Why Smart Executives Fail

Excerpt from "Case Study: GM and the Great Automation Solution"
http://mba.tuck.dartmouth.edu/pages/faculty/syd.finkelstein/case_studies/01.html
[Highlights mine]

Robert Lutz, someone who has witnessed first-hand many of the changes in the auto industry over the years as a senior executive at GM, Chrysler, and most recently Ford, gave this assessment:
"The thought was if we can do a fully automated factory and get rid of all the labor, we would have plants that run day and night fully automatically. But with these totally automated facilities you lose all flexibility and they are extremely capital intensive. The only way you can hope to make a return is to run pedal to the metal at all times. They were prisoners of the great North American manufacturing cost accounting system that says, as you eliminate labor, your costs goes down. But what they forgot was they were getting rid of direct labor but replacing it with indirect labor and huge capital costs. These costs were high because the technicians and other people needed in an automated plant were much more expensive than the hourly laborer. You need to look at every worker. You look at his value added time versus his wait time and you arrange the production flow in such a way that you maximize the value added time of each worker and reduce the waiting time. You concentrate on the worker not on the machinery. Use automation only where necessary".

Cost Analytics & Strategies

This is my new 'go-to-market' term for all things financial analytics - be it Activity-Based Costing/Management, Strategic Cost Management, Strategic Costing, and so on.

I know the date on blog posts can easily be fudged, but October 1, 2010 (100110) is my official copyright/trademark claim for "Cost Analytics" and "Cost Analytics & Strategies".

Hopefully, cached google versions and backups can lay proof to the claim date.

Would you Buy a Can of Coke or Pepsi for $1 Million?

http://leadershipchronicles.blogspot.com/2009/04/would-you-buy-can-of-coke-or-pepsi-for.html

Standard Cost Accounting obscures the true Operational Picture

"[W]hen financial cost-focused accounting was adopted in the U.S. about 100 years ago, its promoters warned that it would not be a good tool for operational management. A growing body of experience at companies implementing lean accounting is showing that they were right. Too many vital decisions are based on standard cost accounting, which obscures the true operational picture."

Source:

http://www.forbes.com/2009/07/28/accounting-management-enterprise-technology-cio-network-accounting.html

Dan Woods is chief technology officer and editor of Evolved Technologist, a research firm focused on the needs of CTOs and chief information officers. He also consults for many of the companies he writes about. For more information, go to evolvedtechnologist.com.

"It was not enough to chase out the cost accountants from the plants. The problem was to chase cost accounting from my people's minds"

Taiichi Ohno, founding father of the Toyota Production System

Lean Accounting

As Activity-Based Costing more realistically reflects cost than Standard Cost Accounting can, it merely reflects existing processes. It takes some time and effort to change the cost model to reflect any process improvements.

Process improvement results from lean initiatives are typically poorly reflected through Standard Cost Accounting methods. Sometimes even leading to doubts in lean principles.

In my mind, Lean Accounting and Value Stream Costing are the natural outgrowth from advanced costing methods and lean thinking. Box scores that contain both operational and financial metrics lead to highly improved decision making.

Companies may not know what they do not know

Cost structures are changing, due to

• Volume changes (economic impact or growth)
• Process improvement
• Across-the-board cuts
• Product mix changes
• Supply chain changes (upstream or downstream)

None of these are likely to be properly reflected by the existing standard cost system

• The update may not happen until the next fiscal year
• The update will contain cost distortion
• Improvements may stay hidden or even show in a negative way

In the meantime, decisions are made or required about

• Products & Customers – Where to focus?
• Pricing – Adding margin on standard cost will not win the quote
• Overhead support – what is really consuming which overhead?

SCM

Activity-Based Costing / Management

A great approach and process for Strategic Cost Management can be based on the Activity-Based Costing methodology.

The term 'Activity-Based Costing' has fallen victim to critical sentiment and I do agree with some of the criticism for certain implementations and approaches. However, thought-leaders and advanced practitioners have taken the basic approaches to completely new levels.

Examples are incorporating capacity management, cost of quality, or applying concepts to value-stream costing.

Even Robert S. Kaplan and Steven R. Anderson - 'fathers' of the original approach - have added the concept of 'Time-Driven Activity-Based Costing'. In reality, that kind of approach long existed before the paper on it was even written.

While the great fad might be over and many failed implementations seemed to have contributed to the bad reputation, there is a surprisingly high number of practitioners and applications of Activity-Based Costing in the business world today reaping the benefits and positioning their organizations more strongly than their competition.

In order to avoid misconceptions and preconceived notions, this blog utilizes the terms 'Strategic Costing' or 'Strategic Cost Management' to reflect advancements in Activity-Based Costing approaches.

Critical Information to use NOW more than EVER!

Current economic developments require operational and strategic decisions:

How well do you understand your cost structure and how do you keep up with rapid changes?

• What’s happening to your raw material prices?
• How are your product volumes changing?
• What impact should your capacity utilization have on cost?
• Which assumptions are embedded in your standard cost accounting?
• How are your lean process improvements affecting your direct labor and cost structure?

How are you reflecting volume and product mix changes in your cost information?

How many quotes are you losing? What issues are surfacing in the RFQ process?

What is your process to develop pricing and pricing strategies?

Which products have you identified to invest in, and which should be discontinued?

What is your process to develop pricing and pricing strategies?

What proactive decisions are you making to accommodate for the rapid change?
In regards to, Products, Overhead, Capacity, and/or Management Support

What happens to your standard cost as volumes change? What about your pricing?
Are you increasing pricing? What would happen to your market share?

Strategic Cost Management. Why? What? How?

CEOs, Presidents, Owners, etc. are constantly examining, tweaking, and/or reinventing their business models towards maximum profitability. In order to do this, they need information about the cost structure and profitability of their products, processes, customers and channels.

It is crucial to know which parts (customers, channels, products, etc.) of the business are more profitable than others. Some parts may actually be removing profit from the bottom line. If all parts are considered to be adding to the bottom line, which parts add less profit than others? Because resources for these parts are underutilized and could be applied to more profitable parts.

Unless the company has a highly sophisticated ERP system with dedicated IT and analytical resources, this information is not readily available. Some companies have to rely on what they can get out of their standard cost systems, but these systems are typically designed for financial reporting, not strategic management decisions.

So, do you have the necessary detail, to confidently make these decisions?

• If you are sophisticated enough to have the information to make these decisions:
  - Is the information based on standard cost?
  Would you mind sharing your tweaks on the standard cost system to avoid averaging and cost distortion, and how you achieved the necessary level of detail?
  - If it is not based on standard cost, what types of analyses did you perform to arrive at the information?


• Your sophistication level is top of the line:
  - What actions has your team taken in the last 90 days based on the information you gather around customers, channels, products, and processes?
  - What other types of decisions do your team members make based on the data and information you have?
  - Are you able to attribute an increase in profitability to these actions and decisions? How would you quantify this?
  - If you decided not to make a certain change, what were your reasons for that decision?
  (for instance, why did company x NOT discontinue product line 5?)
  - How do you manage/incentivise/direct your sales force to go after the most profitable business?
  - How do you monitor changes in product mix and/or profitability? And how do you change your organization's behavior in light of any shifts?
  

Foreword

First off, anyone who still believes that standard cost systems are adequate for today's management decisions need not read on, but first see the Strategic Costing quotes on Words to Lead By or the example on The Leadership Chronicles.

Current targeted topics for this column are:

• Why? What? How? CEOs always need to be examining, tweaking, and/or reinventing their business models. In order to do this, they need information about the cost structure and profitability of their products, customers and channels.
  
  
• Integrate Strategic Cost Management into the existing ERP Standard Cost system or run a parallel system?
  
  
• Taichii Ohno would say, "Costs do not exist to be calculated. Costs exist to be reduced."
  I heartfully agree with this quote, from an operational perspective. Strategically however, an organization cannot determine on which products, product lines, channels, customers, etc. to focus without accurate cost information.
  
  And with accurate I am not talking about cost systems delivering numbers to 1/100 of a penny. Current ERPs can do that, but while the math is correct, the inherent distortions are not even visible. Therefore Warren Buffett's advice applies to Cost Management:
  "It is better to be approximately right, than precisely wrong."



• It's obviously not cheap to conduct Strategic Cost Management.
  But let's put it in perspective: How much did your company spend on the ERP implementation? The software fee, the consultants, the customization? And now all the people dedicated to keeping it running?
  
  And what portion is for financial reporting? And this portion adds what value to your products and services that the customer cares for?
  
  This lets you make which decisions about Customers, Channels, Products, Services? Keeping in mind that the underlying costing principles are geared towards financial reporting, it is more than likely that even if there are reports to support these decisions, there is significant cost distortion present, that can shine good light on bad decisions.
  

Getting down and dirty implementing Strategic Cost Management and how to model:

• Cost assignments/flows
• Macro structure
• Maintaining the 'big buckets', so that you can reconcile and don't lose track.
• Support Services - HR, IT, Maintenance, etc.
• Resource Pools
• Capacity Management
• Cost of Quality
• Cost of Capital
• Time Driven/Consumption Related/Pull
• Components vs. Finished Goods
• Cost to Serve
• Customers/Channels
• Organization Sustaining Cost vs Full Absorption
• How to deal with inventory. What was made each fiscal year is rarely what was sold that year.
  

Under Construction

I have just started working on this thread... check back for more soon.
Leave a comment and I might be inclined to work faster :)