Modern Industrial Management
MATS ENGWALL ANNA JERBRANT BO KARLSON PER STORM
Original title: Modern industriell ekonomi © Studentlitteratur, Lund 2017
Copying prohibited This book is protected by the Swedish Copyright Act. Apart from the restricted rights for teachers and students to copy material for educational purposes, as regulated by the Bonus Copyright Access agreement, any copying is prohibited. For information about this agreement, please contact your course coordinator or Bonus Copyright Access. Should this book be published as an e-book, the e-book is protected against copying. Anyone who violates the Copyright Act may be prosecuted by a public prosecutor and sentenced either to a fine or to imprisonment for up to 2 years and may be liable to pay compensation to the author or to the rightsholder. Studentlitteratur publishes digitally as well as in print formats. Studentlitteratur’s printed matter is sustainably produced, as regards both paper and the printing process.
Art. No 39694 ISBN 978-91-44-14152-7 Second edition 2:1 © The authors and Studentlitteratur 2018, 2020 studentlitteratur.se Studentlitteratur AB, Lund Translation: Ida Stefansson Cover design: Jens Martin/Signalera Cover illustration: Shutterstock/vs148 Printed by GPS Group, Austria 2020
CON T EN T S
Preface 9 Preface to the second edition 11 About the authors 13 Part I Industrial Management 1 INTRODUCTION 17
1.1 Industrial Management as an academic field 17 1.2 Industrial Management – yesterday, today, tomorrow … 20 1.3 The economic cycle of the company 25 1.4 The structure of the book 29 References 30 2 SWEDISH TRADE AND INDUSTRY 31
2.1 Swedish industry is dependent on technology and exports 31 2.2 The economic structure of Sweden 33 2.3 The companies in Sweden 35 2.4 The structure of the business sector 37 2.5 An industrial structure in transformation 47 Summary 49 References 49 3 BUSINESS OPERATIONS AS POINT OF DEPARTURE 51
3.1 The value proposition: goods and services 51 3.2 The value creation 58 3.3 Value capture 68 3.4 The business operations in the value chain 70 3.5 Efficiency, effectiveness, productivity, and profitability 76 Summary 77 References 78 © T h e a u t h o r s a n d St u d e n t l i tt e r a t u r
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4 TECHNOLOGY-DRIVEN DEVELOPMENT 81
4.1 4.2 4.3 4.4 4.5 4.6 4.7
Sources of innovation and technological development 81 The S-curves of technological development 83 How innovations diffuse 85 From product innovation to process innovation 89 Technology shifts 92 Service innovations and new business models 95 The challenge: balancing short-term efficiency and long-term innovation 97 Summary 98 References 99 Part II The value creation system 5 MARKETING 103
5.1 Marketing on different markets 103 5.2 Strategic marketing 106 5.3 Tactical marketing 111 5.4 Operational marketing and sales 117 5.5 Rules and regulations for doing business 121 Summary 124 References 125 6 PRODUCTION 127
6.1 Production under different conditions 127 6.2 Production strategy 130 6.3 Tactical production management 145 6.4 Operational production management 151 Summary 164 References 166 7 PRODUCT DEVELOPMENT 167
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7.1 Product development in different types of businesses 167 7.2 The innovation strategy of the company 169 7.3 The tactical level of product development 179 7.4 Operational level: methods and techniques 189 Summary 195 References 196 © T h e a u t h o r s a n d St u d e n t l i tt e r a t u r
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Part III The financial system 8 PRODUCT COSTING AND ANALYSIS 199
8.1 The basic concepts of accounting and costing 199 8.2 Contribution costing 207 8.3 Step costing 208 8.4 Full costing 210 8.5 Activity-based costing (ABC) 216 8.6 Operations determine the costing methods 219 8.7 Calculations – before and after 221 Summary 222 References 223 9 CAPITAL INVESTMENTS AND INVESTMENT EVALUATION 225
9.1 What is a capital investment? 225 9.2 How are investments evaluated? 228 9.3 Investment calculations 229 9.4 How is the required rate of return calculated? 245 9.5 Capital investment evaluation in practice 248 Summary 249 References 250 10 ACCOUNTING 251
10.1 What is bookkeeping? 251 10.2 T-accounts and double-entry bookkeeping 256 10.3 Systematic order of the accounts 263 10.4 Bookkeeping for VAT 265 10.5 Accurate bookkeeping is not easy in practice 267 Summary 267 References 268 11 FINANCIAL ACCOUNTING 269
11.1 11.2 11.3
Financial accounting 269 The annual financial statements – balance sheet and income statement 271 Administration report, sustainabilty report, cash flow analysis, interim report, notes and the auditor’s report 280
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11.4 Preparation of the financial statements 282 11.5 Taxed profit compared with accounting profit 292 11.6 What do the financial statements tell us? 293 11.7 Consolidated financial statements 300 Summary 303 References 304 12 CORPORATE FINANCE 305
12.1 Capital requirements 305 12.2 Capital structure 313 12.3 Financing the operations 316 12.4 Cash flow analysis 321 12.5 Financial risks 323 12.6 Two sides of financing 330 Summary 331 References 332 13 MANAGEMENT ACCOUNTING AND FINANCIAL CONTROL 333
13.1 Financial control 333 13.2 Distributing responsibilities and measuring performance 334 13.3 Management accounting 335 13.4 The balanced scorecard – a performance measurement tool 339 13.5 Budgeting 341 13.6 The effects of financial control 347 Summary 348 References 348 Part IV Management and organizing 14 BUSINESS STRATEGY AND STRATEGY MODELS 351
14.1 There needs to be a business idea 351 14.2 The strategy realizes the business idea 353 14.3 Models for strategic analysis 361 14.4 After the development of the strategy: the implementation 371 Summary 375 References 376
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15 LEADERSHIP AND HUMAN RESOURCE MANAGEMENT (HRM) 377
15.1 A company and its employees 377 15.2 The employee and the work 384 15.3 Working groups 392 15.4 Management and leadership 396 15.5 A company’s HRM and its HR department 399 Summary 400 References 401 16 ORGANIZING THE BUSINESS OPERATIONS 403
16.1 The juridical form 403 16.2 The company as an organization 407 16.3 Organizing an organization 411 16.4 Organizational structure 413 16.5 Various organizational forms 415 16.6 To coordinate operations 420 Summary 426 References 427 17 PROJECT MANAGEMENT 429
17.1 What is a project? 429 17.2 The goal – the very core of the project assignment 430 17.3 The project process 434 17.4 Project organization 438 17.5 Project management methods 441 17.6 Projects – short-term and flexible 448 Summary 448 References 449 18 CSR AND SUSTAINABLE OPERATIONS 451
18.1 A company’s social responsibility 451 18.2 The environmental issue and climate change 457 18.3 Ethical responsibility 461 18.4 Standards, systems, and guidelines 466 Summary 471 References 471
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Appendix
Glossary: English–Swedish 475 Glossary: Swedish–English 481 Interest tables 487 Index 491
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B USI NESS O PER AT I ONS A S P O I NT O F D EPA R T U R E
The main focus of Industrial Management is the business operations of a company or an organization, i.e., the way the organization develops, produces, and markets its goods and services. One important aspect is to understand the different conditions of different companies, for instance with respect to their customers, products, and production processes (i.e., how different companies create value for their customers). What the company offers, how these offers are created, and how revenue is generated from the company’s operations constitute the core of Industrial Management. In this chapter we discuss three fundamental concepts of Industrial Management: the value proposition, value creation, and value capture. Taken together, these three concepts describe a company’s business model, which is a powerful model for understanding how various elements of the business operations interact and influence each other.
3.1
The value proposition: goods and services
Industrial companies create value by developing, producing, and marketing products. When speaking of products in a general sense, we are usually referring to physical objects. However, more formally, a product can be both a good (tangible product) and a service (intangible product). As discussed in Chapter 1, the academic field of Industrial Management has traditionally revolved around the production of physical goods; however, with time, the production of services has become increasingly important. Thus, to avoid the traditional notion that a product is restricted to a tangible object, it is today more common to speak of the company’s value proposition. This concept refers to the value of what a company is offering to its customers, both products and/or services. The difference between the concepts of goods, service, and value propositions can © T h e a u t h o r s a n d St u d e n t l i tt e r a t u r
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be exemplified by a bar. The goods of the bar are the drinks, snacks and simple meals served. These goods are of course basic; without them the bar would not exist. The bar’s services are the provision of these goods, the serving, the customer service, the speed, and the cleanliness, that is, all the aspects that make us feel the bar visit is pleasant. However, the bar’s value proposition is much broader: it revolves around the customers’ motives for visiting the bar, i.e,. why the customer chooses to go there. The value proposition can thus vary between different visitors. Some go there because they are thirsty, others to rest, some to meet friends, someone hoping to get to know new people, someone to hear gossip, and someone to avoid freezing while waiting for a friend. In this way, the value proposition includes not only the bar’s goods and services, but also the other guests, i.e., who they are, how many they are, and how they behave. In addition, in this context there is often something called network effect, that is, the more visitors a bar has, the more people tend to want to visit it (see further Section 3.2).
Different types of value propositions Some companies sell their products directly to consumers, often called business-to- consumer (B2C). Other companies sell their products to other companies, often called business-to-business (B2B) (see Table 3.1). This is a simple classification since some TABLE 3.1 Examples of various product types.
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Business-to-consumer (B2C) goods
Business-to-business (B2B) goods
Services
Books
Steel
Education
Automobiles
Wood pulp
Machinery service
Toothpaste
Trucks
Maintenance
Groceries
Engines
Consulting
Mobile telephones
Power stations
Telecommunications
Medicines
Mobile telephone systems
Computer service
Dishwashers
Machine tools
Industrial cleaning
Clothes
Electronic components
Electronic payments
Houses
Factories
Transportation
Furniture
Office furniture
Heating
Computers
Computers
Web-based games
Software
Software
Mobile applications
Electricity
Electricity
Streaming media
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Psychotherapy treatment
Management consulting
Computer systems services
Pure goods
Restaurants
Machine tool manufacture
Aluminum smelting
Crude oil production
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Pure services
FIGURE 3.1
Value propositions: Most are a mix of manufacturing and service operations.
products are sold to both consumers and producers. Still, the customer type is often of critical importance for the company’s strategy and operations. Goods and services differ in many ways. Tangible products (goods) can be developed, produced, stored, and delivered. Often, the development, production, and storage of goods occur before the customer is involved or even identified. In addition, the quality of tangible products is often possible to assess and measure in a precise and objective way. It is a different matter for intangible products (services). Because of their intangibility, pure services are produced and consumed simultaneously in a direct, close producer-consumer relationship. Moreover, services cannot be stored and delivered (however, the actual storage and delivery can be a type of service). Furthermore, evaluating the quality of services is often a highly subjective matter. In practice, however, most products are a mix of goods and services. Many tangible products, such as advanced machinery, are sold together with a service agreement. Mobile phone contracts (services) are sometimes marketed with the offer of a new phone (goods) “for free”. Furthermore, the installation of a computerized business system requires considerable work to adapt the system according to the customer’s specifications (see Figure 3.1). In short, when we as consumers purchase a tangible product, the chain of operations in order to provide us with the product consists of a number of services (intangible products). For example, if we purchase a computer via the Internet, we would regard this as buying a physical product. The physical computer and its components were all manufactured and then assembled at different factories around the world. However, many of the activities that enabled the delivery of the computer © T h e a u t h o r s a n d St u d e n t l i tt e r a t u r
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are different types of services; for instance, picking up the order, installing software and configuring the operating system, and transporting the computer to our home. The various services that industrial companies offer their customers can be divided into two types. Firstly, there are services that complement the company’s physical products by facilitating the sale and delivery of the product (e.g., by offering a service agreement) or by adapting the product to the customer’s operations for a smooth transition (e.g., through customization of a new IT system). Secondly, there are services where companies replace the physical product with a service, i.e., instead of purchasing a product, the customer leases the product, subscribes to use it, or even purchases the functions of the physical product. For example, instead of purchasing and operating their own data center for their IT systems, many companies buy these services from external suppliers. Similarly, many companies purchase a set of specified copier and printing services provided by a supplier, instead of purchasing the physical office equipment. The suppliers then provide maintenance and make repairs. In fact, many industrial companies today are trying to develop these kinds of business models as a way to expand their offering and promote long-term and closer customer relationships. Many customers also prefer making regular, fixed, and smaller payments for the services they use instead of making a large investment (see Table 3.2). In some industrial contexts, however, the service is central in itself. One example is modern engineering consulting in construction, IT, or product development. Here, it
TABLE 3.2 Functions of industrial services (based on Cusumano et al., 2015).
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Complementary to physical products
Replacement of physical products
Facilitating
Adapting
Substituting
Services that simplify sales or use of a product but do not significantly affect the product’s functionality.
Services that adapt the product, improve the product’s functionality, or help the customer develop new ways to use it. Closely linked to the product. Requires close cooperation with the customer.
Services that replace the sale of the product.
Examples: • Financial services • Warranties • Insurance • Technical support • Training • Operations support
Examples: • Tailored customization • Systems integration • Technical updates • Development of the customer’s business processes
Examples: • Computer/IT services • Internet data storage • Rentals and leases • Functional sales “Power by the hour”
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is not the service that complements the good, but the other way around. Instead, it is the physical artifact, for example in the form of a report, a presentation document, a drawing or a database, that complements the consulting service.
Value propositions and the corporate strategy How the value proposition is formulated is closely associated with the company’s business concept (sometimes called business idea) and its strategy. The company’s business concept reflects its overall goals, the reason for its existence, and the owners’ vision. A good business concept also reflects more aspirations for the company’s operations than those reflected by its financial goals. The company’s strategy reflects the company’s plans for how it intends to realize its business concept – that is, how the company will provide value to the customers, how it will compete with other companies, and how it will develop its operations in the long term (see Chapter 14). Designing the value proposition is a strategic decision that will influence the company’s operations – for example, which market segment to focus on, what type of expertise will be required, which equipment will be needed and, not least, how the operations are managed and organized. Regardless of whether the company offers goods and/or services, there are three principal competitive strategies to choose from (see Figure 3.2):
Product leadership High Innovation Product functions Product qualities Differentiation Premium price
Customer relationships Unique products Customized Flexibility Service and support
Low costs
Low
Customer loyalty High Customer intimacy
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Economies of scale Efficient operations Standardized solutions Well-known technologies
Low
High
Operational excellence FIGURE 3.2
Three different competitive strategies (based on Treacy & Wiersema, 1993).
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1 Competitiveness by product leadership: The value proposition is based on superior products, i.e., goods and/or services. Through the high quality of the products’ properties and their functions, the company creates a distinctive brand. To maintain this level of quality, the company must invest heavily in innovation and product development. The company is based on its ability to command relatively high (premium) prices for its products. 2 Competitiveness by operational excellence: The value proposition is based on low prices. Because operations processes are efficient and products are standardized, products are manufactured at low cost and in high volumes. Sales prices are low (in relation to the product quality offered). The company is based on its ability to maintain low production costs. 3 Competitiveness by customer intimacy: The company provides custom-made products for its customers. Each unique product is produced to order. Customer loyalty and relationships are very important. The company is based on its ability to maintain operational flexibility in meeting specific customer requirements. In practice, many companies combine these strategies in one way or another. However, there are inherent conflicting logics between these three strategies. High operational efficiency is usually incompatible with high flexibility and highly customized production. Similarly, it is very difficult to develop sophisticated product properties, premier features, and high-quality functionalities and at the same time offer these products at low prices. Thus, a company’s value proposition and its overall strategy must match the company’s three major value-creating processes: product development, production, and marketing (see Chapter 5, 6, and 7). The box below describes the way Atlas Copco (an equipment supplier to the manufacturing and construction industries) does its business (Atlas Copco, 2018).
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Atlas Copco – this is how we do business Sales and service Customer focus is a guiding principle for Atlas Copco. The ambition is to build close relationships with customers to help them increase their productivity in a sustainable way. Customer engagement, sales and service take place through direct and indirect channels (mainly distributors) as well as through digital channels, in order to maximize market presence. The Group has a global reach and sales in more than 180 countries. Sales of equipment is performed by engineers with strong application knowledge and the ambition to offer the best solution for the customer’s specific application. Service and maintenance performed by skilled technicians is an integral part of the offer. Service is the responsibility of dedicated divisions in each business area. The responsibility includes development of service products, sales and marketing, technical support as well as service delivery and follow-up. More than 40 % of revenues are generated from service (spare parts, maintenance, repairs, consumables, accessories, and rental). These revenues are more stable than equipment sales and provide a strong base for the business. Manufacturing and logistics The manufacturing philosophy is to manufacture in-house those components that are critical for the performance of the equipment. For non-critical components, Atlas Copco leverages the capacity and the competence of business partners and cooperates with them to continuously achieve product and process improvements. Approximately 75 % of the production cost of equipment represents purchased components and about 25 % are internally manufactured core components, assembly costs and overhead. Equipment represents less than 60 % of revenues and Atlas Copco has organized its manufacturing and logistics to be able to quickly adapt to changes in equipment demand. The manufacturing of equipment is primarily based on customer orders and only some standard, high volume equipment is manufactured based on projected demand. The assembly of equipment is to a large degree carried out in own facilities. The assembly is typically lean and flow-oriented and the final product is normally shipped directly to the end user. The organization works continuously to use human, natural or capital resources more efficiently, while ensuring highest quality. Innovation Atlas Copco believes that there is always a better way of doing things. Innovation and product development are very important and all products are designed internally. A key activity is to design new or improved products that provide tangible benefits in terms of productivity, energy efficiency and/ or lower lifecycle cost for the customer, and at the same time can be efficiently produced. Atlas Copco protects technical innovations with patents. Innovation also includes better processes to improve the flow and utilization of assets and information. Innovation will improve customer satisfaction and contribute to strengthening customer relations, the brand, as well as financial performance. Overcapacities and inefficiencies must always be challenged.
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3.2
The value creation
The company’s transformation of resources A classic economic model of value creation in industrial companies describes industrial operations as the transformation of various resources (inputs) to products (outputs). A company’s value added is the difference between the economic value of its output (sales price for finished products) and the economic value of its input (cost of the resources that make up the products). Value added is an economic index of the value a firm adds by its operations, in other words: the value a firm creates for its customers in relation to a situation when the customers had performed the resource transformation by themselves. The value creation process is different for different types of operations. In a pure manufacturing company, various inputs are transformed to outputs; that is, to the physical products (goods) sold to customers (see Figure 3.3). Inputs may be raw materials, semi-finished goods, and various other components. The resource transformation process requires production plants, technical equipment, the knowledge and skills of personnel, and (sometimes) external contractors. In a pure service business (Figure 3.4), the transformation and logic of the value creation process are different. The customer is often directly involved in the service operations (e.g., a passenger is transported by an airline). Sometimes the service includes changes in the customer’s operations or property (e.g., car repairs, computer system installations, or transporting goods). Services can also involve knowledge development, for example training and consulting in different areas, or collecting
Resource transformation Technical equipment
FIGURE 3.3
Raw materials Semi-finished goods Components
Input
Value creation in manu facturing operations.
Output
Products
Employees
Resource transformation Technical equipment
FIGURE 3.4
Value creation in service operations.
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Material People Data
Input
Output
Services
Employees
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information, for example by gathering data on behalf of different customers for various statistical analyses.
From line to platform and circle The traditional resource transformation model in Figures 3.3 and 3.4 is linear. The resource transformation goes in one direction, from left to right with clear input and clear output. However, in some cases, the resource transformation and value creation may be bidirectional, that is, there are inputs and outputs on both sides (see Figure 3.5). This means that actors who buy or use the output from the resource transformation, at the same time also provide input to the process themselves. Google is a typical example of this phenomenon. On the one hand, Google offers free search services on the Internet to its users, while Google, on the other hand, uses data on its users’ search behavior to sell targeted advertising services to various companies. Similarly, Faceboook, Microsoft, and other companies also offer “free” services over the Internet, in exchange for user data that can be resold for use, for example, for market research or targeted advertising campaigns. Another example is the company Apple, which through Appstore provides a market of apps, developed by independent developers, to its users. However, there is a fee for developers to upload an app into Apple’s system and Apple also charges the developer a small fee every time someone uses the app. Systems and products that enable such double-sided transactions are often referred to as market platforms (unlike technical platforms, which are discussed in Section 7.2). Such a platform enables different actors to be linked together to create a two-sided market. Typically, market platforms provide services between different actors, much like a broker. Apple, in the example above, allows apps in their products to increase the value of those products to their customers, while also being paid by the app developer. In the same way, for example, the booking service Airbnb charges a service fee to each tenant who books accommodation via Airbnb’s website, but also a fee to the landlord for each mediated rental.
Resource transformation Technical equipment Data Services
Input
Output
Output
Input Employees
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FIGURE 3.5
Value creation of market platforms.
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An important phenomenon related to platforms is the so-called network effects, that is, the value of a platform increases with the number of users on the platform. To take the example of Airbnb again: the more renters who advertise on Airbnb, the more important it is for other renters to advertise via Airbnb, and the more renters there are on the platform, the more potential tenants will be interested in using Airbnb when searching for holiday accommodation. As can be seen in these examples, platforms and multisided markets are often associated with IT and Internet-based services. However, this phenomenon is not new. For example, it is the same logic behind the traditional business models of commercial TV channels, newspapers, and real estate agents. Actually, if you are observant, you can identify aspects of market platforms in almost all businesses and products that are about mediating contacts or connecting actors in different ways. What is new is that the Internet has made this so much more efficient. An additional perspective on value creation is to think circular instead of linear. Circular economy is today a popular concept that emphasizes the need for economic models where value creation takes place in circular cycles rather than the one-way, linear processes that have been dominant so far (see Figure 3.6). Circular economy can be described as a perspective or an endeavor aimed at increasing the ecological sustainability of society. The inspiration comes from the cycle of nature. The idea is that there should be no waste. Instead, waste should, as far as possible, be seen as raw material for value creation. Therefore, products must be deliberately designed to enable them either to be recycled (in the first priority) or that the material in them can be recycled (in the second priority). (See also Section 18.2.)
Technical equipment Raw materials Semi-finished goods Components
Input
Output
Products
Employees
FIGURE 3.6
Reuse Remanufacturing Recycling
Circular value creation.
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Circular economy In 2015, the European Commission adopted an action plan for the circular economy in Europe. The purpose is to enact laws that will lead to the closure of the product life cycle by increasing reuse and recycling. For example, to convert from a linear to a circular economy, a commodity-producing company can take the following measures: • • • • • •
Remove environmentally hazardous substances. Use renewable energy for production and transport. Design products so that they are easy to disassemble in their constituents. Recycle the material in the products. Recycle the energy needed during production. Identify new uses for used products.
Illustration: Sofia Liljander
Circular economy Raw materials Sustainable design
Recycling Manufacturing/ Remanufacturing Collection
Use/Reuse
FIGURE 3.7 Circular economy. Illustration: Sofia Liljander/Naturskyddsföreningen.
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There are many factors that influence this resource transformation, and exactly how the system should be designed to be efficient differs from company to company. There are, however, four factors that are of particular importance in order to understand the logics of different resource transformations, sometimes referred to as “the 4 Vs”: • Volume – the size of the business operations • Variety – the variety of products produced • Variation – the variation in customer demand • Visibility – the level of customer interaction.
Volume of business operations The volume of operations is one of the most important factors that influence the logics of the value creation process. A high production and sales volume enables operations with low unit costs, which in turn is among the most important competitive factors. This is often referred to as economies of scale, which means that a company, through high operating volumes, is able to utilize labor, equipment, and production facilities in a cost-efficient manner so that the fixed costs of the operations can be shared between many units of output. To achieve this, however, it is necessary that the activities of the process are predictable and repeatable, that the process is designed and organized in a systematic way, and that the included sub-processes, activities, and components have a high level of standardization. Standardization also enables specialization of staff and equipment, which in turn creates conditions for greater economies of scale (cf. the characteristics associated with the concept of “industrialization” described in Chapter 1). High-volume production is often capital-intensive. It enables the purchase of expensive and specialized equipment which will increase efficiency even more. On the other hand, competing with high volume and low costs usually requires large investments in specialized equipment and expensive production facilities. High volume is, thus, closely linked with the strategy to compete through operational excellence described in Section 3.1, and there are a number of examples of companies where the ability to maintain a high operating volume is a prerequisite for their existence. Traditional process industries such as extraction of raw materials (oil and gas, iron, etc.) and production of goods such as steel, paper, chemicals, and food, are completely dependent on high operating volumes (cf. Section 2.4). The same applies to the manufacturing of, for example, vacuum cleaners, cars, computers, and electronic components, not to mention rail transports, fast food restaurants, movie theaters, and retail companies like Ikea, H&M, Primark, Wal-Mart, and the Swedish retailer Clas Ohlson. A perfect example of high-volume service operations is McDonald’s, whose restaurants in Sweden alone (according to McDonald’s themselves) serve approximately 435,000 guests on a daily basis. 62
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The standardization and specialization which enable high volume do, however, come at a price: operations become less flexible, which means that standardized products and services only can be offered within a limited range. Moreover, the process is often both difficult and expensive to change. If there is a shift in market demand, or if certain customers wish to customize or complement the standardized products, it can be problematic.
Variety of products produced In companies with high variety in their value proposition (the strategy to compete through customer intimacy in Section 3.1), the production processes usually include a significantly lower level of repeatability, which in turn leads to less predictability and specialization and higher demands on flexibility. The result is higher average costs for each product or service, which in turn means that the company has to create an extra value for the customer that will justify the higher prices compared to a low-cost company with high operating volumes. Compare a fine-dining restaurant with a fast food restaurant. The fine-dining restaurant usually offers a much more varied menu, which requires a wider range of products as well as more skilled and experienced chefs. Normally, the meals also take longer to prepare and are more expensive, which needs to be justified, for example by offering food of higher quality and ensuring that the visit to the restaurant is a pleasant experience. There is, in other words, a classic conflict between high volume in production and high variety in the value proposition. High volume requires high repeatability, specialization, and standardization, while high variety requires a high level of flexibility and the ability to manage a more complex production process. In practice, many companies have to compromise between the two opposing logics. Different companies use different strategies for this. As an example, many businesses with high variety often try to offer their customers package deals. Other companies try to combine different processes, for example by using mass-produced components or sub-processes, which can later be combined into a unique product or service from the customer’s perspective. One example is the Danish company Lego, which in this way manages to combine large-scale mass production of standardized Lego pieces with the constant launch of short series of new kits on the global market.
Variation in demand Demand can vary in more ways than different customers requesting a varied and customized product range. While, for example, insurance companies, water treatment plants, energy producers, and nursing wards in a hospital have a relatively regular demand where shifts can be predicted relatively far in advance, other types of operations, for example, fire departments or emergency rooms, have a demand which is close to impossible to predict, which leads to various effects. The fire department has, © T h e a u t h o r s a n d St u d e n t l i tt e r a t u r
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on one hand, long periods of excess capacity when the firefighters have nothing to do. Emergency rooms, on the other hand, usually have insufficient capacity during long periods, where low-priority patients might have to wait a long time because the medical staff are preoccupied with patients with more acute conditions. Other sectors have seasonal variations in demand, for example, the demand for ice cream is higher in the summer, the demand for hotel rooms at a ski resort is higher in the winter, and the demand for toys is at its peak during the Christmas shopping season in December. An industrial example is the Swedish company Camfil (a world-leading manufacturer of filters for ventilation systems). Since the demand for filters from real estate owners is significantly higher during the summer months than the winter months, Camfil often have excess capacity in the autumn, while they have to build up large stocks before the summer in order to meet the demand which the company knows is coming. In sectors where the demand does not vary, but is stable over time, there are, of course, greater opportunities to standardize production and optimize the efficiency of machinery and labor during production. Consequently, many companies try to forecast the demand in advance so that they can adapt accordingly. Some companies hire seasonal, part-time, or temporary staff to manage the peaks in demand. Many companies also strive to even out the demand over time in different ways, for example by offering lower prices during periods of lower demand and/or higher prices when the demand is at its peak. Another way is to create complementary products with a different demand variation, like when conference and business hotels offer “romantic weekends” on the weekends or when restaurants serve “Sunday brunch” on Sunday afternoons when they have fewer guests. In the same way, there are also many lunch restaurants that combine their lunch service with catering services and thus try to utilize their staff and kitchen resources outside of lunch hours.
Visibility: level of customer involvement In most cases, value creation results from a mix of goods and service production. Figure 3.8 presents a simplified illustration of this resource transformation process. The arrow in the upper box represents the production. The lower box represents the customer experience. As the figure illustrates, some areas of the two boxes overlap although other areas do not. This overlap differs according to the type of operations. The more the boxes overlap, the more experiences of the production process the customer has, i.e., the more customer involvement. Normally customers are not involved in traditional product manufacturing (e.g., the manufacture of automobiles or computers). Thus, there is no overlap of the two boxes. The same is true of certain kinds of services, e.g., delivery of telecom services via the Internet. Similarly, banks and travel bureaus conduct many of their activities in the “back office”. Their customers have no contact or involvement these activities. 64
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business operations as point of depar tur e
Production
Back office
Front office Customer experience
Outcome FIGURE 3.8
Product
The product as the sum of the outcome and the customer experience (based on Johnston and Clark, 2005).
Typically, however, a great deal of service operations requires direct contact with customers. Examples are the “front office” activities of banks and travel bureaus in which the customer experience is part of the product that is purchased. In such cases, the value proposition is a sum of the outcome (end result) plus the customer experience. Traditional manufacturing and the back-office activities of service operations often show many similarities: the value creation is independent of the customer, who only evaluates the final outcome. However, sometimes the two boxes overlap. The greater the overlap between the boxes, the more direct contact the customer has with the production process and the more important the customer’s experience of the production process is for the evaluation of the product as a whole. At a restaurant, for example, the quality of the produced food (the back office) is fundamental. However, from the customer’s perspective, the restaurant’s service, atmosphere, and hospitality (the front office) are at least as important. The same applies to the installation of technical systems or the provision of technical consulting services. Naturally, the technical outcome is the most important aspect, but the customer’s experiences of the technicians or consultants also matters. Were they easy to work with? Did they meet the time schedule? Were they friendly and reliable? In addition, there are service-based value propositions in which the very process constitutes the product, and where there are almost no back-office activities at all (see Figure 3.9 on the next page in which the boxes merge). Typical examples of this kind of service include different types of therapies, such as counseling, massage, or physical therapy. However, such activities are rarely considered as industrialized operations. Based on the customer involvement, the value creation process can be divided into three principal categories: © T h e a u t h o r s a n d St u d e n t l i tt e r a t u r
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The authors of this book are all engineers who are, or have been, teachers and researchers at the Department of Industrial Economics and Management at KTH Royal Goods-dominant logiccurrently work in a number of areas: academic Institute of Technology in Stockholm. They research and education, technology management, and leadership development.
FIGURE 3.9
Back office-dominant logic
Modern Industrial Management
Various degrees of customer involvement in value creation.
Front officedominant logic
Today’s engineers must be able to understand the economic implications of different technological decisions, as well as the technological implications of managerial and1 financial decisions. This is precisely the academic field Goods-dominant logic: Value creationwhat is independent of interactions with the of Industrial Management is about: understanding the interdependencies customers. between technology management, order tovalue efficiently create value. of inter 2 Backand office-dominant logic:inThe main creation is independent actions with the customers, but the customers are involved in central parts of Modern Industrial Management provides an introduction to the basic concepts the process (often at the start and the end of the process). and methods that will enable engineers to explain and support their decisions 3 Front office-dominant logic: The main value creation occurs in direct contact in financial terms. The book focuses on the business operations of modern with the customers; most of the value creation is constituted by the customer industrial companies and covers the entire field of management, from costing experience. to sustainable business development. As such, the book provides a fundamental understanding of this large field, as well as an examination of the most important methods to control, plan,Vsand develop industrial operations. The four summarized Modern Industrial Management provides fundamental theimpact on the facThe four factors volume, variety, variation, andknowledge visibility haveabout a strong value creationtors process of important technology-based covering marketing, that are to take intocompanies, account in order to achieve effective value creation. production, and development, well as theirhigh financial systems, in demand, and Lowproduct operational volume, high as product variety, variation in customer terms of costing, and financing. also discusses human highaccounting, level of customer involvementIt (visibility) tend to involveresource higher production costs management,compared business strategies, organizing, project management, andvariation ques- in customer to high operational volume, low product variety, low tions concerning corporate social and sustainable development. demand, and low levelresponsibility of customer interaction (see Figure 3.10). High production costs The book is aimed at engineering level andhigh practicing per unit mean that thestudents company at hasuniversity to be able to charge prices for their products engineers whoonrequire basicConsequently, knowledge inmany Industrial Management. the market. companies search for ways to reduce production costs per product, for example by increasing volumes by modularizing the products to Second edition reduce product variability, or to even out variations in demand through alternative use of the production equipment during periods of low occupancy. In fact, high volume, low variety, low variation, and low customer involvement are the four typical characteristics Art. No 39694 of business operations that are usually labeled as industrial or industrialized.
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