Category: strategy

Both/and Trumps Either/Or

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The business and political worlds are catching up with what the great religions have long known and science has discovered in the last 200 years.  The deepest understanding and practical progress in all fields is driven by a “both/and” approach, rather than by a deterministic “either/or” approach. 

Post-enlightenment westerners have struggled to fully digest the slippery, evolving dynamic nature of the Asian concept of yin and yang.   Many believers, clerics and secular leaders have simplified, denied or ignored the deeper meanings of the Christian trinity, relationship with Judaism and tension between the vertical (God) and horizontal (community) demands of the faith.  The fully developed religions provide training, terminology, sacraments and advice to attract, retain and grow members, without reducing “the mystery of faith” to a simple recipe.

The western scientific tradition meets the heartfelt needs of man for a deterministic description of the universe, delivering the potential for security expressed in Maslow’s “hierarchy of needs”.  Aristotle, Euclid and Newton are rightfully celebrated for their authoritative development and formalization of logic, geometry and physics.

Nineteenth and twentieth century science shattered the deterministic paradigm, replacing it with a probabilistic paradigm.  This was presaged by Hegel’s philosophical method of thesis, antithesis and synthesis.  Thomas Kuhn’s mid-twentieth century history/philosophy of science documented both the human process of how science progresses and the Necker Cube-like way in which a new paradigm destroys the old and blinds us to any new ways of perceiving.

The Heisenberg uncertainty principle demonstrated that the location and speed of material items was dependent upon the measurement applied and was inherently uncertain.  At the same time, it became clear that the location (energy level) of an electron was only probabilistic!  Kurt Godel’s impossibility theorem destroyed the hope of defining a Euclidean basis for a fully functional arithmetic and algebraic system of mathematics that could include the concept of infinity.  Darwin’s theory of evolution included the concept of random events in populations determining the future of biological species, without necessary guidance from god.  Biology then described the details of genetics, which includes random mutations, reproductive combinations, multiple genes, developmental sequences and the impact of the environment.  Freud described the role which unconscious thoughts, drives and the “mind” can play in determining consciousness and behavior.  Statisticians defined populations, estimates and metrics, emphasizing that there are inherent conflicts in making estimates.  Finally, Einstein developed the theory of relativity, making time, space, matter and gravity functions of each other.  Ironically, Einstein unsuccessfully devoted 20 years of his life to finding a unified theory that would combine all aspects of physics into a deterministic framework.

In the last 50 years we have seen the development of insightful “both/and” approaches throughout the business and political worlds.  Management has evolved from unilateral theories X, Y and Z to situational leadership which uses both task and people factors to deliver results.  Effective thinking coaches have defined the best use of convergent and divergent thinking skills or six thinking hats to improve results.  Jim Collin’s “Good to Great” book highlights the central role of a fixed vision/goal and flexible means/strategies.  Gallup’s Strengthfinder approach to personality profiles overcomes the “either/or” nature of Meyers-Briggs, concluding that some individuals do have apparently conflicting “talents”.  Bottom-up and top-down planning approaches have been incorporated into the balanced scorecard framework.  Goods production has evolved from custom craft work to mass production to a combined lean manufacturing pull system.  Goldratt’s book “The Goal” provides further insight on how defining the goal is logically distinct from the means of reaching the goal.  “Best practices” project management has evolved from informal management to fully prescribed sequential tasks to a new hybrid approach that retains the broad project stages, but allows cycles to resolve issues when needed.

In economics, the Keynesian revolution overturned “Say’s Law” which deterministically stated that supply always creates its own demand.  In governing, representative democracy seems to balance various needs.  In politics, the “third way” attempts to use market mechanisms to deliver liberal objectives.  In religion, the reformed faiths attempt to adapt received faith to current knowledge and realities.

The “both/and” approach is not inherently best, but everyone should be challenged to consider it at all times based upon its impressive track record.

I’d like to thank Mark Cavell, Annamarie Melodia Garrett and Doug Loudenslager for their contributions to identifying this pattern.

Screening for Leadership Experience

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As firms return to a normal economy where success is determined by the ability to set and implement a distinctive strategy, develop new products, processes and customers, and align functional resources in a project based matrix structure, it is time one again to screen for leadership in the hiring process. For the last 2 years, with an abundance of candidates and a preference for risk aversion, hiring managers, human resources and recruiters have laser focused on finding the very best match between a candidate’s industry, functional and positional experience for an open position, without regard to long-term considerations. Hiring managers should insert more behavioral interview questions about leadership into the process and they should screen for evidence of leadership success in the resume review and screening interview process.

Ask ten experts to define “leadership” and you’ll get ten different answers and lists of competencies, but they’ll cluster into a few areas such as building teams, being self-aware, growing personally and professionally, displaying trust and integrity, communicating effectively, motivating/influencing/persuading, helping others to succeed, setting and sharing a strategic vision, taking risks, innovating, being responsible, making tough decisions, showing tenacity and taking a long-run view of what is best for the organization as a whole. A simple leadership checklist can be used to identify candidates who have the leadership experience needed to succeed.

Leadership Screening Checklist

1. Positional responsibility, staff count, manager count, functional variety.

2. Cross-team member, positional leadership, selection by others, larger projects.

3. Non-work leadership roles, professional and civic groups.

4. Progressively responsible roles and promotions across career.

5. Professional mastery/certification and CPE in one or more areas.

6. Five year tenure at most employers.

7. Variety of recommendations available/given in 360 degree fashion.

8. Internal or external teaching, training and documentation experience.

9. Projects/assignments in new, challenging or unpopular business areas.

10. Projects/assignments in high value, visibility or risk business areas.

11. Matrix experience in product development, IT, M&A, national account management.

12. Formal mentoring, association or accountability partner experience.

13. Strategic, product, marketing, financial or operational planning leadership role.

14. Top-level responsibility for a function or business unit of any size.

15. Variety of headquarters/field, line/staff and domestic/international experience.

16. Variety of industry, function and organization size experience.

17. Change management experience through start-ups, rapid growth, turnarounds, recessions, acquisitions or reorganization.

18. Implementation of new professional methods and technologies.

19. Human resources recruiting, retention, promotions, transfers and morale.

20. Responsibility for new products, sales, suppliers and negotiations.

Organizational success today requires leaders who are experienced and confident in challenging and ambiguous environments. Screening for this broader experience and capacity may be more important than hiring someone who has done exactly the required role at the closest competitor for the last five years.

Indiana School Finances

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Indiana state school funding will decline for the next 3 years.  The current 5% expense reduction is just the first step.   School districts need to take bold actions to reduce their underlying cost structures.  Other organizations are reducing costs by 10% and increasing labor productivity by 5-8%.  Innovative schools can achieve the same financial gains while improving the quality of education.  These 20 ideas may be infeasible, but they might help to generate some creative solutions.

  1. Rank order career & technical programs and eliminate the single least effective one.
  2. Replace some career and guidance counselors with web resources and volunteers from local civic group partners.
  3. Assign administrators to jointly teach 1 FTE of classes in a technical field.
  4. Employ technology for teaching and testing and eliminate 1 staff/department.
  5. Carefully define “special needs” education and obtain separate funding or sponsorship.
  6. Double the fees for extracurricular programs to cover all costs, including coaching supplements and subsidies for low-income students.
  7. Maximize the use of capital budgets and bond funding for capital maintenance expenses.  Refinance bonds and use savings for capital maintenance.
  8. Reduce employee benefits by one-half for the first 5 years of employment.
  9. Add an additional teaching period for tenured staff.
  10. Assign a mentee to tenured staff and provide incentives for retention/progress.
  11. Provide teachers with a financial incentive in years 3-6 to remain in place.
  12. Eliminate future degree/credit hours based compensation increases.
  13. Outsource transportation, IT, HR, marketing and financial services.
  14. Extend textbook lives by 2 years.
  15. Move to a used computer strategy, recycling the 3-year-old units from local businesses.
  16. Consolidate library/AV staff and resources with community libraries.
  17. Reduce the cost of transportation by increasing the share of walkers, reducing the number of stops and limiting extra services.
  18. Move discipline problem students to countywide alternative programs after 3 strikes.
  19. Collect fees for AP and dual credit programs.
  20. Increase the use of teacher’s assistants when they can cost-effectively increase classroom sizes while providing quality education.

All changes have costs and benefits.  In a world of 10% less funding, schools that are able to identify the areas where the greatest cost reductions can be found with the least negative impact will be the ones that best serve their students, teachers and communities.  Schools should reach out to their communities for help in generating solutions to the coming crisis.

The Sky Has Stopped Falling

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Between October, 2009 and April, 2010 the US economy lost 4.8 million jobs: nearly 700,000 jobs per month.  In the last three months it has lost a TOTAL of 100,000.

How and why employment will recover faster than expected.

  1. The change from -700,000 jobs to zero is a major trend, indicating net job creation is imminent.  Obama’s budget forecast of 100,000 adds per month is conservative political positioning so that the real results will exceed expectations.  He and his party have an election to contest in November.
  2. GDP growth was 3% in the 3rd quarter and 5% in the 4th quarter, accompanied by eye-popping labor force productivity numbers above 5%.  Some hiring is required to meet existing production needs.  It has begun.
  3. Inventory replenishment will continue as it has in all other recoveries.
  4. More than half of the stimulus money remains to work through the economy. The second stimulus package is necessary political and psychological posturing and will be too late and too little to make a material difference.
  5. Construction has nowhere to go but up after 3 years of decline.  Even with ongoing foreclosures, there is pent-up demand for new housing.
  6. Consumer durable goods’ spending is ready to bounce back.  Cars, washers and televisions have limited technical and acceptable status lives.
  7. Businesses are ready to invest in capital goods, productivity improvements, IT systems, new channels, new products and exports.  Businesses have the resources to invest after lower than average spending since 2000.
  8. 5-8% growth in China and other developing countries increases demand for US exports and raises prices for US imports.
  9. Once the global recovery is underway and the extent of US monetary expansion is plain (leading to inflation), the US dollar value will fall and US exports will increase.
  10. The retirement of the Baby Boomers will lead to specific hiring in sectors of high demand: health care, financial services, housing and travel.
  11. The retirement of Baby Boomers will increase from 2.2M per year to 3.7M per year in the next 8 years, adding an average of 1M jobs per year.
  12. The US population will continue to grow at 1% per year, leading to growth in aggregate demand of 1% per year.
  13. US labor force and total factor productivity continue at high historical rates, generating the underlying added output which leads to wages, profits and rents which create the next round of aggregate demand.
  14. There are long-term positive employment trends in a majority of the US industry sectors.  The US economy has continued its transformation into an information economy.  Manufacturing employment is now less than 10% of the total.  We may have found the bottom for this sector.

 

There are certainly national and global risks in the current economic climate.  However, the US economy has shown increasing resiliency in the last 60 years, recovering from recessions in spite of a variety of headwinds.  The economy has recovered during Republican and Democratic administrations, in spite of helpful and harmful national policies.  There are many reasons to believe that the current recovery will be strong.

10% Labor Force Growth, 1998-2007

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 US Employment by Industry         
         
   1998   2007   Change   Pct 
 Extraction/Utilities       2.3      2.5          0.2 9%
 Construction       6.2      7.6          1.4 23%
 Manufacturing      17.2    13.7         (3.5) -20%
 Wholesale/Retail Trade      18.1    19.8          1.7 9%
 Transport/Warehouse       3.9      4.3          0.4 10%
 Information       3.1      2.9         (0.2) -6%
 Finance/Insurance       5.4      6.0          0.6 11%
 Real Estate       1.7      2.0          0.3 18%
 Profl, Bus, Adm Services      21.2    25.0          3.8 18%
 Education       2.0      2.7          0.7 35%
 Health Care      11.2    14.3          3.1 28%
 Arts, Entertainment, Recreation       1.4      1.7          0.3 21%
 Accommodations/Food       8.1      9.4          1.3 16%
 Other Services       5.3      6.0          0.7 13%
 Government      18.7    20.2          1.5 8%
    125.8   138.1        12.3 10%

Good Riddance to Utopian Views of 2000

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Much of the anxiety being expressed in the political arena today stems from the discovery that the turn of the millennium consensus views of steady assured progress were exaggerated, or just plain wrong.  The events of the last decade have shown that simple, deterministic conclusions are usually wrong.  This is not the first time that western society has had its “progressive” bubble burst.  Even the recent triple play natural disasters (hurricane, tsunami and earthquake) have a parallel in the Lisbon earthquake of 1755, which lead Voltaire to attack the belief that man was living in “the best of all possible worlds”.

In 2000, we thought that representative government would prevail as an increasing number of countries became functional democracies and established democratic traditions.  Cuba was the special exception.  Even China was seen as a potential convert.  Progress was being made in Eastern Europe, Asia, Africa and Latin America.   We now see that China’s leaders intend to maintain power, that progress in Russia and Eastern Europe is fragile and that a new Bolivarian revolution justifies dictatorships.

In 2000, the division of state and religious spheres was clear and settled in Europe, allowing a variety of religions to work within a set of rules.  The Pope spoke out for radical changes to society, but had limited impact.  Some progress in conflict areas lead to hope for progress, as nations from Turkey to Indonesia to Ireland found solutions.  The “consensus” was an illusion.  Islam, Christianity and other religions are not content to work within the context a secular humanist state.  We now see that “true believers” do not fit within the tidy scheme.

In 2000, a decade after the fall of the “iron curtain”, the U.S. stood tall as the only superpower, even after cashing in the peace dividend.  The US, Europe and the UN began to make significant progress in handling the remaining “trouble spots”, in areas that seemed unfamiliar and insignificant.  We now see that Brazil, Russia, India and China would like to join the US, Europe and Japan in a multi-polar world.  The shifting alliances of earlier centuries are the model of our future.

In 2000, after dodging the ironic Y2K threat, the world saw an unlimited future of technological progress.  The older physics, chemistry and energy based economy continued to grow at a healthy pace.  Agricultural and biological innovations promised to feed the world and heal the sick.  Information technology continued to evolve through the internet, telecommunications and knowledge management.  Even the environment was improving, as 30 years of focus on clean air, clean water and eliminating toxic waste had a cumulative positive impact.  We’re still making progress, but concerns about energy and water shortages, Frankenfoods, genetic manipulation and climate change become greater with time, as no simple “solutions” have appeared.

In 2000, international economic progress was in full-stride.  Individual, regional and global trade agreements increased trade and cross-country investment.  International financial crises were managed and outlier countries were guided through an agreed upon recovery plan.  European economic integration continued to deliver benefits with each new step.  Today, we struggle to find common ground for major trade deals.  A variety of crisis recovery models seem valid.  Further European economic integration is possible, but the benefits are not so certain.  International sensitivity to trade, labor, environmental, property rights and investment differences is growing.

In 2000, a mixed capitalist economic model dominated.  There were two flavors, traditional European and Atlantic, but these were differences in style and degree, not in fundamental substance.  Success stories in all areas of the world indicated that this model could and would be replicated.  Today, there are several varieties of state capitalism (Russia, China, France, Japan, and Venezuela) that offer alternatives.

Finally, in 2000, there was a widespread belief that we had moved into a new economic model where the rough edges of capitalism had been tamed.  The business cycle could be managed through independent monetary policy (and a touch of fiscal policy).  Productivity, inflation and unemployment goals could all be attained.  Financial guidelines like price-earnings ratios had been superseded by a “new economy”.  And, risk and volatility had been tamed through portfolio theory, hedging and new financial instruments.

The world is not in worse condition today than it was a decade ago.  Only by moving past the unrealistically utopian views of the turn of the century can we make progress in addressing the challenges we face.

Self-Improving Systems

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General systems theory was outlined in the post-WWII era when innovative thinkers began to consider how and why biological and ecological systems worked — or sometimes didn’t work.  Subsequent applied and theoretical work expanded the use of these insights.  Most importantly, we now understand that successful systems must be self-preserving, self-controlling and potentially self-improving.

A self-controlling system is often described using the thermostat model.  A system has a goal, a measurement device, the ability to compare actual with desired results and some action taken to return the system back within its control limits.  More sophisticated systems have secondary feedback loops to check the measurement, feedback and action steps.  Self-improving systems also have some built-in driver that improves the goal and results through time.

Most development economists have concluded that in the long-run productivity improvements are the key to economic well-being, far surpassing the contributions of simple resource availability.  Productivity improvements are created by individuals’ insights and brilliance, but more often by the cumulative results of self-improving processes.  Hence, our economic future depends upon the broad application of self-improving systems.

The biological model of evolution shows that “survival of the fittest” results in populations that are best ready to thrive in the range of environments encountered historically.  On average, this means that existing species are well positioned for most futures.  It does not rule out decimation due to some new environment, competitor or predator.   Biological pressures through the impact of pollution or global warming could threaten the beneficial effects of the biological model on economic growth.

Biologists and some anthropologists also say that our natural family and other small groups have developed to meet the needs of the species.  In spite of the many changes in culture since the “enlightenment”, these built-in relationships seem solid and provide a self-preserving parenting and small group cycle.

The development of the scientific method and use of peer reviews transformed science from natural philosophy, alchemy and astrology into a cumulative force for progress in scientific understanding.  This force has had a great economic benefit, expanding the use of the scientific method to a broader and broader sphere.  While philosophers and politicians raise valid questions about the ethical use of scientific discoveries, the march of science continues.

Representative democracy with “checks and balances” has also functioned as a self-improving system.  We now understand the need for cultural support for the rule of law.  We know that a variety of representative democratic systems can work well.  We know that there are sometimes populist, military or ruling class pressures that can undermine or destroy a democratic system.  We understand that democracies are often slow, sub-optimal and inconsistent.  Nonetheless, representative democracy has generally been a force for economic progress.  The consensus that western style democracy will be the dominant form of enlightened governance model was much stronger a decade ago, but remains the likely choice for most countries.

Economic systems like capitalism and international trade can also be seen as self-improving systems.  Adam Smith’s “invisible hand” and David Ricardo’s principle of comparative advantage lead competing interests to naturally improve their performance through time.  Modern economists generally agree that capitalism is not automatically “ideal” due to market failures, monopolies, public goods, externalities, unequal distribution of income, deadweight costs of booms, busts and bubbles, and the potential sustained waste of resources due to inadequate demand.  Recommended solutions to these shortcomings that can be implemented through the political process.  As with representative democracy, some form of regulated capitalism is an ongoing positive force for economic growth.

Finally, the systematic adoption of formal quality measurement and improvement systems by most organizations is another form of self-improving system.  By clearly defining goals, measuring progress, adapting and providing support structures that encourage process re-engineering and continuous process improvement, organizations have found that annual productivity improvements are possible in nearly all areas.  The quality revolution continues to expand its reach, moving from operations areas into overhead, service, government and not-for-profit applications.  The set of quality tools and best practices continues to grow.  The pressures of the economic and political marketplaces make sure that this will be a source of progress.

There are areas of modern life where self-improving systems do not provide built-in assurance of progress in the future.  Culture, religion and international relations do not work as self-improving systems today.

Historically, culture continued through inertia or the reinforcing interests of the ruling groups in society.  Without changes in the environment, a self-preserving system was common, even if a self-improving system was not.  Today’s increased level of global communications and cultural awareness provides support to avoid the total disintegration of culture.  The lack of thought leaders or leading cultural influencers today means that subcultures may improve, but the overall culture is not positioned for progress.

Religions were historically integrated with culture and reinforced them.  The “enlightenment” development of secular viewpoints and increased awareness of world religions has greatly complicated attempts by any one religion or ecumenical group to create a self-improving religious system.  Historic attempts to more deeply analyze a religion often resulted in inflexible forms such as scholasticism.  Attempts at reformation with ongoing evolution of doctrine resulted in splinter groups or fatal dilution of core content.  Within the secular humanist tradition, some progress is made through self-help books and applied psychology, but most observers would say that the self-awareness of existential philosophy has been a mixed blessing for people trying to create their own forms of meaning in life.

International relations is also a system without inherent stability.  Contradictory philosophical views dating back to the Greeks have enthusiastic supporters.  The idealistic goals of the United Nations and other world organizations are appealing, but the institutions do not clearly ensure the ongoing improvement of the human condition.  Greater economic and political integration in Europe is offset by the expansion of the number of nation states.  Mutually assured destruction evolved as a self-preserving system at a time of 2 superpowers, but provides no such assurance today.  The rise of Brazil, Russia, India and China to complement the US, Europe and Japan creates a multi-polar world without a clear system for ongoing improvements or avoidance of major conflicts.

The rise of self-improving systems in biology, science, economics, national governance and quality processes provides hope for a future of unlimited possibilities.  The lack of self-improving systems for culture, religion and international relations raises major concerns for the future.

The Quality Paradigm

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The Quality paradigm has emerged as a significant competitor to the Financial paradigm.  The Financial paradigm says that organizational results are best delivered through the sum of individual rational decisions focused on incremental costs and benefits.  The Quality paradigm agrees that costs and benefits matter, but focuses on the underlying process as the primary driver of minimizing inputs (costs) to produce a given output (benefits).  The Quality paradigm has evolved from the “scientific management” studies of “time and motion”.  It has a process engineering focus, aiming to optimize the relationship between inputs and outputs.  Improvements are inherently valuable, without tallying financial valuations.

The Quality paradigm made progress because its effectiveness in Japanese manufacturing became apparent by the 1970’s.  It also gained favor because Western organizations, relying on the financial decision-making tools, were clearly not delivering optimal results. 

The Quality advocates made five major criticisms of the existing practices.   The practices greatly underestimated the total cost of poor quality at 1-2%, while the total costs ranged from 5-10%.  The financial approach often created a cost reduction mindset when greater opportunities existed for improved revenues and margins through quality products and customer service.   The marginal approach overlooked less material cost reduction opportunities that were very significant in the long-run.  It optimized individual functions, while ignoring connection costs.  It underutilized the assets of workers who could make improvements.  While some of criticisms were misplaced or exaggerated, the Quality Paradigm presented a compelling story that lead to changes.  The new, process-based approach was delivering value that the old approach had missed.

The Quality paradigm delivered several insights that could be repeatedly applied to reduce costs, reduce defects, increase volumes, increase timeliness and better meet customer needs.  First, a controlled system inherently reduces errors and risks and leads to improvements.  Second, examining a whole process in terms of well-defined desired outputs focuses staff on the greatest improvement opportunities.  Third, the key to understanding process failures is through understanding the drivers of variability.  Fourth, variability naturally accumulates through a process, leading to greater defects and costs.  Fifth, inventory of time and goods hides current performance and improvement opportunities.  Sixth, there is no practical limit to the improvements possible in reducing variation, reducing defects or improving input/output ratios.  Seventh, a quantum leap process break-through is usually possible.  Eighth, in the long-run quality improvements usually have a net benefit, rather than a net cost.

In the last two decades the Quality paradigm has come to complement the Financial paradigm, leading to a balanced scorecard approach to strategic planning with both financial and operations measures in the performance dashboard.  Finance continues to emphasize costs and benefits while Quality focuses on the underlying processes.  This combination approach is delivering more valuable results for most firms today.

The Financial Paradigm

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The financial decision-making paradigm was developed in the 19th century by the “marginal” school of economics and refined into modern financial tools by the 1950’s.  In essence, it says that by comparing incremental benefits with incremental costs, that rational decisions can and should be made.  While academic economists refined the exact conditions under which this is logically true, practical business professionals have simply just adopted these tools.  Business students learned to choose the greatest net benefits.  Some also learned to calculate the risk-adjusted, interest-rate discounted incremental after-tax cash flows.

In practice, finance professionals and business decision-makers have seen limitations in the theory, but adapted it to make “rational” decisions.  If qualitative factors exist, they are ignored, translated into numbers or considered separately.  If key numbers are unknown, they are estimated, modeled or limited.  If factors are interrelated, a simulation model is run or lesser factors omitted.  Cash flows 30 years out are ignored due to their low present value.  Rules of thumb are used as simple linear relations.  The whole is defined as the sum of the parts.  The principle of diminishing marginal returns is used to eliminate inconvenient, minor or detailed items.

For short-term or long-term decisions, the standard financial decision making tools are adapted to meet most situations.  With experience and business judgment, decisions are made with a high degree of confidence using this single approach.

In addition to the common “adjustments” accepted by financial analysts in practice, there are deeper criticisms regarding the financial paradigm.  It is inconsistent with the historical, accrual cost approach required in public accounting.  Managers are unable to estimate factors, so they are constructed by analysts.  For major investments or decisions, the inherently qualitative factors may be most important.  Fully-loaded costs are used throughout most financial systems, so decisions are guided by “the numbers”. Purely financial incentive systems lead to padding, managed numbers and missed opportunities.   Focusing on financial results alone leads to neglect of the asset, operations and customer levels of the balanced scorecard.  Accounting systems are not structured to monitor key decisions, but to eventually report historical costs.  The financial decision making paradigm does not directly help managers to solve problems or serve customers, but it can create an adversarial relation between line managers and the financial staff.

The 1980’s “quality revolution” lead to a time when there was significant support for a variation on Shakespeare’s maxim: “first, let’s kill all of the accountants”.   Since then, finance and accounting professionals have fine-tuned their models, linked to the balanced scorecard framework, enhanced allocations through activity based costing, simplified ROI models, learned quality paradigms and deliver a mixed dashboard of financial and operations measures.

 The financial decision-making paradigm remains at the core of modern business decision-making because it does a good job of organizing the key factors, determining the level of detail needed to make good decisions and communicating those decisions to others in a consistent fashion.  No paradigm is perfect, but the marginal cost-benefit approach is doing very well moving through its second century.

Production Strategy

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Financial success often depends upon making wise strategic and structural decisions.  The Pareto Principle or ABC rule says that 20% of a firm’s products will deliver 80% of its volume or profit.  For most organizations, on a purely mathematical basis, some version of the Pareto Principle will hold true.  It may be 10% or 33% of the products accounting for most of the results, but this clustering is nearly universal.  Focusing on those activities that provide the greatest “bang for the buck” is a good strategic and tactical approach to business.

Production methods (including services) can also be classified into ABC categories.  The oldest method: custom or handicraft production can be labeled C.  The big breakthrough of standardized parts and mass production can be labeled A.  The hybrid products delivered by modular stages as in an assembly line can be labeled B.  Again, most organizations find themselves with a combination of mass (A), modular (B) and custom (C) produced goods. 

Since mass production has inherent advantages and is the lowest cost approach, firms should add modular products when the incremental benefits outweigh the costs.  Moving to the custom level involves the same benefit/cost comparison.  The incremental percentage margin is set by the marketplace and tends to decline through time as competitors add similar products, better features and benefits are offered and processes are refined and costs removed.   Sales and product managers will usually overestimate the margin benefits, while finance and production managers will underestimate them.  On the marginal cost side, the roles will often be reversed. 

The relative benefits and costs will vary from case to case, but the general structure and decisions will always need to be addressed.  In order to generate higher margins, firms need to offer products which appear to have greater custom appeal and this requires additional costs.  Firms which neglect to evaluate these trade-offs or which allow case by case negotiations often find that they have too many custom products and too little profit — or too few value-added products and too few customers.

There are four strategic approaches to this inherent trade-off.  First, firms can be disciplined and choose just one of the 3 production types.  They can deliver goods in a narrow range (A), using focused factory techniques.  As Henry Ford said, “any color you want as long as it’s black”.  They can adopt an operational excellence strategy and reduce costs through time.  Or, they can develop a modular strategy with well-defined processes for production, product development and marketing (B).  By leveraging the efficiencies of a set of highly effective modular processes, they can deliver new products and services at moderate volume with higher margins.  A product innovation strategy can be delivered this way.  Finally, they can choose a customized production strategy (C) and deliver highest margin niche products to specialized users.  This approach can attempt to leverage mass or modular production, but the real focus is on developing or adapting products to meet specialized needs.  This fits best with the customer intimacy strategy.

Unfortunately, the explosion of product choices in the 1970’s and 1980’s resulted in most firms delivering some messy, unintended combination of A, B and C products.  The mass production world moved from 90% A and a little B to 50% A, 40% B and 10% C in many cases.  Some firms even found one-third each as their production profile.  A second overall strategy has been to outsource the production of A level mass production items to the lowest cost source: in a focused factory, to a market leader, as an import, as a drop ship or through a partner.  A third strategy is to develop a truly modular production line ala Dell and move all production through a single highly refined process.  A fourth strategy is to outsource the customized work to partner firms, IT implementation shops, other engineering firms or to repackaging firms.

It is possible to combine mass, modular and custom product deliver flows within a single firm, but it is not easy.  At a minimum, firms need to make decisions in these terms, monitor the results and adapt to ensure that the marginal benefits justify the marginal costs.