Chapter for Supply

JonesGeorge: Contemporary Management, Fifth Edition

III. Decision Making, Planning, and Strategy

9. ValueChain Management: Functional Strategies for Competitive Advantage

The McGrawHill Companies, 2008

9CHAPTERValue-Chain Management: FunctionalStrategies for Competitive Advantage

Learning Objectives

After studying this chapter, you should be able to:

Explain the role of functionalstrategy and value-chainmanagement in achievingsuperior quality, efciency,innovation, and responsivenessto customers.

Describe what customers want,and explain why it is soimportant for managers to beresponsive to their needs.

Explain why achieving superiorquality is so important, andunderstand the challengesfacing managers and

organizations that seek toimplement total qualitymanagement.

Explain why achieving superiorefciency is so important, andunderstand the different kinds oftechniques that need to beemployed to increase efciency.

Differentiate between two formsof innovation, and explain whyinnovation and productdevelopment is a crucialcomponent of the search forcompetitive advantage.





A Managers ChallengeToyotas Approach to Building Competitive Advantage

In the 2000s, however, under the leader-ship of Toyotas chairman, Jujio Cho, andpresident, Katsuaki Watanabe, the company

sought new strategies to further improve ef-ciency and quality and strengthen its competi-tive advantage over rivals such as Volkswagen,Ford, and DaimlerChrysler.1 It began to imple-ment a series of new strategies, each directedat improving the way its various functionsoperate. One new manufacturing strategy tostrengthen its kaizen program is pokayoke, ormistake-proong. This initiative concentrates

How can managers increase operatingperformance?

Toyota has long been known as a companythat constantly strives to improve its car designand production systems to enhance efciency,quality, innovation, and customer responsive-ness. It pioneered the system of lean produc-tion, a functional strategy that changes theway cars are assembled and results in dra-matic improvements in vehicle reliability. AndToyota has always pursued total quality man-agement, or kaizen, a functional strategy thatmakes production-line employees responsiblefor nding ways to continuously make incre-mental improvements to work procedures thatdrive down costs and drive up quality. Overtime, the thousands of suggestions employ-ees make, individually and in quality groupsor circles, result in innovations to the carassembly process that lead to major improve-ments in the nal product. Employees receivecash bonuses and rewards for their contribu-tions, which enable Toyota to continuouslyincrease car quality and reduce manufacturingcosts.

Assembly line workers for Japanese auto giant Toyota put tiresonto Toyotas vehicle Wish at the companys Tsutsumi plant inToyota, central Japan.





on the stages of the assembly process thathave led to most previous quality problems;employees are required to double- and triple-check a particular stage to discover defectiveparts or to x improper assembly operationsthat would have led to subsequent customercomplaints. Another strategy is CCC21,which involves working with the companyssuppliers to nd ways to reduce the costs ofToyotas car components by 30%a goalthat will result in billions of dollars in savings.Toyota also implemented a new manufactur-ing process called GBL that uses a sophisti-cated new assembly process to hold a carbody rmly in place during production. Thisallows welding and assembly operations to beperformed more accurately, resulting in better-quality cars. GBL has also enabled Toyota tobuild factories that can assemble several dif-ferent car models on the same production linewith no loss in efciency or quality. This is amajor competitive advantage. The companysglobal network of plants can now quicklyswitch among the kinds of cars they are mak-ing depending upon buyers demands for vari-ous models at different points in time.

Other new functional strategies focus onrevamping Toyotas development and designprocess to keep up with changing customerneeds and demographics; for example, theage of the average Toyota car buyer hasbeen steadily increasing, which is a majorcompetitive problem. Despite Toyotas climb-ing global sales (which exceeded $160 bil-lion in 2006), the company has often beencriticized for failing to understand the needsof different kinds of customers. Analystsblamed the problem on centralized decisionmaking at the company and a culture thathad long been dominated by Toyotas cau-tious and frugal Japanese designers. Ratherthan designing innovative, exible vehiclesthat customers were increasingly demand-ing, Toyota continued to focus on cuttingcosts and increasing quality. When the com-panys U.S. designers, for example, argued

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with designers in Tokyo that U.S. customerswanted an eight-cylinder pickup truck, andthat Toyota needed to make such a vehicleto compete with GM and Ford, they wereignored. Headquarters also turned a deafear to the call to make innovative vehiclesthat would appeal to younger customers.Slow sales of its small pickups and compactcars soon showed that the company was notbeing responsive to customers and thatdesign changes were necessary.

To speed innovation and the new productdevelopment process, Cho championed twonew functional strategies that radically alterthe way vehicles are designed: PDCA andObeya. Obeya is based on frequent brain-storming sessions between product engi-neers, designers, production managers, andmarketers and is designed to speed new-model cars to the market. PDCA, or plan-do-check-action, is a strategy designed toempower the companys designers outsideJapan to intervene in the product develop-ment process and champion vehicle designsthat meet the needs of local customers. Theresults of promoting a exible, decentralizedcar design process were the speedy intro-duction of the rugged eight-cylinder Tundrapickup truck and the angular ScionxB com-pact in the United States, as well as theYaris, Toyotas best-selling European car.The Yaris was designed in Europe, and itssuccess there led to its subsequent introduc-tion in Japan, where it also sold well.

Toyotas mastery of value-chain manage-ment through implementing groundbreakingfunctional strategies has made it by far themost protable of the major carmakers. Itsfunctional strategies strengthen its ability topursue both low cost and differentiationbusiness-level strategies and have given it awidening competitive advantage over itsrivals. Toyota replaced Ford as the worldssecond-largest carmaker in 2004, and itseems likely it will replace GM as the worldsbiggest carmaker before too long.





Value-Chain Management: Functional Strategies for Competitive Advantage 343

Figure 9.1Four Ways to Create a Competitive Advantage

Improving Quality Improving Efficiency

Improving Innovation

Improving Responsivenessto Customers

Low costsDifferentiation

Result in a CompetitiveAdvantage from

Toyota has developed many kinds of strategies to encour-age managers in value-creating functions like manufactur-

ing, materials management, and product development to improve the wayfunctional activities are performed to promote the organizations competitiveadvantage. In this chapter we focus on the functional-level strategies managerscan use to achieve superior efciency, quality, innovation, and responsivenessto customers and so build competitive advantage. We also examine the natureof an organizations value chain and discuss how the combined or cooperativeefforts of managers across the value chain are required if an organization is toachieve its mission and goal of maximizing the amount of value its productsprovide customers. By the end of this chapter, you will understand the vitalrole value-chain management plays in building competitive advantage andcreating a high-performing organization.

As we noted in Chapter 8, there are two basic business-level strategies managers can use to add value to an orga-nizations products and achieve a competitive advantageover industry rivals. First, managers can pursue a low-coststrategy and lower the costs of creating value in order toattract customers by keeping product prices as low as orlower than competitors prices. Second, managers canpursue a differentiation strategy and add value to a productby nding ways to make it superior in some way to theproducts of other companies. If they are successful, andcustomers see greater value in the product, then like

Toyota they are able to charge a premium or higher price for the product. Thefour specic ways in which managers can lower costs and/or increase differen-tiation to obtain a competitive advantage were mentioned in Chapter 1 andare reviewed below; how organizations seek to achieve them is the topic ofthis chapter. (See Figure 9.1.)

Overview

FunctionalStrategies, theValue Chain,

and CompetitiveAdvantage





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1. Achieve superior efciency. Efciency is a measure of the amount of inputsrequired to produce a given amount of outputs. The fewer the inputs required toproduce a given output, the higher is efciency and the lower the cost of out-puts. For example, in 1990 it took the average Japanese auto company 16.8employee-hours to build a car, while the average American car company took25.1 employee-hours. Japanese companies at that time were more efcient andhad lower costs than their American rivals.2 By 2004, U.S. companies hadadopted more efcient manufacturing methods and narrowed the cost gap sig-nicantly; however, as the opening case suggests, Toyota continually works toreduce costs to maintain its position as the most efcient carmaker in the world.2. Achieve superior quality. Quality means producing goods and services thathave attributessuch as design, styling, performance, and reliabilitythat cus-tomers perceive as being superior to those found in competing products.3 Provid-ing high-quality products creates a brand-name reputation for an organizationsproducts, and this enhanced reputation allows it to charge higher prices. In thecar industry, for example, besides Toyotas efciency-based cost advantage, thehigher quality of Toyotas products also enables the company to outperform itsrivals because customers are willing to pay a premium price for its cars.3. Achieve superior innovation, speed, and exibility. Anything new or better aboutthe way an organization operates or the goods and services it produces is theresult of innovation. Successful innovation gives an organization somethingunique or different about its products that rivals lackmore sophisticated prod-ucts, production processes, or strategies and structures that strengthen its com-petitive advantage. Innovation adds value to products, and allows the organizationto further differentiate itself from rivals and attract customers willing to pay apremium price for unique products. Toyota is widely credited with pioneeringinnovations in the way cars are built that have made them more reliable, quiet,and comfortable and allowed it to charge a premium price for them. For exam-ple, a Toyota Corolla or Camry is always priced a thousand or more dollarsabove its equivalent U.S. competitor such as the Ford Focus or Five Hundred orthe Chevy Cobalt, Grand Prix, or Pontiac G6, and many customers are willingto pay the higher price.4. Attain superior responsiveness to customers. An organization that is responsiveto customers tries to satisfy their needs and give them exactly what they want. Anorganization that treats customers better than its rivals do also provides a valu-able service some customers may be willing to pay a higher price for. Managerscan increase responsiveness by providing excellent after-sales service and sup-port and by working with customers to provide improved products or servicesin the future. Today, Toyota, like other carmakers, is always on the lookout forchanging customer needs, and as A Managers Challenge described, managersacross its functions apply innovative strategies to design new cars to better meetthose needs.

One way to measure how much managers are concerned with customerresponsiveness is to look at the range of products a company makes and howfast it changes and improves them to better meet their needs. Figure 9.2 showsthe range of vehicles that Toyota currently makes and the kinds of customers itis targeting according to the price they are willing or able to pay. As the gureillustrates, there are few major gaps in Toyotas product range; the companymakes a variety of vehicles that are designed to be responsive to the needs ofthe largest possible range of customers.






Figure 9.2Toyotas Product Lineup

1120K

Price

RAV4Scion xB

FJ Cruiser

Echo, Matrix,Corolla, Yaris

Scion xA

Prius,Camry, Avalon

GS 350,IS 350

GS 450

Sienna Avalon

CelicaGT

MR2,Spyder

CamrySolaraES 350

LS 460 SC 430

Tacoma

Tundra

TundraDouble

Cab

4-Runner,Highlander

Sequoia,RX350

Land Cruiser,GX, LX

No vehicle in category2130K

3145K

4675K

SportsUtility

Vehicles

Passenger/SportsSedans

PassengerVans

PersonalLuxury

Vehicles

SportsCars

PickupTrucks

Functional Strategies and Value-ChainManagementFunctional-level strategy is a plan of action to improve the ability of each ofan organizations functions or departments (such as manufacturing or market-ing) to perform its task-specic activities in ways that add value to an organiza-tions goods and services. A companys value chain is the coordinated series orsequence of functional activities necessary to transform inputs such as newproduct concepts, raw materials, component parts, or professional skills into thenished goods or services customers value and want to buy (see Figure 9.3).Each functional activity along the chain adds value to the product when it lowerscosts or gives the product differentiated qualities that increase the price a com-pany can charge for it.

Value-chain management is the development of a set of functional-levelstrategies that support a companys business-level strategy and strengthen itscompetitive advantage. Functional managers develop the strategies that result inincreased efciency, quality, innovation, and/or responsiveness to customersand thus strengthen an organizations competitive advantage. So the better thefit between functional- and business-level strategies, the greater will be theorganizations competitive advantage, and the better able the organization isto achieve its mission and goal of maximizing the amount of value it givescustomerssomething Toyota excels at. Each function along the value chainhas an important role to play in the value-creation process.

As Figure 9.3 suggests, the starting point of the value chain is often thesearch for new and improved products that will better appeal to customers, sothe activities of the product development and marketing functions become

functional-levelstrategy A plan ofaction to improve theability of each of anorganizations functions toperform its task-specicactivities in ways that addvalue to an organizationsgoods and services.

value chain Thecoordinated series orsequence of functionalactivities necessary totransform inputs such asnew product concepts, rawmaterials, componentparts, or professional skillsinto the nished goods orservices customers valueand want to buy.

value-chainmanagement Thedevelopment of a set offunctional-level strategiesthat support a companysbusiness-level strategyand strengthen itscompetitive advantage.





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important. Product development is the engineering and scientic research activi-ties involved in innovating new or improved products that add value to a prod-uct. For example, Toyotas engineers developed a hybrid gas-saving technologythat has proved popular among car buyers. Once a new product has beendeveloped, then the marketing functions task is to persuade customers that theproduct meets their needs and convince them to buy it. Marketing can help cre-ate value through brand positioning and advertising that increases customerperceptions about the utility of a companys product. For example, in the 1980sthe French company Perrier persuaded U.S. customers that carbonated bottledwater was worth $1.50 per liter bottle rather than the 25 cents it cost to purchasea gallon of spring water. Perriers marketing function had developed strategiesthat made customers want to buy the product, and major U.S. companies suchas Coca-Cola and PepsiCo rushed to bring out their own bottled-water labels tocapitalize on customers growing appetite for bottled water.

Even the best-designed product can fail if the marketing function hasntdevised a careful plan to persuade people to buy it and try it outor to makesure customers really want it. For this reason, marketing often conducts con-sumer research to discover unmet customer product needs and to nd betterways to tailor existing products to satisfy customer needs. Marketing then pre-sents its suggestions to product development, which performs its own researchto discover how best to design and make the new or improved products.

At the next stage of the value chain, the materials management function controlsthe movement of physical materials from the procurement of inputs throughproduction and to distribution and delivery to the customer. The efciency withwhich this is carried out can signicantly lower costs and create more value.Wal-Mart, the U.S. retailing giant, has the most efcient materials managementfunction in the retail industry. By tightly controlling the ow of goods from itssuppliers through its stores and into the hands of customers, Wal-Mart has elim-inated the need to hold large inventories of goods. Lower inventories meanlower costs, and hence greater value creation. Similarly, Toyota insists that itssuppliers establish car component plants close to its factories so that it does nothave to bear the cost of holding a large inventory of car componentsa signi-cant cost savings.

Figure 9.3Functional Activities and the Value Chain

ProductDevelopmentFunction

INPUTSNew product ideasMarketing researchComponent parts

Peoples abilities & knowledgeMachines

GoodsServices

ComputersFunctional skills

CHANGED INTO OUTPUTS

MarketingFunction

MaterialsManagementFunction

Feedback Loop

ProductionFunction

SalesFunction

CustomerServiceFunction






The production function is responsible for the creation, assembly or provisionof a good or service, for transforming inputs into outputs. For physical products,when we talk about production, we generally mean manufacturing and assem-bly. For services such as banking or retailing, production takes place when theservice is actually provided or delivered to the customer (for example, when abank originates a loan for a customer, it is engaged in production of the loan).By performing its activities efciently, the production function helps to lowercosts. For example, the efcient production operations of Honda and Toyotahave made them more protable than competitors such as Renault, Volkswa-gen, and Ford. The production function can also perform its activities in a waythat is consistent with high product quality, which leads to differentiation (andhigher value) and to lower costs.

At the next stage in the value chain, the sales function plays a crucial role inlocating customers and then informing and persuading them to buy companysproducts. Personal selling, that is, direct face-to-face communication by sales-people with existing and potential customers to promote a companys productsis a crucial value-chain activity. Which products retailers choose to stock, forexample, or which drugs doctors choose to prescribe often depend upon thesalespersons ability to inform and persuade customers that his or her companysproduct is superior and thus a the best choice.

Finally, the role of the customer service function is to provide after-sales service andsupport. This function can create a perception of superior value in the minds ofcustomers by solving customer problems and supporting customers after they havepurchased the product. For example, FedEx can get its customers parcels to anypoint in the world within 24 hours, thereby lowering the cost of its own value-creation activities. Finally, customer service controls the electronic systems fortracking sales and inventory, pricing products, selling products, dealing with cus-tomer inquires, and so on, all of which can greatly increase responsiveness to cus-tomers. Indeed, an important activity of sales and customer service is to informproduct development and marketing about why a product is meeting or not meet-ing customers needs so that the product can be redesigned or improved. Hence,the feedback loop links the end of the value chain to its beginning (see Figure 9.3).

In the rest of this chapter we examine the functional strategies used to managethe value chain to improve quality, efciency, innovation, and responsiveness tocustomers. Notice, however, that achieving superior quality, efciency, and inno-vation is part of attaining superior responsiveness to customers. Customers wantvalue for their money, and managers who develop functional strategies that resultin a value chain capable of creating innovative, high-quality, low-cost productsbest deliver this value to customers. For this reason, we begin by discussing howfunctional managers can increase responsiveness to customers.

All organizations produce outputsgoods or servicesthatare consumed by customers, who, in buying these prod-ucts, provide the monetary resources most organizationsneed to survive. Since customers are vital to organiza-tional survival, managers must correctly identify whotheir customers are and pursue strategies that result in

ImprovingResponsiveness

to Customers





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products that best meet their needs. This is why the marketing function playssuch an important part in the value chain, and good value-chain managementrequires that marketing managers focus on dening their companys business interms of the customer needs it is satisfying and not by the type of products itmakesor the result can be disaster.4 For example, Kodaks managers said nothanks when the company was offered the rights to instant photography,which was later marketed by Polaroid. Why did they make this mistake?Because the managers adopted a product-oriented approach to their businesswhich didnt put the needs of customers rst. Kodaks managers believed theirjob was to sell high-quality, glossy photographs to people; why would they wantto become involved in instant photography, which results in inferior-qualityphotographs? In reality, Kodak was not satisfying peoples needs for high-qualityphotographs; it was satisfying the need customers had to capture and record theimages of their livestheir birthday parties, weddings, graduations, and so on. Andpeople wanted those images quickly so thatthey could share them right away with otherpeoplewhich is why today digital photog-raphy has taken off. In the 2000s, Kodak isin serious trouble because its lm-basedphotographic business has declined sharply,and it is losing billions as it tries to positionitself in the digital market to give customerswhat they want.

What Do CustomersWant?Given that satisfying customer demands iscentral to the survival of an organization, animportant question is, What do customerswant? Although specifying exactly what cus-tomers want is not possible because theirneeds vary from product to product, it is pos-sible to identify some general product attrib-utes or qualities that most customers desire:

1. A lower price to a higher price.2. High-quality products to low-qualityproducts.3. Quick service and good after-sales service to slow service and poor after-sales support.4. Products with many useful or valuable features to products with few features.5. Products that are, as far as possible, customized or tailored to their uniqueneeds.

Managers know that the more desired product attributes a companys valuechain builds into its products, the higher the price that must be charged tocover the costs of developing and making the product. So what do managers ofa customer-responsive organization try to do? They try to develop functionalstrategies that allow the organizations value chain to deliver to customers either

Kodak has fallen behind in thedigital camera market by focusingmore on products than oncustomers.






more desired product attributes for the same price or the same product attributesfor a lower price.5 For example, by increasing the efciency of its manufacturingprocess, and by nding new ways to design cars that are less expensive, Toyotahas been able to increase the number of luxury features in its cars at very littleor no extra cost, compared to its competitors. Similarly, Wal-Marts price roll-backs or reductions are possible because it constantly searches for lower-costsuppliers or more efcient ways to manage its product inventory and deliver itto stores. It told its suppliers, for example, that if they did not put new radio fre-quency tags (that allow inventory to be monitored electronically as it movesaround) on their products by 2006, it would cease to buy from them.6 In gen-eral, new IT has allowed many organizations to offer new models of productswith more attributes at a price similar to or even lower than that of earlier mod-els, and so in the last decade customers have been able to choose from a widervariety of higher-quality products and receive quicker customer service.

Managing the Value Chain to IncreaseResponsiveness to CustomersBecause satisfying customers is so important, managers try to design and improvethe way their value chainsoperate so that they cansupply products that havethe desired attributesqual-ity, cost, and features. Forexample, the need to res-pond to customer demandsfor competitively priced,quality cars drove U.S. car-makers like Ford and GMto imitate Japanese compa-nies and copy the way Toy-ota and Honda performtheir value-chain activities.Today, the imperative of sat-isfying customer needs sha-pes the activities of GMsmaterials management andmanufacturing functions. Asan example of the linkbetween responsiveness tocustomers and an organiza-tions value chain, consider how Southwest Airlines, the most protable U.S. air-line, operates.7

The major reason for Southwests success is that it has striven to pursue func-tional strategies that improve the way its value chain operates to give customerswhat they want. Southwest commands high customer loyalty precisely becauseit can deliver products, such as ights from Houston to Dallas, which have allthe desired attributes: reliability, convenience, and low price. In each one of itsfunctions, Southwests strategies revolve around nding ways to lower costs. For

A Southwest ticket agent assists a customer.Southwests operating system is geared towardsatisfying customer demands for low-priced, reliable,and convenient air travel, making it one of the mostconsistently successful airlines in recent years. To helpkeep ights on schedule, Southwests workforce hasbeen cross-trained to perform multiple tasks. Forexample, the person who checks tickets might also helpwith baggage loading.





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example, Southwest offers a no-frills approach to in-ight customer service; nomeals are served onboard, and there are no rst-class seats. Southwest doesnot subscribe to the big reservation computers used by travel agents becausethe booking fees are too costly. Also, the airline ies only one aircraft, the fuel-efcient Boeing 737, which keeps training and maintenance costs down. All thistranslates into low prices for customers.

Southwests reliability derives from the fact that it has the quickest aircraftturnaround time in the industry. A Southwest ground crew needs only 15 min-utes to turn around an incoming aircraft and prepare it for departure. Thisspeedy operation helps to keep ights on time. Southwest has such a quick turn-around because it has a exible workforce that has been cross-trained to per-form multiple tasks. Thus, the person who checks tickets might also help withbaggage loading if time is short.

Southwests convenience comes from its scheduling multiple ights every daybetween its popular locations, such as Dallas and Houston, and its use of airportsthat are close to downtown areas (Hobby at Houston and Love Field at Dallas)instead of using more distant, major airports.8 In sum, Southwests excellent value-chain management has given it a competitive advantage in the airline industry.

Although managers must seek to improve their responsiveness to customersby improving the way the value chain operates, they should not offer a level ofresponsiveness to customers that results in costs becoming too highsomethingthat threatens an organizations future performance and survival. For example, acompany that customizes every product to the unique demands of individualcustomers is likely to nd that its costs will get out of control. This happened toToyota in the 1990s when its managers push to offer customers many differentchoices of specications for a particular model of car increased costs faster thanit generated additional sales. At one point, Toyota factories were producing liter-ally thousands of variations of Toyotas basic models, such as the Camry andCorolla! Toyotas managers decided that the costs of extreme customer respon-siveness exceeded the benets, and they reduced the number of models andspecications of its cars.9 This is why today most models of Toyota vehicleslisted in Figure 9.2 are assembled to three main levels of specicationsbasic,sports, or luxury packages. Customers have less choice, but they also pay alower price and still get more of the attributes they desire.

Customer Relationship Management One functional strategy managers can use to get close to customers and understandtheir needs is customer relationship management (CRM). CRM is a techniquethat uses IT to develop an ongoing relationship with customers to maximize thevalue an organization can deliver to them over time. In the 2000s, most large com-panies have installed sophisticated CRM IT to track customers changing demandsfor a companys products; it has become a vital tool used to maximize responsive-ness to customers. CRM IT monitors, controls, and links each of the functionalactivities involved in marketing, selling, and delivering products to customers, suchas monitoring the delivery of products through the distribution channel, monitoringsalespeoples selling activities, setting product pricing, and coordinating after-salesservice. CRM systems have three interconnected components, sales and selling,after-sales service and support, and marketing.

customer relationshipmanagement (CRM) A technique that uses IT todevelop an ongoingrelationship withcustomers to maximize thevalue an organization candeliver to them over time.






Suppose that a sales manager has access only to sales data that show the totalsales revenue each salesperson had generated in the last 30 days. This informa-tion does not break down how much revenue came from sales to existing cus-tomers versus sales to new customers. What important knowledge is being lost?First, if most revenues are earned from sales to existing customers, this suggeststhat the money being spent by a company to advertise and promote its productsis not attracting new customers and so is being wasted. Second, importantdimensions involved in sales are pricing, nancing, and order processing. Inmany companies, to close a deal, a salesperson has to send the paperwork to acentral sales ofce that handles matters such as approving the customer for spe-cial nancing and determining specic shipping and delivery dates. In somecompanies, different departments handle these activities, and it can take a longtime to get a response from them; this keeps customers waitingsomething thatoften leads to lost sales. Until CRM systems were introduced, these kinds ofproblems were widespread and resulted in missed sales and higher operatingcosts. Today the sales and selling CRM software contains best sales practices thatanalyze this information and then recommend ways to improve the way thesales process operates. One company that has improved its sales, and after-sales,practices by implementing CRM is discussed in the following InformationTechnology Byte.

InformationTechnology

Byte

How CRM Helped EmpireHealthChoiceEmpire HealthChoice Inc., the largest health insurance provider in NewYork, sells its policies through 1,800 sales agents. For years, these agents wereresponsible for collecting all of the customer-specic information needed todetermine the price of each policy. Once they had collected the necessaryinformation, the agents called Empire to get their price quotes. After waitingdays to get these quotes, the agents relayed them back to customers, whooften then modied their requests to reduce the cost of their policies. Whenthis occurred, the agent had to telephone Empire again to get a revised pricequote. Because this frequently happened several times with each transaction,it often took more than 20 days to close a sale and another 10 days for cus-tomers to get their insurance cards.10

Recognizing these delays were resulting in lost sales, Empire decided toexamine how a CRM system could help improve the sales process. Itsmanagers chose a Web-based system so that agents themselves could calcu-late the insurance quotes online. Once an agent has entered a customersdata, a quote is generated in just a few seconds. The agent can continuallymodify a policy while sitting face-to-face with the customer until the policyand price are agreed upon. As a result, the sales process can now be com-pleted in a few hours, and customers receive their insurance cards in 2 to 3days rather than 10.11





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As noted earlier, high-quality products possess attributessuch as superior design, features, reliability, and after-sales support; these products are designed to better meetcustomer requirements.12 Quality is a concept that can be

applied to the products of both manufacturing and service organizationsgoodssuch as a Toyota car or services such as Southwest Airlines ight service or cus-tomer service in a Citibank branch. Why do managers seek to control andimprove the quality of their organizations products?13 There are two reasons(see Figure 9.4).

First, customers usually prefer a higher-quality product to a lower-qualityproduct. So an organization able to provide, for the same price, a product ofhigher quality than a competitors product is serving its customers betterit isbeing more responsive to its customers. Often, providing high-quality productscreates a brand-name reputation for an organizations products. In turn, thisenhanced reputation may allow the organization to charge more for its productsthan its competitors are able to charge, and thus it makes even greater prots. In2005 Lexus was ranked number one, as it has been for the last decade, on the J. D. Power list of the 10 most reliable carmakers, and Toyota was close behind.14

When a company implements after-sales service and support CRM software,salespeople are required to input detailed information about their follow-up vis-its to customers. Because the system is now tracking and documenting everycustomers case history, salespeople have instant access to a record of every-thing that occurred during previous phone calls or visits. They are now in amuch better position to be responsive to customers needs and build customerloyalty, so a companys after-sales service improves. Telephone providers likeSprint and MCI, for example, require that telephone sales reps collect informa-tion about all customers inquiries, complaints, and requests, and this isrecorded electronically in customer logs. The CRM module can analyze theinformation in these logs to evaluate whether the customer service reps aremeeting or exceeding the companys required service standards.

The CRM system also identies the top 10 reasons why customer complaintsare arising. Sales managers can then work to eliminate the sources of theseproblems and improve after-sales support procedures. The CRM system alsoidenties the top 10 best service and support practices, which can then be taughtto all sales reps.

Finally, as a CRM system processes information about changing customerneeds, this improves the way marketing operates in many ways. Marketingmanagers, for example, now have access to detailed customer proles, includingdata on purchases and the reasons why individuals were or were not attracted toa companys products. Armed with this knowledge, marketing can better iden-tify customers and the specic product attributes they desire. It may becomeclear, for example, that a customer group that marketing had targeted has a spe-cic need that is not being satised by a productsuch as a need for a cell phonecontaining a 5-megapixel digital camera and an MP3 player. With real-timeinformation, marketing can work with product development to redesign theproduct to better meet customer needs. In sum, a CRM system is a comprehen-sive method of gathering crucial information about the way customers respondto a companys products. It is a powerful functional strategy used to better aligna companys products with customer needs.

ImprovingQuality






Figure 9.4The Impact of Increased Quality on Organizational Performance

Increasedreliability

Higherprices

Higherprofits

Increasedquality

Increasedproductivity

Lowercosts

The high quality of Toyota/Lexus vehicles enables the company to chargehigher prices for its cars than the prices charged by rival carmakers.

The second reason for trying to boost product quality is that higher productquality can increase efciency and thereby lower operating costs and boostprots. Achieving high product quality lowers operating costs because of theeffect of quality on employee productivity: Higher product quality means lessemployee time is wasted in making defective products that must be discardedor in providing substandard services, and thus less time has to be spent xingmistakes. This translates into higher employee productivity, which meanslower costs.

Total Quality ManagementAt the forefront of the drive to improve product quality is a functional strategyknown as total quality management.15 Total quality management (TQM)focuses on improving the quality of an organizations products and stresses thatall of an organizations value-chain activities should be directed toward thisgoal. TQM requires the cooperation of managers in every function of an organi-zation, and across functions, if it is to succeed.16 The following 10 steps are nec-essary for managers to implement a successful TQM program:

1. Build organizational commitment to quality. TQM will do little to improve theperformance of an organization unless all employees embrace it, and this oftenrequires a change in an organizations culture.17 At Citibank, discussed in detailin the next Management Insight, the process of changing culture began at thetop. First, a group of top managers, including the CEO, received training inTQM from consultants from Motorola. Each member of the top-managementgroup was then given the responsibility of training a group at the next level inthe hierarchy, and so on down through the organization until all 100,000employees had received basic TQM training.2. Focus on the customer. TQM practitioners see a focus on the customer as thestarting point.18 According to TQM philosophy, the customer, not managers inquality control or engineering, denes what quality is. The challenge is fourfold:(1) to identify what customers want from the good or service that the companyprovides; (2) to identify what the company actually provides to customers; (3) toidentify the gap that exists between what customers want and what they actuallyget (the quality gap); and (4) to formulate a plan for closing the quality gap. Theefforts of Citibank managers to increase responsiveness to customers illustratethis aspect of TQM well.

total qualitymanagement (TQM)A management techniquethat focuses on improvingthe quality of anorganizations productsand services.





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ManagementInsight

Citibank Uses TQM to IncreaseCustomer LoyaltyCitibank is one of the leading global nancial institutions and has established agoal of becoming the premier institution in the 21st century. To achieve thislofty goal, Citibank has started to use TQM to increase its responsiveness tocustomers, recognizing that, ultimately, its customer base and customer loyaltydetermine the banks future success.

As the rst step in its TQM effort, Citibank identied the factors that dis-satisfy its customers. When analyzing the complaints, it found that most con-cerned the time it took to complete a customers request, such as respondingto an account problem or getting a loan. So Citibanks managers began toexamine how they handled each kind of customer request. For each distinctrequest, they formed a cross-functional team that broke down the requestinto the steps required, between people and departments, to complete theresponse. In analyzing the steps, teams found that many of them were oftenunnecessary and couldbe replaced by using theright information sys-tems. They also foundthat very often delaysoccurred because em-ployees simply did notknow how to handle arequest. They were notbeing given the rightkind of training, andwhen they couldnt han-dle a request, they sim-ply put it aside until asupervisor could dealwith it.

Citibanks second step to increase its responsiveness was to implementan organizationwide TQM program. Managers and supervisors werecharged with reducing the complexity of the work process and nding themost effective way to process each particular request, such as a request fora loan. Managers were also charged with training employees to answereach specic request. The results were remarkable. For example, in theloan department the TQM program reduced the number of handoffs nec-essary to process a request by 75%. The departments average responsetime dropped from several hours to 30 minutes. By 2000, more than92,000 employees worldwide had been trained in the new TQM processes,and Citibank could easily measure TQMs effectiveness by the increasedspeed with which it was handling an increased volume of customerrequests.

By spending time training employees on how to handlespecic requests, Citibank managers signicantlyimproved their customer service record.






3. Find ways to measure quality. Another crucial element of TQM is the devel-opment of a measuring system that managers can use to evaluate quality. Devis-ing appropriate measures is relatively easy in manufacturing companies, wherequality can be measured by criteria such as defects per million parts. It is moredifcult in service companies, where outputs are less tangible. However, with alittle creativity, suitable quality measures can be devised as they were by man-agers at Citibank. Similarly, at L.L.Bean, the mail-order retailer, managers usethe percentage of orders that are correctly lled as one of their quality measures.4. Set goals and create incentives. Once a measure has been devised, managersnext step is to set a challenging quality goal and to create incentives for reachingthat goal. At Citibank, the CEO set an initial goal of reducing customer com-plaints by 50%. One way of creating incentives to attain a goal is to linkrewards, such as bonus pay and promotional opportunities, to the goal.5. Solicit input from employees. Employees are a major source of informationabout the causes of poor quality, so it is important that managers establish a sys-tem for soliciting employee suggestions about improvements that can be made.Quality circlesgroups of employees who meet regularly to discuss ways toincrease qualityare often created to achieve this goal. Companies also createself-managed teams to further quality improvement efforts. 6. Identify defects and trace them to their source. A major source of product defectsis the production system; a major source of service defects is poor customer ser-vice procedures. TQM preaches the need for managers to identify defects in thework process, trace those defects back to their source, nd out why theyoccurred, and make corrections so that they do not occur again. Today, ITmakes the measurement of quality much easier.7. Introduce just-in-time inventory systems. Inventory is the stock of raw materi-als, inputs, and component parts that an organization has on hand at a particulartime. When the materials management function designs a just-in-time (JIT)inventory system, parts or supplies arrive at the organization when they areneeded, not before. Also, under a JIT inventory system, defective parts enter anorganizations operating system immediately; they are not warehoused formonths before use. This means that defective inputs can be quickly spotted. JITis discussed more later in the chapter.8. Work closely with suppliers. A major cause of poor-quality nished goods ispoor-quality component parts. To decrease product defects, materials managersmust work closely with suppliers to improve the quality of the parts they supply.Managers at Xerox worked closely with suppliers to get them to adopt TQMprograms, and the result was a huge reduction in the defect rate of componentparts. Managers also need to work closely with suppliers to get them to adopt aJIT inventory system, also required for high quality.9. Design for ease of production. The more steps required to assemble a productor provide a service, the more opportunities there are for making a mistake. Itfollows that designing products that have fewer parts or nding ways to simplifyproviding a service should be linked to fewer defects or customer complaints.For example, Dell continually redesigns the way it assembles its computers toreduce the number of assembly steps required and it constantly searches fornew ways to reduce the number of components that have to be linked together.The consequence of these redesign efforts has been a fall in assembly costs andmarked improvement in product quality that has led to Dells becoming thenumber-one global PC maker.

quality circles Groupsof employees who meetregularly to discuss waysto increase quality.

inventory The stock ofraw materials, inputs, andcomponent parts that anorganization has on handat a particular time.

just-in-time (JIT)inventory system Asystem in which parts orsupplies arrive at anorganization when theyare needed, not before.





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The third goal of value-chain management is to increasethe efciency of the various functional activities. Thefewer the input resources required to produce a given vol-ume of output, the higher will be the efciency of the

operating system. So efciency is a useful measure of how well an organizationutilizes all of its resourcessuch as labor, capital, materials, or energyto pro-duce its outputs, or goods and services. Developing functional strategies toimprove efciency is an extremely important issue for managers becauseincreased efciency lowers production costs, which allows an organization tomake a greater prot or to attract more customers by lowering its price. Severalimportant functional strategies are discussed below.

Facilities Layout, FlexibleManufacturing, and EfciencyThe strategies managers use to lay out or design an organizations physical workfacilities also determine its efciency. First, the way in which machines andworkers are organized or grouped together into workstations affects the ef-ciency of the operating system. Second, a major determinant of efciency is thecost associated with setting up the equipment needed to make a particular prod-uct. Facilities layout is the strategy of designing the machine-worker interfaceto increase operating system efciency. Flexible manufacturing is a strategybased on the use of IT to reduce the costs associated with the product assembly

ImprovingEfciency

10. Break down barriers between functions. Successful implementation of TQMrequires substantial cooperation between the different value-chain functions.Materials managers have to cooperate with manufacturing managers to ndhigh-quality inputs that reduce manufacturing costs; marketing managershave to cooperate with manufacturing so that customer problems identied bymarketing can be acted on; information systems have to cooperate with all ofthe other functions of the company to devise suitable IT training programs;and so on.

In essence, to increase quality, all functional managers need to cooperate todevelop goals and spell out exactly how they will be achieved. Managersshould embrace the philosophy that mistakes, defects, and poor-quality mate-rials are not acceptable and should be eliminated. Functional managersshould spend more time working with employees and providing them withthe tools they need to do the job. Managers should create an environment inwhich employees will not be afraid to report problems or recommend im-provements. Output goals and targets need to include not only numbers orquotas but also some indicators of quality to promote the production ofdefect-free output. Functional managers also need to train employees in newskills to keep pace with changes in the workplace. Finally, achieving betterquality requires that managers develop organizational values and norms cen-tered on improving quality.

facilities layout Thestrategy of designing themachine-worker interfaceto increase operatingsystem efciency.

exiblemanufacturing The setof techniques that attemptto reduce the costsassociated with theproduct assembly processor the way services aredelivered to customers.






Figure 9.5Three Facilities Layouts

Finalproduct

a. Product layout

Finalproduct

b. Process layout

Finalproduct

c. Fixed-position layout

process or the way services are delivered to customers. For example, this mightbe the way computers are made on a production line or the way patients arerouted through a hospital.

FACILITIES LAYOUT The way in which machines, robots, and people aregrouped together affects how productive they can be. Figure 9.5 shows threebasic ways of arranging workstations: product layout, process layout, and xed-position layout.

In a product layout, machines are organized so that each operation needed tomanufacture a product or process a patient is performed at workstationsarranged in a xed sequence. In manufacturing, workers are stationary in thisarrangement, and a moving conveyor belt takes the product being worked on tothe next workstation so that it is progressively assembled. Mass production isthe familiar name for this layout; car assembly lines are probably the best-known example. It used to be that product layout was efcient only when prod-ucts were created in large quantities; however, the introduction of modularassembly lines controlled by computers is making it efcient to make productsin small batches.

In a process layout, workstations are not organized in a xed sequence. Rather,each workstation is relatively self-contained, and a product goes to whicheverworkstation is needed to perform the next operation to complete the product.Process layout is often suited to manufacturing settings that produce a variety ofcustom-made products, each tailored to the needs of a different kind of cus-tomer. For example, a custom furniture manufacturer might use a process layoutso that different teams of workers can produce different styles of chairs or tablesmade from different kinds of woods and nishes. Such a layout also describes





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how a patient might go through a hospital from emergency room, to X-rayroom, to operating theater, and so on. A process layout provides the exibilityneeded to change a product, whether it is a PC or a patient. Such exibility,however, often reduces efciency because it is expensive.

In a xed-position layout, the product stays in a xed position. Its componentparts are produced in remote workstations and brought to the production areafor nal assembly. Increasingly, self-managed teams are using xed-position lay-outs. Different teams assemble each component part and then send the parts tothe nal assembly team, which makes the nal product. A xed-position layoutis commonly used for products such as jet airlines, mainframe computers, andgas turbinesproducts that are complex and difcult to assemble or so large thatmoving them from one workstation to another would be difcult. The effects ofmoving from one facilities layout to another can be dramatic, as the followingManager as a Person suggests.

Manager asa Person

Paddy Hopkirk Improves FacilitiesLayoutPaddy Hopkirk established his car accessories business in Bedfordshire,England, shortly after he had shot to car-racing fame by winning the MonteCarlo Rally. Sales of Hopkirks accessories, such as bicycle racks and axlestands, were always brisk, but Hopkirk was the rst to admit that his operat-ing system left a lot to be desired, so he invited consultants to help reorganizethe system.

After analyzing his factorys operating system, the consultants realized thatthe source of the problem was the facilities layout Hopkirk had established.Over time, as sales grew, Hopkirk simply added new workstations to theoperating system as they were needed. The result was a process layout inwhich the product being assembled moved in the irregular sequences shownin the Before Change half of Figure 9.6. The consultants suggested that tosave time and effort, the workstations should be reorganized into the sequen-tial product layout shown in the After Change illustration.

Once this change was made, the results were dramatic. One morning thefactory was an untidy sprawl of workstations surrounded by piles of cratesholding seminished components. Two days later, when the 170-personworkforce came back to work, the machines had been brought together intotightly grouped workstations arranged in the xed sequence shown in theillustration. The piles of components had disappeared, and the newly clearedoor space was neatly marked with color-coded lines mapping out the newow of materials between workstations.

In the rst full day of production, efciency increased by as much as 30%.The space needed for some operations had been cut in half, and work inprogress had been cut considerably. Moreover, the improved layout allowedsome jobs to be combined, freeing operators for deployment elsewhere in thefactory. An amazed Hopkirk exclaimed, I was expecting a change but noth-ing as dramatic as this . . . it is fantastic.19






Figure 9.6Changing a Facilities Layout

After ChangeBefore Change

Storage bins

Machine 1

Frompressmachine

M/c 3 M/c 4

M/c 2

Welding

Paintshop

Storagebins

Frompressmachine

M/c 3M/c 4

M/c 2Machine 1

Welding

Paintshop

Axis-stand production line at Paddy Hopkirk Factory

Source: The Application of Kaizen to Facilities Layout, Financial Times of January 4, 1994, p. 12. Reprinted by permission of Financial TimesSyndication, London.

FLEXIBLE MANUFACTURING In a manufacturing company, a majorsource of costs is the costs associated with setting up the equipment needed tomake a particular product. One of these is the cost of production that is forgonebecause nothing is produced while the equipment is being set up. For example,components manufacturers often need as much as half a day to set up automatedproduction equipment when switching from production of one component part(such as a washer ring for the steering column of a car) to another (such as a washerring for the steering column of a truck). During this half-day, a manufacturing plantis not producing anything, but employees are paid for this nonproductive time.

It follows that if setup times for complex production equipment can bereduced, so can setup costs, and efciency will rise, that is, the time that plantand employees spend in actually producing something will increase. This sim-ple insight has been the driving force behind the development of exible manu-facturing techniques.

Flexible manufacturing aims to reduce the time required to set up productionequipment.20 By redesigning the manufacturing process so that production equip-ment geared for manufacturing one product can be quickly replaced with equip-ment geared to make another product, setup times and costs can be reduceddramatically. Another favorable outcome from exible manufacturing is that acompany is able to produce many more varieties of a product than before in the





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same amount of time. Thus exible manufacturingincreases a companys ability to be responsive to itscustomers.

Increasingly, organizations are experimentingwith new designs for operating systems that not onlyallow workers to be more productive but also makethe work process more exible, thus reducing setupcosts. Some Japanese companies are experimentingwith facilities layouts arranged as a spiral, as the letterY, and as the number 6, to see how these congura-tions affect setup costs and worker productivity. At acamcorder plant in Kohda, Japan, for example, Sonychanged from a xed-position layout in which 50workers sequentially built a camcorder to a exiblespiral process design in which 4 workers perform allthe operations necessary to produce the camcorder.This new layout allows the most efcient workers towork at the highest pace, and it reduces setup costsbecause workers can easily switch from one model toanother, increasing efciency by 10%.21

An interesting example of a company that built anew factory to obtain the benets from exible manufacturing is German com-pany Igus Inc. Igus makes over 28,000 polymer bearings and energy supply cableproducts used in applications the world over. In the 1990s, Iguss managers real-ized they needed to build a new factory that could handle the companys rapidlygrowing product line. The product line was changing constantly as new productswere innovated and old ones became obsolete. At Igus new products are oftenintroduced on a daily basis, so this need for exibility is the companys primerequirement. Moreover, because many of its products are highly customized, thespecic and changing needs of its customers drive new product development.

Iguss new factory was designed with the need for exibility in mind. As bigas three football elds, nothing in the factory is tied down or bolted to the oor.All the machines, computers, and equipment can be moved and repositioned tosuit changing product requirements. Moreover, all Igus employees are trainedto be exible and can perform many of the production tasks necessary. For exam-ple, when one new product line proved popular with customers, its employeesand production operations were relocated four times as it grew into larger spaces.Igus can change its operating system at a moments notice and with minimal dis-ruption, and since the company operates seven days a week, 24 hours a day,these changes are occurring constantly.

To facilitate these changes, workers are equipped with power scooters tomove around the plant quickly and recongure operations. This also allowsthem to move quickly to wherever in the factory their skills are most needed.Employees are also equipped with mobile phones so that they are always oncall. Iguss decision to create a exible factory of the future has paid off. In thelast decade its global sales have tripled.

Just-in-Time Inventory and EfciencyAs noted earlier, a just-in-time inventory system gets components to the assem-bly line just as they are needed and thus drives down costs. Using a JIT inven-tory system, component parts travel from suppliers to the assembly line in a

Housing units move on the production line asemployees of Toyota Motor Corporation work during theinstallation process at the company's Kasugai HousingWorks, one of the plants of Toyota home-brand houseson Kasugai, Aichi Prefecture, Japan. Toyota enteredthe housing industry 30 years ago where it applies theplant technology and experience it gained throughproducing cars.






small-wheeled container known as a kanban. Assembly-line workers empty thekanbans and then the empty container is sent back to the supplier as the signalto produce another small batch of component parts, and so the process repeatsitself. This system can be contrasted with a just-in-case view of inventory, whichleads an organization to stockpile excess inputs in a warehouse just in case itneeds them to meet sudden upturns in demand.

JIT inventory systems have major implications for efciency. Major cost sav-ings can result from increasing inventory turnover and reducing inventory hold-ing costs, such as warehousing and storage costs and the cost of capital tied up ininventory. Although companies that manufacture and assemble products canobviously use JIT to great advantage, so can service organizations.22 Wal-Mart,the biggest retailer in the United States, uses JIT systems to replenish the stockin its stores at least twice a week. Many Wal-Mart stores receive daily deliveries.Wal-Marts main competitors, Kmart and Sears, typically replenish their stockevery two weeks. Wal-Mart can maintain the same service levels as these com-petitors but at one-fourth the inventory holding cost, a major source of cost sav-ing. Faster inventory turnover has helped Wal-Mart achieve an efciency-basedcompetitive advantage in the retailing industry.23 Even a small company canbenet from a kanban, as the experience of United Electric suggests in the fol-lowing Management Insight.

ManagementInsight

United Electrics Kanban SystemUnited Electric Controls, headquartered in Watertown, Massachusetts, is themarket leader in the application of threshold detection and switching tech-nology. At one time, the company simply warehoused its inputs and dis-pensed them as needed. Then it decided to reduce costs by storing theseinputs at their point of use in the production system. However, this alsocaused problems because inventories of some inputs actually started toincrease while other inputs were used up without anyone knowing whichinput caused a stoppage in production.

So managers decided to experiment with a supplier kanban system eventhough United Electric had fewer than 40 suppliers and they were totally upto date with its input requirements. Managers decided to store a three-weeksupply of parts in a central storeroom, a supply large enough to avoid unex-pected shortages.24 They began by asking their casting supplier to deliverinputs in kanbans and bins. Once a week, this supplier checks up on the binsto determine how much stock needs to be delivered the following week.Other suppliers were then asked to participate in this system, and now morethan 35 of its major suppliers operate some form of the kanban system.

By all measures of performance, the results of using the kanban systemhave been successful. Inventory holding costs have fallen sharply. Productsare delivered to all customers on time. And even new products design-to-production cycles have dropped by 50% because suppliers are now involvedmuch earlier in the design process so that they can supply new inputs asneeded.





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Self-Managed Work Teams and EfciencyAnother functional strategy to increase efciency is the use of self-managedwork teams.25 The typical team consists of 5 to 15 employees who produce anentire product instead of just parts of it.26 Team members learn all team tasksand move from job to job. The result is a exible workforce, because teammembers can ll in for absent coworkers. The members of each team alsoassume responsibility for scheduling work and vacations, ordering materials,and hiring new memberspreviously all responsibilities of rst-line managers.Because people often respond well to being given greater autonomy andresponsibility, the use of empowered self-managed teams can increase pro-ductivity and efciency. Moreover, cost savings arise from eliminating super-visors and creating a atter organizational hierarchy, which further increasesefciency.

The effect of introducing self-managed teams is often an increase in efciencyof 30% or more, sometimes much more. After the introduction of exible man-ufacturing technology and self-managed teams, a GE plant in Salisbury, NorthCarolina, increased efciency by 250% compared with other GE plants produc-ing the same products.27

Process Reengineering and EfciencyThe value chain is a collection of functional activities or business processes thattake one or more kinds of inputs and transform them to create an output that is ofvalue to the customer.28 Process reengineering involves the fundamental rethink-ing and radical redesign of business processes (and thus the value chain) to achievedramatic improvements in critical measures of performance such as cost, quality,service, and speed.29 Order fulllment, for example, can be thought of as a busi-ness process: When a customers order is received (the input), many differentfunctional tasks must be performed as necessary to process the order, and thenthe ordered goods are delivered to the customer (the output). Process reengi-neering boosts efciencywhen it reduces the numberof order-fulllment tasksthat must be performed, orreduces the time they take,and so reduces operatingcosts.

For an example of pro-cess reengineering in prac-tice, consider how Fordused it. One day a man-ager from Ford was work-ing at its Japanese partnerMazda and discovered quiteby accident that Mazdahad only ve people in its accounts payable department. The Ford manager wasshocked, since Fords U.S. operation had 500 employees in accounts payable. He reported his discovery to Fords U.S. managers, who decided toform a task force to gure out why the difference existed.

processreengineering Thefundamental rethinkingand radical redesign ofbusiness processes toachieve dramaticimprovement in criticalmeasures of performancesuch as cost, quality,service, and speed.






Ford managers discovered that procurement began when the purchasingdepartment sent a purchase order to a supplier and sent a copy of the purchaseorder to Fords accounts payable department. When the supplier shipped thegoods and they arrived at Ford, a clerk at the receiving dock completed a formdescribing the goods and sent the form to accounts payable. The supplier,meanwhile, sent accounts payable an invoice. Thus, accounts payable receivedthree documents relating to these goods: a copy of the original purchase order,the receiving document, and the invoice. If the information in all three was inagreement (most of the time it was), a clerk in accounts payable issued payment.Occasionally, however, all three documents did not agree. And Ford discoveredthat accounts payable clerks spent most of their time straightening out the 1% ofinstances in which the purchase order, receiving document, and invoice con-tained conicting information.30

Ford managers decided to reengineer the procurement process to simplify it.Now when a buyer in the purchasing department issues a purchase order to asupplier, that buyer also enters the order into an online database. As before,suppliers send goods to the receiving dock. When the goods arrive, the clerk atthe receiving dock checks a computer terminal to see whether the received ship-ment matches the description on the purchase order. If it does, the clerk acceptsthe goods and pushes a button on the terminal keyboard that tells the databasethe goods have arrived. Receipt of the goods is recorded in the database, and acomputer automatically issues and sends a check to the supplier. If the goods donot correspond to the description on the purchase order in the database, theclerk at the dock refuses the shipment and sends it back to the supplier.

Payment authorization, which used to be performed by accounts payable, isnow accomplished at the receiving dock. The new process has come close toeliminating the need for an accounts payable department. In some parts ofFord, the size of the accounts payable department has been cut by 95%. Byreducing the head count in accounts payable, the reengineering effort reducedthe amount of time wasted on unproductive activities, thereby increasing theefciency of the total organization.

Information Systems, the Internet, and EfciencyWith the rapid spread of computers, the explosive growth of the Internet andcorporate intranets, and high-speed digital Internet technology, the informationsystems function is moving to center stage in the quest for operating efcienciesand a lower cost structure. The impact of information systems on productivity iswide-ranging and potentially affects all other activities of a company. For exam-ple, Cisco Systems has been able to realize signicant cost savings by moving itsordering and customer service functions online. The company has just 300 ser-vice agents handling all of its customer accounts, compared to the 900 it wouldneed if sales were not handled online. The difference represents an annual sav-ing of $20 million a year. Moreover, without automated customer service func-tions, Cisco calculates that it would need at least 1,000 additional serviceengineers, which would cost around $75 million.

Dell Computer also makes extensive use of the Internet to lower its costs; by2004 more than 90% of Dells PCs were sold online.31 Dells Web site allowscustomers to customize their orders to get the system that best suits their partic-ular requirements. In this way, Dell increases its customer responsiveness. Dell





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As discussed in Chapter 6, technology comprises the skills,know-how, experience, body of scientic knowledge,tools, machines, computers, and equipment used in thedesign, production, and distribution of goods and ser-

vices. Technology is involved in all functional activities, and the rapid advanceof technology today is a signicant factor in managers attempts to improve theway their value chains innovate new kinds of goods and services or ways to pro-vide them.

Two Kinds of InnovationTwo principal kinds of innovation can be identied based on the nature of thetechnological change that brings them about. Quantum product innovationresults in the development of new, often radically different, kinds of goods andservices because of fundamental shifts in technology brought about by pioneer-ing discoveries. Examples are the creation of the Internet and the World WideWeb, which have revolutionized the computer industry, and biotechnology,which has transformed the treatment of illness by creating new, genetically engi-neered medicines. McDonalds development t of the principles behind the pro-vision of fast food also qualies as a quantum product innovation.

Incremental product innovation results in gradual improvements andrenements to existing products over time as existing technologies are perfectedand functional managers, like those at Toyota, learn how to perform value-chainactivities in better waysways that add more value to products. For example,Googles staffers have made thousands of incremental improvements to the com-panys search engine itself since its debut, changes that have enhanced theengines search capabilities, given the engine the ability to work on all kinds ofmobile devices, and made it available to users who search in their native tongues.

ImprovingInnovation

has also put much of its customer service function online, reducing the need fortelephone calls to customer service representatives and saving costs in theprocess. Each week, some 200,000 people access Dells online troubleshootingtips. Each of these visits to Dells Web site saves the company a potential $15,which is the average cost of a technical support call.32 If just 10% of these onlinevisitors were to call Dell by telephone instead, it would cost the company $15.6million per year.

Dell, like most other large companies today, uses the Internet to manage itsvalue chain, feeding real-time information about order ow to its suppliers,which use this information to schedule their own production, providing compo-nents to Dell on a just-in-time basis. This approach reduces the costs of coordina-tion both between the company and its customers and between the companyand its suppliers. By using Web-based programs to automate customer and sup-plier interactions, the number of people required to manage these interfaces canbe substantially reduced, thereby reducing costs. This trend extends beyondhigh-tech companies. Banks and nancial service companies are nding thatthey can substantially reduce costs by moving customer accounts and supportfunctions online. Such a move reduces the need for customer service representa-tives, bank tellers, stockbrokers, insurance agents, and others. For example, itcosts about $1 to execute a transaction at a bank, such as shifting money fromone account to another; over the Internet the same transaction costs about $0.01.

quantum productinnovation Thedevelopment of new, oftenradically different, kinds ofgoods and servicesbecause of fundamentalshifts in technologybrought about bypioneering discoveries.

incremental productinnovation The gradualimprovement andrenement to existingproducts that occurs overtime as existingtechnologies areperfected.






Product developmentThe management of thevalue-chain activitiesinvolved in bringing new orimproved goods andservices to the market.

Quantum product innovations are relatively rare; most managers activitiesare focused on incremental product innovations that result from ongoing tech-nological advances. For example, every time Dell or HP puts a new, faster Intelor AMD chip into a PC, or Google improves its search engines capability, thecompany is making incremental product innovations. Similarly, every time autoengineers redesign a car model, and every time McDonalds managers work toimprove the avor and texture of burgers,fries, and salads, their product develop-ment efforts are intended to lead to incre-mental product innovations. Incrementalinnovation is frequently as important as ormore important than quantum innovation.Indeed, as discussed below, it is often man-agers ability to successfully manage incre-mental product development that results insuccess or failure in an industry.

The need to speed innovation andquickly develop new and improved prod-ucts becomes especially important whenthe technology behind the product isadvancing rapidly. This is because the rstcompanies in an industry to adopt the newtechnology will be able to develop prod-ucts that better meet customer needs andgain a rst-mover advantage over theirrivals. Indeed, managers who do notquickly adopt and apply new technologiesto innovate products may soon nd theyhave no customers for their productsanddestroy their organizations.

Increasingly, to become more responsive to existing customers and attractnew customers, managers are trying to outdo each other by being the rst tomarket with a product that incorporates a new technology or that plays to a newfashion trend. In the car industry, for example, a particular car model used to bekept in production for ve years, but today this has dropped to three years ascar companies compete to attract new and existing customers to buy theirnewest models. In sum, the greater the rate of technological change in an indus-try, the more important it is for managers to innovate.

Strategies to Promote Innovation and Speed Product DevelopmentThere are several ways in which managers can promote innovation and encour-age the development of new products. Product development is the manage-ment of the value-chain activities involved in bringing new or improved goodsand services to the market. The steps that Monte Peterson, former CEO ofThermos, took to develop a new barbecue grill show how good product devel-opment should proceed. Peterson had no doubt about how to increase Ther-moss sales of barbecue grills: motivate Thermoss functional managers to createnew and improved models. So Peterson assembled a cross-functional productdevelopment team of six functional managers (from marketing, engineering,

In the 1950s, McDonaldsrevolutionized the restaurantbusiness with its fast foodprinciples.





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manufacturing, sales, and nance) and told them to develop a new barbecuegrill within 18 months. To ensure that they were not spread too thin, he assignedthem to this team only. Peterson also arranged for leadership of the team torotate. Initially, to focus on what customers wanted, the marketing managerwould take the lead; then, when technical developments became the main con-sideration, leadership would switch to engineering; and so on.

Team members christened the group the Lifestyle team. To nd out whatpeople really wanted in a grill, the marketing manager and nine subordinatesspent a month on the road visiting customers. What they found surprised them.The stereotype of Dad slaving over a smoky barbecue grill was wrong: morewomen were barbecuing. Many cooks were tired of messy charcoal, and manyhomeowners did not like rusty grills that spoiled the appearance of their decks.Moreover, environmental and safety issues were increasing in importance. InCalifornia charcoal starter uid is considered a pollutant and is banned; in NewJersey the use of charcoal and gas grills on the balconies of condos and apart-ments has been prohibited to avoid res. Based on these ndings, the teamdecided that Thermos had to produce a barbecue grill that not only made thefood taste good but also looked attractive, used no pollutants, and was safe forbalcony use (which meant it had to be electric).

Within one year the basic attributes of the product were dened, and leader-ship of the team moved to engineering. The critical task for engineering was todesign a grill that gave food the cookout taste that conventional electric grillscould not provide because they did not get hot enough. To raise the cookingtemperature, Thermoss engineers designed a domed vacuum top that trappedheat inside the grill, and they built electric heat rods directly into the surface ofthe grill. These features made the grill hot enough to sear meat and give itbrown barbecue lines and a barbecue taste.

Manufacturing had been active from the early days of the developmentprocess, making sure that any proposed design could be produced economi-cally. Because manufacturing was involved from the beginning, the teamavoided some costly mistakes. At one critical team meeting the engineers saidthey wanted tapered legs on the grill. Manufacturing explained that tapered legswould have to be custom-madeand would raise manufacturing costsand per-suaded the team to go with straight legs.

When the new grill was introduced on schedule, it was an immediate success.The study of many product development successes, such as that of ThermossLifestyle team, suggests three strategies managers can implement to increase thelikelihood that their product development efforts will result in innovative, andsuccessful, new products.

INVOLVE BOTH CUSTOMERS AND SUPPLIERS Many new productsfail when they reach the marketplace because they were designed with scantattention to customer needs. Successful product development requires inputsfrom more than just an organizations members; also needed are inputs fromcustomers and suppliers. At Thermos, team members spent a month on theroad visiting customers to identify their needs. The revolutionary electric barbe-cue grill was a direct result of this process. In other cases, companies have foundit worthwhile to include customer representatives as peripheral members oftheir product development team. Boeing, for example, has included customers,the major airlines, in the design of its most recent commercial jet aircraft, the777 and the new Dreamliner. Boeing builds a mockup of the aircrafts cabin and






Figure 9.7A Stage-Gate Development Funnel

Gate 1 Gate 2

Ideas Ship

Stage 1 Stage 2 Stage 3

then, over a period of months, allows each airlines representatives to experi-ment with repositioning the galleys, seating, aisles, and bathrooms to best meetthe needs of their particular airline. Boeing has learned a great deal from thisprocess.

ESTABLISH A STAGE-GATE DEVELOPMENT FUNNEL One of themost common mistakes that managers make in product development is tryingto fund too many new projects at any one time. This approach spreads the activ-ities of the different value-chain functions too thinly over too many differentprojects. As a consequence, no single project is given the functional resourcesand attention that are required to make it succeed.

One strategy for solving this problem is for managers to develop a structuredprocess for evaluating product development proposals and deciding which tosupport and which to reject. A common solution is to establish a stage-gatedevelopment funnel, a technique that forces managers to make choicesamong competing projects so that functional resources are not spread thinlyover too many projects. The funnel gives functional managers control overproduct development and allows them to intervene and take corrective actionquickly and appropriately (see Figure 9.7).

At stage 1, the development funnel has a wide mouth, so top managers ini-tially can encourage employees to come up with as many new product ideas aspossible. Managers can create incentives for employees to come up with ideas.Many organizati

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