual promotions and sales tracking allow firms to anticipate the needs of smaller and smaller groups of customers.

 Information or transaction costs continue to fall. EDI and simple electronic markets reduce transaction costs at every stage. Supplier websites, catalogs, pricing, ratings and portals reduce the costs of transactions. Formalized information sharing, vendor managed inventory and evaluated receipt settlements further reduce costs. Standard project and document collaboration systems reduce the cost of product development. Formalized risk management and emergency preparedness resources and plans reduce potential liabilities for all.

 Personal attention grows, in spite of the increased complexity of systems and use of high-technology. Firms know more about each other through partnerships, joint suppliers, product development projects and customized offerings. Firms which have adopted customer intimacy as their primary strategy have organized to become customer centric, employing customer relationship management systems (CRM) to shape their data. As routine transactions are automated, sales, customer and technical service staff focus their time on personal attention.

 Customers will be fully satisfied when there are no product defects and no risk of product defects, when goods and services are delivered at the second they perceive a need, when no purchase is delayed as being too large or unusual, when products are free or customers are paid to take them, when products are uniquely created for their needs, when transaction costs are zero and when they feel like they are the only customer in the world. Tremendous progress has been made towards those goals in the last 30-50 years, often beyond what was imaginable even 20 years ago. The rate of progress towards those ultimate goals has not yet slowed.

Framing Politics With a Ruler

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Peggy Noonan’s suggestion to use a 36 inch ruler to gauge right versus left in politics does help to explain the opposing views of tea partiers, Republicans and Democrats.  Noonan describes 0 inches as pure right and 36 inches as pure left (opposite of what you might expect).  She bemoans her perception that modern-day politicians negotiate between the 25 and 30 inch mark on the far left end of the ruler.  She asserts that tea partiers will try to move back to the 5 inch mark.

In politics, he who sets the framework usually wins the game.  Using American history since the agricultural 1770’s, urbanizing 1860’s, industrial 1920’s or depression 1930’s as a base, a case can be made that post-war politics and economics has been debated on the left end of the ruler, with a mixed economy government share of GDP at 20% and government spending/taxing share of GDP at 25-30%.  These shares of the economy double those of laissez-faire capitalism, the roaring twenties or the depression.  Noonan takes this long-run historical view of how the yardstick should be labeled.

Noonan is right in pointing out that politicians of both parties in a democratic system inherently seek to spend more money.  The rise in government spending in the Bush presidency after the unusual decline in government spending in the Clinton presidency (with Republican congress) is a modern reminder.  Tea partiers are right to have gut level concerns that government spending will continue to climb unchecked.  The trend in 2000-2008 was up.  Extraordinary banking and industry bail-out funds were piled on top of the stimulus spending for the Great Recession.  Health care and social security spending increases are expected in the next two decades.  Whether the various spending increases are justified or not, the trend is clearly up, without any clear countervailing force in Washington.

Those on the left might agree with the challenge to be faced, but they use a different scale to gauge left versus right, object to the accusation that they have driven up government spending, hold the Republicans responsible for inciting anger in the tea partiers and offer different long-run solutions.

If the scale is set between 100% individual, 0% government pure libertarianism versus 0% individual, 100% government pure socialism, the Democrats argue that the post-war game has all been played on the right (0-18 inch) side of the ruler.  Government share of GDP is 20%.  Government spending and taxes share of GDP is 30-35%, including all transfers.  This did not increase between 1960 and 2008.  The US tax burden at 27% of GDP is only 75% of the 36% average level for 30 developed countries.  Only Mexico, Turkey, Korea and Japan spend less than the US.  Total government spending in western European democracies is 40-55%.  Government spending did increase with the Vietnam War and Great Society policies, but was reduced by the Reagan revolution.  Government spending fell from 37.2% of GDP in 1992 to 32.6% in 2000. 

Democrats argue that their fiscal discipline was demonstrated in 1992 to 2000 when they balanced the federal budget and reduced the deficit, employing the “pay as you go” policy to force spending cuts to offset spending increases.  They point to Bush led Medicaid and defense spending increases as the cause of increased government by 2008.  They see the Bush tax cuts as redistribution to the wealthy and don’t see the overall tax-cut initiated economic growth claimed to increase net tax revenues.

Democrats argue that they have not purposely increased the long-run share of government in the economy.  They claim that the one-time investments/guarantees for the banking/auto industries were necessary for the whole economy, addressed issues that had grown for decades, will be partially recaptured and do not require continued funding.  Similarly, they pursued a moderate one-time Keynesian fiscal stimulus in response to a deep recession, just as was done by other governments of all parties in all countries for the last 60 years.  The stimulus spending lies between the 4.7% of GDP boost in 1982 and the 2.3% growth in 1992. Democrats argue that these actions are necessary and moderate and would have been undertaken by a responsible Republican successor to the Bush administration.

Democrats argue they are unfairly characterized as “big spenders” by the Republicans.  This simple accusation has stirred a populist response from “regular Americans”.  While Democrats have historically focused populist rage on big business and big banking, the Republicans and tea partiers have effectively used big government, Washington, elites, foreign countries and religions as targets, tying them to the Democratic Party.  Democrats argue that the monetarist, supply side, tax cut economic policies of the Republican Party since Reagan have been adopted for their populist simplicity and political effectiveness alone, further polarizing economic policy making.

Finally, Democrats have adopted part of the Republican play book in fundamentally looking to the private sector to drive the future economic growth required to support even the historic level of government spending.  The stimulus spending was partially focused on future industrial growth and infrastructure.  The banks and auto firms are returning to pure private ownership.  Small business lending and investment tax credits have become a focus.  Health care reform maintained private providers and insurers as the core of the system.  The costs of the war in Iran have been reduced.  A bipartisan group has been appointed to work on the Medicare/social security future.  Steps are being taken to promote exports.  A reduced public sector role for the mortgage industry has been proposed.  Obama and many Democrats have continued the pro-business approach used by Clinton.

On the other hand, Republicans can fairly point to steps taken by the Democrats that indicate a continued desire to “tax and spend”.  The stimulus bill benefited state government, construction and other Democratic interests disproportionately.  Health care reform achieved growth in government commitments without structural cost solutions.  Labor unions were given special treatment in the auto bail-out.  Fannie Mae and Freddie Mac’s roles were not touched in the banking reform.  The financial consumer protection agency smacks of unlimited and uninformed regulation.  The proposed increase in taxes for high earners is significant and is not coupled with structural spending reforms.  A second mini-stimulus has been approved and unemployment benefits have been extended to record lengths.

The current economic situation has raised the stakes for politics.  We should expect to see ongoing attempts to define the ruler and place the participants at marks that favor one group or another in the public eye.

Time for the Tea Party

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Why It’s Time for the Tea Party (excerpt) – Peggy Noonan – WSJ -9/17/2010

I see two central reasons for the tea party’s rise. The first is the yardstick, and the second is the clock. First, the yardstick. Imagine that over at the 36-inch end you’ve got pure liberal thinking—more and larger government programs, a bigger government that costs more in the many ways that cost can be calculated. Over at the other end you’ve got conservative thinking—a government that is growing smaller and less demanding and is less expensive. You assume that when the two major parties are negotiating bills in Washington, they sort of lay down the yardstick and begin negotiations at the 18-inch line. Each party pulls in the direction it wants, and the dominant party moves the government a few inches in their direction.

But if you look at the past half century or so you have to think: How come even when Republicans are in charge, even when they’re dominant, government has always gotten larger and more expensive? It’s always grown! It’s as if something inexorable in our political reality—with those who think in liberal terms dominating the establishment, the media, the academy—has always tilted the starting point in negotiations away from 18 inches, and always toward liberalism, toward the 36-inch point.

Democrats on the Hill or in the White House try to pull it up to 30, Republicans try to pull it back to 25. A deal is struck at 28. Washington Republicans call it victory: “Hey, it coulda been 29!” But regular conservative-minded or Republican voters see yet another loss. They could live with 18. They’d like eight. Instead it’s 28.

For conservatives on the ground, it has often felt as if Democrats (and moderate Republicans) were always saying, “We should spend a trillion dollars,” and the Republican Party would respond, “No, too costly. How about $700 billion?” Conservatives on the ground are thinking, “How about nothing? How about we don’t spend more money but finally start cutting.”

What they want is representatives who’ll begin the negotiations at 18 inches and tug the final bill toward five inches. And they believe tea party candidates will do that..

Talent Day

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As George Orwell demonstrated in his novels, words and word frameworks have tremendous power.  It’s time to replace Labor Day with Talent Day.

The term Labor Day reinforces several old misconceptions and needless conflicts.   Labor connotes physical labor, which became less important to the economy as energy and innovation moved the economic focus from agriculture to manufacturing to services to information.  Labor echoes the Marxian concept of class solidarity which has limited applicability in a dynamic world.  Labor is conceptually distinct from capital in the economic factors of production model, but the two are blended in many economic forms and their returns can be structured the same way.  Public sector (unionized) labor is contrasted with productive private sector capital in political ads, even though public sector employment is a shrinking share of the economy, supplanted by innovative contracting and outsourcing.  The old “labor” no longer exists.

Instead, firms rely upon a variety of human resource talents to succeed.  Physical labor or energy is the least important talent.  Hours worked or energy expended is a minor source of productivity and economic success.

Professional skills and knowledge have become more important and valued in all functions and industries.  Compare the skill levels of nurses, machinists, warehouse workers, purchasing agents, salesmen, engineers, maintenance technicians, auto mechanics, insurance adjusters, physical therapists, bankers or accountants today with those of 50 years ago.  Entry-level jobs today require professional, IT, process, quality and communications skills beyond those of master professionals in the post-war era.

The oddly named “soft skills” have also been upgraded in the last few decades.  In a world that is no longer static, mechanical and bureaucratic, all employees are required to have the skills required for a dynamic, organic and evolving workplace.  Individual character, responsibility and self-management is required.  Supervisors have been eliminated.  Research, development, innovation and improvement are expected of all employees.  Employees and contractors are expected to have teamwork skills, to understand processes that cut across functions and to manage constant change.

The human resources sector is also being asked to assume the risk management function once largely absorbed by capital.  With less labor intensive organizations, the role of financial capital is lowered.  With less employee loyalty, staff are asked to assume greater business risk of unemployment.  With greater outsourcing, contracting and narrow functional specialization in evolving technical fields, individuals are investing in skills with less assurance of ongoing usage.

On this Labor Day, let’s celebrate the value of talent in the new economy and the end of “labor” as a misused word and concept.

Book Reviews

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I’m very busy in my new role with Tripp-Lite in Chicago.  I have published many book reviews on Amazon.com in the last 2 months, including:

Pontoon, Garrison Keillor

Pere Goriot, Balzac

The Limits to Power, Bacevich

The City, Kotkin

Hitchhikers Guide to Universe, Adams

Ragtime, Doctorow

Siddhartha, Hesse

What’s the Matter with Kansas?, Frank

The American, James

No Ordinary Time, Goodwin

Prize Winner of Defiance, Ohio, Ryan

Enjoy!

Better Management, Less Demand for Labor

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The Bush administration experienced a weak jobs recovery from 2002-2007 and the Obama administration is facing even stronger headwinds in 2009-2010.  Are there structural factors that are more important than the widely discussed business cycle and macroeconomic policy factors?

On the labor supply side, the growth of internet based job applications processes has greatly improved the effective supply of high quality candidates for all positions.  This increases the expectation of firms of finding great fit candidates.  On the other hand, until recently workers had inflexible wage expectations due to worker experience, pride, assets and family income alternatives.  The decline in family housing and investment assets together with the greater experience of long-term unemployment has recently increased the willingness of potential employees to be flexible in seeking work.  Human resources departments remain reluctant to greatly reduce hiring wages in fear of turnover, legal and internal equity challenges. 

Extended unemployment benefits reduce the incentive to find work for some individuals, but this has a relatively minor labor supply impact.

Much greater structural changes have been experienced on the demand side of the equation.   Perhaps most important has been the ongoing growth in labor productivity, which has reduced the effective demand for incremental employment.   Increased staff flexibility in working long hours has also reduced the demand for peak-time or just in case workers

Firms have become more aggressive and experienced in downsizing employee groups as dictated by business conditions, thereby reducing the demand for labor.  This could eventually result in greater future employment demand, since the expected future cost of maintaining partially productive staff is reduced.  It appears that this cost reduction has been offset by a greater awareness that hiring an employee is a long-term investment decision.  Firms that have been trying to rework the employment bargain from one of life-time loyalty to one of “fair dealing” remain very reluctant to plan for future downsizing, so they have set higher new staff addition thresholds, subject to the sensitivity analysis once reserved for major capital investments.

Firms have also become more aware of the all-in cost of hiring.  Health care benefits costs per employee have increased significantly, especially as a percent to wages for hourly and entry-level jobs.   Internet application processes have increased hiring costs for many firms.  The level of firm-specific training required for break-even in many jobs has increased.  With better models of hiring, firms are less willing to hire “good enough” candidates who do not fully meet all functional, industry, character and culture needs, resulting in positions which remain open for longer periods.   Overextended managers have less incentive to add permanent positions.  Firms are also less likely to invest in entry-level professional staff positions due to the higher turnover and lack of investment returns.

Labor force reductions have escalated in the last decade.  Downsizings are conducted when indicated, even in times of plenty.  Marginally productive or engaged staff members are moved up or out sooner.  Employees in obsolete functions see their jobs eliminated.  Protected functions or industries are quite rare today.   In a labor intensive business world, firms are more aggressive in pairing staff.

Productivity improvement projects have become less labor investment intensive.  Much improvement comes from getting more value out of the existing resources.  The declining role of physical capital creates fewer tag along positions.   Firms have learned to manage peak seasons and major projects with less incremental staffing.    Information technology investments had stimulated some new forms of project and analytical staff needs in the last 30 years, but that demand is flat today.  Firms have adopted standard process and project management templates that reduce the demand for new positions to accompany IT investments.

Firms are now fully aware of the use of contractors, part-time staff, consultants, outsourcing and imports to fill most functions.  The need to hold partially employed staff is greatly reduced.  Many processes have been re-engineered specifically to allow outsourced resources to be used to accommodate peak demands.  

Finally, overall business investment has been weak in the post Y2K period.  Firms have learned to manage inventories much better.  They have installed significantly higher project hurdle rates based upon their experience with project failures.   The lower market cost of capital has been a very minor factor outside of industries like real estate and banking.   Through productivity improvements, the effective capital stock has increased without as much new investment.  Sensitivity to the risks of change has caused firms to reduce the number of minor investment projects.

Business investment has been especially weak in the last 3 years, with firms freezing capital expenditures until the overall economic climate is resolved.  This includes fiscal, monetary, trade, tax and regulation policies.  The credit crunch has reduced hiring by small firms.

In general, firms have become much more effective in managing their capital, inventory, technology, brand and labor resources.  Many of these changes in the last decade have reduced the demand for labor.  Some of these changes may have a long-term impact on the minimum or natural unemployment rate, while others will cycle through business profits to business investment to increased labor force demand in the long-run.

Functional Specialization

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Functional specialization may be the single most effective survival and progress strategy in the world.

At the biological level, organisms specialize within niche environments. Only the best of the best survive.

In economics, functional specialization is the winning strategy at the country, state, firm and individual levels.

David Ricardo’s theory of comparative advantage continues to apply at the country and state level.  Limited by by the size of the potential market, countries and states specialize in what they are economically comparatively best positioned to produce and use trade to improve their overall level of well-being.  The extent of international and state trade continues to grow, with no end in sight.

From Adam Smith to Alfred Marshall to Milton Friedman, many economists have focused their attention on the purely competitive market model.  Alternative monopoly, oligopoly and monopolistic competition models were developed to describe the real world where every profit maximizing firm attempts to differentiate their market position and leverage their market power.  They avoid perfectly competitive markets like the plague.

Michael Porter synthesized this in his theory of core competency, noting that firms could not be the very best at everything, but that they could become world class in a limited area.  The specialization could be in products, channels, customers, functional competencies or strategies.  Treacy and Wiersma made this more specific, observing that successful firms tended to pursue only one of three generic strategies: customer intimacy, product innovation or operational excellence.  Firms have subsequently learned to outsource nearly every functional area.

At the individual level, functional specialization has grown through time.  Classic male and female roles were differentiated in man’s history.  Hunters and gatherers.  Hunters and farmers.  Priestly and political roles.  Traders.  Warriors.  Guilds.  Professions.  Tax collectors.  Court attendants.  Scientists.  Degrees.  Doctorates.  Certificates.  Professional specialists. Industry specialists.  Business specialists.  Subspecialists.  ERP Rainmakers.  Etc.

At every level, functional specialization continues to grow because it is effective and efficient.  Functional specialization provides cost effective results in the short-run and the long-run.  It manages risk and capacity effectively. 

The use of functional specialization as an effective country, state, firm and individual strategy has become increasingly sophisticated and detailed in every half-life of history: millennia, century, decade and year!  It continues because the human population and market have grown and because transportation, politics, communications and science have advanced.

Is there no end to the application of functional specialization?

Functional Specialization Limits

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There are many costs and risks which offset the benefits of functional specialization.

As Adam Smith noted, the benefits are limited by the extent of the market.  At any point in time, there are only so many customers for a given product or service.

Functional specialization and trade are limited by transaction costs.  In an earlier age, vertical and horizontal integration strategies were effectively pursued because transaction costs were high.  Specialized internal or external providers require investments in communications, marketing, contracting, evaluation, incentives, training, negotiations, influence, hand-offs, shipping and receiving. 

Alignment of interests requires meetings, contracts, communications, incentives, negotiations, penalties and time.

Functional specialization is limited by transportation, finance and communications costs across country, state, firm and departmental borders.

Outsourced functional specialization also incurs the added costs of marketing and supplier management.

In general, firms have developed effective strategies to overcome these limitations.