9789144121024

Modern Industrial Management

MATS ENGWALL ANNA JERBRANT BO KARLSON PER STORM

Original title: Modern industriell ekonomi © Studentlitteratur, Lund 2017

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Art. No 39694 ISBN 978-91-44-12102-4 First edition 1:1 © The authors and Studentlitteratur 2018 studentlitteratur.se Studentlitteratur AB, Lund Translation: Ida Stefansson Cover design: Jens Martin/Signalera Cover illustration: Shutterstock/vs148 Printed by Interak, Poland 2018

CON T EN T S

Preface 9 About the authors 11 Part I Industrial Management 1 INTRODUCTION 15

1.1 Industrial Management as an academic field 15 1.2 Industrial Management – yesterday, today, tomorrow … 18 1.3 The economic cycle of the company 23 1.4 The structure of the book 26 References 27 2 SWEDISH TRADE AND INDUSTRY 29

2.1 Swedish industry is dependent on technology and exports 29 2.2 The economic structure of Sweden 31 2.3 The companies in Sweden 33 2.4 The structure of the business sector 35 2.5 An industrial structure in transformation 45 Summary 47 References 47 3 BUSINESS OPERATIONS AS POINT OF DEPARTURE 49

3.1 The value proposition: goods and services 49 3.2 The value creation 55 3.3 Value capture 62 3.4 The business operations in the value chain 64 3.5 Efficiency, effectiveness, productivity, and profitability 69 Summary 71 References 72 © 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 73

4.1 4.2 4.3 4.4 4.5 4.6 4.7

Sources of innovation and technological development 73 The S-curves of technological development 75 How innovations diffuse 77 From product innovation to process innovation 81 Technology shifts 84 Service innovations and new business models 86 The challenge: balancing short-term efficiency and long-term innovation 87 Summary 89 References 90 Part II The value creation system 5 MARKETING 93

5.1 Marketing on different markets 93 5.2 Strategic marketing 96 5.3 Tactical marketing 101 5.4 Operational marketing and sales 107 5.5 Rules and regulations for doing business 111 Summary 114 References 115 6 PRODUCTION 117

6.1 Production under different conditions 117 6.2 Production strategy 120 6.3 Tactical production management 133 6.4 Operational production management 142 Summary 154 References 156 7 PRODUCT DEVELOPMENT 157

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7.1 Product development in different types of businesses 157 7.2 The innovation strategy of the company 159 7.3 The tactical level of product development 167 7.4 Operational level: methods and techniques 175 Summary 183 References 184 © 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 187

8.1 The basic concepts of accounting and costing 187 8.2 Contribution costing 194 8.3 Step costing 196 8.4 Full costing 198 8.5 Activity-based costing (ABC) 203 8.6 Operations determine the costing methods 207 8.7 Calculations – before and after 209 Summary 210 References 211 9 CAPITAL INVESTMENTS AND INVESTMENT ANALYSIS 213

9.1 What is a capital investment? 213 9.2 How are investments evaluated? 216 9.3 Investment calculations 217 9.4 How is the required rate of return calculated? 232 9.5 Capital investment analysis in practice 236 Summary 237 References 238 10 ACCOUNTING 239

10.1 What is bookkeeping? 239 10.2 T-accounts and double-entry bookkeeping 244 10.3 Systematic order of the accounts 250 10.4 Bookkeeping for VAT 253 10.5 Accurate bookkeeping is not easy in practice 254 Summary 254 References 255 11 FINANCIAL ACCOUNTING 257

11.1 11.2 11.3

Financial accounting 257 The annual financial statements – balance sheet and income statement 259 Administration report, cash flow analysis, interim report, and the auditor’s report 268

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11.4 Preparation of the financial statements 269 11.5 Taxed profit compared with accounting profit 279 11.6 What do the financial statements tell us? 280 11.7 Consolidated financial statements 286 Summary 288 References 289 12 CORPORATE FINANCE 291

12.1 Capital requirements 291 12.2 Capital structure 298 12.3 Financing the operations 301 12.4 Cash flow analysis 305 12.5 Financial risks 308 12.6 Two sides of financing 314 Summary 315 References 316 13 MANAGEMENT ACCOUNTING AND FINANCIAL CONTROL 317

13.1 Financial control 317 13.2 Distributing responsibilities and measuring performance 318 13.3 Management accounting 319 13.4 Balanced scorecard – a performance measurement tool 323 13.5 Budgeting 325 13.6 The effects of financial control 330 Summary 331 References 332 Part IV Management and organizing 14 BUSINESS STRATEGY AND STRATEGY MODELS 335

14.1 There needs to be a business idea 335 14.2 The strategy realizes the business idea 337 14.3 Models for strategic analysis 345 14.4 After the development of the strategy: the implementation 355 Summary 359 References 360

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15 LEADERSHIP AND HUMAN RESOURCE MANAGEMENT (HRM) 361

15.1 A company and its employees 361 15.2 The employee and the work 368 15.3 Working groups 376 15.4 Management and leadership 380 15.5 A company’s HRM and its HR department 383 Summary 384 References 385 16 ORGANIZING THE BUSINESS OPERATIONS 387

16.1 The juridical form 387 16.2 The company as an organization 391 16.3 Organizing an organization 395 16.4 Organizational structure 397 16.5 Various organizational forms 399 16.6 To coordinate operations 404 Summary 410 References 411 17 PROJECT MANAGEMENT 413

17.1 What is a project? 413 17.2 The goal – the very core of the project assignment 414 17.3 The project process 418 17.4 Project organization 422 17.5 Project management methods 425 17.6 Projects – short-term and flexible 432 Summary 432 References 433 18 CSR AND SUSTAINABLE OPERATIONS 435

18.1 A company’s social responsibility 435 18.2 The environmental issue and climate change 441 18.3 Ethical responsibility 444 18.4 Standards, systems, and guidelines 449 Summary 453 References 454

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Appendix

Glossary: English–Swedish 457 Glossary: Swedish–English 463 Interest tables 469 Index 473

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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 they develop, produce, and market their 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.

1.1

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, if we take a closer look, a product can refer both to 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. © 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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Various 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 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 material 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). 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 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.

(goods) “for free”. The installation of a large computerized business system requires considerable work to adapt the system according to the customer’s specifications. 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 somewhere in the world.

However, many of the activities that enabled the delivery of the computer 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 (see Figure 3.1).

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 © 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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TABLE 3.2 Functions of industrial services (based on Cusumano et al., 2015).

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”

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).

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.

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): 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 52

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Product leadership High Innovation Product functions Product qualities Differentiation Premium price

Customer relationships Unique products Customized Flexibility Service and support

Economies of scale Efficient operations Standardized solutions Well-known technologies Low costs

Low Low

High

Operational excellence

Customer loyalty High Customer intimacy

FIGURE 3.2

Three different competitive strategies (based on Treacy & Wiersema, 1993).

products’ properties and their sophisticated 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 volume. 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: A company manufactures 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, of course, many companies combine these strategies in one way or another.

However, it is important to remember that 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, premiere 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: innovation, production, and marketing. We will return to these processes further on in this chapter. © 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 box below describes the way Atlas Copco (an equipment supplier to the manufacturing and construction industries) does its business (Atlas Copco, 2018).

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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1.2

business operations as point of depar tur e

The value creation

The company’s transformation of resources A classic 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).

The value creation process is different for different types of operations. In the 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 also 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., as the passenger of an airplane). Sometimes the service includes changes in the customer’s operations or property (e.g., car repairs, installing a computer system or transporting goods). Services can also involve knowledge development, for example training and consulting in different areas, or collecting information, for example by gathering data on behalf of different customers for different types of statistical analyses.

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

Resource transformation Technical equipment Raw materials Semi-finished goods Components

Input

Output

Products FIGURE 3.3

Value creation in manufacturing operations.

Employees

Resource transformation Technical equipment Material People Data

Input

Output

FIGURE 3.4

Employees

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Services

Value creation in service operations.

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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 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. High operating volume 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. Chapter 2). The same applies to the manufacturing of, for example, vacuum cleaners, cars, computers, and electronic components, not to mention train companies, 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 400,000 guests on a daily basis.

The standardization and specialization which enable high volume do, however, come at a price: operations become less flexible, which means that standardized products and 56

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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 in relation 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 opposition between high volume in the 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 later can be combined into a unique product or service from the customer’s perspective.

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 different types of effects. The fire department has, 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. © 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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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 they know 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 interaction In most cases, value creation results from a mix of goods and service production. Figure 3.5 presents a simplified illustration of this resource transformation process. The arrow in the upper box represents the operations. 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 (see Figure 3.5).

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 mobile telephone 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 with such activities.

Typically, however, a great deal of the operations in the service sector 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 sproduct 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 58

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Production

Back office

Front office Customer experience

Outcome FIGURE 3.5

Product

The product as the sum of the outcome and the customer experience (based on Johnston and Clark, 2005).

show many similarities. Generally, 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 impression 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 3.6 on the next page in which the boxes merge). An example of this kind of service is different types of therapies, for instance massage. However, such activities are rarely considered as industrial operations.

Based on the customer interaction, the value creation process can be divided into three principal categories (we will come back to the strategic consequences of these later): 1 Goods-dominant logic: Value creation is independent of interactions with the customers.

2 Back office-dominant logic: The main value creation is independent of interactions with the customers, but the interactions take place in central parts of the process (often at the start and the end of the process).

3 Front office-dominant logic: The main value creation occurs in direct contact with the customers; most of the value creation involves the customer experience. © 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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Goods-dominant logic

Back office-dominant logic

FIGURE 3.6

Various degrees of customer involvement in value creation.

Front officedominant logic

The four Vs summarized The four factors volume of business operations, product variety, variation in demand, and level of customer involvement have a strong impact on the factors that are important to take into account in order to achieve effective value creation. Low operational volume, high product variety, high variation in customer demand, and high level of customer interaction tend to involve higher production costs than high operational volume, low product variety, low variation in customer demand, and low level of customer interaction (see Figure 3.7). High production costs mean that the company has to be able to charge high prices for their products on the market. Consequently, many companies search for ways to reduce production costs per product, for example, by increasing volumes by modularizing the products to 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 of business operations that usually are labeled as industrial or industrialized.

Different emphasis in different business operations Above, we have discussed value creation by focusing on the company’s production process. However, the company’s innovation and marketing processes are equally important. Product development, production, and marketing are the three sub-processes that together constitute the company’s value creation. The product development process involves developing business and value propositions, creating new ideas and utilizing them. The production process is about realizing the company’s value proposition as efficiently as possible. The marketing process involves bringing the value proposition 60

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Unique products Wider individual tasks Less systemization High unit costs Flexible output Complex production Match customer needs High unit costs

Changing capacity Unsure forecasts Low utilization High unit costs

Low

High

High

Short waiting tolerance Satisfaction governed by by customer perception High Customer contact skills needed High unit costs

Volume

Variety

Variation in demand

Visibility

FIGURE 3.7 The four Vs and their impact on value creation (after Slack et al., 2010).

business operations as point of depar tur e

High

High repeatability Specialization Capital intensive Low unit costs

Low

Well defined output Routine High degree of standardization Low unit costs

Low

Predictable capacity needs High degree of standardization High utilization Low unit costs

Low

Time lag between production and consumption High degree of standardization High staff utilization Centralization Low unit costs

to the market, getting the products sold, and influencing the customers’ perception of the value of the goods and services that the company provides.

The value creation of different companies consists of different combinations of these three processes, which means that they are of different importance in a company’s operations. One way to understand this is to analyze how the costs are divided between different types of value creation. Figure 3.8 gives some examples of how the cost structure in value creation can vary between different companies and industries. Company 1, to the left, represents a traditional manufacturing company: most of the costs, and thus most of the operations, are in production. Company 2 has the largest share of its costs in the form of purchases, such as raw materials and components. Today, many manufacturing companies have this cost structure: instead of doing everything themselves, the trend has for a long time been to purchase increasingly more work from various types of suppliers (see Section 3.4). Company 3 is a company dominated by (product) development and research, something which is common in the pharmaceutical industry. Company 4, on the other hand, is dominated by various marketing activities, such as advertising, promotion, and customer relations. Fashion, perfume, and cosmetics are some examples of businesses which often report this type of cost structure.

In practice, however, the cost allocation may vary considerably between different companies. The cost allocation, of course, does not have to be in line with the customer value, but it provides a rough idea of what the company’s value creation revolves around. © 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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PA R T I

I n du s t ria l Ma n ag ement

100 % Marketing

Marketing

Product development

Product development Production

Marketing Marketing Product development Product development

Production Production

FIGURE 3.8

The cost structure in value creation varies between different industries and companies.

Purchases Purchases

Purchases 0%

1.3

Company 1

Company 2

Company 3

Production Purchases Company 4

Value capture

To survive in the long term, a company must retain some of the value it creates for its customers in the form of revenues to generate profit. This is referred to as value capture.

The way this is done, the so-called revenue model, is often closely associated with the value proposition the company offers its customers.

Most of the traditional revenue models are built around unit sales – that is, the company receives payment for each unit sold based on the cost of producing the unit, plus a profit margin. Because cost-based pricing is easy for everyone to understand, companies tend to price their goods and services on a per unit basis. Thus, sales prices reflect the cost of raw materials, labor, and overhead, plus a profit. However, the price that customers are willing to pay for a product cannot be objectively determined.

Market conditions set sales prices based on rather vague ideas about the value of the product for the customer, the price competitors set for an equivalent product, and the alternative products the customer could have purchased at the same price.

There are, nevertheless, a number of other ways to generate revenue and to “capture” a share of the value created for the customers. One way is through additional sales in what is often called the aftermarket. This means that the company sells additional equipment, spare parts, maintenance, or other product-specific services to customers who have bought the company’s products and thus become somewhat dependent on them (from the supplier perspective this is often called the company’s “installed base”).

Typical examples are car retailers that often provide original spare parts and accessories, or car workshops dedicated to specific automotive brands.

A common version of this revenue model is sometimes called “Razors and Blades”.

The name comes from the now famous strategy used by Gillette for its brand of men’s safety razors. The razors were cheap, but the replacement blades were relatively costly. In 62

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a nutshell, this strategy tempts consumers to buy an inexpensive product that requires more expensive consumables. This revenue model is commonly used with both consumer and producer goods. For example, compare the price of a desk printer with the price of its ink cartridges, which of course are specifically designed for each type of printer.

Another version of this revenue model, which is often associated with luxury products, is to sell accessory products and add-on services under the same brand even though these products/services have no direct connection to the original products. For example, the luxury automobile manufacturers, Porsche and Ferrari, also sell clothes collections under their brands. The idea is to strengthen customer loyalty through brand identification as well as generating significant additional revenues.

A third type of revenue model is to rent or lease out products instead of selling them.

Although the company retains ownership of the product, the customer pays for the right to use the product. This model is often combined with various kinds of maintenance and warranty contracts that guarantee a certain level of product performance.

A fourth revenue model is licensing. In this model, the customer purchases the right to manufacture or sell a product, to use a technology, or to use a company-owned intangible asset (e.g., patents and trademarks). A prime example of this is the Danish brewery Carlsberg, which, among other things, does business by licensing the production of its Sol beer to other breweries all around the world. Other examples are famous fashion companies, such as Armani, Hugo Boss, and Prada, which gain revenue by licensing their brands to cosmetics, perfumes, and other beauty products manufactured and sold by L’Oréal, and others.

There are several other types of revenue models. In one model, the supplier company receives revenue from the customer’s product use. One example is “pay-per-view” in which customers pay to watch events via private broadcasting. Another model is freemium (“free” + “premium”) in which customers pay for digital products such as software, games, and other Internet services. Adobe and Spotify, among others, use this revenue model in which the customer receives the basic product free of charge, but typically must pay a fee to get access to some of the product’s key features, to improved functionality, or to related Internet services.

Furthermore, in affiliated marketing, used by for example Google and Facebook, the products (goods or services) are offered free of charge to users while the company receives revenue through the sale of advertisements targeted at particular users.

Publishers of free newspapers, commercial radio/television companies, and telecom­ munication companies (in the latter case, the so-called “free telephony”) also use this revenue model.

While this list of revenue models is not all-inclusive, it does reveal the breadth, ingenuity, and diversity of such models. The point is that these models are very often as strategically important as the company’s product design. Development of new

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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 Institute of Technology in Stockholm. They currently work in a number of areas: academic research and education, technology management, and leadership development.

Modern Industrial Management Today’s engineers must be able to understand the economic implications of different technological decisions, as well as the technological implications of managerial and financial decisions. This is precisely what the academic field of Industrial Management is about: understanding the interdependencies between technology and management, in order to efficiently create value.

Modern Industrial Management provides an introduction to the basic concepts and methods that will enable engineers to explain and support their decisions in financial terms. The book focuses on the business operations of modern industrial companies and covers the entire field of management, from costing 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, and develop industrial operations.

Modern Industrial Management provides fundamental knowledge about the value creation process of technology-based companies, covering marketing, production, and product development, as well as their financial systems, in terms of costing, accounting, and financing. It also discusses human resource management, business strategies, organizing, project management, and questions concerning corporate social responsibility and sustainable development.

The book is aimed at engineering students at university level and practicing engineers who require basic knowledge in Industrial Management.

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