ABOUT THIS CONTENTThe task of analyzing an opportunity and its industry can seem overwhelming. One way to bring some order to the chaos is to chart the production process of the company. The objective is to understand the sequence of events, identify the elements you control, set the incentives so that everyone has the same objectives, pick a strategy and charge ahead. After an appropriate time you can pause, sample the market response, adjust, and charge ahead again.
The task of analyzing an opportunity and its industry can seem overwhelming. One way to bring some order to the chaos is to chart the production process of the company.
The objective is to understand the sequence of events, identify the elements you control, set the incentives so that everyone has the same objectives, pick a strategy and charge ahead. After an appropriate time you can pause, sample the market response, adjust, and charge ahead again.
The objective is to capture every step in its proper order and to consider the time lags and information flows between each. Try to consider every function performed by someone in the company.
The needs of the customer should drive the entire process. What primary need does the product or service provide? Put yourself in the customer’s shoes. Why do they buy? What happens to them personally if the product fails or succeeds? What happens to their company if the product fails or succeeds? Can the customer accurately determine the value added or is it fuzzy?
If your product is part of your customer’s raw materials, is it an important part? Is the customer making high or low margins (how sensitive are they to costs)? How important is time? Image?
What other options does the customer have? What substitute products satisfy the same need? What quality or price tradeoff does the customer make with the substitutes? What would happen to our unit sales if we decreased prices by ten percent? If we increased prices by ten percent? Twenty percent?
Identify the inputs that go into your product. Generally these can be subdivided into two areas: energy (labor and fuel) and raw materials. First focus on the costs. Which raw materials make up the majority of your costs? Can these costs be reduced by pitting one supplier versus another? How big a component is transportation? Is it worth relocating?
Next focus on availability. Which materials are in short supply? Why? Are there alternate materials or production methods to lessen our dependence? Is it worth the effort and costs to change? Should we expand the number of suppliers?
Examine the raw material inventory Can we reduce the delivery time and inventory on hand? What effect does this have on the bottom line? What risk is there that the production operation will have to stop? What would it cost if it did?
The process includes any steps or changes that add value to the inputs. Break them down into as many intermediate steps and discrete parts as you can. What machinery (including people) do you need to start? What will it cost to produce one item? One hundred items? One million items?
In some industries a large number of inputs or outputs must be inspected or processed to select a final high quality product. If this is the case, what is the expected rejection rate at each stage? How does this affect the cost of a finished product? How can we improve the accuracy or lower the costs of this process?
Determine the cost for each step of the process. Examine the effects on each stage of combining steps or breaking them apart. Examine the effects on the costs of each stage of increasing or decreasing throughput. Which tasks are critical for satisfying the customer? Look for tasks that are not critical. These can be outsourced, freeing up time and resources for processes that add value.
Distribution is an often overlooked part of the process. Examine how the products or services are delivered to the customer. What other services, including education and advertising, are performed during distribution? In what other ways can the product be delivered? What are the costs and quality issues associated with each?
Administrative tasks include the collection and dissemination of information and issues regarding centralization or control. Each of these tasks involves costs. The key is to determine if the costs are justified given the value added or if there is a better way to accomplish the same objectives.
What information must be collected to run the business? Is there a cheaper way to collect these data? Are we collecting information that no one uses? Are there reports that no one reads?
What tasks must be coordinated or centralized? What would be the effect of decentralizing these tasks? What value does management add? What would happen if we eliminated the headquarters staff! How important is the culture of the company to the final product? Why? Assign a cost to each administrative task and attempt to determine the value added.
Now it is time to experiment with the process. First, make certain that you have charted every task and material in the process. Make sure you have included the time for each step and any inventory lags. Next, attempt to determine the cost of each step and how it varies with volume.
Finally, considering what the customer wants, how much value is added by each step?
There are two process objectives:
- Reduce costs or compress the time between order and delivery without lowering the value to the customer, or
- Increase the value to the customer without increasing costs. At the same time, from a longer term perspective, we need to be searching for ways to erect barriers to entry
At the same time, from a longer term perspective, we need to be searching for ways to erect barriers to entry.
Some questions or issues to address to optimize the process:
- Are we doing anything for which the customer is not willing to pay? If so, eliminate it.
- If we begin to increase throughput, what bottlenecks develop? What effect does volume have on price? What negative effects do economies of scale have on flexibility?
- What steps are crucial for adding value? Can we out source the others?
- Can we design a pseudo-market incentive system to improve coordination between steps and reduce administrative costs?
- How can we reduce inventory? What are the risks and costs if we run out of inventory?
- How can we increase the yield or quality? How much will it cost?
- Can we collect more timely market information and communicate it quickly throughout the process to adjust to changing customer needs?
- What would increase the value added to the customer and what would it cost?
- What steps can we take to build barriers to entry or vault existing barriers?
- Does it make sense to forward or backward integrate or form an alliance with a specific customer or supplier?
- Do the incentives for people in each step of the process match what we would like for them to accomplish?
- Are there any steps of the process that can be combined or performed simultaneously to shorten the production time?
- What data can we collect to improve the efficiency of the process?
The Dangers of Myopia
Do not become too enamored with your specific process. Remember that the ultimate goal is to satisfy the needs of the customer. Do not loose sight of the basic needs that your product satisfies. Ask your customers why they buy and ask them often. Assume without testing at your own risk.
Times change, people change and markets change. Companies that become attached to one paradigm or process or are obsessed with tweaking a finely tuned machine often find themselves leapfrogged by changing technology, changing tastes or changing times. State your assumptions explicitly and constantly test them against the market and new developments.
Breaking a business into its value added steps makes the key success factors easier to identify and the ICA simpler to decipher. Any business, whether a service oriented concern or manufacturer, can be reduced to its essence this way.
There are no free lunches. Almost every action requires tradeoffs between cost, quality flexibility and competitive position. The goal is to provide only what the customer wants in a way that the competition cannot easily or quickly copy. Once you have improved the process, it is time to test the changes and begin to look for new improvements. The market will not be far behind.