The Executive Edge Newsletter June 2008
Breaking the Volume Obsession Habit
Five Steps for Outsourcing Success
Exclusive White Paper: Taking Back Cost Structure Control
What You Don’t Know Can Hurt You
QuickStat: Midsize Companies Bolster ERP Budgets
Breaking the Volume Obsession Habit
By Dr. Jagdish N. Sheth
Perhaps a more businesslike term for this self-destructive habit would be “cost inefficiency.” But it comes to the same thing: Your costs are too high for the revenue you’re generating, or, in the simplest formulation, you’re spending too much money to make money. In a non-monopoly situation, this occurs when prices have crashed due to intense competition or excess industry capacity, but your costs remain the same.
The consequences of volume obsession, like overeating, are incremental. Once we’re fat, we know we’re fat. We don’t need to be told (and often resent it when we are told). But the process of overeating – a doughnut here, a second helping there – that results in being fat is somehow easier to overlook. The price of staying lean, like that of freedom, is constant vigilance.
How to Break the Volume Obsession Habit
Breaking the volume obsession habit requires a strategic vision and a time commitment for planning and implementation activities. It can also be a painful process when the remedy involves workforce reduction. However, because volume obsession has a direct negative impact on the financial well-being of a company, it must be dealt with.
Identify where our costs are
This sounds self-evident, but a lot of companies still don’t know how to create the appropriate revenue/cost alignment. If revenues are skewed, if 20 percent of customers are generating 80 percent of revenue, profitability is likely to be even more skewed. It may be that 10 percent of your customers are actually making money for you, and 90 are being subsidized. More and more companies are coming to realize that if the customer is the revenue generator, costs should align that way. The new platform is sometimes called customer relationship management (CRM). At its heart is the “customer profitability analysis” – calculating costs and revenues on a per-customer basis.
Convert cost centers into revenue centers or profit centers
As noted, it’s not unusual for companies to designate sales as their revenue-generating function and then define other functions as cost centers in support of sales. It doesn’t have to be that way. A fresh approach can sometimes turn even strategic functions from cost centers into revenue or profit centers.
Virtually any function – R&D, manufacturing, logistics (like shipping), customer support – can be reorganized into a revenue center. Almost all the cheese at your local supermarket, whatever the brand, is stocked by Kraft, just as most cigarette racks are owned and operated by RJ Reynolds. In this case, these two mega-companies have turned inventory management into a revenue producer. Companies with extra capacity at their call centers can produce revenue from customer support by taking calls for other companies. Now when you read about companies that have reorganized to make individual functions more “entrepreneurial,” you know how to translate: they’re transforming cost centers into moneymakers.
Decentralize profit and loss to more and smaller business units
If you have centralized P&L at the top, you may have poor oversight over how your individual units are doing. One corrective is to apply the EVA principle described earlier: delegate to each unit the responsibility of justifying its costs, including non-operating costs or hidden costs. Require each unit to pay its own way, to cover even shareholder dividends, income taxes, and the cost of capital – costs that might have been passed up to the corporate level. Let managers know that they will be supported only if they can generate more than enough revenue to cover these costs; otherwise, they will be divested.
Move from vertical integration to “virtual integration”
Throughout the 20th century, vertical integration has been the model. This model doesn’t make as much sense as it used to, for a couple of reasons. First, it’s difficult to have enough oversight to make sure every unit in a vertically integrated business is running with optimum efficiency. In fact, the system is likely to have some cost inefficiency because, basically, you’re buying from yourself; no market mechanism is at work. … And second, even if your units are efficient, there’s still an excellent chance that a specialist company can do it better. The new model is “virtual integration” – concentrating on the one or two things you do best and letting others do the rest.
Outsource non-core functions
If you’re not quite ready for virtual integration, you can still increase efficiency and cut costs by outsourcing non-core functionality to outsiders that have appropriate economies of scale. Today more and more firms are beginning to outsource what used to be considered “strategic” functions. For instance, pharmaceutical companies are realizing that even some of their R&D work can be contracted out. While they concentrate on next-generation drugs, they can outsource the job of reformulating and improving older drugs whose patents might be about to expire.
Downsize (or rightsize) the company’s management
Most companies, as they grow and prosper, start adding levels of management. It’s possible, and often advisable, to compress some of these management layers. Consider professional services companies, which tend to offer the “flattest” paradigm. In law or accounting firms, or in IT consulting, everyone is a revenue producer. The partner who runs the shop is called the managing director or managing partner, but he’s not a full-time bureaucrat with a hierarchy of managers under him. He spends half his time as a manager or coordinator and the other half earning money doing the same work the other firm members do.
Reengineer your processes
One key process to examine is what’s known as “factory forward.” Why “factory forward?” Why not “customer backward” into the factory? This kind of process reengineering wrings out all the costs caused by inefficient inventory management. … In our increasingly services-oriented economy, services generally are demand-driven, not supply-driven. What’s happening now is that the demand-driven model is being recognized as viable for manufacturing operations as well.
Move toward “mass customization”
Demand-driven manufacturing leads naturally to the next phase of reengineering: “mass customization.” This seeming oxymoron – also known as “agile production” – essentially means producing customized products with the cost economy of the assembly line. … The point is not so much “lower volume,” but rather volume on demand, or a demand/supply alignment that creates zero inventory. Over the past decade, as consumers have become more demanding and markets have splintered, mass customization has swept through industries as diverse as car-making, consumer electronics, clothing, retailing, and fast food.
Implement target costing
In U.S. business, the standard practice (born during the beginning of the Industrial Age) has been to price our products based on what it costs to make them. We don’t really know what a new product will cost until we’ve finished making it. It was the Japanese who recognized the fallacy in this model and inverted the process. They understood that the manufacturer cannot control the price. The competitive market determines the price. But what the manufacturer can control is costs. In other words, price doesn’t come out at the end of the formula; it goes in at the beginning. The real formula is market price minus target return equals target cost.
Become a world-class customer
Remember that for most customers procurement is the biggest cost – often 65 to 70 percent of the total. So pursuing excellence in procurement can be a critical cost-reduction mechanism. How? Not by strong-arming your suppliers into reducing the price, but by nurturing them and making the m emotionally loyal to you. Just as you have your own best customers, those you enjoy doing business with the most, so you need to be that kind of customer for your suppliers. If you treat your suppliers with as much respect as you do your customers, they will want to do business with you.
To “go lean” is a tough request in this world of ours. It runs counter to the archetype of success: spending, consuming, growing “fat and happy.” This archetype is deeply ingrained – in society as well as in business. But the story across industries has the same general outline: In the face of increasing competition (often global), prices are falling, but cost structures, full of fat like clogged arteries, remain high, and margins inevitably collapse. Many, at the eleventh hour, are taking measure like those just outlined. Others, more likely to survive, will take these steps as precautions, rather than as desperate remedies.
Dr. Jagdish N. Sheth is the author of The Self-Destructive Habits of Good Companies...And How to Break Them (Wharton School Publishing), from which this article is excerpted. Dr. Sheth is a world-recognized authority on global competition, strategic thinking, and customer relationship management. He is the Charles H. Kellstadt Chair of Marketing Strategy in the Goizueta Business School at Emory University, and has served as a distinguished faculty member at the University of Southern California, the University of Illinois, Columbia University, and the Massachusetts Institute of Technology. Dr. Sheth has published more than two dozen books and hundreds of research papers in different areas of marketing and business strategy.
Five Steps for Outsourcing Success
The practice of outsourcing, or moving job functions from internal staff to outside vendors, has increased dramatically in the past few years. Organizations large and small have turned to the practice of outsourcing to improve efficiency, cut costs and free resources up to concentrate on core competencies.
Yet turning key functions over to an outside entity, regardless of its qualifications and expertise, comes with its own set of challenges. Companies must take a measured approach, from selecting the right outsourcing partner all the way through to managing and integrating the now-outsourced process into overall operations, in order to reap all the benefits of outsourcing.
These best practices can help your outsourcing program succeed:
Understand your competencies
Outsourcing can’t be done offhandedly. You need to define your company’s core mission and determine which operations are central to that mission. Then consider outsourcing non-essential functions. For example, if your key differentiator is customer service, it may not make sense to outsource your call center, since you can potentially lose control of quality and customer feedback. Rather, it may be smarter to deploy full-time, highly trained employees on that core function while assigning HR, manufacturing, logistics or other less strategic functions to an external partner.
Exercise due diligence in evaluating partners
Just as you would check references and investigate the background of a potential full-time hire, the same rigorous vetting process should apply when taking an outsourcing partner. Ask for feedback from other clients who have used their services and be sure to voice any and all concerns about their abilities or how they work. It makes sense to select an outsourcing partner who has specific expertise in your particular market segment – for example, if your business is technology manufacturing or mass-market retail, find an outsourcing provider that has industry knowledge and clients in that particular area.
Clearly define scope and schedules
Define your requirements and expectations carefully, and communicate them clearly and continuously to your outsourcing partner. It helps to give outsourcers as much information as possible about the way you work and how you expect their service to be delivered. This is especially important in heading off misunderstandings with overseas outsourcers, where relationships can be complicated by language, legal, cultural or time-zone differences. Specify in writing your payment terms, service-level agreements, schedules and milestones, and any other aspect of your product or service delivery. Communicate changes clearly as they occur so no one is left in the dark.
Start small
To be sure you are comfortable with an outsourcing provider, start with a small pilot project. This lets you work out any kinks without jeopardizing mission-critical business practices. This also provides a manageable and measurable basis upon which to quantify results.
Avoid the “out of sight, out of mind” trap
Many companies outsource a key business function only to have it fall off their radar. In order for an outsourcing relationship to work, companies have to establish key knowledge transfer mechanisms, which keep the core business connected to the outsourced function. Establishing internal liaisons to work regularly with the outsourcing provider is one way to ensure this happens. Companies also need to formalize how the outsourcing provider communicates key information. This kind of feedback loop ensures that your business is not at risk of losing control of the outsourced function.
Exclusive White Paper: Taking Back Cost Structure Control
An integrated business management system can help businesses reduce labor expenses, inventory and other costs – an essential consideration in today’s inflationary environment. As a result, companies can enjoy higher gross margins while offering customers more competitive terms.
Download in pdf format
What You Don’t Know Can Hurt You
By Ken Dickinson
Sam Renfro is the third generation leader of Granite Industries, a family-owned distribution company providing products and services to electric, gas and water utilities. He had just finished a call with Joe McDonald, CEO of InfoTek, a supplier whose product line accounted for more than 30% of Granite’s business.
On the call, Joe told Sam that he wanted Granite Industries to be InfoTek’s master distributor for the western region of the U.S. This would require the two companies to share inventory data in real time.
Sam was excited. He had been looking for ways to grow his business, take advantage of his multiple warehouse locations and unify his inventory and product management. He immediately prepared a list of questions for his CPA Linda Hollingsworth:
- ·Who does he call? His management team is great, but no one has any time to spare
- What will this cost?
- Software projects have historically gone over budget and have under-delivered on performance
- Consultants are expensive, and someone has to spend time with them to bring them up to speed on the company and the industry
- Can his already-taxed internal systems and IT staff handle additional requirements?
Using SaaS
When they spoke, Linda assured Sam that there were affordable options for sharing inventory data. She had recently researched for another client the viability of Software as a Service (SaaS), a software implementation option that has matured significantly in the past few years. She recommended a firm to review packages and services and recommend the best option for Granite. Her enthusiasm about the low cost of implementation and the predictable usage costs encouraged Sam to move forward.
This scenario is being played out every day – across a wide range of industries – as our economy becomes more integrated and more global. Like Sam’s team at Granite, the most small or medium businesses (SMBs) have partnerships with a variety of suppliers. These partnerships extend the businesses’ reach and leverage their assets. At the same time, the typical SMB lacks the financial and human resources to research options and implement the best software solution to fully capitalize on those partnerships.
In the end, many SMBs settle for incremental improvement instead of investing in the most current and sophisticated business management applications. These newer options can potentially improve an SMB’s business by orders of magnitude – all for a reasonable cost. The key is to become educated on these options.
Software wish list
Ideally, companies like Granite Industries would adopt a business technology solution that would provide:
- A 360-degree view of their business
- Simplicity in integration with clients and suppliers
- Automated tools for managing people, inventory, projects and partners
- A common look and feel for all functional areas that is intuitive for current staff and easy for new hires to learn
- Adaptability to organizational changes
- More than just ERP: full-spectrum business support including HRIS, warehouse management, service order management with warranty information, project and billing management, price quotes and proposals, manufacturing, accounting, budgeting and forecasting, and full order management under one umbrella
- Compliance with tax and management laws built in and updated regularly
- Centralized software version control and update
- Minimal implementation cost and effort
- No incremental IT infrastructure or staff
- No incremental software purchase
- No software maintenance and support costs
- Predictable, fixed monthly costs
- Worldwide 24x7 availability
- Full system monitoring and data protection
This has been the wish list for SMBs for the past decade. CEOs like Sam have been asking more frequently:
- Why can’t I buy all of the software and processing for my business like I can buy other online services like SalesForce.com?
- Why do I have to settle for technology that has not changed in 20 years to run my business, when I can experience full Internet functionality and integration like I use in everyday life as a consumer?
- Why can’t I expect the same up-to-date technology and functionality in the systems I can run my full business on?
Functionality for SMBs
The good news is that a few world-class vendors have heard the question loud and clear and now offer products that answer this need. Vendors such as SAP are using the experience and solution knowledge they have gained working with global enterprises to provide rich but affordable and intuitive functionality to SMBs.
Sam is now able to evaluate SaaS as a viable implementation option that will provide full data integration with InfoTek for the master distribution arrangement, and also will provide Granite Industries a platform to improve their business processes and management significantly with minimal investment and no incremental ongoing IT cost.
Ken Dickinson has spent more than 20 years working with businesses to evaluate business challenges and architect solutions for them. Ken attended University of New Mexico and earned a BBA and an MBA. Ken has worked for Deloitte & Touche, CGI, and Tatum, LLC. Ken now lives in Denver, CO and continues to serve the SMB space working for SAP supporting their Business ByDesign SaaS offering. You can contact Ken at Ken.Dickinson@sap.com.
QuickStat: Midsize Companies Bolster ERP Budgets
Midsize companies are increasingly focusing on increasing revenue, profitability and customer satisfaction. As a result, these businesses plan to increase their ERP budgets on average by 5.1% this year, according to new research from AMR Research Inc. ERP software enables companies to streamline business processes and more effectively connect with customers, an essential platform as the marketplace becomes more global. The report also found that by 2010, 43% of companies aim to employ a single, global financial and shared services ERP system.
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